Dynamics in the long-haul aviation market : the growing Gulf threat and its sustainability

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Dynamics in the long-haul aviation market:

The growing Gulf threat and its sustainability

J.N. Rompas

University of Amsterdam, Faculty of Economics and Business Studies

MSc Business Studies – Strategy, Master Thesis (6314M0218), Student-number – 10347143 Supervisor: Jaap G. de Wit

A B S T R A C T

The competition in the market of intercontinental air passenger services has become increasingly more dynamic, due to the continuously expanding Gulf carriers. This paper exposes the competitive positioning of three Gulf carriers (Emirates, Etihad Airways, Qatar Airways), relative to that of three European carriers (KLM, Lufthansa, British Airways), in two dimensions (cost and network). Although all Gulf carriers are pursuing network expansions, substantial intra-Gulf carrier differences were found in their expansion strategies By identifying and analyzing 22 airline characteristics that are indicative of competitive advantages (both created and fixed), it is shown that the Gulf carriers seem to enjoy an advantageous position compared to the European carriers for the majority of them. Regarding purposeful strategic positioning, a major driver for numerous competitive advantages is shown to be the specific market focus that exists among the Gulf carriers. Furthermore, it is shown that substantial fixed advantages are identified originating from the distinctive airport and governmental interactions, thereby favoring Gulf carriers’ external environment over that of the European carriers. Even if the created advantages are ignored, the externally induced advantages would still continue to persist. Moreover, if European carriers are able to uplift most of the external barriers that inhibit them to compete equally, thereby eliminating governmental and airport induced competitive advantages, the relative geographical position towards specific emerging economies remain fortunate to the Gulf carriers. While the analysis showed a lower favorability in terms of O&D passengers, the Gulf location is, and will remain to be, in the ideal position to act as a T&T intersection between numerous current and emerging economies, which signals a positive future in terms of growth opportunities that may arise from these markets.

Date: Tuesday, 1-July-2014 Word count: 21,313

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University of Amsterdam

List of Tables and Figures

Tables

Table 1. Airport charges and Governmental taxes. Table 2. ASK in millions for CY2012 and CY2013.

Table 3. Emirates collaborations regarding code-sharing and joint frequent flyer programs as of December 2013. Table 4. Equity partners Etihad Airways as of June 2014.

Table 5. Members of the OneWorld airline alliance as of May 2014. Table 6. Global airline alliances and Gulf carriers as of June 2014. Table 7. Average weekly frequency per route per airline as of May 2014. Table 8. Average aircraft age as of May 2014.

Table 9. Generated ASK per employee for CY2013. Table 10. Tax rates per country for December 2013.

Table 11. Fuel prices per region in USD per barrel as of April and May 2014. Table 12. Airlines and their main base of operating.

Table 13. Passenger Service Charges and Passenger Safety & Security Charges per airport in USD as of January 2014. Table 14. Airport capacity in flight movements for CY2013.

Table 15. Population per country and main base city.

Table 16. Economy ranking based on ‘ease of doing business’ as of June 2013.

Table 17. Top 3 regions and destinations served in terms of available seats, based on the weekly flight as of May 2014. Table 18. Transit & Transfer attractiveness for European and Gulf carriers for the current top markets as of May 2014. Table 19. BRIC and MINT country capitals and correspond airports.

Table 20. Transit & Transfer attractiveness for European and Gulf carriers for the BRIC and MINT capitals.

Table 21. Summary of cost and network indicators for, Emirates, Etihad Airways, Qatar Airways, KLM, Lufthansa and British Airways.

Figures

Figure 1. Hub and Spoke system. Figure 2. Multi-hub network.

Figure 3. Flight offerings Gulf carriers and European full-service carriers. Figure 4. Full-service carriers their possible choice of network structure. Figure 5. Airline input cost structure as defined by IATA.

Figure 6. CASK functions per aircraft capacity, route length and aircraft efficiency. Figure 7. Economies of Scope and Density.

Figure 8. Types of Hubs and Traffic.

Figure 9. Growth of network size of, Emirates, Etihad Airways and Qatar Airways for CY2010-2013.

Figure 10. Gulf carriers’ relative network size in destinations, for CY2010, CY2013 and European carriers’ relative network size as of May 2014. Figure 11. Passengers transported for Emirates and KLM in millions for CY2007-2013.

Figure 12. Code-sharing partners Etihad Airways as of December.

Figure 13. Average distance travelled per passenger in kilometers for CY 2013.

Figure 14. Passenger Load Factor for Emirates, Etihad Airways, KLM, Lufthansa and British Airways. Figure 15. Fleet composition as of December 2013.

Figure 16. Ratio fleet ownership and leasing as of December 2013. Figure 17. Average capacity per operating aircraft for CY2013. Figure 18. Average cost per employee in USD for CY2013.

Figure 19. Landing Charges for DXB, AUH, DOH, AMS, FRA and LHR in USD as per January 2014. Figure 20. Parking Charges for DXB, AUH, DOH, AMS, FRA and LHR in USD as per January 2014. Figure 21. Airport capacity in flight movements for CY 2013.

Figure 22. GDP per capita, per country.

Figure 23. International Tourist Arrivals in millions for CY2012.

Figure 24. Current Top destinations and regions served in terms of available seats as of May 2014. Figure 25. BRIC and MINT economies and their geographical positions.

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Acronyms

Abbreviation Definition First

occurrence

AMS Amsterdam Airport Schiphol 4.2.2.

ASK Available Seat per Kilometer 2.1.2.b

AUH Abu Dhabi International Airport 4.2.2.

BA British Airways 3.3.2

BRIC Brazil, Russia, India, China 2.2.2.b

CASK Cost of Available Seat per Kilometer 2.1.2.b

CWC Carriers-Within-Carriers 1.3.3

DOH Doha International Airport 4.2.2.

DXB Dubai International Airport 4.2.2.

EK Emirates 3.3.2

EU-FSCs European Full-Service Carriers 3.3.1

EY Etihad Airways 3.3.2

FFP Frequent Flyer Program 4.1.1.a

FRA Frankfurt Airport 4.2.2.

FSCs Full-Service Carriers 1.1

GDP Gross Domestic Product 2.2.2.b

H&S Hub and Spoke 1.1

IATA International Air Transport Association 1.3.3

ÌCAO International Civil Aviation Organization 2.1.2.c

KL KLM 3.3.2

LCCs Low-Cost Carriers 1.2

LH Lufthansa 3.3.2

LHR London Heathrow Airport 4.2.2.

