Branded Global Alliance Competition in the New Era of Metal Neutrality
Paul V. Mifsud
Airneth Column
October 2010
By Paul V. Mifsud
Despite the fact that international airlines fly to many parts of the world, they are not truly global enterprises. Airlines do not participate in the global economy in the same manner as other industries. Unlike other forms of international trade, the provision of international aviation services is substantially limited by restrictive trade barriers based on such things as nationality based safety oversight, limitations on foreign market access and cross border ownership. With a few recent exceptions, airlines continue to access global markets through a system of government negotiated bilateral air transport service agreements that provide access to “gateways” in distant locations, but not to the local air transport markets.
In the era of the global economy, airlines have been developing strategies to overcome the limitations of this bilateral system. As these strategies evolve, some airlines may find that they have taken the wrong path. One such strategy is participation in a Branded Global Alliance (BGA). Today, there are three major BGAs known as The Star Alliance, oneworld and SkyTeam.1 Nearly fifty of the world’s airlines participate in one or another of these alliances with varying degrees of integration. As a result of recent US Department of Transportation (DOT) decisions, the shape of these alliances may be undergoing significant changes that will affect participants in ways unforeseen when they first joined their alliance.
To understand these developments, it will be helpful to review the role of these alliances. In the somewhat distant past, when airlines were heavily regulated, airline passengers and shippers accessed destinations around the world from national market to national market through a system of interline transfers between airlines. This was the product of the regulated air transport system of the IATA era, when airlines set uniform fares with multilateral interline agreements. Such a system is no longer an effective or reliable means to serve today’s fast paced business travel or modern budget conscious tourism.
The global trend toward airline local and regional deregulation, privatization of national airlines and growth of local low cost airline competitors has forever altered the old ways. Moreover, these trends have affected the former economic stability of the major national airlines and limit their willingness to support unprofitable routes and services.
Nevertheless, the demands of the global economy require convenient and reliable access to all the markets of an expanding world economy. Development of the BGAs has been a response to these changing circumstances. However, these alliances are an evolving strategy that is very much a work in progress.
These BGAs have grown from the original modern cross border airline alliance based on antitrust immunity developed by KLM Royal Dutch Airlines and its partner Northwest Airlines as part of the United States’ first Open Skies agreement that was negotiated with the Netherlands in 1992. Since that time almost twenty years ago, this business form has evolved into three highly competitive air transport networks of planetary scope that link travelers and shippers to the far corners of today’s world markets. Airlines that participate in the BGAs are able to offer their customers easy and efficient access to and from destinations on these networks.
But as noted above, the nearly fifty airlines participating in these alliances participate at different levels of network marketing and operational integration. The more integrated participants have been granted “antitrust immunity” (ATI) from one of the world’s most strict competition regimes i.e. the US “antitrust” laws. Those airlines with ATI are able to set prices, allocate routes and otherwise operate as though they are one airline. Among the airlines with ATI, some are global in extent and some are limited to specific markets such as “The North Atlantic.”
Airlines that do not have ATI can participate in the alliances networks and some marketing programs but are prohibited from even discussing price, route allocation or anything else that would make them less aggressive competitors with their partners. In other words, the alliances are made up of partners who can legally cooperate and partners who are required to compete with each other.
Until recently, such differences were of little consequence. Despite the right to use ATI to operate as though the partners were one airline, few took advantage of the opportunity. For over a decade, only KLM and NW had achieved “Metal Neutrality,” a term that the US DOT defined as:
“…an industry term meaning that the partners in an alliance are indifferent as to which operates the “metal” (aircraft) when they jointly market services. Without a metal neutral sales environment, the partners have a strong economic incentive to book passengers on their own aircraft in order to retain a larger share of the revenue for themselves, which may not be in the best interest of the consumer or the alliance as a whole. Metal neutrality may be achieved through revenue and/or comprehensive benefit sharing arrangements2.”
The remaining alliances and their participating carriers preferred to operate within a framework of looser cooperation.
But this changed when--as a result of the Air France KLM merger--the ATI alliance of NW-KLM and DL Air France, Alitalia and Czech airlines applied to consolidate their ATI. Initially, the DOT rejected the application citing a number of reasons including the lack of sufficient specific public benefits to warrant approval3. Following the Open Skies air transport agreement between the US and EU, the applicants again approached the DOT for consolidated ATI, this time citing their plan to enter into a metal neutral joint venture.
This time the DOT approved the application stating:
“…the Joint Applicants now supply a detailed joint venture agreement that integrates international operations to such an extent as to suggest metal neutrality and seamless travel across one joint network. The proposed alliance is likely to result in the introduction of new capacity and greater availability of discount fares across the entire joint network – benefits that we tentatively find to be substantial in the circumstances of this case. Building on the highly integrated common bottom line arrangement in the Northwest/ KLM alliance, the 4-way JV represents a significant shift in the way in which SkyTeam plans to deliver benefits to the traveling and shipping public.”
Since that case, it appears that a metal neutral joint venture has become a DOT requirement for a grant of ATI. The DOT has conditioned subsequent ATI approvals with the specific requirement that the major participants in both the Star Alliance and oneworld parties enter into a metal neutral joint venture within 18 months of approval.
