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Impact of size and scale effects on internationalization:

the effects in the transition between the export marketing phase and international marketing phase

The case of transavia.com

University of Groningen

Faculty of Economics and Business Master Thesis

2008

Bruno van der Linden

Van Oldenbarneveldtplein 9-I 1052 JK Amsterdam

+31 6 25038200 brunovdlinden@home.nl student number 1272950

Supervisor: Rob D. Menko Msc MBA

Adjunct Faculty

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Preface

The thesis you have before you is the final chapter of my Business Administration Master studies, specialization Marketing, at the University of Groningen. After 6 months of internship at transavia.com in Paris and 6 more months at transavia.com in Amsterdam, I have been able to see in practice what I have learned all those valuable years in Groningen.

I proudly present this work, but I realize that this would not have been possible without the help of certain people, whose support has meant a lot to me.

I would like to thank my parents who have supported me during all those years in Groningen and in France. They have always encouraged me to look beyond the usual path of possibilities and see what else is out there. This has inspired me in many ways.

In France, I would like to thank Vice President Hélène Abraham for providing me with the opportunity to do my internship at transavia.com in Paris. As a student, I was extremely lucky to be able to work so closely with a person with such experience and knowledge. She has given me the opportunity to see what challenges an airline has to face in its start-up period.

In the Netherlands, I am very grateful for the possibility Niki van Wijk, head of E-commerce, gave me to do my internship at transavia.com part-time, which left me enough time to do research and write my thesis. Also, I would like to thank all the employees who helped me gather data during this period and whose knowledge proved to be very valuable. Especially the respondents to the expert interviews, as they have given up a great deal of their time for me.

And last, but certainly not least, I am very grateful for the pleasant and fruitful collaboration I had with my thesis supervisor, Rob Menko. His critical notes and expert knowledge on this topic proved to be very helpful in the process of writing this thesis. Also, I would like to thank Erjen van Nierop, my second thesis supervisor in Groningen.

I look back on my time as a university student with a lot of joy and satisfaction. I am grateful for the chances it has given me and I look foreward to the time ahead of me with great confidence.

Bruno van der Linden

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Summary

This research investigates the influence of size and scale effects on internationalization, specifically during the transition between the export marketing and phase and the international marketing phase. Using a theoretical framework, two hypotheses were tested by using a case study. The effect of size on the barriers to entry includes three variables.

First, due to large size, resources could be dedicated to foreign marketing know-how by standaridizing both marketing practices and marketing planning, reducing the effect of the barrier to entry concerning advertising expenses the firm has to make to inform potential passengers about its flights on the new routes. Also, creating brand awareness played on important role on the barriers to entry during the transition.

The availability of financial resources due to larger size of the firm, proved to be very efficient to overcome one specific barrier to entry; the need for financial capital during the transition.

Research and development is the last variable that is embedded in the size effects, but not enough support is found to validate the hypothesis that R&D influences the barriers to entry during this transition in a sustainable manner.

The case discusses two relevant dimensions of scale, one had a mere positive effect on the growth of the production; the product level dimension. Standardization of production factors and distribution channels lead to an increase in production as well as a lower production costs. The increase in planned production capacity positively influenced the growth of the production by improving the utilisation of the production factors. Finally, indirect scale effects positively influence the growth of the production as the effect of labour costs decrease when the firm increases its capital intensity during the transition.

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Table of Content 1. Introduction ...5 1.1 Thesis composition...5 1.2 Motive ...6 1.3 Purpose ...6 1.4 Problem statement...7 1.5 Research question...7 1.6 Sub questions...7

1.7 Case description: transavia.com ...8

2. Theoretical framework...12

2.1.1 Phases of Internationalization...12

2.1.2 Process model of internationalization...13

2.1.3 Choice of variables ...14

2.2 Size effects ...15

2.2.1 On the topic of know-how ...16

2.2.2 On the topic of finance...17

2.2.3 On the topic of research and development ...18

2.2.4 On the topic of barriers to entry...19

2.3 Scale effects...22

2.3.1 On the topic of dimensions of scale ...22

2.3.2 On the topic of planned production capacity ...23

2.3.3 On the topic of growth of production ...24

2.4 Conceptual model ...25

2.4.1 Hypotheses ...26

3. Research design ...27

3.1 Research Method ...27

3.2 Data collecting method and research methodology...28

3.3 Size ...29

3.3.1 Know-how...30

3.3.2 Finance...30

3.3.3 Research and development ...30

3.3.4 Barriers to entry ...31 3.4 Dimensions of scale ...31 3.4.1 Production capacity ...31 3.4.2 Growth of production...32 4. Results ...33 4.1 Firm size...33 4.1.1 Barriers to entry ...35 4.1.2 Know how ...36 4.1.3 Finance...39

4.1.4 Research & Development ...40

4.2 Scale...42

4.2.1 Planned production capacity ...45

4.2.2 Growth of production...46

5 Conclusion and discussion...48

5.1 Discussion...51

5.2 Implications for research ...52

5.3 Implications for Managers ...53

5.4 Direction for further research ...53

6. Bibliography...55

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1. Introduction

One topic that has continued to interest both academics and managers alike is the process of internationalization of a firm. This is the process a firm goes through from operating solely in the domestic marketplace, expanding internationally via exporting and then entering the new markets through the setup of a subsidiary firm in the foreign market. According to the literature on this topic and traditional internationalization models, a firm expands internationally by adjusting its core strategies in order to enlarge its chances of success in the foreign market. The growing level of international trade has fostered a significant need for research on internationalization of the marketing field. However, while current models of internationalization provide a foundation for understanding, there is a lack of research towards the impact of internal variables of the firm during the specific phase of internationalization.

The transition between the export marketing and international marketing phase will be discussed in more depth in this thesis using a case of a firm, which has recently entered a foreign market. The effect of firm size on barriers to entry and the

scale effects on the growth of production will be examined in detail. The effect of firm

size on barriers to entry is considered by looking at three elements: know-how, R&D and finance. Scale effects are examined by looking at the dimensions of scale and the effect of the planned production capacity on the growth of the production.

1.1 Thesis composition

The study will have a linear-analytical structure. According to Yin (2003), this is the most common structure when the research will be presented in the form of an article. This means that the thesis starts with the research question followed by the relevant literature. The research methodology is discussed and the results of the research are presented, ending with a conclusion and a discussion of the results.