MINT Mexico, Indonesia, Nigeria, Turkey 2.2.2.b

MTOW Maximum Take-Off Weight 2.1.2.c

O&D Origin and Destination 2.2.2.b

PSC Passenger Service Charge 4.2.2.a

PSSC Passenger Security & Safety Charge 4.2.2.a

QR Qatar Airways 3.3.2

RPK Revenue Passenger Kilometer 1.3.3

T&T Transit and Transfer 2.2.2.b

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Introduction

As per 2014, the commercial airline industry is estimated to generate an astonishing USD 743.000.000.000 in revenues (International Air Transport Association, 2013). On top of that, air traffic is expected to grow the upcoming years, indicating the significant role the aviation industry has taken in our society. This paper addresses two key groups regarding this industry, namely European and Gulf full-service carriers, and their relative competitive competition.

Research has shown that the airline industry has been subject to different waves of change, causing airlines to adapt and evolve over time (Franke & John, 2011). However, due to the recent dynamics in the airline industry, a more current analysis of the industry remains absent. This paper attempts to provide a detailed overview of the current and emerging strategies and their future effects on the airline industry. For which the emphasis is set on the continuously expanding Gulf carriers and their strategies.

The first Chapter of this paper consists of a literature review that reflects on the past developments of the aviation industry, in order to provide a more complete picture of the current state of the industry. Chapter two will clarify the chosen framework and selected indicators that identify potential competitive advantages. Subsequently, Chapter three will explain the chosen research method and selected cases used in the analysis. Additionally, the chosen cases will be compared in Chapter four, in terms of the discussed indicators. Finally Chapter five will discuss the findings, conclude with the paper’s limitations and suggest future research directions.

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CHAPTER 1:

Literature review

The last 25 years the aviation industry has been subject to a variety of major phenomena, each impacting the industry in a specific way. These different waves of impacts disrupted the airline industry, changed the market structure and thus caused incumbent firms to adapt and evolve over time.

1.1 Golden Age

In the ‘90s, due to the liberalization of the European market, as well as the European-United States transatlantic market, the airline industry experienced a significant growth. This led to the so-called “Golden Age” for airlines, a period which was largely characterized by airlines that competed based on Porter’s concept of differentiation (Porter, 1980). Airlines following this type of strategy are often referred to as full-service carriers (FSCs) (Hunter, 2006). FSCs place their emphasis on increasing offered product value, which indicates a business model focused on revenue optimization (Franke, 2004).

Furthermore, during this period, network expansions became of great importance, encouraging the exploration of connectivity possibilities. An increase in connectivity was eventually achieved through the introduction of hub-and-spoke systems (H&S) (de Wit, 1995). These systems exist when air traffic is focused on one center airport (hub), which functions as the main connecting point, receiving and distributing passenger to other airports, as illustrated in Figure 1 (Dennis, 1994). This type of system, where passengers’ itineraries include a change of plane at a hub airport, also provides additional competitive advantages (e.g. increased production efficiency) (Brueckner & Spiller, 1991; Nero, 1999).

Figure 1. Hub and Spoke system.

The rise of H&S systems, combined with FSCs’ hunger for network expansion, triggered the emergence of global alliances (Evans, 2001; Fan, Vigeant-Langlois, Geissler, Bosler, & Wilmking, 2001). This, in turn, enabled the

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University of Amsterdam development of inter-hub connections which led to the establishment of worldwide multi-hub networks, as seen in Figure 2.

Figure 2. Multi-hub network.

Initially, the previously mentioned differentiation strategy of FSCs resulted in airlines differentiating mostly in their on-board services. However due to the rise of H&S systems, FSCs’ differentiation in product offerings was complemented by the increase of differentiation in connectivity. Although the FSCs offered a different degree in product offerings and connectivity, air travel passengers remained constrained to choose mostly between airlines with relatively similar strategies.

1.2 The New Millennium

Around the new millennium, the “Golden Age” came to an abrupt end. This was due to several events among which, an economic downturn and the fear of terrorism. This downturn, had struck the previously dominating FSCs hard, which, together with the continuously increasing air transport liberalization, paved the way for the success of low-cost carriers (LCCs) (Dobruszkes, 2009; Franke, 2004).

1.2.1 Business model innovation: Low-Cost Carriers

Even though LCCs existed before 2000, their success only became apparent after the second major disruption of the market, which in turn stimulated the rise of new LCCs. Although the LCCs had different origins, such as offshoots of FSCs or derivatives of regional operators, they all deviated from the classic FSCs in terms of their business model (Dobruszkes, 2006). Rather than engaging the market based on product differentiation, focused on revenue optimization, LCCs’ strategies were based on Porter’s concept of cost leadership and thus focused on cost minimization (Franke, 2004; Porter, 1980). This led to minimal product offerings, often defined as a ‘no-frills’-strategy (Franke, 2004; Williams, 2001). However, complementary services, such as in-flight meals, often remained available through additional charges. Eventually this type of additional revenue generation, also defined as ‘ancillary

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University of Amsterdam revenue’, became of great importance in the LCC business model (Graham & Shaw, 2008). After the initial period of success, the new LCC model was increasingly confronted by market saturation. This caused many LCCs to attempt to differentiate themselves from other LCCs by altering their product offerings, such as long-haul services (e.g. Norwegian Air Shuttle), which were not associated with the traditional LCC business model (Alamdari & Fagan, 2005).

The LCC business model and success have been popular topics in the literature (Dobruszkes, 2006; Francis, Humphreys, Ison, & Aicken, 2006; Hunter, 2006; Müller, Hüschelrath, & Bilotkach, 2012; Sarker, Hossan, & Zaman, 2012; Tretheway, 2004). In the literature there is some agreement, that the original operations of Southwest airlines and Ryanair exhibit the ‘purest’ form of a LCC (Dobruszkes, 2006; Francis et al., 2006; Tretheway, 2004). They are recognized as the pioneers and leaders of the rise of LCCs and are therefore often used as a benchmark for classifying airlines’ business models (Klophaus, Conrady, & Fichert, 2012; Mason & Morrison, 2008). Although many studies list several aspects associated with LCCs, such as point-to-point travel and fleet homogeneity, consensus about an exact definition of a LCC remains absent.

Thretheway (2004) for example, states that the LCC business model is defined as offering a very simple and low-cost service targeted at passengers with simple itineraries. Whereas Dobruszkes (2009) is more specific, stating that ‘pure LCCs’ can be identified based on their fare price, claiming that LCCs offer half the airfare price compared to FSCs and/or retain a maximum rate of EUR 0.10 per km. In turn, Lenartowics, Mason & Foster (2013) define LCCs by comparing them to FSCs, in terms of their network structure, whilst Alderighi, Cento, Nijkamp & Rietveld (2012) state that LCCs are simply airlines that are designed to achieve cost advantages compared to FSCs. Adversely, Wensveen & Leick (2009) adopt the perspective that all airlines, regardless of their business model, essentially have the same root costs (fuel, labor and maintenance) and therefore claim that there is no such thing as a LCC business model. Although definitions vary widely, it is apparent that these type of airlines experienced significant growth during this period (Dobruszkes, 2009).

