Mergers, Acquisitions, and Alliances in the Global Airline Industry - Case Study Example

Strategic Methods (Mergers, Acquisitions and Alliances) in the Global Airline Industry Student’s name Course Tutor’s name 15 March 2013 Strategic Methods (Mergers, Acquisitions and Alliances) in the Global Airline Industry The airline industry has mixed fortunes for entrepreneurs; while the allure of profit-making continues attracting several investors to the industry, the reality on the ground is perhaps not as attractive. In fact, British business mogul Richard Branson once said that “the best way to become a millionaire is starting as a billionaire and going into the airline business” (Branson cited by Miller 2012, para. 12). Though a debatable claim, Branson’s sentiment is just an indication of the tough operating climate that the global airline industry faces. As would be expected, airlines, just like other businesses faced with tough economic times, are always on the lookout for ways through which they can create value for their shareholders, their customers and their partners. As noted by Nair, Palacios and Ruiz (2011), airlines are increasingly operating across and beyond traditional industry definitions and boundaries. In other worlds, airlines are increasingly opening up and accommodating to new business models (Nair et al. 2011, p. 48). In this paper, the adoption of mergers, acquisitions and alliances will be investigated for their strategic nature. Specifically, the paper will seek to establish the strategic motives for airlines going into mergers, acquisitions or alliances. The strategic fit of the two organisations, potential gains and risks, and the outcomes of the action by airlines will be established. The British Airways-Iberia Merger While the legally binding and definitive merger agreement between British Airways (BA) and Iberia was signed in April 2010, the merger talks had been ongoing for more than two years during which Riley (2012, n.pg) observes that the negotiations were “complex and often strained”. The merger brought together the British flagship carrier, BA, and the Spanish National carrier Iberia. The merger led to the formation of International Airlines Group (IAG), a new holding firm for BA and Iberia, and latter for BMI. As a group, IAG is currently rated as the third largest airline group in Europe with 377 airplanes, which fly to 200 destinations across the world (IAIR Group 2013, about us). The group has an estimated 54 million passengers annually. The motives of the BA-Iberia merger Before delving into the motives behind the BA-Iberia merger, it is important to note that the two airlines had developed links for many years dating as far back as 1998 when BA bought 13% shares in Iberia (Riley 2012, para. 1). In 1999, a preliminary merger took place, where IAG was conceptualised and BA shareholders were given 55% of the new firm; Iberia’s shareholders got the remaining 45% stake. The two airlines however continued operating independently. The relations between the two airlines were further cemented by the cooperation and route-sharing between them, which started in 2003. Prior to the global financial crisis in 2007, BA had expressed its interest in merging with Iberia, but the talks stalled only to resume at the height of the financial crisis in 2009 as indicated by Riley (2012, para.1). A merger is defined as the process through which “two firms, often about the same size, agree to go forward as a single new company rather than remain separately owned and operated” (McClure 2013a, n.pag). As a business decision that has consequences for shareholder, the merger options that a company has are explained in Appendix A. However, and as explained above, both BA and Iberia agreed to operate under the new firm IAG going forward. Notably, they could have decided to get into an acquisition, where the financially stronger of the two firms would have bought out the other, or into a strategic alliance, where they could continued operating under separate entities but acting as partners in strategic processes. The initial strategic plan for the merger is detailed in Appendix B. The motive of opting for a merger other than an acquisition or a strategic alliance was perhaps informed by the complexities of both airlines being national carriers in their respective countries, but in the same European region. As Gaughan (2007, p. 13) observes, a horizontal merger – i.e. when two competitors combine – gives the new firm “an increase in market power that will have anti-competitive effects”. With such knowledge, firms often merge with the motive of expanding or consolidating market share. In the BA-Iberia case, the former has access to Asian and North American routes, while the latter had an established presence in the Latin American routes. Following the merger, the two airlines got access to a larger market. Coming at a time when the combined airline industry was experiencing major losses, the BA-Iberia