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The theoretical framework contains the conceptual model. This model graphically displays the relationships between the dependent and the independent variables and is the guideline to evaluate the theory with the empirical data.

The research design considers the data collection method and the research methodology.

The results chapter provides information about the results of the examination of the data, analyzed using the methods described in the research design.

In the conclusions and discussion, the research question is answered based on the findings. The discussion concerns the subjective interpretation of the conclusions. The implications for research and for managers of the study are mentioned and directions for further research are suggested.

1.2 Motive

The motive to this research is to implement multiple skills and methods acquired during the Master of Business Administration at the University of Groningen to conduct a scientific research on the topic of size and scale effects during internationalization. As regards the motive and relevance of this research, a distinction can be made between the theoretical-scientifical and practical aspects.

From a theoretical-scientifical point of view, this research is relevant because not enough is said in the research literature about the specific influences on the firm in the transition between the export- and international marketing phase.

From a practical point of view, this research is relevant because of the dynamic aspects of the research topic. Due to the rapidly changing environment, firms have to deal with in the international market, the previous research about the aspects of this specific phase are rapidly become outdated. By testing the hypothesis with empirical data, this study reflects the circumstances in the actual environment. The results of this study can serve as guidelines for a firm who is considering developing its market internationally.

1.3 Purpose

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especially in the transition between export marketing and international marketing. The business case of transavia.com, an airline who is currently developing its market outside of The Netherlands, will be used to refine the theory with empirical data. Given the complex environment and the pressure from increasing competition, it is relevant for an airline to make optimal use of marketing advantages in this transition.

1.4 Problem statement

The problem addressed in this research finds its roots in the fact that a firm often needs to internationalize to cope with the growing competition. The difference between a firm in the export marketing phase and a firm that finds herself in the international marketing phase is substantial. For instance, the focus of the firm shifts from the domestic market alone to the foreign countries as well. The step towards this international marketing phase leaves the company confronted with many uncertainties. It must therefore develop a marketing program that is capable of successfully coping with these uncertainties in the transition. Until now, much research has focussed on the different phases of internationalization, but not enough on the transition from one phase to another. Hypothetically, any transition from one phase of internationalization to another can be a source for further research. This would be well beyond the scope of this particular research. This thesis will focus on the transition between the export- and international marketing phase, for two reasons: first, due to time constraints it is preferable to choose one phase to examine. Second, the case selected for this research is a case, which presents elements in this particular transition between export- and international marketing.

1.5 Research question

“What is the influence of size and scale effects on the internalization process of the firm in the transition between the export- and international marketing phase?”

1.6 Sub questions

The main research question stated above, leads to sub questions dealing with the influence of the different variables on internationalization.

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Size:

1. What is the influence of know-how on barriers to entry? 2. What is the influence of finance on barriers to entry? 3. What is the influence of R&D on barriers to entry?

Scale:

4. What is the influence of the planned production capacity on the growth of the production?

5. What is the influence of the dimensions of scale on the growth of the production?

1.7 Case description: transavia.com

Under the brand name “transavia.com”, Transavia Airlines provides competitively priced air travel along with an up-to-date and innovative range of travel-related products and services. These flights are offered from the Dutch airports Amsterdam Airport Schiphol, Rotterdam Airport and Eindhoven Airport, as well as from other Dutch regional airports. transavia.com is a 100 % daughter of the Air France – KLM group.

In the Business-to-Business (B2B) market these activities are undertaken in the form of charter flights for tour operators, whereas the accent in the Business-to-Consumer (B2C) market is on scheduled flights for individual passengers. Customers may also book seats directly for a large number of charter flights, so that these customers have a year-long choice of around 90 destinations. Furthermore, transavia.com operates ad hoc flights and leases aircraft capacity to other airlines, either with or without crew and technical support.

Strategy

The strategy at transavia.com is aimed at positioning the company as a “web-based” flight brand, and at close collaboration with business partners in the expansion of its package of products. transavia.com would like to distinguish itself in the marketplace by basing its activities on “low cost, low fare with individual service”.

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The company remains alert to any opportunities for developing its activities in other European markets, in addition to the Netherlands and France.

transavia.com is a company that finds itself in a very turbulent environment. This environment is rapidly changing and under influence of strong price competition where costs like fuel prices are rapidly rising.

transavia.com had been coping with this turbulent en highly competitive environment with a unique and successful hybrid business model. This hybrid model means that transavia.com combines both charter flights and scheduled flights on a low-cost base within the same company. Flights are therefore most of the time a mix of ‘regular’ passengers and charter passengers.

Business to Business

transavia.com carries out charter flights principally for Dutch tour operators. These flights depart mostly from Amsterdam Airport Schiphol and Rotterdam Airport. Charter flights also depart from the regional airports at Maastricht Aachen, Groningen Eelde and Eindhoven. transavia.com’s market share in this market was 62% in 2007 (2006: 57%) (Annual Report 2007/2008). Modern IT tools like ‘transpartner’ in the distribution channel to B2B implemented by transavia.com have increased the efficiency between transavia.com and the tour operator. This tool allows the tour operator to access directly transavia.com’s stock of available seats.

Business to Consumer

In the B2C market, transavia.com offers seats on scheduled services and ‘seat only’ seats for a large number of charter destinations. There were 21 scheduled destinations in the summer of 2007 and 25 in the winter.

A total of 2.4 million passengers were carried on these scheduled services in 2007/2008, 2.3% more than in the previous year (Annual Report 2007/2008).

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transavia.com in France

transavia.com in France has been active in the French market for low-cost scheduled services and charters, using the transavia.com brand name and accompanying business model, since May 2007. The start-up of the French transavia.com forms the basis for this case study as the position of transavia.com in France fits the criteria of the phases of internationalization described in following chapter in certain aspects: transavia.com in France finds itself between the phase of export marketing and the next phase, that of international marketing. Therefore, using transavia.com in France as the case for this research, provides accurate and firsthand research information about internationalization and, in particular, the transition between the two phases.