This growth and emergence of LCCs made substantial inroads in the market for short- and medium-haul air travel, by adding a new dimension to the domain of air travel, thereby providing passengers a choice between two types of carriers that differ greatly in their business models.

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1.2.2 Full-Service Carriers and the long-haul market

Whilst LCCs were disrupting the short- and medium-haul market, competition in a number of long-haul markets was driven by another group of carriers. This increase in rivalry was mostly triggered by the rise of airlines from the Persian Gulf, which provided transfer alternatives for the major European hubs between Europe, Central and South East Asia, as well as Africa (See Chapter 4).

The phenomenon of Gulf carriers is also an issue of research that has been of interest to many researchers (de Wit, 2013; McKechnie, Grant, & Katsioloudes, 2008;; O’Connell, 2011;; Vespermann, Wald, & Gleich, 2008). Whilst the Gulf area provides a basis for several airlines, the main focus has been on full-service Gulf carriers that service intercontinental flights and operate large hub-and-spoke systems. From an international point of view, these airlines (e.g. Emirates, Etihad Airways and Qatar Airways) emerged as global competitors, becoming a serious threat for, specifically, European FSCs in the intercontinental traffic market. The literature assigns their success to a combination of multiple factors.

Hooper, Walker, Moore & Al Zubaidi (2011), emphasize the benefits of the location of the Gulf area due to its geographical centrality. Such argument refers to Ricardo’s concept of ‘comparative advantages’, which concern advantages that stem from productivity differences due to country specific characteristics, relative to other countries (Maneschi, 1992). Gains from such ‘comparative’ advantage are thus a result of differential efficiency (Stoelhorst & Bridoux, 2008). In this specific context the difference in efficiency is then, according to Hooper et al. (2011), reflected in the geographical favorability of the Gulf area regarding air transport networking. However, in contrast, Grimme (2011) notes that for some routes, the geographical location of the Gulf actually results in detours compared to European FSCs. He allots Gulf carriers’ success to their focus on secondary airports, that enables provision of ‘secondary-hub-secondary’ flights compared to European FSCs’ ‘secondary-hub-hub-secondary’ offerings, as seen in Figure 3. However, on primary destinations both European and Gulf carriers provide similar single hub transfer flights, causing such advantage to disappear in these markets.

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European full-service carriers

Gulf carriers

= European carriers flight Figure 3. Flight offerings Gulf carriers and European full-service

carriers.

Furthermore de Wit (2013) stresses that the location of the Gulf area positively affects the Gulf carriers’ operations by means of differing external environments compared to FSCs. This causes, among others, cost advantages for Gulf carriers (e.g. lower taxes and airport related charges). These cost advantages are complemented by the cost advantages that arise from their modern and fuel-efficient fleet, which according to Vesperman et al. (2008) explains most of Gulf carriers’ success. A similar explanation is chosen by O’Connell (2011) who states that higher operating margins compared to European FSCs mostly explains the rise of Gulf carriers. Finally Squalli (2014) states that the local governments’ ownership enables inimitable synergies, which lie at the heart of the Gulf carriers’ success.

To sum up, the Gulf carriers, whilst acting as an imperfect substitute for the European FSCs, disrupted the market for long-haul transfer travel, by increasing the travel options for passengers in the long-haul market (Grimme, 2011). This increase in offerings, in combination with the comparative advantages that Gulf carriers have over other FSCs, caused segments of the relatively stable long-haul market to be subject to much fiercer competition.

1.3 The third wave

The most recent increase in the dynamics of airline business models arose because of the accumulation of different phenomena impacting the aviation industry. Among these phenomena were global issues, such as the rise in oil prices and the financial crisis of 2008, as well as industry specific issues, such as the growth limitations for LCCs and the continuous growth of Gulf carriers (Franke & John, 2011;; O’Connell, 2011) .

1.3.1 Maturing short- medium-haul markets

Today, due to maturing markets, LCCs are forced to adapt their business models in order to sustain their growth (de Wit & Zuidberg, 2012; Sarker et al., 2012). As a consequence, the upcoming dynamics in the airline industry are

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University of Amsterdam often predicted, resulting in numerous potential future scenarios (Franke & John, 2011; Linz, 2012; Mason & Alamdari, 2007).

Sometimes it is concluded that the clear distinction between LCCs and FSCs is becoming ambiguous, supporting the emergence of hybrid carriers. Hybrid carriers are airlines that have incorporated features from both the traditional FSC as well as the traditional LCC business model (Klophaus et al., 2012). Establishments of such type of carrier, originate from both FSCs as well as LCCs, as a reaction to the market developments (Dennis, 2007). Elaborating on this perspective, several frameworks were developed in order to classify airlines based on their business model, showing that indeed a business model continuum is more appropriate than a clear distinction of two types of airlines (Daft & Albers, 2013; Lohmann & Koo, 2013; Mason & Morrison, 2008).

Indications can also be found in the literature that signal a shift in market focus by means of business model innovation, towards the long-haul traffic market (e.g. intercontinental premium only and intercontinental low-cost) (Franke & John, 2011). Thereby, considering a maturing low- and medium-haul market, supporting the idea of the long-haul market as the new major battle arena for airlines (Wensveen & Leick, 2009).

1.3.2 The Gulf carrier evolution

Considering specific segments of the long-haul market, the continuous growth of the Gulf carriers adds another dimension to the competitive environment. Fleet and airport expansions indicate that the growth of Gulf carriers is far from declining (Topham, 2013). Since the Gulf area’s regional demand has already proven to be insufficient for filling the current capacity, Gulf carriers will seek their growth in certain long-haul markets, thereby increasing the pressure on European FSCs (Vespermann et al., 2008).

1.3.3 European Full-Service Carrier’s answer

Next to the previously mentioned developments, European FSCs are taking actions in order to maintain and gain their share of the market. Their competitive response towards the LCC threat, with regards to short- and medium-haul flights, consists of different reactions (Fageda, Jiménez, & Perdiguero, 2011; Morrell, 2005). Some FSCs are adjusting their business model, focusing more on cost reduction, thereby partially adopting the LCCs strategy, (Dennis, 2007) whilst others respond by setting up low-cost subsidiaries in order to compete with the LCCs more directly (Dennis, 2007; Homsombat, Lei, & Fu, 2014).

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University of Amsterdam In order to achieve cost reductions, FSCs are taking on different approaches. These approaches consist of, among others, exploiting secondary hubs, changing catering charges, reducing labor costs and reducing distribution costs (Dennis, 2007). Of these approaches, the implementations of the latter two are considered to be most difficult for FSCs (Fageda et al., 2011). In order to achieve a full adaptation of the LCC business model, therefore competing more adequately with the LCCs, some FSCs have chosen to set up low-cost subsidiaries.

