Fundamentals of Management 7th Edition by Ricky Griffin

Exercise 2

Let's say you're a businessperson in New York who needs to fly to Hong Kong. Logging on to Orbitz, you find that American Airlines (AMR) offers a nonstop round-trip flight for $2,692. Because Orbitz recommends that you "Act Fast! Only 1 ticket left at this price!" you buy your ticket online. On your departure date, you arrive at the American Airlines ticket desk, only to be referred to the Cathay Pacific Airways counter. Your flight, the ticket agent informs you, is actually operated by Cathay, and she points to the four-digit "codeshare number" on your ticket. Bewildered but hoping that you're still booked on a flight to Hong Kong, you hustle to the Cathay counter, where your ticket is in fact processed. Settled into your seat a few hours later, you decide to get on your laptop to see if you can figure out why you are and aren't on the flight that you booked. Going back to Orbitz, you find that, like American, Cathay does indeed offer a nonstop round-trip flight to and from its home city of Hong Kong-for $1,738. It dawns on you that if you'd bought your ticket directly from Cathay, you'd be sitting in the same seat on the same airplane for almost $1,000 less.
If this scenario sounds confusing, that's because it is, even to veteran flyers. What's confusing about it is the practice of code sharing, which works like this: You buy a ticket from Airline A for a flight operated by Airline B on a route that Airline A doesn't otherwise serve. This practice is possible if both airlines, like AMR and Cathay, belong to the same airline alliance (in this case, One world).
On the surface, the advantages to the airlines may seem mostly a matter of perception: An airline seems to be serving certain markets that it doesn't actually serve and flying certain routes more frequently than it actually does. The networks formed by code sharing agreements, however, are real, and the breadth of an airline's network is a real factor in attracting high-margin corporate travelers. In fact, the spread of code sharing has led directly to the formation of much larger "alliances" of carriers who cooperate on a substantial level, including codes haring and shared frequent-flyer programs. The three largest airline alliances are the Star Alliance, which includes United Airlines, US Airways, Air Canada, Air China, and Scandinavian Airlines; Sky Team, which includes Delta, Air France, Alitalia, and Dutch-based KLM; and One world, which includes AMR, Cathay, Qantas, British Airways, and Japan's JAL.
An airline alliance is one form of a virtual organization- in this case, a temporary alliance formed by two or more organizations to pursue a specific venture or to exploit a specific opportunity. Although each member remains an independently owned and managed organization, alliance members can save money by sharing sales, maintenance, and operational facilities and staff (such as check-in, boarding, and other on-the-ground personnel), and they can also cut costs on purchases and investments by negotiating volume discounts. The chief advantages, however, are breadth of service and geographical reach-in short, size (both perceived and real). Star Alliance, for example, operates 21,000 daily flights to 1,160 airports in 181 countries. According to the most recent data, its members carried 603.8 million passengers for a total of nearly 1 trillion revenue passenger kilometers (1 rpk means that 1 paying passenger was flown 1 kilometer). Based on rpk (which is really a measure of sales volume), Star commands 29.8 percent of global market share in the airline industry-greater than the combined market share of all airlines that don't belong to any of the three major alliances.
Note that our definition of a virtual organization indicates a "temporary alliance," and shifts by members of airline alliances are not unheard of. In January 2009, for example, a few months after merger talks had broken down with United Airlines, Continental Airlines, a member of Sky Team since 2004, announced that it was joining United in the Star Alliance. According to one analyst, the move, which took effect in October 2009, "was obviously a precursor to a full-blown merger," and, sure enough, Continental and United merged in May 2010 under a parent company called United Continental Holdings. The new airline remains a member of the Star Alliance.
The Continental-United merger was particularly bad news for both AMR, a member of One world and the country's largest stand-alone airline, and US Airways Group, a member of Sky Team and the fifth largest U.S. carrier. With the merger of Continental and United, says Vaughn Cordle, chief analyst at Airline Forecasts, a specialist in industry investment research, "the odds of … bankruptcy for US Airways and American increase because it will be too difficult, if not impossible, for them to remain viable as standalone businesses…. [W]ithout a new strategic direction and significant changes in the industry's structure," Cordle predicts, AMR and US Airways "will continue on the slow … path to failure."
Cordle recommends consolidation, and many analysts say that AMR management had begun considering its options even before the Continental-United merger. The best strategy, adds George Van Horn, an analyst at the research firm IBISWorld, needn't be a merger but could involve some kind of looser alliance. Who is the likely partner if AMR decides to consolidate? John Kasarda, an aviation expert at the University of North Carolina's Kenan-Flagler Business School, thinks that an AMR-US Airways merger isn't out of the question: "It would be more out of necessity," he admits, but both airlines have been "asleep at the switch" and can expect their respective shareholders to demand some kind of action. A merger, however, would require US Airways to leave the Star Alliance, and US Airways says that "we highly value our membership in Star and maintain that it's the strongest alliance."
In any case, observers agree that AMR needs to make some kind of strategic move. Once the world's largest airline, it's now number three, behind the new Continental-United and Delta Airlines. Among U.S. airlines, AMR has the lowest margins and highest costs, and it's also the only U.S. airline that lost money in 2010. IBISWorld's Van Horn points out, however, that AMR has considerable experience at the kind of deal making in question: American, he reminds potential investors, "helped originate the whole idea of alliances and partnerships. If somebody should be good at it, you could make the argument they should be."
According to one industry analyst, "in a scale business … size does matter." What does he mean by "a scale business"? Why is the airline industry "a scale business"? Once you've thought about these two questions, how would you describe the "specific opportunity" which, as virtual organizations, airline alliances are designed to exploit?