The aim of the Air France - KLM group is to make best use of the benefits of synergy within the Air France - KLM Group. The way in which transavia.com in France is set up and its image are identical to transavia.com in the Netherlands. The substantive and operational expertise, specific to the operation of a low-cost schedule and charter airline, are being supplied by transavia.com from the Netherlands. The existing transavia.com website has been extended with information concerning transavia.com in France and functionalities for the French market.

transavia.com in France has its own management team and has eight of its own aircraft (all Boeing 737-800s), including crews. (28 aircrafts for transavia.com in the Netherlands) During the reporting year 2007 - 2008, transavia.com in France carried 545,000 passengers (5,4 million for transavia.com in the Netherlands).

The expansion of transavia.com in France is an extra incentive for the company to stay alert to any opportunities for further expansion of the activities under the transavia.com brand name elsewhere in Europe, based on the same successful standards and operating methods.

The strategic orientation concerning transavia.com in France has three main considerations.

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Second, it is of strategic interest to the Air France – KLM group to block access to the Paris airports. This leaves less routes available for other carriers which can become direct competitors for transavia.com.

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2. Theoretical framework

The theoretical framework will start with broader theories, which form the basis for the research in this thesis.

First, because this research focuses on the transition between export marketing and international marketing, the phases of globalisation and their characteristics are explained in more detail.

Next, the basic process model of internationalization is discussed and the choice of the research variables “size and scale effects” is explained.

After these theories are discussed, the hypotheses will provide input for the conceptual model.

2.1.1 Phases of Internationalization

The following section will elaborate on the phases of internationalization. To be complete, all the phases are described though not all are needed for this research.

Phase 1 : Domestic Marketing : The company manufactures its products and services and sells those within the country itself. There is no international phenomenon at all in this situation.

Phase 2 : Export Marketing : The company starts exporting products and services to another country as well. This is the very basic stage of global marketing. The approach of the marketer in this stage is said to be ‘ethnocentric’ because although he is selling goods and services to foreign countries, product development is totally based upon the taste of local customer. So, focus is still on domestic market

Phase 3 : International Marketing : Now, the company starts selling products and services to various countries and the approach is ‘polycentric’ i.e. the company is differentiating its products and services for different countries.

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producing different goods and services for different countries, the company tries to identify different regions for which it can deliver the same product. Similar products and services for countries lying in one region but different from products offered in countries of another region. This approach is called the ‘regiocentric approach’.

Phase 5 : Global Marketing : This is the final stage of evolution. In this phase the company really operates in a large number of countries and, for the purpose of achieving cost efficiencies, it analyses the requirements and needs of customers of all these countries and develops a single product or service, which can satisfy the needs of all. This approach is called the ‘geocentric approach’.

Marketing in the international phase tends to be seen as synonymous with a standard strategy across international markets (Global Marketing), but they differ. Marketing in the international phase is fully tailored for each country and is being developed locally, whereas marketing in the global phase can be considered as a coherent overarching strategy for the parts of the world in which an organization operates with an international marketing of standard offerings. (Levitt, 1983)

2.1.2 Process model of internationalization

Firms have to deal with the enormous increase in globalization of markets and competition. That fact requires each company to decide whether it must become a worldwide competitor to survive (Yip, 1988). Firms in the internationalization process attempt to expand their sales into foreign markets as foreign markets provide new and potentially more profitable markets (Hollensen, 2004). The literature has often described the internationalisation process as a gradual development process. A good example is the Uppsala model by Johanson and Vahlne (1977).

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Many studies have focussed on the internationalisation process using the Uppsala framework (Bilkey and Tesar, 1977; Cavusgil 1980; Johanson and Vahlne, 1990; Aaby and Slater, 1989) and arguing that this model has “general acceptance in the literature” (Andersen, 1993).

2.1.3 Choice of variables

In this study, the view of Johanson and Vahlne is adopted. In the transition, lack of market knowledge and market resources are still constraining factors (Johanson and Vahlne, 1977). In this specific phase, the firm does not have activities in several countries (yet). The firm will have to deal with allocating market resources to international activities based more on the unknown than on real market conditions. At the same time, the firm is pursuing growth in the newly entered market. This study investigates on the issues mentioned above, but does it from a broader view. Two closely related variables are the focus of this research: size and scale effects.

The choice for these two specific variables is based on the following:

First, both the effects of size and scale on the internationalization process have changed. Although much research (for example Aaby and Slater, 1989, Johanson and Vahlne, 1990, Cavusgil 1980) is done about the different phases of globalisation, not enough is said about the effects of size and scale for a firm that is still in-between these phases. Traditionally, smaller sized firms encounter greater difficulties during their internationalization process (Barney, 1996). Scale effects can be important for a firm who is capable of combining these scale effects when internationalizing to enhance production growth (Shen, 1965). Combining could for example mean a firm increases its production to the demands and characteristics of the local market and leaves the decision-making either dispersed or centralized in the firm. Other variables may also play a role during the transition, although not so much mutually related as

size and scale are according to previous research (see for example Bain, 1954, 1956

and Gold, 1981)

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the local French market. During this transition, the impact of size on the internationalization process differs from before the transition (Calof, 1993). As we will see in this thesis, size influences the entry to international markets. Furthermore, by starting the operation in France, the scale on which the firm operates is rapidly changing. Again, the scale effects during this transition are changing more rapidly (Shen, 1965). Therefore, the variables size and scale are of interest to this research during the transition.

Second, both variables are internal variables. This has the advantage that this research can focus on the effects of these internal variables of the firm and leave external variables out of the scope. Because the influence of external variables on the results cannot be ruled out completely, this thesis qualifies the relation between the variables as ‘all other things being equal’ i.e. ceteris paribus.

Now that both the process model of internationalization and the phases of internationalization are explained in more detail, the next step is to discuss the influence of the independent variables size and scale effects on the dependent variables barriers to entry and production growth in the transition between export-and international marketing. This is done in the next section export-and will end with a graphical representation of the conceptual model.

2.2 Size effects

The size of the firm has a strong influence on the decision to internationalize. The horizons of a smaller firm versus that of a larger firm are much more limited. Traditionally, most research has started with the premise that small and medium sized companies suffer from size disadvantages that prevent or limit their ability to compete internationally (Calof, 1993). When discussing the decision to develop the market internationally, three aspects about smaller firms can be found in the literature. They are:

 less aware of the potential of developing internationally  less confident of their ability to develop internationally

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to effectively engage in international activity and the better the firms appear to be suited to absorb the risk associated with internationalization and overcoming barriers to entry (Rajshekhar, 2003).