The response that encompasses the creation of low-cost subsidiaries, thereby forming a new organization structure, is often defined as the carriers-within-carriers (CWCs) structure (Graham & Vowles, 2006). This structure provides two options with regards to classifying the airline’s network. The airline can either choose for a “point-to-point” network or a “mixed” network (Lin, 2012). In the former, the FSC’s original one-stop flights are replaced by the CWC’s non-stop flights, whereas in the latter, both the FSC’s non-stop flight as well as the CWC’s one-stop flight are offered, as illustrated in Figure 4.

One-stop flight network

Point-to-Point network

Mixed network

Figure 4. Full-service carriers their possible choice of network structure.

The CWC business model itself is not new, however current developments within this model have been somewhat ambiguous (Graham & Vowles, 2006; Pearson & Merkert, 2014). Even though its success has yet to be determined, these new developments will most certainly have an impact on the competition.

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University of Amsterdam In order to comprehend potential effects of the aforementioned developments, a more detailed understanding of the key players in the industry has to be established. However, because a full industry analysis is beyond the scope and time of this research, the focus of this paper is set on the dynamics in the long-haul market. As aforementioned, increasing competition in specific segments of the long-haul market, is driven by the continuously expanding Gulf carriers. It is therefore not unexpected that the Middle East has evolved into the world’s fastest growing market in terms of air travel. In June 2014, the International Air Transport Association (IATA) reported the Middle East carriers to have experienced the highest growth worldwide, indicating the significance of their potential future impact on the overall industry (International Air Transport Association, 2014b). In 2013, the Middle East carriers achieved, with an 11.9 percent increase in Revenue Passengers Kilometers (RPK), more than 1,5 times the growth of the world’s second fastest growing region, Asia, whose carriers realized a ‘mere’ increase of 7.2 percent, whereas the European carriers realized an RPK growth of 4.0%. By identifying the key players from the Middle East, along with understanding their success as well as their current and future growth strategies, upcoming industry developments may be better comprehended.

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CHAPTER 2:

Theoretical framework

The effects Gulf carriers have on the aviation industry as a whole are based on their degree of success, which originate from their established competitive advantages. The current literature has adopted different perspectives towards Gulf carriers, exposing several competitive advantages of the major Gulf carriers, which are often linked with each other. This paper adopts the perspective of two asserted key advantages enjoyed by Gulf carriers, namely: Cost advantages and Network advantages. Although these concepts are intertwined, both notions are treated separately in order to simplify theorizing and to avoid circular references.

In order to comprehend how these advantages are applicable for carriers from the Gulf, a framework identifying the main drivers for airline cost and network advantages is developed. By exploring the underlying factors, thus enabling a comparative analysis, a more complete understanding of the Gulf carriers’ development and effect on the industry is possible. This Chapter explores important cost and network indicators, which will subsequently be analyzed and compared in Chapter 4, regarding the selected cases.

2.1 Cost advantages

An extensive analysis of the airline industry has shown that, for the last 40 years, the airline industry operated at an average net margin of 0.1% (International Air Transport Association, 2011).Such a margin illustrates the significant size of airlines’ costs relative to their generated revenue, and provide an explanation of the industry’s overall struggle with cost control. Since a complete overview of the cost structure of airlines is beyond the scope of this research, the following section will briefly outline the general input cost structure of airlines, after which selected key cost inputs will be discussed in detail.

2.1.1 Airline input cost structure

The asserted cost advantages of Gulf carriers can be explained by exploring the key drivers for their cost structure, which can be segmented into various groups. The adopted cost-categorization is modeled after the IATA endorsed cost structure, and exists of an initial separation of non-operating expenditures and operating expenditures. Doganis (2002) describes the former as expenses that are not directly related to an airline’s own air service operations and concludes that:

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“The nature of each airline’s non-operating costs ... is probably unique [and thus] inter-airline comparisons of … non-operating costs are of little value” (p. 78).

Since a comparative analysis is the main focus of this paper, airlines’ cost structures will further be discussed in terms of operating expenditures.

The operating expenditures of an airline have been defined and discussed by different authors, specifically in the context of Gulf carriers (de Wit, 2013;; O’Connell, 2011). Following Doganis (2002), operating expenses can be subdivided into direct operating costs and indirect operating costs, which is grounded on cost classification based upon aircraft dependency. In other words, operating costs that change when the aircraft type changes are considered direct operating costs, whereas operating costs that are unaffected by such changes, are classified as indirect operating costs.

A complete illustration of the specific categories and the associated sub-categories can be found in Figure 5. Since, as aforementioned, assessments on all sub-categories are not relevant and possible, the focus of this paper is centered on potential cost advantages in terms of direct operating costs. These costs are assumed to reflect possible cost advantages at best, and are thus considered most suitable for this analysis.

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Figure 5. Airline input cost structure as defined by IATA. Source: Doganis (2002).

The direct operating costs are identified in the form of three sub-categories, which are comprised of 12 distinct cost groups. However, in the context of this paper, the direct operating costs are explained by five distinctive cost groups that overlap with those identified by Doganis (2002). These five groups account, on average, for more than 70 percent of the operating costs of airlines and are discussed below (International Air Transport Association, 2011).

2.1.2 Aircraft induced operating costs

The recognized cost groups are costs associated with employment, fuel, charges and taxes, maintenance and aircraft ownership. Input Cost Structure Non-Operating Costs Retirement of property or equipment Interest paid on loans Loss of affiliated companies Other (such as currency losses) Government Subisidies/ Taxes Operating Costs Direct Operating Costs (DOC) Flight operations Maintenance and Overhaul Depreciation and Amortization Indirect Operating Costs (IOC) Station and ground expenses Passenger services Ticketing, sales and promotion General and administration Other operating costs

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(a) Labour costs

Labour costs, which exists of employee costs for flight crew as well as engineering personnel, depend on the number of employees and the average cost per employee. During its evolvement, the aviation industry has been built upon the aspect of safety, which is pursued by the extensive set of different rules and regulations. With regards to labour policies, rules and regulations are deeply rooted in the authorization of operating activities, such as flight and maintenance licensing. These operating licenses are often linked to specific aircraft types and can therefore create constraints in personnel deployment, especially in the case of heterogeneous fleets.

The number of required employees, can thus be controlled for, by enhancing deployment possibilities through preserving a uniform fleet. Furthermore advantages in labour costs are also dependent on the governmental labour policies and costs of living of the countries in which the airline operates. Such policies and living costs determine the average wages of employees, which can differ significantly per region and country (International Air Transport Association, 2011).

(b) Fuel

Airlines’ most significant operating costs exist of fuel costs, which, on average, accounts for 25.4 percent of airlines’ total operating costs (International Air Transport Association, 2011). Fuel costs are dependent on two factors, fuel prices and fuel consumption.

Over the years, average jet fuel prices have fluctuated significantly, ranging from USD 28.8 (2003) to USD 111.8 (2012) per barrel (International Air Transport Association, 2014c). Although the prices airlines pay for jet fuel are derived from company specific contracts, which are unobtainable for this research, differences in regional prices for jet fuel may, to a certain extent, indicate cost advantages for airlines.

