Airline alliances becoming the new "mergers"

NEW YORK Fri Feb 26, 2010 2:37pm EST

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NEW YORK (Reuters) - The days of airline alliances offering little more than code-sharing agreements are gone. Instead, alliances may well be the new mergers.

In an era when airlines are losing billions of dollars amid volatile fuel prices and a pullback in spending, every carrier is looking to cut costs and increase scale.

Limited by restrictions on mergers with foreign airlines and waiting for someone else to make the move within the United States, U.S. airlines are now seeking to expand their alliances and trying to extend synergies within current partnerships.

The three major alliances -- Star, SkyTeam and oneworld -- are global networks of carriers that allow members to streamline costs while sharing revenue.

"I think we are seeing an evolution, seeing these alliances become tighter-knit partnerships," AMR Corp AMR.N Chief Financial Officer Tom Horton said at the Reuters Travel and Leisure Summit earlier this week. AMR is the parent of American Airlines.

"They started as loose marketing agreements, for code-sharing, frequent linkages, emergence of global alliance groupings," he said. "We are now seeing those groupings forming tight economic relationships."

American is part of the oneworld alliance, along with 11 other members that include British Airways BAY.L, Cathay Pacific (0293.HK) and Australian carrier Qantas (QAN.AX).

GETTING COMPETITIVE

Evidencing the importance of alliances, American recently ended a fierce battle to keep Japan Airlines JALSF.PK in oneworld as Delta Air Lines (DAL.N) tried to lure it to SkyTeam.

The months-long fight included offers of a billion dollars by each side and intense campaigning in Tokyo and Washington.

JAL, despite being in bankruptcy, is valuable because it offers access to the world's second-largest economy and an extensive network in Asia. SkyTeam, which lost out on JAL, has 10 airlines, including Delta, Air France-KLM (AIRF.PA) and China Southern Airlines (600029.SS).

Horton also said that American was in advanced talks with China Eastern Airlines (600115.SS) to bring it into the oneworld alliance. The Chinese carrier responded by saying it was speaking with all three alliances, in a sign of the competition involved in luring airlines into such networks.

Alliances are now racing to expand their network, fully aware that the most diverse route map and the biggest presence in the busiest markets will make the strongest alliance.

The chief financial officer of UAL Corp's United Airlines UAUA.O, Kathryn Mikells, said the carrier was seeking alliances in South America and Brazil.

United is a founding member of Star Alliance, which has 26 carriers including Continental Airlines CAL.N, US Airways LCC.N, Lufthansa (LHAG.DE) and Air New Zealand (AIR.NZ).

FOCUS SHIFTS TO COST

Alliance members are now trying to shift the focus from sharing revenue to cutting costs.

"We are now focusing more on the cost side, by co-locating at airports, sharing IT systems, doing joint investments in information technology," United's Mikells said.

Still, saving costs through alliances has its challenges. "We try to work really hard with our alliance to try to save costs, but it's really hard because you have different types of airlines in different countries," US Airways Chief Financial Officer Derek Kerr said at the summit.

The airline industry, which has lost $50 billion in the past 10 years, including $11 billion in 2009 alone, is seeking ways to become profitable again.

U.S. airlines are open to mergers, but those are difficult because the integration of technology is expensive and combining the labor forces is complicated. Additionally, both processes take years to accomplish.

Also, U.S. law restricts foreign ownership of an airline to 25 percent of voting stock, preventing global consolidation and forcing U.S. carriers to eke more out of alliances instead.

"What you will see United and other industry participants doing, is basically within the regulatory framework that we have today, trying to get some merger-like benefits without merging," United's Mikells said.

United, Continental and Japanese carrier ANA (9202.T) in December asked the U.S. government for approval to jointly price, market and schedule international flights without antitrust prosecution.

Earlier this month, American Airlines and British Airways won tentative approval from the U.S. government for similar immunity. And last week, AMR and JAL filed a joint application for similar antitrust immunity.

But alliances will not serve as ideal substitutes for mergers, all airline executives said at the summit.

"If we focus more, we could probably have some more cost-savings from alliances," US Airways' Kerr said. "But the domestic U.S. industry needs a merger."

(Additional reporting by Tim Hepher in Paris; Editing by Steve Orlofsky)

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