Firm size has been measured using multiple empirical indicators, such as firm sales, equity and market value. However, the two most common measures are firm assets and employment. In choosing one of these two empirical indicators to measure firm size, some researchers (see for example Tseng, 2007) have assumed that they are interchangeable. Organizational behaviorists and sociologists have most commonly used employment to measure size while economists have primarily used assets. These measures are appropriate given differing research interests and definitions of size. In this study, both measures will be used.

However, firm size must not only be viewed in terms of financial capital but also in terms of human capital. An increase in a firm’s resources (i.e. financial and human) will increase its ability to absorb risks and overcome barriers to entry associated with internationalization.

This study employs the internal view of the firm. Therefore -regarding the effect of size on the barriers to entry- the resources of the firm during the internationalization process will be considered (Bradley, 1999).

Concerning this point of view, larger firms tend to have more resources such as foreign marketing know-how, adequate financing and research & development to devote to overcoming the possible barriers to entry in the transition. These three elements mentioned by Bradley will be discussed in detail in the following section.

2.2.1 On the topic of know-how

As resources are limited, it is of importance for a firm to assess what resources will have the greatest use when devoting them to international market development.

The Resource Based View of the firm sees the firm as a collection of resources (Penrose, 1959) and highlights the firm’s resource heterogeneity on its competitive position (Barney, 1996). In line with this reasoning, the resource availability influences the fact that certain firms are superior to others in the international marketplace and firms exhibit different levels of international market development.

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relate to know-how and skills, and property-based resources that relate to specific and well-defined assets. (Tseng, 2007) Marketing resources can be identified as knowledge-based resources.

The strength of knowledge-based resources is that, unlike financial and or physical assets, they can be replicated and shared among several sites without incurring the full costs of re-creating them in every transfer. (Martin and Salomon, 2003) Firms can draw upon the experience and expertise of operating in their source country and/or other foreign countries, and make the set of marketing resources available to foreign locations at relatively low costs. (Dunning and McQueen, 1981) Marketing resources are the assets used to differentiate products from competitors and build positive brand images (Erramilli et al., 1997). The standardization of marketing practices formed in the export phase also enables the firms to provide more consistent offerings to their customers, and more uniform marketing planning and control procedures to their overseas operations (Chung, 2003). The transition to the international marketing phase demands for a differentiation of those marketing practices. Dunning and McQueen for example stress the advantage differentiated marketing practices provide. In this study, the focus will be on the effect of these marketing practices during the transition.

2.2.2 On the topic of finance

Reviewing the literature revealed that previous research identified the internationalization step between export- and international marketing as costly and difficult (O’Farrel et al, 1998). Internationalization can be successful as long as the firm has the ability to commit financial resources to the new foreign market (Cort, 2006) Increasing the financial resources which are committed to the new foreign market, thus increasing its financial base, will increase its ability to be successful in the internationalization process.

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capital market; the financial reserves of a large firm are better suited to provide the internal funds to undergo this step in internationalizing.

To examine the role of financial resources, it is necessary to break them down in two classes. The first class, internal funds, consists of liquidity at hand and unused debt capacity to borrow at normal rates. The second class, external funds, consists of new equity and for example junk bonds.

The preferred type of finance depends on the type of foreign market expansion. Either the market expansion consists of an unrelated expansion (expansion to a foreign market for the first time) or it consists of a related expansion (expansion within country boundaries or subsequent expansions for a MNE). The transition from export marketing to international marketing can be seen as an expansion to a foreign market for the first time. When it comes to an unrelated expansion, it is thought to be risky by the capital market and therefore, external funds will in general not be available for unrelated projects. This is because the information about the expansion is either unknown to the capital market or unacceptable ex ante. Unrelated expansions have to deal with this lack of information and perceived risk. Therefore, these expansions are favourable to internal finance by internal funds (Chatterjee, 1990)

While the resource-based approach does not allow to make a prediction about the direction of association between size and the type of expansion, large initial size of the firm may be associated with unrelated expansions (Chatterjee, 1990).

2.2.3 On the topic of research and development

The effect of research and development on the international market development has showed that R&D policy plays a strategic role in internationalization. The link between R&D activities and internationalization emphasized in the open economy growth model by Grossman and Helpman (1990, 1991) can be of use to examine the situation within a firm. Cohen and Klepper (1996) reviewed literature on R&D and firm size of the last 30 years and concluded that: “the likelihood of a firm reporting positive R&D rises with firm size”

The R&D efforts may be aimed at three different goals: cost reduction, product or service innovation or quality improvements. Either way, the process of R&D is aimed at developing the next generation of a product or service.

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formation of factors of production. (Gwanghoon, 2004) The firm that has the more favourable conditions for the formation of effective (human) capital, e.g. better exogenous quality of (human) capital, develops a comparative advantage in (human)-capital-intensive goods and has favourable conditions when internationalizing.

The firm that uses its size to allocate more resources to the R&D sector develops a comparative advantage in its services, which are human-capital intensive. The more this comparative advantage is present, the more it generates a limited degree of market power and co creates profit opportunities. When developing a new product or service that substitutes imperfectly for existing brands, the innovator can establish a market niche (Grossman and Helpman, 1990). The potential profits justify the amount of resources dedicated to R&D.

In addition, the effect of internationalizing R&D yields better services that target international markets and reduces the duplication of effort that would arise under locally confined competition. In fact, this implies that advanced firms that are open to an international pre-emptive R&D competition converge absolutely to a higher rate of successful internationalization (Grossman and Helpman, 1990).

The theories discussed in this chapter are based on a market with free entry. Firms may dedicate resources to R&D whenever the incentive to do so is present. Then, in an equilibrium with an active R&D department, the expected returns to this activity must be “normal”; that is, they must reflect the opportunity cost of capital and compensate for any undiversifiable risk (Grossman and Helpman, 1990). In reality however, barriers to enter a foreign market may exist. These barriers to entry influence the amount of resources the firm decides to allocate to R&D as the ability of the firm to overcome certain barriers to entry depend on the level of R&D during the internationalization process.