Whereas airlines’ influence on jet fuel prices is limited, airlines are able to exert full control over their fuel costs in terms of fuel consumption. Cost advantages in fuel consumption depend on the efficiency of such consumption and is explained by means of the Available Seat per Kilometer (ASK) metric. This metric is often used as a basic indicator of aircraft performance and is defined as the available seats times the kilometers flown. The ASK of a flight is thus dependent on both the route length and aircraft seat capacity. A closely related metric that incorporates airline expenses, is the average Cost per ASK, also known as CASK.

These metrics can be paired with the concept of economies of scale, which hold that an increase in an airline’s output results in a smaller increase in costs, and may therefore lead to substantial cost advantages (Wei & Hansen,

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University of Amsterdam 2003). Since the application of this concept, in the literature regarding airline operations, has been somewhat ambiguous, clarification of this concept is provided below (Jara-Díaz, Cortés, & Ponce, 2001).

Economies of scale, in this context often referred to as economies of technological scale, arise when changes in aircraft seat capacity occur, for example by utilizing larger aircraft or operating denser seating configurations. This will, for a fixed network hence a similar flight route, increase the ASK, as indicated in Figure 6. From this perspective, due to the distribution of the high, fixed fuel costs over a larger amount of seats, fuel costs per seat will decrease for increasing ASK (Caves, Christensen, & Tretheway, 1984; Flores-Fillol, 2009; Jara-Díaz et al., 2001).

Economies of Technological Scale Airline Economics Aircraft Efficiency

Figure 6. CASK functions per aircraft capacity, route length and aircraft efficiency. Source: Doganis (2002).

Moreover, airlines are, regarding fuel-cost savings, naturally enticed to increase their route length, for example by shifting their focus from short-haul to medium- and long-haul flights. Operating longer routes, assuming utilization of the same aircraft, will increase the ASK, since the route length will increase. This leads, due to the distribution of high, fixed fuel costs over a larger distance, to a decrease in fuel costs per kilometer and consequently to a decrease in CASK. This phenomena is presumed to be a fundamental characteristic of airline economics, for which research has shown that, for US carriers, 17.6% of the difference in unit costs was explained by the difference in average stage length (Caves et al., 1984). A third way to gain fuel-cost advantages is through the deployment of newer, more efficient aircraft. Such aircraft efficiency is based on both engine performance and aircraft design, and can substantially impact fuel consumption. More efficient aircraft can therefore lead to cost savings per flight, whilst operating a similar route length for a similar amount of passengers.

It must be noted that the previously mentioned concepts refer to decreasing CASK, thus cost per seat. However, in practice, fuel costs are not spread across available seats, but over the amount of paying passengers. It is evident that an increasing load factor, thus a higher amount of passengers, will positively affect the spread of fuel cost per passenger. Whereas the concepts mentioned earlier are focused on the CASK, load factors are indicative of the actual

CA SK Aircraft capacity CA SK Route length CA SK Aircraft age

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University of Amsterdam amount of passengers. Following this reasoning, higher load factors decrease the actual cost per passenger, therefore increase the generated revenue per passenger.

To sum up, airlines can achieve lower fuel consumption per passenger, hence lower their CASK, by increasing the ASK, which can be done by increasing the stage length and aircraft capacity, or by utilizing more efficient aircraft. However, in practice, the notion of load factors plays an important role, regarding the actual decrease in costs per passenger instead of per seat.

(c) Charges & Taxes

The third cost input that is considered, exists of the charges and taxes that airlines are obligated to pay for operating. Due to the variations in airport policies and national governmental institutions, airlines tend to differ in their costs structure, in terms of charges and taxes, per, respectively, airport and country (Whitley, 1992; Zuidberg, 2014). According to the International Civil Aviation Organization (ICAO) (2000), taxes and charges differ in the purpose for what they are raised and state that:

“… charges are levies to defray the costs of providing facilities and services for civil aviation while taxes are levies to raise general national and local government revenues that are applied for non-aviation purposes.” (p. 3).

Therefore, charges to which an airline may be subject to, exist of airport charges such as landing-, passenger service- andATC-charges, and, taxes, such as corporate- and income-tax. The general charges and taxes to which an airline may be subject to can be found in Table 1 (Zuidberg, 2014).

Table 1.

Airport charges and Governmental taxes.

Airport Charges Governmental Taxes

Passenger Facility Charges Individual Income tax

Security Charges Corporate Tax

Take-off/Landing Fees Parking charges Source: (Zuidberg, 2014).

Because variations exist on both charges and tax level, significant competitive cost advantages can arise, depending on the airports in the network. Differentiation in airport charges originates from the different elements used to determine these charges. Important variables influencing these costs are the Maximum Take-Off Weight (MTOW), flight destination, noise production and emission output (Zuidberg, 2014). It must be noted that although charges may differ per airport, airlines that utilize the same airport will experience equal charge expenses. Hence, overall cost advantages are expressed in terms of applicable charges and taxes for airlines´ main bases. In contrast, because IATA’s

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University of Amsterdam policy advocates tax limitations through stimulating reciprocal agreements between countries, multiple taxations for airline operations are avoided. Thus, taxes enable airlines with similar operations to differ in their tax expenses, due to the different tax responsibilities per country.

(d) Maintenance

Another major operating expense arises from airlines’ maintenance activities, which consists of unscheduled and scheduled maintenance. Since the former is a function of quality, usage and misfortune, gaining cost advantages through fewer unscheduled maintenance activities is deemed unlikely. Furthermore, the frequency of scheduled maintenance is also expected to be similar among airlines, due to the mandatory maintenance activities as a function of flight hours.

However, both scheduled and unscheduled maintenance costs are based upon labour costs and component prices. Thus competitive cost advantages in maintenance, may be gained through exploiting a homogeneous fleet thereby enabling maintenance synergies (Al-kaabi, Potter, & Naim, 2007). In terms of labour costs, such synergies can lead, to the reduction of needed skill variety and thus in required labour forces. Another effect of a homogeneous fleet may exist of a decrease in aircraft component inventories through, for example, component cannibalizing or bulk component purchases.

(e) Amortization and depreciation

The fifth considered operating expense consists of amortization and depreciation costs. Both concepts relate to the gradually disbursement of assets, for which the former refers to intangible assets, whereas the latter applies to tangible assets (Berk & DeMarzo, 2007). Although amortization and depreciation can be applied on many different assets, the focus here lies on airlines’ depreciation expenses in terms of aircraft purchases. The purpose of aircraft depreciation exists of, spreading aircraft purchasing costs over multiple years and generating a financial reserve funded by the depreciation rates (Doganis, 2002). Since the rate of aircraft depreciation is determined by the airline, cost advantages are dependent on the type of strategy the airline choses.