merger was also intended to use the complementary capacities that the two airlines had to cement their position in the market and shield themselves from further loss making. As Stuhl (2004) notes, most mergers, acquisitions or even strategic alliances are motivated by the allure of utilising synergies between or among firms going into such arrangements. In the BA-Iberia case for example, the new holding firm formed as a result of the merger – IAG – was poised to consolidate the airline market further for purposes of creating more economies of scale. So far, IAG has taken under its fold one more struggling airline in the region operating under the BMI banner. According to Kleymann and Seristo (2004, p. 5), price wars between competing airlines are by the far the major reasons why small airlines find the business as being unsustainable. With consolidation however, the price wars will be reduced, and the losses will reduce. Hub-dominance is also another motive that could inspire mergers, because as indicated by Riley (2012), the IAG acquisition of BMI gives the former access to large landing slots at Heathrow airport, thus meaning that BA could use the same to enlarge its destination flights to emerging markets. Although the economies of scale motive is viable for any business considering a merger, acquisition or strategic alliance, Kleymann and Seristo (2004) observes that there is a limit to the economies of scale-related benefit that players in the transport industry (and most specifically in the airline industry) can get. The writers observe that “true scale effects have only been observed among growing smaller airlines: increasing an airline’s size from, say, two aircraft to twenty does carry scale benefits” (Kleymann& Seristo 2004, p. 5). However, the significant scale economies are unlikely in the long-run especially where large airlines have merged. Put into context, and assuming that Kleymann and Seristo’s (2004) observation is true, it is apparent that scale economies are minimal especially in relation to technological economies. According to Kleymann and Seristo (2004) scale economies that airlines hope to attain through mergers, acquisitions or strategic alliances can be categorised into three formats: technological economies; managerial economies; and financial economies. Technological economies are attainable based on the large-scale production that airlines can engage in. Kleymann and Seristo (2004) observe that such scale economies are limited to the plant level, where aircraft sizes can be used to ensure that routes with more passengers are serviced by higher-passenger capacity airplanes. Managerial economies on the other hand refer to improved use of labour. For example, following the BA-Iberia merger, the BA CEO Willie Walsh took over the management of IAG. As a result of the loss-making trend of the two merged firms, Iberia is to date still laying off some of its staff, which corresponds with a 15% capacity cut requirement in its restructuring process as indicated by Topham (2013), thus indicating that it could perhaps attain some managerial economies. Financial economies are on the other hand realised through “reductions in unit costs when purchases, sales and financial transactions are made on a large scale” (Kleymann & Seristo 2004, p. 6). Still, the attainment of financial economies in the airline industry is handicapped by the regulatory environments in which they operate, especially in relation to labour contracts. Already, and as indicated by Topham (2013) the labour strikes protesting layoffs are compounding Iberia’s loss making, which is increasingly eating into BA’s profit margins. Still, IAG’s CEO maintains that the cost-sharing arrangement made possible by the merger has improved BA’s profitability and that by 2015, Iberia will have recouped from its loss-making stint (Topham 2013). Overall, the IAG revenue has increased by 10.9% from the previous year thus indicating the possibility that the cost-saving motives of the merger would eventually pay off. Further, IAG had achieved €313 million in cost savings consequent to the merger hence indicating that its motives were perhaps well informed. Strategic and managerial fit between BA and Iberia According to Chorn (1991, p.20), the concept of strategic fit “considers the degree of alignment that exists between competitive situation, strategy, and organisation culture and leadership style”. In other words, the strategic fit concept is used in reference to the appropriateness of alignment of different elements in a firm. Chorn (1991) further identified production, administration, development and integration as the four logics through which a firm can act, control, create and integrate for purposes of enhancing its outputs. Following Chorn’s definition, it can be argued that strategically, BA and Iberia strived for the same outputs having worked in the same industry. Their energy, goals, objectives were probably similar, as