2.2.4 On the topic of barriers to entry

Now that the characteristics of the independent variable firm size have been elaborated, the next step is to continue with the dependent variable barriers to entry. To define the term barriers to entry for this study, the extensive survey of Blees et al (2003) is used. There are multiple ways to examine barriers to entry. In this study, the focus will be on the existing company that enters a new foreign market.

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above the long-run competitive level to exploit this profit level. As a result of entry, the profit level of the incumbents will decrease to the longrun competitive level. Entrants are also important agents of change. Firms with new ideas or production processes will enter the market. Thus these two effects of entry contribute to allocative as well as to dynamic efficiency in the market. (Blees et al, 2003)

One may expect that firms of different sizes will face different barriers to entry. Big companies can overcome certain barriers to entry much easier and they may be able to influence the competitive positions in an industry to a greater extent than smaller companies can. Small companies are often the first and most directly affected by the harm caused by price fixers and market allocators or anticompetitive behaviour of incumbents (Golodner, 2001).

So, clearly not all firms entering the international market face the same issues. There are several distinctions to be found in the literature. The distinction between small and large entrants is of special interest. The large entrants can be defined as firms who already are in the business and are seeking to internationalize their business to the entered country. Theoretically, these companies possess large (organizational) experience; they have well-established relationships with suppliers, customers, and distribution networks; and they usually have (access to) financial capital. Smaller firms, on the other hand, have less technological and organizational experience (or in the case of a start-up, they may lack experiences altogether); and above all they have less (access to) financial capital.

It is clear that smaller sized firms encounter more difficulty in overcoming barriers to entry. This can be clarified by an example used by Blees (2003).

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When examining the literature, the recurring statement is that large firms have less chance in finding themselves confronted to a barrier when undertaking the step to develop on the international market.

Following this reasoning, the subsequent hypothesis (H1) can be drawn from it: Firm size has a negative effect on barriers to entry.

Negative in this case means that the larger the size of the firm, the smaller will be the

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2.3 Scale effects

Where economies of scale are present, growing firms reap greater profits and command the resources needed for further growth (Shen, 1965). There is much faith in the benefits of “scale increases” when developing on the international market, but it has not gained enough support in the relevant theoretical and empirical literature. In this study, the definition given by Gold (1981) is used:

“scale is the level of planned production capacity which determines the extent to which specialization has been applied to the subdivision of the component task and facilities of a unified operation”

By emphasising on the planned structure of a unified production process, this definition offers an operational basis for differentiating “scale” from “size”, for it recognizes that increases in size involving a comparable proliferation of products or activities, or involving mere duplication of smaller scale relationships, or the intermittent accretion [i.e. irregular growth] of diverse production units, may yield no production economies at all (Gold, 1981). This means that a firm that enters the international market might achieve an increase of production not merely by increasing the firm size, but more importantly by using the scale effect. Using higher levels of specialization trough producing a narrower range of more standardized products, has an impact on the firm, leading it to profit from the scale effects. (Gold, 1981). The more standardization there is between products or services, the larger the technical possibilities of gaining advantages from scale. (Silberston, 1972).

2.3.1 On the topic of dimensions of scale

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One way to further define the meaning of scale, is to regard the average cost of production of a product or service as a function of the following three aspects:

1. Time periods 2. Products 3. Units

The definition of these aspects used in this research is provided by Silberston (1972). Time periods does not fall into the scope of this research as this research focuses on the initial entry phase between export and international marketing. Time periods are too short to be used in this research. In addition, the case selected for this research provides no ground for research on this topic.

Products relates to the savings from spreading initial costs over the output of a

product or service, and to the possibilities for mechanisation, etc., that come from high output per unit of time. This is relevant to the savings in design and capital costs that may be obtained from producing similar products or services, especially if the same equipment can be used for them. Marketing economies may also apply when a group of similar products or services is made.

Units relates to the savings that may arise from increases in the scale of the

firm, e.g., savings in administration. The degree of depth or vertical integration is also relevant here, since it affects the possibilities for technical linkage within the plant.

2.3.2 On the topic of planned production capacity

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2.3.3 On the topic of growth of production

This study tries to identify the influence of scale effects on growth of production in the phase between export- and international marketing. Growth is considered as one of the most essential objectives of a firm, contributing to its survival and success. Growth is desirable for the firm because it (a) creates value for its shareholders and (b) contributes to organizational strengthening (Rodriguez et al, 2003). The literature suggests that the use of scale effects favours competitiveness and stimulates growth.

Reviewing literature on the subject of scale effects on growth, one finds a much cited theory of Gibrat (1931): the Law of Proportional Effect. This law states that size or scale does not influence growth. In this Law, growth is described as a random phenomenon, resulting from several factors that act in a multiple fashion on the initial size of the firm.

Many researchers oppose to this view and indeed stress that the effects of scale do influence growth of production variability. (See for instance Dunne, Roberts and Samuelson, 1989; Dunne and Hughes, 1994; and Fariñas and Moreno, 1997) In this study, the principal theory of Mata and Machado (1995) is adopted. Because the more recent literature does confirm a positive relation between scale and production growth, this study will continue with these arguments which state that a firm’s growth of production is influenced positively by economies of scale. Since there are opposing views in literature about this topic, one of the goals of this thesis is to provide more support for this view.

Some theories on scale effects argue that an important impact of economies of scale on growth of production is indirect (Shen, 1965). There is a relation between the use of scale by a firm and the different input structures they have. This difference has to do with the changes in the relative prices of input (e.g. price of labour or technology) The greater capital intensity of a large firm means that, as labour becomes relatively more expensive, a large firm using more capital intensive goods in the production process, will acquire a relative scale advantage over a small firm (Shen, 1965). The costs of production, due to these indirect scale effects, are spread over a larger production scale and influence growth of production positively.

These arguments lead to the following hypothesis (H2):

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2.4 Conceptual model

The conceptual model is a graphical way to structure the relationship between the variables given in the hypothesis. The model represents the five phases of internationalization described earlier. The accolade stresses the fact that the rest of the model only concerns the phase between export and international marketing. Within this phase, the relation between the variables is explained.

The independent variables are: size and scale effects. Their relation with the

dependent variables, barriers to entry and production growth, is shown by an arrow.

The sign in that arrow defines the influence the independent variable has on the dependent variable: firm size has a negative effect on barriers to entry and scale effects have a positive effect on production growth.