Depreciation expenses are directly added to the operational expenses, thus lower rates of depreciation positively affects operational expenses. However low rates of deprecation increase the total time-span of pay-off. Conversely, choosing high depreciation rates negatively influence short-term depreciation costs, but will benefit the airline in the long-run since higher non-operating profits are generated when the aircraft are sold. Another advantage of high depreciation rates concerns protecting profits through the tax write-off nature of depreciation rates. However, airlines

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University of Amsterdam do not necessarily require aircraft ownership in order to operate. Nowadays, aircraft leasing has proven to act as a suitable substitute, for which Doganis (2002), notes that,

“… during the last twenty years a growing proportion of aircraft are leased in, rather than purchased” (p. 90).

Costs that arise from aircraft leasing are similarly recognized as operating expenses, but are, to a certain extent, not determined by the airline itself. An advantage of aircraft leasing, consists of the freedom airlines obtain since aircraft leases are less restrictive than aircraft purchases, whereas aircraft purchasing locks the airline into long-term depreciation costs, aircraft leasing requires relatively short commitment periods. Leasing also eliminates the risk of selling aircraft below the desired or market value. Finally, leases provide airlines the opportunity to operate the preferred type of aircraft whenever they want (Aercap, 2014).

Both aircraft purchases and aircraft leasing have advantages and disadvantages and airlines may choose to adopt either one, or a mix of both notions. Overall cost advantages through depreciation, are thus not adequately reflected in lower depreciation costs. However, comparisons of airlines’ fleet financing, in terms of ownership and leasing, may indicate airlines’ view as to which of these two notions they consider most advantageous.

2.1.3 Key cost indicators

Identifying potential cost advantages in operating expenditures, is attempted by means of analyzing the key cost indicators discussed earlier. The variables that influence cost inputs for airlines are considered to exist of national labour policies, fleet homogeneity, passenger load factor, fleet efficiency, route lengths, aircraft capacity, (main) airport charges and home country taxes. Furthermore, airlines’ choice for aircraft ownership or aircraft leasing, indicates the specific advantages airlines aim to exploit.

2.2 Network advantages

The second dimension that is considered, in terms of competitive advantages, concerns the advantages that may arise due to an airline’s network structure. Air traffic networks for airlines and airports have been extensively discussed in the literature (Brueckner & Spiller, 1991;; O’Kelly & Bryan, 1998;; Verma, Araújo, & Herrmann, 2014; Y. Zhang, 2010). A common starting point has been the separation between H&S and point-to-point networks (Caves et al., 1984). However, considering the focus of this paper, a different approach is more appropriate. On the issue of

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University of Amsterdam competitive network advantages, this paper adopts the perspective of competition on two separate, complementing dimensions.

The first dimension concerns competition based on the airline’s connectivity abilities. By adding new destinations to its current network, airlines are able to exert full control of its competitive strength in this dimension. Whereas, competition in the second dimension, which concerns competing through the airline’s main base, is more fixed and therefore less controllable in terms of gaining network advantages.

2.2.1 Connectedness and Connectivity strategies

In its most basic form, an airline’s product exists of air transport from point A to point B. Hence, adding a new destination, which can be understood as adding a new product, indicates an increase in the airline’s product scope (Jara-Díaz et al., 2001). The amount of products offered are then equivalent to the amount of different destinations an airline serves and therefore indicative of the network size of an airline (Caves et al., 1984). As Aguirregabiraia & Ho (2010) note, an airline’s network can be seen as

“… a set of city-pairs that the airline connects via non-stop flights” (p. 1).

Thus, as a result of serving a new destination, the airline’s network, as defined above, increases by one, whereas the total one-stop connections increases by the amount of initial destinations. Since airlines are able to combine their products (for example adding route C to network A-B, not only creates A-C, but also B-A-C and so forth), additional destinations enhance existing product offerings significantly, which demonstrates complementarities between different products (Gimeno & Woo, 1999). The aforementioned synergy, benefitting from the complementarity between multiple products, thereby considerably increasing the amount of offered one-stop connections, is often known as economies of scope (Panzar & Willig, 1981). This is further explained by Teece’s (1980) definition of economies of scope, who states that:

“Economies of scope exist when for all outputs y1 and y2, the cost of joint production is less than the cost of producing each output separately.”(p. 2)

The notion of economies of scope is then applicable in the following setting. Suppose airline X operates routes A-B, airlines Y operates routes B-C and airline Z operates route A-B-C. These combined operations are naturally

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University of Amsterdam operated at lower costs when airline X adds destination C to its network (A-B), thus creating a new network (A-B-C), as explained above. This effect of economies of scope is also known as economies of spatial scope. However, Romero-Hernandez & Salgado (2005) note that when an airline serves Y different destinations, it is potentially able to serve Y * (Y-1) different routes between these destinations, whereas the emphasis is on ‘potentially’, since such reasoning does not incorporate differences between the actual and potential flight routes served by an airline.

A second implication of adding new routes to an airline its network is the increase in passenger feeds to the initial network. Adding new destinations will generate a new inflow of passengers that enable new feeding opportunities for existing routes, which, in turn, raises the demand for existing routes. This increase in demand allows for higher load factors and greater exploitation of economies of technological scale, through utilization of larger aircraft. It may be evident that adding destinations in the form of ‘inter-hub’- linking will have the greatest impact on exercising economies of scope, due to the larger amount of passenger inflows in the airline’s network (O’Kelly & Bryan, 1998).

However, increasing the network size is not a necessity for achieving higher passenger inflows. Pursuing a larger passenger feed into the airline’s network may also be achieved by increasing the flight frequency of the current flight routes. Following Mason & Morrison (2008), high flight frequencies are expected to indicate effective use of aircraft and cost savings. Since, for a fixed network, higher frequencies means more passengers, and thus a thinner spread of the overall fixed costs (e.g. aircraft ownership costs and overhead costs) over a larger number of passengers. This concept is also known as economies of density, and requires a sufficient travel demand for the existing route. The significant role of traffic density is proven by Douglas (1984), who found that for US carriers, for a given size of network, 45.0% of the difference in unit cost was explained by the difference in the density of service.

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Economies of spatial Scope

Passenger inflow into the network

Economies of Density

Figure 7. Economies of Scope and Density. Source: Doganis (2002); Mason & Morrison (2008))

The effects of network expansion are shown in Figure 7. These effects imply that an airline may continue to operate new destinations despite negative profits, because operating the new destination can considerably benefit other routes (Aguirregabiria & Ho, 2010). In order to operate new destinations, airlines may choose different strategies to expand their network. The growth strategies airlines may choose from, exist of the strategic typologies of mergers & acquisitions, alliances, and organic growth, which are not mutually exclusive (Lyons, 1991). The choice of growth strategy may differ per airline, whereas Zou, Chen, & Ghauri (2010) indicated that the different growth strategies require diverse resources and are associated with distinct performance outcomes.