probably was their use of measurements, systems, and need for stability to attain order in their respective operating environments. Development-wise, the two airlines probably pursued similar innovations, new processes or equipment, and were probably discontinuing some of the outdated equipment in a similar manner. Strategically therefore, it could be argued that the two airlines had attained a fit in three (production, administration and development) of the four logics identified by Chorn (1991), with the only remaining area being integration. Through integration, Chorn (1991) observes that firms are able to cooperate, work in teams, and create synergy, which ideally enhances cohesion in product or service provision. Following Chorn’s (1991) definition, the following are the areas in which BA and Iberia attained a strategic fit through the merger: The managerial fit According to Dyer et al. (2004), managerial fit occurs when the management practices and expectations of two firms seeking to do business together are compatible. Kale et al. (2002) observe that the importance of selecting a partner is underscored by the need for partners to mutually contribute to a collaborative relationship that follows a give-and-take mutual policy especially in relation to the transfer of knowledge and skills. Bleeke and Ernest (1993) further observe the need for firms seeking to work together through mergers, acquisitions or alliances to possess complementary geographic markets, technology, products, skills, and/or efficiencies. Cui, Ball and Coyne (2002, p. 344) further observe the need to avoid “self-centred assumptions and expectations” arguing that they may lead to misfit managerial behaviour. The managerial fit in the BA-Iberia merger appears to have stemmed from factors shown in the text box below: . Potential gains The gains of the BA-Iberia merger include: An enhanced revenue generation from the combined destinations formerly served by BA and Iberia separately Increased capacity to attract more customers due to the increased coverage Improved connections, frequencies, and competitive prices for customers Enhanced strategic position in the aviation industry hence improving both airlines’ competitive positions Greater growth potential in future, especially through optimising the Madrid and London dual hubs Estimated €400m worth of annual synergies reflected in the costs saved and/or revenues generated through network management, joint selling, fleet maintenance, office functions and information technologies (Business Traveller 2009). Potential risks Cultural challenges dealing with employees from both firms. As Stahl (2004) observes, any corporate combination needs to be based on trust and partnership rather than on power and domination. Applied into the BA-Iberia merger context, it is possible that IAG’s insistence on layoffs in Iberia as part of the latter’s restructuring would be opposed by the employees as has been the case in the recent past and as indicated by Parker, Johnson and Oakley (2012). Considering the unpredictable nature of the operating environment, IAG stands the risk of unforeseen external occurrences such as disruptions in air travels due to climatic conditions among other things (Riley 2012). Industrial relations is also a constant challenge on both the BA and Iberia sides, especially considering the regulatory environments in both Britain and Spain, hence making managerial decision-making in regard to the workforce relatively inflexible. By the time of the merger, BA has a shortfall of £3.7 billion in its pension fund, which CEO Walsh admitted was a liability (Walsh 2009). He however said that Iberia was fully aware of the shortfall, and that BA would handle it without sharing the cost burden with Iberia’s shareholders. Still, analysts thought that the shortfall would have implications on BA’s revenue management and by extension, IAG’s profit-making. Finally, the global economy is inherently risky since the economic cycle often catches many businesses unaware. The demand for airline travel may be affected by countless things including threats of terrorism or travel bans to specific destinations. When such happens, the profits projected for IAG would no doubt be affected. Outcomes relative to expectations Parker, Johnson and Oakley (2012, para. 4) observe that while the BA-Iberia merger was meant to create a “powerful new force in global aviation”, three years later, the holding company IAG was still struggling with the loss-making Iberia, while BA was seemingly performing well, but below the projected revenues. The profit and loss making of BA and Iberia respectively was projected to the reporting of a €120 million loss by IAG in 2012 (Parker et al. 2012). The comparative financial performances of both BA and Iberia for the 2011-2012 period are indicated in Appendix C. It has also been noted that IAG has challenges in dealing with structural and cyclical factors that affect its operating companies