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2.4.1 Hypotheses

(H1) Firm size has a negative effect on barriers to entry.

(H2) Scale effects have a positive influence on the growth of the production.

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3. Research design

This chapter will discuss the methods used in this study. The goal of this chapter is to explain why certain methods are applied and how the data is used.

3.1 Research Method

The research question leads to a conclusion which is explanatory of nature and tries to provide insights on the effects of the variables. In addition to this, the research question is related to ‘a contemporary set of events, over which the investigator has no control’. According to the research strategies discussed by Yin (2003) these conditions give input for the type of research strategy chosen in this design: the case study.

Construct validity is ensured by using three sources of evidence: ‘hard’ data provided by the organization itself (year reports, social year reports), and data provided by key employees within the organization through expert interviews and ‘soft’ data collected by the researcher during the time spent within the organization by other means (experience for example). By ensuring that the line of reasoning of the research questions and evidence for those questions can be followed by the reader of this study, the chain of evidence will be maintained.

The internal validity is ensured by employing explanation building in the conceptual model of this study. Explanation building consists of ‘explaining’ a phenomenon by stipulating a presumed set of causal links about it.

It is often argued by critics of the single case study that it has poor basis for generalization. However, the purpose of this thesis is to compare the results from the study to the conceptual model and try to validate this model according to the broader theory, using the airline industry as an example.

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Several circumstances imply a choice between a single-case or multiple-case design. First, theories on the impact of size and scale effects on internationalization are well formulated in existing literature. This study challenges these theories for a specific phase in the internationalization process: the phase between export- and international marketing.

Second, both size and scale effects have been previously used in the airline industry. The case can be seen as representative to similar conditions within the internationalization process in this industry.

Finally, the collection of the data is being done during a long period of time within the industry itself, making it a unique opportunity to observe and analyze the different phenomena.

Following these circumstances, both the nature of the study and the nature of the theory determine the choice between a holistic or embedded design. Because the study examines the global nature of the firm without dividing it in subunits and because the literature used in this study itself is holistic in nature, the study uses a holistic design. To summarize, the study is constructed with a single-case holistic design.

3.2 Data collecting method and research methodology

Data collection started in August 2007 until September 2008. The data is collected using several sources.

Documentation is used essentially when constructing the conceptual model using existing literature on the topic of size and scale effects on internationalization. This literature consisted mostly of academic journals or papers and to a lesser extent of scientific books.

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The main advantage in using these data is that transavia.com has recently started to expand its market in France and is still continuing to do so. The data are therefore very recent. Using the up-to-date information from the transavia.com case will provide this study with solid empirical support, as internationalization is an important topic within the airline industry. By comparing the theories in this study with the empirical data from the case, this study results in a conclusion that lays the foundation for the actual ideas on the impact of size and scale effects in the transition between export- and international marketing and provides a framework for future strategy.

In order to enhance the quality of the analyses made in this study, these data will be enriched by conducting focused interviews. Questions referred to very specific topics. Respondent were either employees on higher positions with an overview of the operations in the whole firm or employees with specialized knowledge on a certain topic. Where possible, data are triangulated to improve the construct validity of the study, using multiple sources of evidence. This triangulation is done by starting the case study by participating actively in the organization of transavia.com in France as well as in the Netherlands. Information and data acquired on the topic of this study during this period is then compared to the other sources used in this study such as the internal documents, the archival records and the expert interviews. By using these multiple sources to describe the same events and facts described in this study, they are supported by triangulated data. Furthermore, the reliability is increased by observing the principle of maintaining a chain of evidence throughout the thesis, which means that it is possible for the reader of this thesis to follow the source of the evidence from the problem statement at the beginning of this thesis to its conclusions. This is achieved by using sufficient citations to the relevant literature used in the theoretical chapter of this thesis. Also, the case study database, consisting of for example many internal documents as well as the results of the interviews, contains the actual evidence.

3.3 Size

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3.3.1 Know-how

Marketing resources can be identified as knowledge-based resources. Marketing resources are the assets used to differentiate products from competitors and build positive brand images. As to their measurement, marketing resources are gauged by conventional measures; the ratio of marketing-related expenses to total revenue.

To measure to what extent the firm was able to draw upon the experience and expertise, and make the set of marketing resources available to foreign locations at relatively low costs, we will look at what expenses on knowledge-based resources the firm was able to save.

3.3.2 Finance

Due to the nature of the international expansion in the underlying case, we will focus on the preferred type of finance related to an unrelated expansion; internal funds. The standard measures for liquidity are usually used as a proxy for availability of internal capital. These are the debt to market value ratio or DEMKT (ratio of long-term debt to market value) and the current ratio or CR (ratio of current asset to current liabilities). Low values of DEMKT and high values of CR would also imply a low leverage. Practically speaking a firm with enough internal funds will not need to borrow. Hence it will almost always have a low leverage.

By measuring how much additional internal funds had to be raised during the transition, it is possible to explain the effects size had on the ability to reduce the (financial) risks associated with this phase.

3.3.3 Research and development

The firm that uses its size to allocate more resources to the R&D sector develops a comparative advantage which generates a degree of market power capable of lowering the barriers to entry during the transition.

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3.3.4 Barriers to entry

To measure the effects on barriers to entry, the possible barriers have been identified using a comprehensive list of possible barriers relevant in the sector the firm in the case is operating in. The list is provided by previous research by Schnell (2005) and can be found in appendix 3.

This (adapted) list has been handed out to 7 managers. These persons have been selected because they were strongly involved with the internationalization process of the firm and the strategic position they hold within the organisation. Their knowledge and insights on the transition between export and international marketing is substantial. The questionnaire contained a list of 17 barriers linked to a 5 point Likert scale per question. The respondent had to rate to what extent according to him or her, the barrier has influence on a potential entrant to the market the firm operates in.

The question asked to the respondents was: “To what extent do you agree the following barriers impede entry of a new firm in the market?”

3.4 Dimensions of scale

To analyse the various dimensions of scale, the average cost of production can be regarded as a function of either products or units. The product in this case concerns transporting a passenger by airplane from its origin to its destination. More precisely, ‘products’ in this case concerns flying one revenue passenger one mile. Units concerns all the production factors within the firm utilised in relation to this product. “Products” is measured by calculating the ratio of the costs of production to the total output, excluding the costs not associated with production.

