The Airline Trade

The history of the airline industry is littered with inter-line mergers and acquisitions. What is remarkable is that virtually all of these mergers have been between airlines from the same country: the country in which both airlines were registered. US deregulation in 1978 led to a flurry of merger activity amongst US-based airlines; sometimes inducing mergers between airlines based at the same airport, as was the case with Northwest/Republic at Minneapolis and TWA/Ozark at St. Louis.

In Europe, the modern trend in merger activity was set in motion in 1974 when British Airways was formed from the merger of British European Airways (BEA) and British Overseas Airways Corporation (BOAC). The original distinction the UK drew between BEA and BOAC served as a model for airline industry organisation in countries of the British Commonwealth: one airline would operate domestic and short haul international routes, whilst the other served long haul intercontinental routes.

That model has now been changed, with the BEA/BOAC merger in the UK being followed by similar tie-ups in Canada, Australia and New Zealand. The closest parallel to the original BEA-BOAC model may shortly be broken if current discussions between Air India and Indian Airlines result in merger.

The pattern of mergers and acquisitions within national boundaries continues. One of the most important mergers in recent years was that between Japan Air Lines (JAL) and Japan Air System (JAS). This was a marriage between an international carrier, and a domestic one, and the division of responsibilities remains much as it was in pre-merger days. This merger is an example of the long-established policy of successive Japanese governments to permit mergers between indigenous companies in the hope that their larger size will enable them to compete better with foreign competition.

A similar motive might lie behind the attempt by Ryanair to take over its fellow Irish airline Aer Lingus. In the past, Ryanair’s operations have been limited to short haul routes within Europe, whilst Aer Lingus has for many years operated some long haul flights, principally on routes across the North Atlantic.

There has already been some consolidation in the low cost sector, notably Ryanair/Buzz and easyJet/Go. But now, with Aer Lingus in the process of re-inventing itself as a low cost carrier, and with Ryanair contemplating the possibilities — opened up by the recent US-EU ‘Open Skies’ agreement — of new low cost services between Europe and United States using secondary airports, a merger between the two Irish airlines might have a certain rationale to it.

Cross-border mergers continue to be rare events. This is because governments still adhere to the principle that airlines should be ‘substantially owned and effectively controlled’ by nationals of the state in which the airline is registered. Ownership clauses in bilateral air service treaties effectively limit the grant of traffic rights to airlines registered in one or other of the two states involved.

So, if an airline of one state were to take over an airline of another state, serious doubts would arise over traffic rights on international routes. The merger might invalidate the rights previously held by the airline being taken over. As a result of this, cross-border activity has been largely limited to trade investments or multinational consortia of airline interest in neighbouring countries.

Trade investments date back considerably. In the 1940s and 1950s, some well-established US and European airlines often owed sizeable stakes in foreign airlines just starting up — at one time BEA held 40 per cent of Alitalia and BOAC, 50 per cent of Egyptair. The airline ownership map was then redrawn on more nationalistic lines, until the recent upsurge in interest in equity holdings, notably Singapore International Airlines purchasing 49 per cent of the share capital of Virgin Atlantic. As for multinational consortia there have only ever been a handful of instances, of which only three (Gulf Air, LIAT and SAS) survive to this day.

Despite the restrictions, two cross-border ‘mergers’ of a kind have taken place in Europe recently: Air France/KLM in 2004 and Lufthansa/Swiss in 2005. In the first case, a complicated ownership structure was established to permit the two airlines to operate as subsidiaries of the combined Air France-KLM, under their own separate brandnames and liveries; and in this way traffic rights are protected.

In the second case, Lufthansa has still not formally completed the takeover of Swiss, a full two years after the deal was announced. The reason for this is the protection of traffic rights. It is possible that there will be more cases like these, especially after the recent EU-US ‘Open Skies’ agreement which has, in effect, introduced the concept of an ‘EU airline’.

If two EU airlines now merge — such as perhaps BA/Iberia — then their traffic rights are automatically secure, given that the agreement allows airlines to operate on any route between the EU and US. Of course, the question of traffic rights to third countries remains; in Iberia’s case, on routes to/from South America. So if BA (which already holds 10 per cent of Iberia’s equity, with an option to increase its shareholdings by a further 30 per cent) wishes to take over Iberia, it may need to employ techniques similar to those used by Air France and Lufthansa.

But in any case, BA might be less interested in taking over Iberia than in merging with American Airlines, one of its partners in the oneworld alliance. Here, the ownership restrictions still present major impediments, since no more than 25 per cent of the voting equity of an US airline can be held in foreign hands.

The fundamental problem in air transport is that it is a global industry served by national firms. If airlines are going to conduct business in much the same way as global firms in other industries do (for example banking, telecoms, the motor industry and IT) then they must be freed from the restrictions on ownership and traffic rights. The ‘Open Skies’ agreement does not really move the industry far in this direction. What would achieve more is an EU-US ‘Open Aviation Area’, in effect a free trade area in air transport.

Pat Hanlon is a Senior Lecturer at Birmingham Business School. His book is entitled "Global Airlines: Competition in a Transnational Industry."