(a) Acquisitions

Increasing the number of destinations an airline serves through acquiring existing airlines is seen as the most costly and most risky strategic option (Zou et al., 2010). Besides the high costs, potential integration difficulties place a great risk on this type of expansions (Hoskisson & Hitt, 1990). Such integration difficulties often encompass the assimilation

# of on e-st op de sti na tion s # of non-stop destinations CA SK # of non-stop destinations CA SK Flight Frequencies in Network

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University of Amsterdam of required resources and cultural differences, which may destabilize the acquiring airline’s internal processes (Carbone & Stone, 2005). Nevertheless, if successful, acquisitions allow airlines to rapidly obtain external assets (e.g. connectivity possibilities, knowledge or aircraft), and provides relative quick entry in new markets (e.g. cheap and fast access to slots), without experiencing time-consuming physical adjustments (Merkert & Morrell, 2012; Zou et al., 2010).

In general, a choice for acquisition growth is presumed to require sufficient financial resources and acquisition experience, and is often motivated by profit performance (Zou et al., 2010). However, King, Dalton, Daily, & Covin (2004) their meta-analysis established that, on average, acquisition growth has no or a negative effect on the acquiring firm’s financial performance and noted that such growth

“… may be no more difficult to successfully execute than other alternative strategies for business growth and development.” (p. 10)

On the other hand, Iatrou & Mason (2009), found that airline acquisitions do have a considerable positive effect on airline operations, especially through the enhancement of the exploitation of economies of scale, density, scope and financial synergies. Although acquisition growth can deliver substantial benefits, it has several great hurdles to overcome. The most essential factors constraining acquisition growth consists of, regulatory mechanisms in the form of trust concerns, labour issues and foreign ownership rules (Fan et al., 2001; Iatrou & Mason, 2009). Such anti-trust regulations often hold the assumption of an increase in price, due to the expected decrease in competition that follows airline acquisition. However, Threteway (2008) cautions the approach for assessing airline mergers, as they may generate wrong conclusions. He claims that due to the classical textbook approach towards acquisition assessments, other important factors like economic efficiency in the form of higher quality services are often disregarded.

Moreover, Merkert & Morell (2012), suggest that an airline may limit the disadvantages by retaining the acquired airline as separate operating entities, but that acquisition growth is decreasingly beneficial for airlines that produce less than 32 billion ASK. They concluded that airline acquisitions will become inevitable for airlines to survive, however only to a certain degree. They advise limited operational growth, regardless of the type of growth strategy, for airlines that process over 100 billion ASK, because in such cases further growth would

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“... not make any sense in terms of scale efficiency. In fact, they would be even counterproductive as diseconomies of scale apply”. (p. 2, 862)

(b) Alliances

Another strategic option, alliances or partnerships between airlines, is a more common phenomenon in the airline industry (Bilotkach & Hüschelrath, 2012). This growth strategy is often motivated by risk reduction, due to risk sharing, which helps to encourage airlines to follow new or innovative paths (e.g. new flight routes or markets) (Lyons, 1991). Furthermore, they offer growth opportunities through learning and cooperation and allow airlines to combine their resources (e.g. flight routes or knowledge) or to obtain complementary resources. (Zou et al., 2010). In addition to the benefits mentioned above, airlines may often engage in alliances if cross border cooperation is the case, since alliances enable airlines to circumvent foreign ownership rules and anti-trust restrictions for cooperation, which, as mentioned before, form the major obstacles for acquisition growth (Bilotkach & Hüschelrath, 2012). The main outcome of engaging in such collaborations, exist of a rapid increase in connectivity through the establishment of code-sharing and interline agreements.

Codeshare agreements

The former option, code-sharing, is achieved by engaging in partnerships, often in the form of non-equity alliances. Code-sharing entails the addition of flights by offering air travel on flights operated by other airlines, thereby assigning multiple flight numbers to a single flight. Code-sharing encourages higher load factors, stimulate greater aircraft capacity, and is often paired with airlines sharing their customer loyalty program (Bilotkach & Hüschelrath, 2012). However, such additional exploitation of economies of technological scale is outweighed by the exploitation that is paired with airline acquisition (Iatrou & Mason, 2009).

Interline agreements

Similar to code-sharing, expanding product offerings through interlining also requires, although to a lesser extent, collaboration with other airlines. Interline agreements encompass the handling of passengers on itineraries that include multiple airlines (International Air Transport Association, 2014e). In such cases one airline issues one ticket for multiple flight segments, for which the first segment is operated by the issuing airline and the subsequent segments are operated by others. Passengers that utilize airline interline agreements pay one ticket price to the issuing carrier,

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University of Amsterdam who then divides the revenue among the interlining airlines. Such a mechanism allows an airline to attract more passengers, due to the ability to offer connections that lie outside the airline’s own network.

Both code-sharing and interline agreements refer to collaborations between two airlines for a specific operation. However, due to the rise of global alliances, which consists of collaborations of airlines, an airline is able to gain immediate access to a wide range of code-sharing and interlining opportunities with different airlines. Whereas one-on-one airline alliances have their greatest positive effect on economies of scale, joining a global airline alliance has its most substantial effect on economies of scope (Iatrou & Mason, 2009). In this case alliances have a more positive effect than any other growth strategy, since none of them can

“… match the network reach of an eight- nine- or sixteen-member alliance. After all, the main drive behind alliance formation was … the desire to expand their geographic scope of their network so as to achieve global

scale” (Iatrou & Mason, 2009, p. 4).

Thus, establishing growth through alliances is built on networking relationships and is focused on gaining competitive advantages in, for example, knowledge, new markets and business legitimacy (Zou et al., 2010). However, engaging in alliances also comes with certain risks, such as the continuing contrasts of cooperation and competition between the allying airlines. Whereas cooperation may lead to increasing inter-airline dependency, competition will, due to opportunism, negatively impact the reliance on trust and thus increase costs (Das & Teng, 2000).

(c) Organic growth

A third approach for increasing product offerings is through organic growth, which refers to the addition of new destinations by simply operating new destinations, without support from other carriers. Organic growth allows greater potential to enter niche markets and to build market share (Zou et al., 2010).

Organic growth is most likely to be successful when the airline possesses strong marketing capabilities and is often driven by performance measurements in the form survival. The survival rate is expected to be the highest for airlines following an organic growth strategy, due to their focus on gaining optimal control of their operations, which results in the ability to respond more adequately to changes in the market (Zou et al., 2010). In comparing both acquisitions and alliances, Iatrou & Mason (2009) conclude that:

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“It is not the positive impact of mergers but also their negative aspects that are by far greater than those of alliances” (p .5)

Thereby indicating that it is more risky for airlines to choose acquisitions growth over alliance growth. Whereas an organic growth strategy bares the lowest risk, it also, relatively, achieves the slowest growth in network size.

