How governance policies in the passenger airline industry shape the major airlines’ international strategies.

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How Governance Policies in the Passenger Airline

Industry Shape the Major Airlines’ International

Strategies

A Multiple Case Study

Master Thesis

MSc. Business Studies – International Management Supervisor: Dr Johan Lindeque

Second reader: Dr Michelle Westermann-Behaylo Student: Eduard Posthumus Meyjes

Student ID: 10195068

Date: 31 January 2014

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Abstract

This research adds a contribution to the regionalisation/globalisation discussion, by investigating a highly regulated industry that has been underexplored within this line of research and by studying the dynamics of formal institutions and firm-specific advantages in the process of internationalisation of key players in this industry. This research investigates the global/regional orientations of the five largest airlines in the world by revenues, how formal institutions in the industry influence the internationalisation of these airlines and how these airlines react to these influences.

Applying a multiple-case study design, data on regionalisation/globalisation was collected from the airlines’ annual reports for the years 2008-2012. The retrieved quantitative results were supplemented with qualitative data from news articles from the Financial Times for the same period.

All airlines show home-region orientations with clear home-country effects and industry specificity. Formal institutions in the industry are argued to both constrain and enable airlines in their process of internationalisation. The constraints imposed are overcome by forming strategic alliances which provide the airlines with alliance-specific advantages that both help the airlines to overcome formal institutions’ influence that they could not have overcome themselves and provide airlines with recombinations of FSAs and CSAs to benefit from they would not have had access to individually.

Keywords: regionalisation, globalisation, internationalisation, aviation, formal institutions,

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Acknowledgements

First and foremost, I would like to thank Dr Johan Lindeque for supervising my research. We met each other during most of the courses during my master International Management of which I have learnt a lot and so I felt privileged to be supervised by him. I am most grateful for his patience and support during my thesis research. Thanks to his expertise, enthusiasm, constructive feedback and valuable guidance, I was able to conduct and complete this research and therefore I owe him my sincere gratitude. It does not come as a surprise to me that Johan is one of the most valued lecturers of the University of Amsterdam, praised for his knowledge about and enthusiasm for International Business and support provided to students.

Second, I wish to express my gratitude to my fellow students who have been participating in the group study. Together we have been able to replicate the Rugman and Verbeke (2004) research on the regional orientations of all Global 500 MNEs, which created an interesting data set for the current and for future research. In addition, we have shared ideas and knowledge on the topics of regionalisation theory, underlying concepts and approaches to the individual research, which helped me in the process of the study.

Last, but certainly not least, I would like to thank my family and friends who have been supporting me during my study and specifically during my research. Their listening, support and understanding, especially over Christmas, has been incredible.

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Index of Tables and Figures

Table 1. Classification and industries Global 500, adapted from Rugman (2005) ... 13

Table 2: Case selection ... 27

Table 3: Data set ... 29

Table 4: Typologies and specification(s) of orientations, adopted from (Rugman 2005) 30 Table 5: Coding scheme ... 31

Table 6: Within-case analysis Lufthansa... 34

Table 7: Within-case analysis International Airlines Group ... 44

Table 8: Within-case analysis AMR Corporation ... 54

Table 9: Within-case analysis Delta Airlines ... 64

Table 10: Within-case analysis Air France-KLM ... 74

Table 11: Cross-case analysis... 84

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1. Introduction

As a significant part of International Business studies, the debate about globalisation and regionalisation has been receiving increasing attention from scholars in recent years (Dunning, Fujita & Yakova 2006; Rugman & Girod 2003; Rugman & Verbeke 2004, Rugman & Collinson 2004; Rugman & Verbeke 2007; Osegowitsch & Sammartino 2008; Kolk & Margineantu 2009; Ghemawat 2003; Filippaios & Rama 2008; Dikova & van Witteloostuijn 2007; Oh & Rugman 2006), with arguments both in favour of globalisation and against regionalisation theory and vice versa.

On one side of the debate, globalisation - in the sense of “the international integration of markets in goods, services and capital” (Garrett 2000, p. 400) - is argued to be caused by the information technology revolution, the increased opportunity costs of closure and the ideological change over time (Garrett 2000). At a firm level, the role of the multinational enterprise (MNE) has traditionally been to drive the process of globalisation and advocate global strategies with homogenous goods and services (Levitt 1983; Yip & Hult 2012). On the other side of the debate, regionalisation theory has been contextualised as the need for the combination of local responsiveness and global integration in business strategy (Bartlett & Ghoshal 1989). This view has found support in Ghemawat’s (2003) research that markets are neither completely isolated nor integrated across borders and thus require distinctive local strategies. An empirical test for the regionalisation theory was initiated by Rugman and Verbeke (2004) who concluded that most of the MNEs that claimed to be global are in fact pursuing regional strategies.

Regionalisation of MNEs is explained in the international business literature by means of two theoretical positions. From an institutional-based view the transaction cost economics approach provides an explanation for selectivity in internationalisation (Rugman & Verbeke 2005), since MNEs face the liability of foreignness within both the informal and formal institutional constraints structuring the economic, political and social landscape (Zaheer 1995; North 1990). These location characteristics determine the attractiveness of entry for MNEs, referred to in the literature as country-specific advantages (CSAs) (Rugman 2005). Regionalisation theory argues that expanding regionally, MNEs are confronted with lower levels of intra-regional liability of foreignness and thus lower transaction costs in comparison to inter-regional expansion (Rugman & Verbeke 2007).

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6 From a resource-based view, tangible and intangible resources and capabilities, which are valuable, rare, inimitable and organisable are argued to be the key to competitive strategic advantages (Barney 1991).

According to Verbeke (2013), MNEs create firm-specific advantages (FSAs) with their resources and capabilities, which they then exploit outside their home-country, consequently foreign direct investment and international sales follow. When expanding, the non-location-bound FSAs can be relatively easily adapted to optimise their exploitation potential at minimised transaction costs (Rugman & Verbeke 2007). On the contrary, location-bound FSAs require more substantial investment to become deployable outside the home country, increasing transaction costs (Rugman & Verbeke 2007).