“Units” (or firm) is measured by calculating the ratio of the costs of production to the total output, including the costs not (directly) associated with production.

3.4.1 Production capacity

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total industry capacity. The greater MES relative to industry output, the greater the effect of the economies of scale (Bain, 1956). Calculating the MES for the entire industry capacity is beyond the scope of this research. As a proxy for this measure, we will measure the production capacity defined as the total amount of Available Seat Kilometers the firm in the case is able to produce expressed as percentage of the total capacity supplying the market. By comparing the situation right at the first moment of the expansion and one year after the expansion, we will be able to provide insights in the effects of economies of scale on the production growth.

3.4.2 Growth of production

In view of the specificity of the case selected for this research, we will adopt a production measure used in the aviation industry. This is the Available Seat Kilometer (ASK). This item is the total number of seat kilometers that were available to passengers (i.e. aircraft kilometers flown times the number of seats available for revenue passenger use). Cargo is not considered, as there are no cargo operations.

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4. Results

In this chapter, the most important empirical data from the case will be discussed according to the theoretical framework. Successively, the paragraphs in the theory will be attended to. First, the influence of firm size and its variables, i.e. know-how,

finance & R&D, on barriers to entry are discussed. Then the scale effects and their

influence on production growth are discussed.

4.1 Firm size

transavia.com is the second largest carrier in the Netherlands after KLM in terms of total asset value, number of aircraft and employees. Direct national competitors of transavia.com in the Dutch charter market are Arke Fly and since 2007 Amsterdam Airlines.

Arke Fly has only three aircraft in operation in the Dutch market in the year 2007. Amsterdam Airlines has only one and is planning to introduce 2 more aircraft by the end of 2008. transavia.com had 28 aircraft operational in the Dutch market by the beginning of the year 2007. The largest Dutch competitor, Martinair, has ended its short haul services in the European continent, focussing only on long haul services. Martinair is therefore no direct competitor of transavia.com anymore.

To evaluate the size of the firm in terms of assets and in terms of human capital, data from the current year is compared to data up to the financial year 2003/2004. These figures are shown in table 1:

07/'08 06/'07 05/'06 04/'05 03/'04

Net worth of assets NL (in millions) 611 628 664 652 644

Net worth of assets France (in millions) 138 27

Total 749 655

Number of employees NL 1779 1668 1548 1482 1549

Number of employees France 162 58

Total 1941 1726

Table 1: Net worth of assets and number of employees

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2008, which was the year transavia.com found itself in the transition and financed its expansion in France. For the Dutch firm only, the net worth of assets in 2006 – 2007 and 2007 – 2008 is lower due to an increase of the debt that had to be made for the initial investment in transavia.com in France. The net worth of assets of the Dutch and the French firm combined continue to grow.

The number of employees has shown a gradual increase over the year with a more than gradual increase in the years 2006 – 2007 and 2007 – 2008. 2007 was the year in which the expansion in France started and management and staff were hired to manage the firm in Paris.

The new French charter market for transavia.com is mainly dominated by foreign carriers (Royal Air Maroc, Atlas Blue, Jet4You). These charter airlines are small and financially weak (source: Strategic Committee Air France – KLM 2006/2007). The average number of aircraft of transavia.com’s direct charter competitors is 7 aircraft (transavia.com in France owns 7 one year after start-up). This is shown in graph 1.

French charter airlines

5 12 4 11 8 9 5 0 2 4 6 8 10 12 14 Star Airl ines Euro pe A irpos t Blue Lin e Aigl e Az ur Air M edite rane e Cors air Axis Airw ays N u m b e r o f a ir cr a ft

Graph 1: Number of aircraft of French charter companies

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French competitors and will grow larger in the years to follow. Table 2 provides the projected growth in the following years for transavia.com in France.

'07/'08 '08/'09 '09/'10 '10/'11 '11/'12 '12/'13 Number of aircraft 4 7 9 10 10 11 Number of flights 2718 5824 7175 7972 7175 8769 Flight hours 13 140 29 963 38 659 42 954 42 954 47 250

Table 2: Projected growth transavia.com in France (source: Strategic Committee Air France – KLM)

4.1.1 Barriers to entry

Each barrier on the list of 17 barriers provided to the 7 managers was rated on the degree to which the manager agreed the mentioned barriers impeded entry of a new firm in the market. A selection is made of the barriers with the highest rating. The three barriers rated with the highest scores on the Likert scale were:

- capital is needed to introduce a new route in general (average rating of 4) - advertising expenses to inform potential passengers about your flights on the

new route (average rating of 3,25)

- preferred slots (regarding daytime) are not available (average rating of 4)

The last barrier, preferred slots, requires additional clarification, as it is a technical element. The Regulation 93/95/CEE defines slot: ‘‘The scheduled time of arrival or departure available or allocated to an aircraft movement on to specific given at an airport’’. In a different manner, the Regulation 793/2004/EC defines the slot as ‘‘the permission given by a coordinator in accordance with this Regulation to use the full range of airport infrastructure necessary to operate an air service at a coordinated airport on a specific date and time for the purpose of landing or take-off as allocated by a coordinator in accordance with this Regulation’’.

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4.1.2 Know how

Marketing resources are measured by the ratio of marketing related expenses to total revenue. Table 3 shows the data on this ratio.

04/05 05/06 06/07 07/08

Marketing related expenses in NL (in millions) 9,8 11,4 12,9 12,9

Revenue (in millions) 521 597 684 719

Ratio 1,9% 1,9% 1,9% 1,8%

Table 3: Ratio of marketing related expenses to Revenue

The table shows a steady ratio of resources directed towards marketing ends compared to the revenue. These numbers however only consider the expenses in the Netherlands because the resources were all coming from transavia.com in the Netherlands prior to the expansion, but are useful to compare the investments in France during the transition.

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Although it has not been pointed out as a potential barrier to entry, transavia.com made optimal use of the effects a brand name can have. Especially during the transition, transavia.com profited from the strong brand name it has already in the Netherlands. Part of the French campaign during the transition was to use this strong brand name and to add the even stronger and very well known name of the mother firm, Air France – KLM, in the media. Entering the French market under a new and independent name would have cost the firm a large amount of resources to place a strong, new brand name in the French market. By choosing to enter the French market under the same name, it saved a lot of resources by replicating the brand and avoided having to re-incur the full costs of (re)creating the brand in the transition.