Airlines may differ in their choice of strategic growth option, considering their different objectives and resources. Therefore, due to the focus of different types of measurements of performance outcomes, a strict comparison between these strategies in terms of competitive advantages is reasoned unsuitable.

2.2.2 Aerodrome characteristics

Despite the increasing deregulation of the airline industry, general exercise of routes fully outside airlines’ home country has been relatively low, causing airlines to focus their operations on one main airport (Forsyth, 2011). This central focus is also a result of both legal restrictions and cost savings that arise from operational synergies.

Concentrating on one central airport creates a glass ceiling to the opportunities in terms of operating routes, and thus ascribes a key role to both the main base’s capacity as well as its geographical location in gaining network advantages. Consequently, the following section will adopt a perspective in terms of the airline’s main base, which is recognized as the airport that is based in the airline’s home country and receives the highest degree of operation activity.

(a) Airport capacity

Growing in network size, thus adding new destinations to its current network, requires sufficient capacity at the airline’s main hub, whereas increasing transit and transfer traffic is specifically most demanding in terminal capacity. Although airport capacity depends on many factors, it is often expressed by two variables, namely arrival and departure capacity per hour (Gilbo, 1993). Hence, advantages in terms of airport capacity, can be measured by the difference in average and maximum runway capacity utilization of the airline’s main base. Such differences indicate the airport’s ability to meet demand and to provide maximum connectivity between a maximum cluster of arriving flights, followed by a maximum cluster of departing flights. When an airport is unable to meet the capacity demand, air traffic congestion may arise that can have negative implications for the airport (over-investment in capacity) and the airline (higher slot costs) (A. Zhang & Zhang, 2006). Furthermore, Gilbo (1997) showed that for US carriers, excess demand tends to cause delays that result in an average additional operating cost of USD 1600 per hour. Even more extreme

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University of Amsterdam were the findings of Milan (1997), who found average costs associated with delays, for European carriers, to be USD 1330, USD 2007 and USD 3022 per hour for medium, large and heavy jets (as cited in Wu & Caves, 2000). Thus, airport capacity advantages refer to the capacity utilization margin of the European and Gulf carriers’ main bases.

(b) Geographical location

Another network advantage that may arise from the airline’s main base is grounded in its geographical position, whereas the ability of an airport to generate geographical comparative advantages for airlines refers to the airport’s ability to attract passengers. This paper attempts to assess airport attractiveness in two different dimensions, specifically on the two different functions airports fulfil in terms of air passenger travel.

In one function, the airport provides air traffic entry/exit, whereas in the other, the airport provides connections between air traffic. Passengers that utilize the first function are called Origin & Destination (O&D) traffic, whereas passengers exploiting the second function are termed Transit & Transfer (T&T) traffic.

Origin & Destination Traffic

Naturally, attracting O&D traffic is dependent on the local geographical position of the airport. Network advantages are then measured in airports’ distance to attractive locations regarding economic development, size, and business and leisure attractiveness. Such values are proposed to be indicated by the corresponding characteristics of the countries in which the main bases are situated. Economic development and size can then be related to the country its Gross Domestic Product (GDP) per capita and the total population of the country, whereas the attractiveness for business and leisure is represented by the ease of doing business and amount of international tourists of the country.

Transit & Transfer Traffic

Contrasted with attracting O&D traffic, the ability to attract T&T traffic relies on the regional and global geographic position of the airport. Hence, network advantages are dependent on the airports’ geographical position relatively to other airports and attractive markets. An additional division of T&T traffic can be made, based on the route length of the connecting flights, which is derived from the H&S concept mentioned earlier where air traffic is concentrated on one central airport, as shown in Figure 8 (Aguirregabiria & Ho, 2010).

The first form of T&T air traffic flow concerns connecting long-haul flights through one main airport, which then operates as an hourglass hub (Burghouwt & de Wit, 2005). The airport attractiveness then, depends on the global geographic positioning for both the inbound as well as the outbound flight.

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Hourglass Hub

Hinterland Hub

Figure 8. Types of Hubs and Traffic.

The second form of T&T connecting activity occurs when an airport connects shorts-haul flights with long-haul flights. Here the airport acts as hinterland hub for which its attractiveness is dependent on both the regional geographical positioning as well as global geographic positioning (Dennis, 1994). However, the emphasis of this paper, regarding T&T traffic, is set on the hourglass functionality of the airport.

Since global geographical advantages are considered relatively to other airports and markets, a distinction has been made between current markets, and growing markets. Current markets are identified as the destinations and regions that presently receive the strongest focus of the European and Gulf airlines, whereas growing markets are identified as several economic centers, in terms of developing countries. Identifying the latter countries, is based on O’Neil’s (2001) well-known BRIC acronym, representing Brazil, Russia, India and China, which refers to the four developing countries that showed the highest economic potential, whereas the IATA (2011) suggests that:

“The BRIC economies have very underdeveloped travel markets and are likely to be a very large source of new travel demand in the decades ahead.” (p. 5)

However, it is argued that these four economies have, to a certain extent, not lived up to their expectations, consequently giving rise to the acronym MINT. The MINT countries, which stand for Mexico, Indonesia, Nigeria and Turkey, are perceived as the new important upcoming players in the world economy, but are yet to gain such popularity

D₆ D₄ H₃ D₁ D₃ D₂ D₆ H₃ S₁ S4 S₃ S₆ D₂ D₄ D₃ D₁

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University of Amsterdam and support as the BRIC-economies (Adibe, 2014). Thus, these eight countries are estimated to achieve the highest economic growth in the upcoming years and are therefore deemed appropriate to act as potential future air travel markets.

The section above concerns the geographical advantages of the airport in terms of attracting passengers. It may be evident that attracting O&D and T&T passengers for one airport can differ greatly with other airports. However, the volume of O&D passengers is assumed to be relatively small, since it only concerns air travel demands from either passengers starting or ending their air travel at the relevant airport. Conversely, the volume of T&T traffic is considerably larger, since such traffic covers multiple demands from and to different regions. Thus, it seems that although attracting a larger volume of O&D passengers in terms of the geographical position of an airport is beneficial, its geographical positioning for attracting T&T is reasoned to be of a substantially higher value.

2.2.3 Key network indicators

To sum up, airlines’ operations with regards to flight frequency and number of destinations served, indicates their strength in terms of connectivity. Whereas both characteristics indicate passenger inflow, the latter is also indicative of the scope of the airline’s different product offerings which is determined by their preferred expansion strategy. Regarding airport network advantages, an airline’s main base capacity utilization margin, and local, regional and global geographical positioning act as an important measure for assessing airlines’ network advantages, for which the latter aspects refer to the relative distance and positioning towards attractive cities and markets.

Dynamics in the long-­haul aviation market : the growing Gulf threat and its sustainability