While moving towards an integrated explanation theory of regional MNEs, Rugman and Verbeke (2005) make the suggestion that firms not just deploy their FSAs in geographic locations where exogenously determined CSAs are largest, but link the investments to melding the present CSAs with their existing FSAs through location-specific thinking. Although this theory argues that as an outcome of the calculation of adaptation costs in a response to the locations of institutions, that when considering recombinations of existing and additional FSAs, MNEs usually expand in their home region first rather than other regions (Rugman & Verbeke 2005), empirical (longitudinal) evidence continues to be sought across sectors and outside the Global 500 list of MNEs to further clarify the understanding of this issue (Verbeke 2013).

This research adds a perspective to those lines of inquiry that focus on the interaction effects between formal institutions and the international entry strategies pursued by MNEs and the associated dynamics, in order to gain better understanding of the internationalisation processes. The current study will explore the regional/global orientations of five major apparently global airlines, and their pursued international strategies in the context of regional and global aviation governance. The aviation industry is particularly interesting for two reasons. Firstly, no research on the regionalisation of this sector have been conducted before. Secondly, research in this field is highly relevant, given that the current competitive market and industry liberalisation issues are heavily debated (Wittmer 2011; Héritier & Karagiannis 2011).

Since the development of global aviation transportation started in the early 1900s, the international industry has been an integral part of the world economy due to its large contribution to world economic growth. According to the International Air Transport Association (IATA), the worldwide revenues in 2012 were 679 billion dollars, of which 538

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7 billion dollar is attributed to passenger airlines (IATA 2013). The largest players in the field are Lufthansa Group, United Continental Holdings, International Airlines Group, AMR Corporation, Delta Airlines and KLM-Air France (Fortune Global 500 2012).

From an institutional perspective the industry experiences different degrees of governance and liberalisation across the globe. Inter-regional (e.g. the EU-US Open Skies Agreement) and intra-regional treaties (e.g. the proposed Single European Sky) are changing the ’rules of the game’ for the sector in the most vital way since the central agreement of international civil aviation was reached at the Chicago Convention in 1944. A common practice in terms of international strategy within the industry is to engage in strategic alliances, such as the Star Alliance (2013), SkyTeam (2013) and Oneworld (2013). The interactions between the fixed and changing institutions that enable and constrain the regional/global exploitation in the industry and the recombinations of MNE’s FSAs is central to understanding the international strategies of these airlines. This leads to the following research question for this study:

How do regional and global governance policies in the aviation industry shape the major airlines’ international strategies?

Replicating Rugman and Verbeke’s (2004) research, 2012 cross-sectional data was collected for the 500 largest enterprises in the world in terms of revenue by means of a group study prior to this research project. Subsequently, longitudinal quantitative and qualitative data for the selected airlines was collected. A multiple-case study approach was adopted in which quantitative data is collected through scrutinising the annual reports of the selected cases. Revenues, assets and number of employees were recorded to complement the data. Qualitative data is collected through newspaper articles in the Financial Times for the years 2008 to 2012.

This research attempts to increase the knowledge of and insights into the interactions between formal institutions and international strategies and contributes to the scientific debate of regionalisation, formal institutional influences and the pursued entry strategies of MNEs. More specifically, this research examines how certain formal institutions can shape MNEs’ international strategy to engage in inter-firm relationships. The outcome will also have managerial implications for firm strategists and governance within the industry to shape future ideas and management.

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8 From an institution-based view, findings indicate that airlines are both constrained and enabled in their strategic choices by the formal institutions present in the industry. From a resource-based view, the MNEs’ FSAs seem to be too location-bound to offset the liability of foreignness faced, making them incapable of overcoming the formal institutions. Findings indicate that in order to overcome the transaction costs and liability of foreignness created by the regional and global institutions, airlines engage in strategic alliances. The function of these alliances seems to be twofold. Firstly, alliance-specific advantages are created that allow airlines to overcome the liability of foreignness, which the carrier is unable to circumvent individually. Secondly, alliance-specific advantages are created that provide airlines with recombinations of FSAs and CSAs to benefit from, which the carrier would otherwise not have had access to.

The remainder of this study is structured as follows. The next section reviews the literature on the key dimensions for this research. Regionalisation theory will be discussed elaborately, before reviewing the explanations of this phenomenon in terms of the institutional-based perspective and the resource-based perspective. Subsequently, entry modes in international business and specifically strategic alliances as a strategy pursued by MNEs to recombine and redeploy FSAs in relation to institutional hazards will be discussed. Based on this review, seven propositions are formulated which involve the origins of constraints and enablers of MNE internationalisation processes and the responses to these within international strategies. Next, the methodology section will describe the research philosophy, multiple case design, the context of formal institutions in the aviation industry and the case selection, and how the data was collected and analysed. The validity of the formulated propositions is analysed in the results and discussion sections. Finally, the conclusion section will address the key findings, scientific relevance and managerial implications, the limitations of this research and suggestions for future research.

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2. Literature review

This study aims to explore the nature of regional/global strategies pursued by international firms and what enables or constrains these strategies. Within the International Business literature the institution-based view (North 1990; Scott 2008) and the resource-based view (Barney 1991; Peteraf 1993) as adopted in the firm specific (FSA) concept (Rugman & Verbeke 1992) provide two perspectives for studying the geographical scope and dispersion of MNEs (Rugman 2005; Rugman & Oh 2012). This study focuses on the pursued strategy within a specific sector and seeks to explain these strategies in terms of the aforementioned perspectives. In this review of the literature the conceptual foundations are elucidated. First, the key concepts of the regionalisation and globalisation debate will be discussed, before reviewing the role of institutions and firms’ resources within this context. Subsequently, the literature on several entry modes and specifically on the strategic alliances considered by MNEs to enable them to engage in foreign direct investment are reviewed as a specific part of international business.

2.1 The (semi)globalisation and regionalisation debate

The emergence of globalisation - in the sense of “the international integration of markets in goods, services and capital” (Garrett 2000, p. 400) - is a frequently debated subject in International Business studies. Although some have argued that this phenomenon can hardly be referred to as new, when compared to the levels of market integration during the economic internationalisation at the beginning of the 20th century (Katzenstein, Keohane & Krasner 1998; Sachs et al. 1995). Several causes have been proposed.