Recently, the DOT tentatively decided to reject a request for ATI between Delta Airlines and Virgin Blue. This request involving a relatively small carrier was not very controversial and many similar requests had routinely been granted in the past. In making its tentative decision, the DOT citing its precedent in the original SkyTeam decision said:
“..We have emphasized the high standard necessary to justify a grant of immunity and the need for applicants to demonstrate that substantial public benefits are likely to be produced at the time the immunity is requested. For example, in the SkyTeam case in 2005, we tentatively denied a request for antitrust immunity because there was both insufficient information in the record to make a complete assessment of public benefits and the competitive conditions were in flux. There, as in this case, the Department identified barriers to integration that we believed reduced the incentives of the airlines to integrate their operations and pass on the benefits of immunized cooperation to consumers.”
Thus, in the last year the non-immune players in the three BGAs are facing the prospect of being legally required to compete against major partners who are legally required to compete as though they are one entity against their smaller partners. And it appears that all future requests for ATI will require participation in a metal neutral joint venture.
To make matters more interesting, in the past, with some minor exceptions, the major partners with ATI tended to be centered on the North Atlantic market. Now however, both Star alliance and oneworld senior partners United and American Airlines have pending ATI applications for metal neutral joint ventures with ANA and JAL respectively. These applications came on the heels of the US Japan Open skies Agreement.
Thus the American carriers in two of the three BGAs are in the process of negotiating two separate metal neutral joint ventures with their key European and Pacific partners.
Historically the European-Pacific, the US-Pacific and the North Atlantic markets have been seen as three separate and distinct markets. Little role is seen for the US carriers in the Pacific-European traffic streams, or for the Pacific carriers in the North Atlantic or the Europeans in the US-Pacific markets.
However, the BGAs are global alliances and the goal is to transport passengers and shipments seamlessly around the globe. The requirement for metal neutrality emphasizes the development of seamless service. This push for global seamless service should also be seen against the backdrop in which the Pacific market is undoing a seismic transition as China has emerged as the world’s number two economy offering the broadest aviation growth opportunities anywhere in the world.
As discussed above, the fifty airlines participating in the three BGAs find themselves involved with partners and competitors that were likely not foreseen when they first joined their respective BGA.
Two of the three American carriers will soon be involved with two separate metal neutral joint ventures. One set of partners is in the Pacific and the other set is in the North Atlantic. At this time, competition law requires the Pacific and European partners of the Americans to compete vigorously against each other, despite the fact they are each in part of the same BGA.
The American carriers will be discussing detailed pricing, route development and otherwise operating with each partner as though they were a single carrier. In this connection, it is interesting to note that the scope of the antitrust immunity varies among the different alliance partners. Some enjoy immunity on a global basis and some are limited to a region, such as the North Atlantic.
Because there is no immunity between the Pacific and European carriers, the US carriers must be careful about disclosing their knowledge of their European and Pacific partners pricing, marketing and operational objectives and limitations. In the US, exchange of such sensitive information is itself sufficient to warrant an allegation of an antitrust violation.
At this time, the Chinese have yet to enter into an Open Skies arrangement with either the US or Europe. Similarly, there is no Open Skies regime between Europe and Japan. However, it is interesting to consider what might happen if and when further Open Skies accords are reached.
As we’ve seen in the past, ATI is an inducement that the US offers to countries that enter into an Open Skies agreement. Now however, ATI requires a metal neutral joint venture. How would the various alliances handle such an opportunity? Will we see any US- Japanese-Chinese JVs? Or will the US carriers seek separate metal neutral JVs among the Chinese and Japanese? What then of the Pacific BGA partners without ATI?
If Europe enters into Open Skies with China and/or Japan, will there be metal neutral JVs between Europe and the Pacific and, if so, with which carriers?
As noted at the outset, the BGAs have been slow to embrace metal neutrality, despite the opportunity provided by the various ATI approvals. This is because revenue sharing can be very difficult among airlines of disparate sizes, markets and cultures. On the other hand, the DOT metal neutral requirement is providing the leading players considerable experience in structuring such deals.
Delta Airlines is headed by a CEO who as a lawyer at Northwest almost twenty years ago was an architect of the first metal neutral JV. The SkyTeam European carriers have not only met their DOT deadline, but they also have added Alitalia to the joint venture. It is likely such expertise will be able to accelerate the learning curve and facilitate more complex JV arrangements.
Since the Japanese market has only two major international carriers, both of whom are negotiating metal neutral JVs. Delta has a real incentive to secure a metal neutral JV with its Chinese partner in the event an Open Skies agreement presents an opportunity. If such an opportunity presented itself, it could prove interesting.
In the event of a Chinese Open Skies agreement, it is interesting to speculate on whether any of the BGAs could construct a single European-Pacific-US metal neutral JV. Or whether the complexity of such arrangements will result in various players competing with various partners in a variety of metal neutral joint ventures within and without the current three BGAs.
The answer to the question may determine, at least for the foreseeable future, whether aviation can develop into a true global enterprise.
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1. Star Alliance is composed of 28 major airlines including United Airlines, Lufthansa, air Canada, ANA, Swiss, SAS, BMI, etc.; oneworld contains 11 major airlines including American Airlines, British Airways, JAL, Iberia, Qantas etc. and SkyTeam has 13 major airlines including Delta, Air France/KLM. Alitalia, Aeroflot, china Southern, AeroMexico etc.
2. U.S. DOT Joint Application of AMERICAN AIRLINES, INC.;BRITISH AIRWAYS PLC;FINNAIR OYJ;IBERIA LÍNEAS AÉREAS DE ESPAÑA, S.A.;ROYAL JORDANIAN AIRLINES; Under 49 U.S.C. §§ 41308-41309 for approval of and antitrust immunity for alliance agreements; Show Cause Order February 13, 2010.
3. SkyTeam, Docket OST-2004-19214, Show Cause Order 2005-12-12 at 2, 30, and 37 (December 22, 2005).