The large size of the firm enabled standardization of marketing practices at transavia.com to provide more consistent offerings to its customers and more uniform marketing planning and control procedures on the French operations. This has been researched using focussed interviews. transavia.com made its product offering more consistent during the transition on three levels: the core product benefits, product attributes and support services.

 Core product benefits: both firms, in the Netherlands and in France, used exactly the same type of aircraft with the exact same configuration.

As the fleet in France during the transition was still small, thanks to the larger size of the fleet in Holland, Dutch aircraft could be implemented temporary in France at peak moments. Due to the same functional features, the customer would be unaware of this temporary exchange.

 Product attributes: one of the goals of transavia.com was to have two local firms but one strong brand. Especially during the transition, the brand name was virtually unknown in France, but had already reached nearly 90 % awareness in the Netherlands. To make use of this already strong brand name in the Netherlands, transavia.com decided to use exactly the same design and visual branding in France as in the Netherlands. This holds also for the crew onboard the French aircraft.

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tour operators) channel too, as French B2B clients had their own practises and routines and had some initial difficulties to adapt to the Dutch business model.

As far as marketing planning and control is concerned, having a consistent offering to the customers was essential, in particular because the goal was to have no visual differences between the two firms in the eye of the customers. “transavia.com in France has its own local marketing team. Marketing issues respect the brand guide made by transavia.com’s local agency in the Netherlands.” (source: Bronmateriaal “Soleil”) Having this consistent offering meant planning and controlling practises applied in the Netherlands could be copied to the firm in France. Advertisement campaigns are developed together to use existing knowledge due to large experience in the firm in the Netherlands on tactics to reach the customer. Also, the timing of campaigns is coordinated between the two countries so that they are launched together. This has the advantage that the costs for the campaigns can be lowered due to larger advertisement purchase and that the coverage is international.

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4.1.3 Finance

To finance the expansion to France, the sources of the funds were internal. The healthy balance sheet made it possible for transavia.com to provide the larger part of these funds. An investment of 15 million Euros was made for the expansion of the firm in France in 2006 – 2007. An additional investment has been made in 2007 – 2008 of the order of 7,2 million Euros (source: transavia.com Annual Report 2007/2008). Although the lion’s share has been financed by transavia.com, Air France – KLM, in the role of the mother firm, did provide additional funds and financial guaranties, using its favourable position on liquidity at hand (source: KLM Annual Report 2007/2008) This can be seen as an internal fund as the holding Air France – KLM is for hundred percent owner of transavia.com. Table 4 shows the low leverage of the firm.

07/'08 06/'07 05/'06 04/'05 03/'04

Current ratio 0,76 0,54 0,62 0,58 0,46

Debt to market value ratio 1,31 1,32 1,38 1,49 1,33

Table 4: Current and Debt to market value

The changes in both the ratios are negligible even though investments were made in the last two years. For example, an external financing would change the debt to market value ratio. The fact that the ratios have nearly not changed in this case is largely due to the fact that financing of the funds was internal. In the case of internal financing, the size of the firm influences the amount of financial resources a firm can internally generate. transavia.com was large enough to provide the larger part of the investment needed to start the expansion in France. Would the firm have been smaller, external resources would possibly be necessary to expand.

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4.1.4 Research & Development

In order to research R&D at transavia.com, the product has first to be defined. This leads to the conclusion that it is rather a service than a product and defined as providing low-fare transportation by airplane between two points. Given the fact that the production factors airplanes are standardised products not produced by transavia.com, R&D at transavia.com is aimed at improving the quality of providing this service and in reducing the costs of providing it.

Cost reduction: the focus of development has been fleet renewal during this

period. transavia.com has opted for the implementation of brand new aircraft for its start-up in France. transavia.com ordered 7 Boeing 737-800 aircraft at the start of 2007, with options on three further aircraft. The average cost of this type of aircraft is 72 million dollars resulting in a total amount for the 7 aircraft of 504 million dollar. (source: Boeing Commercial Prices) Many aircraft manufacturers like Boeing offer price reductions if orders become larger. transavia.com own a large fleet and used its size to obtain this advantage. As discussed earlier, R&D can be measured by absolute levels of spending. By placing a larger order, price reductions had been obtained from the manufacturer in the order of 6 % resulting in a total saving of more than 30 million dollar. (source: Corporate Controlling Report). These aircraft are intended as replacements for older aircraft of the same type in the Dutch fleet, which will keep the fleet ‘young’, and to start the fleet in France with modern and efficient aircraft. Older and more fuel consuming aircraft in the Dutch fleet were taken out of service prematurely and replaced by the newer and more fuel efficient ones. The benefit is that operating costs can stay predictable and relatively low. A young fleet is also favourable from an environmental perspective. Five of the aircraft, which are being replaced, have now been sold to investment companies on sale and lease-back transactions.

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Quality improvements: most of the resources for research have been directed

on improvements to the main distribution channels of transavia.com. This concerns both the Business to Consumers website as well as the Business to Business website ‘transpartner’. Again, R&D can be measured in terms of absolute spending. transavia.com spends about 800.000 Euros a year on improvements on the website. In 2007, 95 % of the sales were realized through the website (source: E-commerce Report).

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4.2 Scale

To measure the scale effects on the growth of production, the average cost of production have been regarded as a dimension of either products or units.

On product level, the costs per Available Seat Kilometer include all the costs directly associated with production. Graph 2 shows a projection on the following years and indicates a strong downward pressure on the costs per ASK declining from 5,48 Euro cents per AKS to 4,58 Euro cents per ASK. The savings on the costs start to increase substantially in the transition and are the strongest in the year following the transition. 4 4,2 4,4 4,6 4,8 5 5,2 5,4 5,6 C o s ts p e r A S K 0 1 2 3 4 5 6 7 8 9 P e rc e n ta g e o f s a v in g s

Costs per ASK Percentage of savings Costs per ASK 5,48 5,4 5,32 5,24 5,17 4,77 4,54 Percentage of

savings

1,55 1,50 1,53 1,98 8,39 4,15 03/'04 04/'05 05/'06 06/'07 07/'08 08/'09 09/'10

Graph 2: Costs per ASK and Percentage of savings

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