The causes for this phenomenon that Garrett (2000) identifies are 1) the information technology revolution, 2) the increased opportunity costs of closure and 3) the ideological change over time. Garret’s (2000) first cause is that information technology determinism has shrunk time and space and that governments can no longer restrict or stop cross-border activity. The second cause is similar to the first, but takes a more moderate approach to a government’s position. This view states that governments could still separate their countries from external markets, but the costs of doing so have become sufficiently large to favour liberalisation, due to the potential efficiency gains. The final cause models the critical role of the government as existing within a shifting continuum of ideology and political construct, which is not independent nor specifically focussed on improving the economic condition of society as a whole (Garrett 2000). Within this ‘swinging pendulum’ of globalising

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10 international business, different scholars have also attempted to identify the antecedents as well as the consequences of this phenomenon in international strategy at a firm level. Traditionally, scholars argued MNEs as driving globalisation and advocating global strategies with homogenous products and services (Levitt 1983; Yip & Hult 2012) while simultaneously the argument holds that the increasingly integrated and demanding world combined with advanced technology drives MNEs to homogenise their products and services (Levitt 1983).

Contrary to these beliefs, regionalisation theory is defined by the need for a distinction between local and global contexts, as spearheaded by Prahalad and Doz (1987) and extended by Bartlett and Ghoshal (1989). These scholars demonstrate the call for a combination of global integration and local responsiveness in business strategy. Global integration is defined as worldwide production and distribution of homogenous goods and services in an attempt to create economies of scale and scope (Bartlett & Ghoshal 1989). Local responsiveness is defined as the ability of MNEs to comprehend local preferences in customer demand and to acknowledge national regulations and standards in order to exploit the national differences between locations (Bartlett & Ghoshal 1989). In the transnational strategy, these approaches are argued to be complementary rather than substitutes (Rugman & Verbeke 1992).

Ghemawat (2003) finds support in the fact that markets are neither completely isolated nor integrated across borders, and consequently require distinctive local business strategies. Although most measures for market integration such as capital and labour have been increasing in the past decades, the picture of total integration in terms of economic theory is far from absolute. This ‘semiglobalisation’ era, in which differences between countries cannot be ignored by MNEs, allows for attention to be paid to location-specific international business strategy compared to relatively more ‘mainstream’ global strategy (Ghemawat 2003).

At a firm level, Rugman and Verbeke (2004) identified globalisation in terms of sales distribution as a myth and raised issues of the regionalisation of MNEs across various industries and locations. This theory has been empirically tested by the recognition of the phenomenon by Rugman and Verbeke (2004). They found that there are only nine MNEs amongst the Fortune Global 500 that have substantial presence in all three regions of the triad (NAFTA, the expanded Europe and Asia). On the contrary, many of the world’s largest firms are regionally internationalised (Rugman & Verbeke 2004). This phenomenon has subsequently received attention by an increasing number of scholars and has been addressed in several special issues of the Management International Review (2005), European Management Journal (2009), International Marketing Review (2009) and the British Journal of Management (2014).

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Orientations and statistics

Rugman and Verbeke (2004) identified four typologies of regional/global orientation, including 1) global, 2) bi-regional, 3) host-region oriented and 4) home-region oriented. The classification in one of these categories is dependent on the specification of regions and criteria for the value of sales, assets and other relevant (industry-specific) measures. Sales values are however used as key indicators for measuring international geographical dispersion. Besides the home region, where the MNE’s home country is located, there are two regions in which they can be present.

Global MNEs are characterised by most evenly dispersed activities across the three regions of the triad. Bi-regional oriented are those MNEs that have the majority of their activities concentrated in only two of the regions. MNEs which have more than half of their activities in one region different from their home region are termed host-region oriented. Home-region oriented MNEs are characterised by having most of their activities around their home country. Most MNEs in Rugman and Verbeke’s (2004) research fall into this latter category. A statistical summary of their findings can be found in table 1.

Although the research has been debated by many scholars, because of the argued arbitrary nature of the cut-off points between typologies, insufficient attention to the home market size, limitations of the sample and the fact that regionalisation may in fact come from a ‘home-country effect’ (Osegowitsch & Sammartino 2008; Rugman & Verbeke 2008b) subsequent research continued to search for more evidence in different disciplines and across different sectors to identify industry/sector (Rugman & Verbeke 2008b) and issue specificity (Kolk 2010) of the regionalisation argument.

Home country effect

The notion and importance of the ‘home country effect’, referring to the predominance of the domestic market, rather than other countries in the home region, has received considerable attention from scholars in articles with commentaries (Dunning, Fujita & Yakova 2006; Osegowitsch, Sammartino 2008) and responses to these (Rugman & Verbeke 2007; Rugman & Verbeke 2008b). Although replications broadly support the findings of the initial study, alternatives and refinements to the study are proposed, in which explanations of regional concentrations of MNE activities reflect home country specifications, rather than distinctive strategies pursued (Dunning, Fujita & Yakova 2006).

In the majority of further research with additional data, different approaches, commentaries and responses to these, regionalisation also indicated high domestic sales and

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12 the predominance of a home country effect (Osegowitsch & Sammartino 2008; Oh 2009; Rugman & Verbeke 2008b; Dunning, Fujita & Yakova 2006). For most MNEs, in many instances, regionalisation also means a strong presence in the domestic markets, reflected in high percentages of domestic sales, contrasting relatively low percentages of sales in the rest of their home region, and in the rest of the world (Rugman & Verbeke 2008b). These shifts from firm-level to country-level concepts and from micro-level to macro-level analysis display calls for refinement in the interaction effects between multinational strategies and country-specific characteristics. Considering the important role of national governments in the emergence of national flag airline carriers and the fact that the aviation sector is (formerly) highly regulated, this research adds contributions to regionalisation theory by studying the importance of the home-market size.

Industry specificity

Another issue that plays an important role in regionalisation theory is industry specificity, regarding broader categories (manufacturing and services), but also specific industries. Within Rugman and Verbeke’s (2004) initial study, differences were identified between industries. In general, manufacturing firms of the Global 500 seem to expand more in foreign regions than service firms do. In general, service firms are more location-bound than manufacturing firms (Rugman 2005). The ‘location-bound’ sectors show the highest percentage of intra-regional sales across, transportations services comes third with 83.7 % in intra-regional sales. Only merchandisers (87.9 %) and telecommunications and utilities (83.7 %) display higher percentages of intra-regional sales. Airlines Air France and British Airways are two exceptions within this industry, although with 50.2 % and 64.8 % intra-regional sales respectively, these carriers are still defined as home-region oriented (Rugman 2005).

