Air France - KLM and the position of Schiphol

Airneth Column
June 2010
By Dr. Eric Pels

On September 30 2003 the alliance (merger, or takeover) between Air France and KLM was finalized. A holding company, Air France-KLM, was created, with airlines Air France and KLM continuing as separate brand names. The holding has its seat in Paris, but KLM operates under Dutch law, because of the traffic rights. Worries that KLM would disappear, and/or Amsterdam Airport Schiphol would loose its position as the hub of KLM’s network and become a regional airport led to agreements which guaranteed KLM’s and Schiphol’s positions for a number of years. These agreements gave certainty about the existence of KLM, and the hub at Schiphol, at least until 2011/2012 (depending on the agreement).

Since these agreements were only temporary, the worries about the future of KLM and Schiphol continued to exist. In May 2010 the Dutch minister of transport announced that the earlier agreements would be extended indefinitely. This is important to the Dutch economy according to the minister, because business travelers can fly everywhere from Amsterdam, and Amsterdam remains a transfer point for intercontinental passengers. “The value of Schiphol for the Dutch economy is safeguarded for the far future”. ‘Mainport Schiphol’ as we refer to the airport in the Netherlands, will therefore continue to play an important role in transport and economic policies, and the airport itself can continue to invest in its airport city concept.

As an economist, of course I have some critical remarks. First, did the minister and Air France KLM agree on the definition of ‘indefinite’ and the conditions under which ‘indefinite’ could turn ‘definite’? But more importantly, why did Air France and KLM enter an alliance agreement, and what are the implications? Theoretically speaking, there are a few arguments: to get rid of competition, to reduce operating cost per unit of output by increasing load factors and cashing in on synergy effects. A senior manager expressed the following opinion in a TV interview: “Alliances have two purposes: Stop competing with each other and jointly beat up on the other guy. All the rest is fluff” (Kleymann and Seristö, 2004). Of course the merger between Air France and KLM has no anti-competitive effects, at least according to Air France-KLM, because the networks were complementary. Of course there are other opinions. But when we disregard the competitive effect of alliance formation for a second, and look at other reasons (i.e. the ’fluff’), the unit cost play an important role. By increasing load factors, the cost per seat or passenger may decline. Many empirical studies point out the importance of such ‘density economies’. Air France and KLM may compete with each other in certain indirect markets, if they offer the same range of destinations. This leads to relatively low load factors, and relatively high cost per unit of output (so in the end this is a competition argument again). But Air France and KLM claim their networks are complementary, so this argument would not be valid. But if the networks are truly complementary (e.g. Air France focuses on Africa and KLM on Asia), higher load factors may be achieved when the hub operation is concentrated on one airport. Network models show that Air France-KLM gets the highest profits when the entire hub operation is moved to Paris. This of course depends on available capacity and room to grow (which would favor Paris over Amsterdam), and the allocation of traffic rights (which could give Amsterdam room as a secondary hub, as long as we are annoyed by such rights).

So maybe the hub position of Amsterdam Airport Schiphol is not so obvious in the long run. But this is of course not a new idea. In the late 1990s Amsterdam Airport Schiphol already concluded that there would be room for 3, or at most 4, major hubs in Europe because of density effects: size matters. If such a position could not be obtained, a regional hub would be the second-best option.

All-in-all, Schiphol’s position as a hub or regional hub is not so certain in the long run. From a theoretical point-of-view, a secondary/regional hub position may be the best option for Schiphol in Air France-KLM’s network, if there are capacity limitations at the main hub and there is no competition between the airports for (regional) passengers. Both conditions do not seem to favor Schiphol. Is this bad news? Maybe not for the shareholders of Air France-KLM, who look at return on investments. Yes, for the airport itself. Yes, for the minister who just said how important the hub position is for the economy. But is it bad for the country/economy? If we want such a position, we have to pay. With a relatively small home market, such a network is relatively expensive: size matters. And one thing we recently learnt with the exercises with the ticket tax: if (origin-destination or transfer) passengers find cheaper alternatives elsewhere, Schiphol may not be the preferred alternative.

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References:
Kleymann and Seristö (2004), Managing strategic alliances, Aldershot: Ashgate

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