thus making its cost base less competitive compared to other budget airlines operating on the same routes. One such challenge has been identified by Parker et al. (2012) as the seemingly high salaries of Iberia captains and their relatively fewer working hours compared to the budget airlines. For example, with a salary of €197,000, the Iberia captain flies 629 hours annually. By contrast, a Ryanair captain with a salary of €148,000 flies for 850 hours annually. In other words, the budget airlines are better at utilising their workforce compared to say, Iberia. Competition on the long-haul flights (especially for Iberia) is further undermining the profit-making potential of IAG. Parker et al. (2012) note that IAG is facing stiff competition from the likes of Latam Airlines Group, which was formed after merging Chilean and Brazilian airlines. On BA’s case, Parker et al. (2012) notes that the British flagship carrier has made tremendous improvements in its profit-making, mostly because of its link with American Airlines through joint ventures. Overall, the merger between BA and Iberia is performing below expectations. As Parker et al. (2012) and Topham (2013) note however, much of the underperformance is linked to Iberia, which is facing challenges in its home market. In the event that Iberia does not recoup its profitability, Parker et al. (2012, para. 20) observe that IAG “could be forced into a write-down of the Spanish carrier’s €249m of goodwill and other intangible assets”. If such was to happen, there is little doubt that the effects would be felt by BA shareholder too, who hold a 56% stake in IAG. References Bleeke, J & Ernest, D 1993, Collaborating to complete: using strategic alliances and acquisitions in the global market place, Wiley, NY. Business Traveller 2009, ‘BA and Iberia to merge’, viewed 14 March 2013, . Chorn, N H 1999, ‘The “Alignment” theory: creating a strategic fit’, Management Decision, vol. 29, no. 1, pp. 20-24. Cui, C C, Ball, D & Coyne, J 2002, ‘Working effectively in strategic alliances through managerial fit between partners: Some evidence from Sino-British joint ventures and the implications for R&D professional’, R&D Management, vol. 22, no. 4, pp. 242-257. Dyer, J H, Kale, P & Singh, H 2004, ‘When to ally and when to acquire’, Harvard Business Review, vol. 82, nos. 7/8, pp. 108-115. Gaughan, P.A 2007, Mergers, acquisitions, and corporate restructurings, John Wiley & Sons, London. IAIR Group 2013, ‘About us’, viewed 14 March 2013, . International Airlines Group 2012, ‘Annual report and accounts’, pp. 1-24, viewed 15 March 2013, http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDk2NTYzfENoaWxkSUQ9NTM1NTIyfFR5cGU9MQ==&t=1. Kale, P, Singh, H, & Perlmutter, H 2002, ‘Alliance capability, stock market response and long-term alliance success: the role of the alliance function’, Strategic Management Journal, vol. 23, no. 8, pp. 747. Kleymann, B & Seristo, H 2004, Management strategic airline alliances, Ashgate Publishing Ltd., Aldershot, UK. McClure, B 2013a, ‘Mergers and acquisitions: definition’, Investopedia, viewed 14 March 2013, < http://www.investopedia.com/university/mergers/mergers1.asp#axzz2Nap1LCOd> McClure, B 2013b, ‘Mergers and Acquisitions: Breakups’, Investopedia, viewed 14 March 2013, < http://www.investopedia.com/university/mergers/mergers4.asp#axzz2Nap1LCOd>. Merger Project 2010, ‘Merger project between International Consolidated Airlines Group, S.A. (Surviving company), IBERIA, Lineas Aereas de Espana, S.A (Non-surving company), and BA Holdoco, S.A (non-surviving Company)’, viewed 15 March 2013, http://media.corporate-ir.net/media_files/irol/24/240949/mergerplan.pdf. Miller, T 2012, ‘Screw business as usual: An interview with Sir Richard Branson’, viewed 14 March 2012, http://blog.sfgate.com/tmiller/2012/01/09/screw-business-as-usual-an-interview-with-sir-richard-branson/ Nair, S K, Palacios, M & Ruiz, F 2011, ‘The analysis of airline business models in the development of possible future business options’, World Journal of Management, vol. 3, no. 1, pp. 48-59. Parker, A, Johnson, M & Oakley, D 2012, ‘Iberia’s bumpy ride’, Financial Times- analysis, viewed 14 March 2013,< http://www.ft.com/intl/cms/s/0/97b37f44-3f9b-11e2-b0ce-00144feabdc0.html#axzz2NUjqWuLT>. Riley, J 2012, ‘6 essential M&A cases: BA & Iberia Merge to form IAG’, Tutor2u, viewed 14 March 2013, . Stahl, G K 2004, ‘Getting it together- the leadership challenge of mergers and acquisitions’, Leadership in Action, vol. 24, no. 5, pp. 3-6. Topham, G 2013, ‘IAG defends BA-Iberia merger as Spanish airline falls to near -€1bn loss’, The Guardian – Business, viewed 14 March 2013, . Walsh, W 2009, ‘British Airways-BA and Iberia merger analysts’ presentation – Final transcript’, Thomson Reuters, viewed 14 March 2013, . Appendix A: Merger/acquisitions options Appendix B: Initial strategic plan Appendix C: Operating profit and loss performance of IAG Source: International Airlines Group (2012) Read More