Subsequent studies were conducted in broader categories, such as manufacturing and services (Rugman & Verbeke 2008a), but also more industry-specific in particular sectors such as cosmetics (Oh & Rugman 2006), automotive (Rugman & Collinson 2004), food and beverage (Filippaios & Rama 2008; Gardner & McGowan Jr 2010), retail (Rugman & Girod 2003), accounting (Kolk & Margineantu 2009), financial services (Grosse 2005) and electric utilities (Kolk, Lindeque & van den Buuse 2013). These studies indicate that globalisation/regionalisation is very much dependent on the nature of the industry and the degree of existing integration. This research adds a contribution to this notion by focusing on one specific sector, passenger aviation, which is characterised by the location-bound nature of airports and landing slots.

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Orientation Global Bi-regional Host-region Home-region Insufficient data No data Total

Specification 20 % < sales < 50 % all three triad regions

20 % < sales < 50 % two of three triad

regions

> 50 % sales one region other than home region

> 50 % sales in home

region N.A. N.A. N.A.

General statistics

No.of MNEs 9 25 11 320 15 120 500

% of 500 1.8 5.0 2.2 64.0 3.0 24.0 100.00

% of 380 2.4 6.6 2.9 84.2 3.9 N.A. 100.00

% intra-regional sales 38.3 42.0 30.9 80.3 40.9 N.A. N.A. Industries

Manufacturing 9 24 3 131 13 N.A. 180

Aerospace & defense 0 2 0 8 1 11

Chemicals & pharmaceuticals 0 4 1 11 2 18

Computer & electronics 7 4 0 22 3 36

Construction & building 0 2 0 9 0 11

Energy & petroleum 0 1 0 27 3 31

Food, drug & tobacco 1 2 0 9 2 14

Motor vehicle & parts 0 4 2 23 0 29

National resources 0 1 0 15 1 17

Other manufacturing 1 4 0 7 1 13

Services 1 1 8 189 1 N.A. 200

Banks 0 0 1 39 0 41

Entertainment & publishing 0 0 1 8 0 9

Merchandisers 1 0 2 60 0 63

Other financial services 0 0 1 26 0 27

Telecommunication & utilities 0 0 0 27 0 27

Transportation services 0 0 0 13 0 13

Other services 0 1 3 16 1 21

Total manufacturing &

services 9 25 11 320 15 380

Notes: (1) Intra-regional sales were reported as >90% for companies that reported foreign sales as less than 10%. For calculation purposes, this number was estimated at its lowest point of 90%. Data are for 2001. Numbers might not add due to rounding

Table 1. Classification and industries Global 500, adapted from Rugman (2005)

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Explanations for regionalisation

Regionalisation of MNEs is explained in the International Business literature by means of two streams of research. From an institutional-based view the transaction cost economics approach provides an explanation for selectivity in internationalisation (Rugman & Verbeke 2005), since MNEs face the liability of foreignness (Zaheer 1995; North 1990). Regionalisation theory argues that expanding regionally, MNEs are confronted with lower levels of intra-regional liability of foreignness and thus lower transaction costs in comparison to inter-regional expansion (Rugman & Verbeke 2007).

From a resource-based view, which has become broadly embedded within the international business literature (Peng 2001), tangible and intangible resources and capabilities which are valuable, rare, inimitable and organisable are argued to be the key to competitive strategic advantage (Barney 1991). Regionalisation theory argues that exploitation of firm-specific advantages (FSAs) created by MNEs is more easily adapted intra-regionally relative to inter-regional adaptation (Verbeke 2013).

2.2 Institutional-based theory and global governance

According to North (1991, p. 97) institutions are “the humanly devised constraints that structure political, economic and social interaction”. They consist of both formal and informal constraints, of which the former are related to constitutions and laws and the latter relate to customs, traditions and codes of conduct. Amongst standard economic constraints, institutions set ‘the rules of the game’, which organisations must follow and hence define the strategic choice set of MNEs (North 1991).

In later work, North (2005) emphasises the interconnectedness between institutions and uncertainty. Interconnected global markets with informal institutions create uncertainty, which provides the rationale for more formal institutions to create economic structure and order. This results in a complex mix of informal and formal constraints and while uncertainty may be reduced, it is not eliminated. The constraints imposed “have, themselves, uncertain outcomes reflecting both our imperfect understanding of our environment and the equally imperfect nature of both the formal rules and the informal mechanisms we use to enforce those constraints” (North 2005, p. 2). In an increasingly interconnected world economy, uncertainties and the outcomes of institution’s policies become more complex and hazardous for MNEs, in what North (2005) called a ‘non-ergodic’ world of continuous change, in which it is rarely possible to predict the future based on past patterns.

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15 When MNEs internationalise, the transaction cost economics suggests selectivity, since firms face the liability of foreignness by both the informal and formal institutional constraints structuring the economic, political and social landscape (Zaheer 1995; North 1990). These location characteristics determine the attractiveness of entry for MNEs by the creation of country-specific advantages (CSAs) (Rugman 2005). Hazards of informal institutions faced by MNEs relate to normative and cognitive distance between the MNE’s home country and the host country (Ghemawat 2001) and formal hazards are related to (the quality of) the governance system and the regulative distance between the MNE’s home country and the host country (Dikova & van Witteloostuijn 2007). In this sense, both formal and informal institutions constrain the MNE’s strategic choices. The formal deficiencies generally represent hazards, which cannot be resolved easily by a MNE’s strategic choices, while informal differences represent hazards, which can be resolved at least partly by the MNE’s strategy (Cuypers & Martin 2009; Li & Rugman 2007).

Proposition 1a: When regional and global formal institutions in the aviation industry raise transaction costs and the liability of foreignness, they constrain multinational enterprises in their process of internationalisation

Proposition 1b: When regional and global formal institutions in the aviation industry lower transaction costs and the liability of foreignness, they enable multinational enterprises in their process of internationalisation

Rugman (2005) questions the need for global formal institutions like trade agreements and government policies, given the evidence that most MNEs operate regionally predominantly. Since globalisation is lacking, so is the multilateralism for governments. WTO policies are demanding global free trade, but economic and political power is regional in nature. According to Rugman (2005), regional integration with a limited amount of participants, that are both geographically as well as comparatively economically and institutionally close (e.g. EU, NAFTA, ASEAN) is easier to pursue than global integration. In consequence, firms should pay much more attention to the regional agreements and policies, instead of an irrelevant global strategy or multilateralism (Rugman 2005).

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2.3 Firm-specific advantages

According to Peng (2001) strategy research and international business research have been converging, by which “the resourced-based view has provided a powerful theoretical perspective within which a substantial body of international business research is embedded” (Peng 2001, p. 819). Spearheaded by Wernerfelt (1984) and Barney (1991), the emergence of the resource-based view (RBV) has been a key development in strategic management and subsequently in international business research. The underlying theory of the RBV approaches a firm not through its activities in the market, but as a unique bundle of tangible and intangible resources and capabilities (Wernerfelt 1984). In order to create a sustainable competitive advantage, the resources and capabilities within this bundle should be valuable, rare, inimitable and organisable (Barney 1991).

According to Verbeke (2013), MNEs create firm-specific advantages (FSAs) with their tangible and intangible resources and capabilities, which they then exploit outside their home country, consequently international sales arise. The created FSAs can be either stand-alone resources and routines or a recombination of activities, and can be separated in location-bound and non-location-location-bound FSAs (Verbeke 2013).

When expanding regionally, the non-location-bound firm-specific advantages can be more easily adapted to optimise their exploitation potential in a host location. Location-bound specific FSAs should be amplified to be deployed within an entire region (Rugman & Verbeke 2007). Inter-regionally, the location-specific investments would be more substantial if activities are established outside the home-region, in order to deploy the MNE’s non-bound and non-bound FSAs across borders and to develop or access location-bound FSAs in host-regions or require the creation of new recombinations of FSAs in order to offset the costs of increased levels of bounded rationality and complex internal networks (Rugman & Verbeke 2007).

Aligning these FSAs with the location-specific environment (in either the home or host country) allows the MNE to gain benefits from their strategy, but also to circumvent potential environmental constraints (Verbeke 2013). In line with the resource-based view this view proposes that a firm’s resources and its capability to recombine and adapt them to different and various foreign conditions drive its international strategy and thus attempts to enhance performance. The performance on circumvention of environmental constraints of firm-specific advantages is arguably dependent on the capability to adapt or transfer these intra-regionally and inter-regionally.

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17 Proposition 2a: The lower the degree of international transferability of a MNE’s firm-specific advantages, the larger the degree of liability of foreignness faced inter-regionally and thus the less likely it is for the MNE’s firm specific advantages to enable them to overcome the liability of foreignness

Proposition 2b: The higher the degree of international transferability of a MNE’s firm-specific advantages, the smaller the degree of liability of foreignness faced inter-regionally and thus the more likely it is for the MNE’s firm specific advantages to enable them to overcome the liability of foreignness

According to Peng (2001), international business research should develop beyond the resource-based view and integrate institutional theory to fully understand the dynamics of internationalisation. “Important institutional factors influencing product and factor markets (e.g., regulations) have been taken for granted by most researchers, and thus faded into the background” (Peng 2001, p. 821). While attempting an integrated explanation of regional MNEs, Rugman and Verbeke (2005) suggest that firms not only deploy their FSAs in geographic locations where exogenously determined CSAs are largest, but link the investments to combining the present CSAs with their existing FSAs through location-specific thinking. . Although this theory argues that as an outcome of the calculation of adaptation costs in a response to the locations of institutions, that when considering recombinations of existing and additional FSAs, MNEs usually expand in their home region first rather than other regions (Rugman & Verbeke 2005), empirical (longitudinal) evidence continues to be sought across sectors and outside the Global 500 list of MNEs to further clarify the understanding of this issue (Verbeke 2013).

2.4 Entry modes in international business

To internationalise, MNEs engage in foreign direct investment, as they are market-, resource-, efficiency- or strategic asset seeking (Dunning & Lundan 2008). Strategic decisions on how to enter a foreign market have been subject to research for many years. Decisions are theorised to be dependent on location (country) specific factors, industry specific factors, product specific factors and firm specific factors (Kumar & Subramanian 1997).

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18 Also, different entry modes offer different characteristics in terms of resource commitment, exposure to risk, control and ownership and profit potential for the multinational enterprise (Pan & Tse 2000). Kumar and Subramaniam (1997) argue that firms and managers facing these oftentimes subjective strategic decisions typically have to deal with multifaceted implicit aspects, such as characteristics of the decision makers’ ((bounded) rationality, ability, motivation and constraints of time and resources) and characteristics of the decision problem (unfamiliarity, ambiguity, complexity and instability).

Kumar and Subramaniam (1997) provide a hierarchical model of market entry modes, which has been refined by Pan and Tse (2000), in which modes of entry can be first distinguished between equity-based entry modes and non-equity-based entry modes. At a next level, equity modes are divided into equity joint ventures and wholly owned subsidiaries, while non-equity modes are separated into export and contractual agreements.

In terms of the aforementioned characteristics resource commitment, exposure to risk, control and ownership and potential returns, joint ventures provide moderate outcomes, while wholly owned subsidiaries provide high outcomes. Exports score low on risk and return, but moderate on control. Contractual agreements score low on all characteristics (Kumar & Subramanian 1997). Glaister and Buckley (1996) note that most international business literature is focused on three modes of entry into foreign markets in an organisation’s pursuit to internationalise: licensing, entering joint ventures or establishing a wholly owned subsidiary. As these entry modes all offer different opportunities and characteristics to internationalise, these are important strategic decisions for MNEs in their pursuit of a regional or global presence.

2.5 Strategic alliances as an entry mode

Although inter-firm cooperation as an entry mode is hardly new, the increasing frequency of cooperative partnerships or strategic alliances by firms over the past few decades, has led to a growing interest from scholars in the field (Glaister & Buckley 1996; Osborn & Hagedoorn 1997; Reus & Ritchie 2004). Alliances are generally defined as “inter-firm collaborations over a given economic space and time for the attainment of mutually defined goals” (Buckley 1992, p. 91). On one hand, the broad definition of alliances includes almost all kinds of inter-firm arrangements, arguably these should all be called strategic alliances. On the other hand, the narrower view suggests strategic alliances refer only to substantive ties between parent firms, featuring long-term interdependence, continued contributions and shared controls (Das & Teng 1998). Although there are many forms of alliance, all forms imply the “creation of

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19 interdependence between autonomous economic units, bringing new benefits to the partners in the form of intangible assets, and obligating them to make continuing contributions to their partnership” (Todeva & Knoke 2005, p. 125-126).

Strategic alliances can therefore be seen as formations of cooperative arrangements that aim to for achieve organisational goals through collaboration, rather than through competition (Todeva & Knoke 2005). Heightened worldwide competition, short product-life-cycles, the rise of new competitors and rapid technological change impact the MNEs and increase the need for alternative long-term competitive strategies (Todeva & Knoke 2005). According to Todeva and Knoke (2005), current markets revolutionise the nature of corporations, by driving them to search for these ways of gaining a competitive advantage, which should arguably be derived from MNEs’ capability to cooperate with other firms.

The alliances that arise can either be non-equity based (bilateral contract-based and unilateral contract-based alliances) or equity-based (joint ventures and minority equity alliances), for which aspects differ in degree of access to the relation’s network and the simultaneous protection of own resources, but also in terms of joined (political and economic) power to influence the competitive landscape and environment (Das & Teng 2000).

Within the stream of research on strategic alliances different perspectives are adopted. Research is concerned with the (strategic) motives to engage in the forming of alliances, which vary corresponding to the environmental characteristics as well as the firm-specific aspects (Todeva & Knoke 2005). According to Todeva and Knoke (2005), motives for inter-firm relationships vary across the dimensions of business environment factors, industrial factors, organisational factors and (globalised) commodity chains and the decisions take place at four levels: organisational, economic, strategic and political.

Theoretical perspectives for these motives are rooted in theories of economics, transaction cost, resource dependency, organisational learning and strategic positioning (Glaister & Buckley 1996). Other research in this field is concerned with the more specific selection criteria for alliance formation to succeed (Bleeke & Ernst 1991; Brouthers, Brouthers & Wilkinson 1995; Harvey & Lusch 1995; Nielsen 2003) and the performance outcomes of these formations (Nielsen 2007; Pansiri 2008).

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Institution-based view of alliances in the aviation sector

As discussed in the review of regionalisation literature, in this study the first explanation for the process of MNE’s internationalisation is provided by the institutional based view, based on transaction cost theory and the liability of foreignness. The level of liability of foreignness that firms face when internationalising determines the attractiveness of certain entry modes. The institutions encountered lead to formal requirements or arrangements, which can either create opportunities, and enable firms to internationalise, or those that impose imperfect outcomes and constrain MNEs in their strategic choices.

Within the process of internationalisation of MNEs, strategic alliance formation is shaped by regulatory and institutional arrangements in the countries where business is done (Todeva & Knoke 2005). The business environment of MNEs is comprised of “legal requirements, macro-economic policies, price controls, financial capital markets, distribution channels, and methods of contract enforcement” (Todeva & Knoke 2005, p. 130) that can either create opportunities or constrain the firm’s choices to inter-firm arrangements. In that case, alliance formation is based on national advantages, including the economy, legal structure and the cultural dimensions of potential partners and allows for conformity to local, regional or international policies (Harvey & Lusch 1995; Glaister & Buckley 1996).

Proposition 3: To overcome transaction costs and the liability of foreignness created by regional and global institutions in the aviation industry, multinational enterprises form strategic alliances

Although empirical evidence exists in this field, most of the research is focused on explanations of alliance formation at a macro-economic level and the creation of general market opportunities, rather than at a meso-level and the circumvention of industry-specific constraints (Todeva & Knoke 2005). Industrial context impacts the formation of alliances along a variety of dimensions, depending on factors such as the intensity of competition, barriers of entry to the market, knowledge intensity and the need for technological innovation (Todeva & Knoke 2005). According to Osborn and Hagedoorn (1997), analyses of domestic and international alliance formation apply concepts of a transaction cost economics perspective, but they also discuss the multiple interpretations of the concepts. They suggest that more future research could focus first on sectorial and national differences, should involve more multilevel analyses (national, industry, firm and alliance level and should incorporate more non-transaction cost arguments for alliance formation (Osborn &

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21 Hagedoorn 1997). This study takes these suggestions into account by concentrating on one sector in different regions and by synthesising regional and formal institutions within the resource-based view of alliance formation.

Firm-specific advantages and alliances in the aviation sector

As discussed in the review of regionalisation literature, an explanation for the process of MNE’s internationalisation is also provided by the resource-based view. MNEs create firm-specific advantages (FSAs) with their tangible and intangible resources. These are subsequently deployed and exploited outside the home country in their process to internationalise. Depending on whether the firm-specific advantages are location-bound, decisions are made to augment location-bound advantages to be deployed within an entire region, or to invest substantially in establishment of location-specific advantages outside the home-region in order to develop or access location-bound FSAs in host-regions.

The resource-based view proposes that one of the central motives for MNEs in developing cooperative arrangements is that they provide opportunities to tap into the network’s competencies, resources and skills in order to create a competitive advantage (Ireland, Hitt & Vaidyanath 2002). More specifically, alliances create opportunities to gain access to technology, have the potential to acquire means of distribution, increase learning and internalisation of skills and competencies, and advance the development of products or services (Todeva & Knoke 2005). Since it is, in general, expensive, difficult and time-consuming to build a global brand and an international presence, from a market-seeking perspective, alliances facilitate international expansion to foreign markets and access to these markets relatively easily in a short timespan (Glaister & Buckley 1996).

The alliance-specific advantages are thus an extension of the FSAs held by the individual MNEs and can both have a circumventive function as well as a beneficial function to the individual MNE. In the former view, the alliance provided the MNE with opportunities to overcome liability of foreignness faced in international expansion, whereas in the latter view, it provides the MNE with opportunities to access beneficial advantages they would not have had individually.

Proposition 4: Multinational enterprises create alliance-specific advantages through the formation of inter-firm relationships in the aviation industry to overcome the liability of foreignness faced in their market-seeking activities (barriers of entry), which the MNE’s firm specific advantages are unable to circumvent.

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22 Proposition 5: Multinational enterprises create alliance-specific advantages through the formation of inter-firm relationships in the aviation industry by recombining firm-specific and country-specific advantages inter-regionally, to which they would otherwise not have had access.

While seemingly globalised, the airline industry is a sector, that is underexplored within the regionalisation/globalisation debate. Airlines are typically involved in international business due to the intrinsic global nature of their services, but expectations are that major airlines are typically home-region oriented. It is expected that these orientations are mainly due to the changes in regional and global governance policies within the industry, as these institutions shape the international business environment for the industry. Since institutions either enable or constrain MNEs in their pursuit for international success, interconnectedness is expected between these policies and the business strategies practised. Subsequently, the pursued strategies are proposed to affect the resources and capabilities of the MNEs and the degree to which an MNE achieves regional/global presence in the exploitation thereof. The interconnectedness between the degree of internationalisation, global and regional regulatory environment and the resources created by airlines’ international strategies is the object of interest in this research.

3. Methodology

This chapter describes the methodology used in this study. First the research philosophy will be discussed, then the multiple case study research design is discussed. Next, context for the research will be provided by an overview of the regional and global formal institutional arrangements present in the aviation industry and by the presentation of the selected cases. Subsequently, the means of data collection and analysis will be discussed.

3.1 Research philosophy

In conducting scientific research, there are many approaches available to the researcher on which methodology to apply. The methodology is dependent on the nature of the research question and the nature of the phenomenon studied, but also on the assumptions made by the researcher (Myers 2013). The research philosophy adopted by the researcher involves assumptions on how the world is viewed, what constitutes knowledge of reality and how the phenomenon under investigation is perceived (Saunders et al. 2011).

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23 This research takes a post-positivist approach, i.e. that there is an objective reality, which is observable by the researcher, who is himself capable of being objective (Saunders et al. 2011). With this approach, the researcher seeks for generalisation of the results to existing theory to understand the phenomenon studied (Yin 2003; Eisenhardt 1989). For the nature of this study, the literature review has drawn on existing theoretical concepts from which propositions have been developed that will be linked to the qualitative results, reflecting the post-positivist philosophy (Eisenhardt 1989). Consequently, only the most basic precautions will be taken to prevents the various biases that a subjective observer could bring to the results (Saunders et al. 2011).

3.2 Multiple case study research design

This study will be completed by means of a qualitative multiple-case study, with a similar design to that adopted by Rugman and Collinson (2004) and Kolk, Lindeque & van den Buuse (2013). A multiple-case study is most often set up to derive an in-depth understanding of the cases selected, within their real-world context, in which the boundaries between the phenomenon studied and the context are unclear (Yin 2003). Therefore, case studies can add perspectives to existing quantitative data by gaining insights in underlying relationships and understanding the broad range of contextual and other complex conditions (Yin 2003). Case studies can also propose new theory, which in turn can be tested quantitatively. Contrary to quantitative study methods, this study design goes beyond isolated variables in a quest for new twists and turns (Yin 2003). According to Myers (2013) one of the largest disadvantages of quantitative research is that a lot of explanation and context is lost. The current case study allows the in-depth nested research of a collection of firms representing the major airlines in the global market for passenger aviation, with the objective to draw conclusions with respect to the drivers of their regional/global international strategies and the role of governance policies in their internationalisation processes.

Yin (2003) proposes conditions, which create relevant opportunities to apply a case study method. First of all, the nature of the research question is important. Research papers that address an explanatory question to an underexplored phenomenon are particularly suitable for case study designs, since the rich data from the research is more likely to provide insightful explanations than alternative research methods. The cases in this study are expected to provide deeper and richer insights into the airlines’ strategies and the process of regionalisation/globalisation.

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24 Secondly, when it is important to study the phenomenon in its real-world context, a case study is favoured so as to collect the data in a natural setting, rather than relying on derivations of data (Yin 2003).

There is, however, also a large disadvantage associated with conducting case studies. Firstly, the results of qualitative case studies are often difficult to expand to larger populations and different locations, because the sample sizes applied are too small to allow for statistical generalisation (Myers 2013), but theoretical generalisation is adopted as a means of evaluating the findings of the research (Payne & Williams 2005). The external validity can further be improved by the application of a multiple-study design, as in this research. Eisenhardt (1989) states that each additional case within a multiple-case study increases the generalisability of the findings. As opposed to holistic cases, the current study also pays attention to embedded units of analysis – a technique which involves clustering of cases, increasing opportunities for comprehensive analyses, strengthening the results of the individual cases (Yin 2003).

3.3 Global airline industry

This section provides an overview of the contextual setting of both regional and global formal institutions in the aviation industry. The aviation industry is dominated by sets of complex regulations and organisations, which are not all relevant to this study. Therefore, the context set in this section may not be exhaustive, but will briefly address the important institutions in the industry to which will be referred in this research. Since the case selection involves only airlines from the EU and the US, their regional institutions and organisations will be discussed, but institutions and organisations in other regions will not.

The institutional context of the aviation sector

Within the aviation industry, airlines are confronted with a large amount of governance policies on both a regional and a global level. These governance policies are currently heavily debated in regional and global politics, with opposing views on aviation liberalisation and competition issues (Wittmer 2011; Héritier & Karagiannis 2011). In light of the regional and global presence of MNEs in this industry, it is useful to examine the patterns of development of formal governance in aviation. The distinction between global and regional governance is important, as it can explain the potential differences in regionalisation for different moments in time.

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25 Global formal institutions in the aviation industry

The Chicago Convention (CHI), signed in 1944, embodies the central agreement of international civil aviation. This convention enabled the market to develop after World War II, while negotiating several competition guidelines to safely coordinate and regulate international air travel (Wittmer 2011). Although the nine ‘freedoms of air’ introduced under CHI have changed significantly since the agreement was signed, the main articles and annexes remain, creating relatively protected domestic markets and isolated regions across the global aviation industry.

Recent inter-regional developments involve bilateral ‘Open Skies’ agreements between for instance the US and the EU signed in 2007. These agreements include freer market competition, cooperation in activities and allow airlines to fly between two points between the countries that are involved in the agreement.

Regional formal institutions in the aviation industry

On a regional level in Europe, the aviation industry is regulated by the European Community, whose predecessor the ECC was founded in 1957 (Wittmer 2011). A proposal was made in the 1970s to liberalise the market and increase competition. The European Court of Justice decided in favour of the institutions proposing and the proposal was adopted. While individual states, airlines and other stakeholders have been trying to slow down the process of liberalisation in Europe, the EC has been deregulating the market slowly, but surely. Foreign investors are now allowed to acquire up to 49 per cent of a European airline.

In the US, the Department of Transportation (DoT) fulfils the role of regulator for the US aviation market, overseeing the Federal Aviation Administration. Together with the Department of Justice, the US authorities are liberalising the intra-regional aviation industry under scrutiny, which is known to be fragmented. At the same time the governmental stance towards international integration is negative. Through arguments based in sovereignty and protectionism, the US only allows foreign investors to invest only up to 25 per cent in US airlines.

Case selection

Building on previously conducted multiple-case studies on regionalisation/globalisation in industry-specific sectors, such as retail (Rugman & Girod 2003), automotive (Rugman & Collinson 2004) and European electric utilities (Kolk, Lindeque & Van Den Buuse 2013), cases were selected from the Fortune Global 500, which lists the 500 largest MNEs globally

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26 in terms of revenue. The following firms have been identified: Lufthansa Group (Germany), United Continental Holdings (USA), International Airlines Group (UK), Delta Airlines Group (USA) and KLM-Air France (France). This section will allow an in-depth study of the dynamics between formal institutions in the aviation industry and the strategies to internationalise that are pursued.

Since the selection is based on prior research and on their suitability to “illuminate extending relationships and logic among constructs” (Eisenhardt & Graebner 2007, p. 27), cases are sampled for theoretical reasons like replication of findings and extended explanation of existing regionalisation theory (Eisenhardt & Graebner 2007). In terms of regions covered, the theoretical sample represents North America and Europe, as these are the regions where the largest airlines are based. Although a representation of all regions in the embedded cases would improve the generalisability, theoretical sample and multiple cluster selection of the three largest alliances Star Alliance, Oneworld and SkyTeam provide a grounded, accurate and robust clarification of whether findings are idiosyncratic to a single case or consistent across cases (Eisenhardt & Graebner 2007). By theoretical sampling, similarity across cases is even expected to build theory for future research (Eisenhardt 1989).

Aside from building on the existing theory in this field, the selected cases also display the advantage of being publicly listed firms and consequently reporting on their performances (by region) is readily available through online annual publications, which is essential to this research. Table 2 provides an overview of the selected cases, the alliance units in which these are embedded, and their indicators of importance to this theoretical sample.

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27 Notes: (1) Regional orientation are provided here for an overview. The quantitative background of these analyses is discussed in chapter four, with the results.

Data are for 2012 (Fortune Global 500 2012)

Table 2: Case selection

Alliance Embedded case GLOBAL

500 2012 Sales 2012 (m) Home country Home region Orientation

Star alliance Lufthansa Group

248 € 30,135 Germany Europe Home region

United Continental Holdings

283 $ 37,110 United States North America N.A.

One World

International Airlines Group (British Airways & Iberia)

494 € 18,117 United Kingdom Europe Home region

AMR Corporation (American Airlines & US Airways

463 $ 24,825 United States North America Home region

Sky Team Delta Airlines

308 $ 36,670 United States North America Home region

Air France-KLM

324 € 25,649 France /

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3.4 Data collection

The data was collected through two processes. The first data collection contains quantitative data reflecting the regional presence in 2012 of the Fortune Global 500 list. These 500 companies were assessed by means of a group study by students of the University of Amsterdam for their regional presence, in order to replicate Rugman and Verbeke’s (2004) research. Data was collected through systematic reading of the annual publications (annual reports, financial reviews and corporate responsibility reports) and manual recording of their quantitative data on their core geographical markets in terms of revenues, non-current assets and employees. Reports were recorded in a shared database. Subsequently, longitudinal data of the selected cases was collected individually on the six passenger airlines from the annual reports for the years 2008 to 2012. This collection again included data on revenues, non-current assets, employees and reported presence in different regions within the extended triad.

While these are all accepted measures to assess regional presence (Rugman & Verbeke 2008a), in view of limitations in the suitability of the data for the aviation sector and the insufficiency of data on regional measures, revenue per region was selected to be the key indicator for determining the regional orientation. Non-current assets and employees were found unsuitable for the aviation sector, due to the nature of the assets (mostly airplanes) and interpretation of ground staff in relation to actual presence. Although desired industry-specific measures such as landing slots, routes, number of planes could have increased the validity, these have not been found to be reported per region. During the collection of this data, one of the selected cases (United Continental Holdings) was discarded, due to the unavailability of quantitative data on their presence in geographical markets. Since this study focuses on explanations of regional orientations, this information is regarded as essential to the research.

The second data collection comprised secondary reports on the strategies and governance policies of the remaining five passenger airlines. To obtain further insights in the underlying strategies the regional presence data is supplemented with secondary sources, i.e. news articles published in the Financial Times between 2008 and 2012 were collected from the LexisNexis Academic database. Search terms include the focal companies’ names, ‘Lufthansa’, ‘British Airways’, ‘Iberia’, ‘International Airlines Group’, ‘American Airlines’, ‘Delta Airlines’ and ‘Air France-KLM’. This resulted in a very broad range of news articles, which were in turn systematically reviewed to identify strategic decisions and events for the selected firms. An overview of the data set is provided in table 3.

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Table 3: Data set

3.5 Data analysis

This section elaborates on the analyses applied to the retrieved quantitative and qualitative data for this research. Quantitative data was used to indicate the degree to which the selected airlines are internationalised in terms of their revenues, while qualitative data searched for the explanations for the found orientations of the airlines.

Quantitative data

Quantitative data was analysed by means of Microsoft Excel. Based on the entered figures derived from the data collection, the Fortune GLOBAL 500 firms were given a regional orientation in the same manner as in Rugman and Verbeke’s (2004) research (global orientation, bi-regional orientation, host-region orientation, home-region orientation), based on their specification of regional sales, as presented in table 4. Developed from Ohmae’s (1985) initial triad concept and Rugman and Verbeke’s (2004) extension, the study group specified five regions (North America, Europe, Asia-Pacific, Latin America and the Middle East and Africa). For the longitudinal analysis, data for the selected cases was analysed following the same procedure applied in the group research.

Alliance Embedded case Search term Articles Financial Times

Selected for coding

Star alliance Lufthansa Group

Lufthansa 864 80

One World _{International Airlines Group} (British Airways & Iberia)

British Airways Iberia International Airlines Group 801 511 265 119 AMR (American Airlines &

US Airways

American Airlines 790 82

Sky Team Delta Airlines

Delta Airlines 448 86

Air France-KLM

How governance policies in the passenger airline industry shape the major airlines’ international strategies.