Lufthansa’s Strategic Challenges when a Star Alliance Member Exits

Table of Contents

1. Introduction: Changes in the Airline Industry

2. Theoretical Framework
2.1. Strategic Management Analysis in a Hypercompetitive Industry
2.1.1. Hypercompetition
2.1.2. External Analysis
2.1.3. Internal Analysis
2.2. Building Competitive Advantage
2.2.1. Business Level Strategy
2.2.2. Corporate Level Strategy
2.3. Scenario Analysis with the TAIDA Model
2.3.1. Scope and Dimensions
2.3.2. Scenario Planning with the TAIDA Model
2.4. Summary

3. Empirical Case - Lufthansa’s Competitive Advantage
3.1. Strategic Management Analysis in the Hypercompetitive Airline Industry
3.1.1. Deregulation of Markets
3.1.2. External Analysis of the Airline Industry
3.1.3. Internal Analysis of Lufthansa
3.2. Building Competitive Advantage
3.2.1. Business Level Strategy of Lufthansa
3.2.2. Corporate Level Strategy of Star Alliance as a Strategic Alliance
3.3. Summary

4. Scenario Analysis
4.1. Defining Scenarios
4.2. Analysing the Four Different Scenarios
4.3. Summary

5. Conclusion

6. References

7. Appendix

List of Figures

Figure 1: SWOT Analysis

Figure 2: D’Aveni Hypercompetitive Model ‘New 7-S’s’

Figure 3: Porter’s Five Forces Framework

Figure 4: Porter’s Generic Strategies

Figure 5: The Five Phases of the Scenario Process

Figure 6: Scenario Overview

Figure 7: Porter’s Five Forces Applied on the Airline Industry

Figure 8: Porter’s Generic Strategies Applied on Lufthansa

Figure 9: Scenario Cross

Figure 10: Overview of scenario data

List of Tables

Table 1: Types of Tangible and Intangible Resources

Table 2: Advantages and Disadvantages of Building a Network

Table 3: Economic Forecast Divided Into Regions

Table 4: Advantages and Disadvantages of Building a Strategic Alliance

Table 5: Overview of the Three Biggest Alliances

1. Introduction: Changes in the Airline Industry

The airline industry is a highly competitive market which was already applicable in the beginning in the 1970s where the industry was described as nearly ‘perfectly competitive’ (Sheth, 2007, p. 25).

Since 1938, the U.S. governmental organization Civil Aeronautics Board (CAB) has controlled the airline industry with the aim to achieve an average rate of return. They have regulated prices which were fairly high, routes and additional services for existing and new carriers to protect the railway system for a drop in customer numbers. This was very time consuming for companies due to the fact, that the CAB mostly denied inquiries or restricted them entirely. However, after the World War II, individuals demanded a safer, cheaper and faster transport system (Fischer, 1997, pp. 38-39) / (Robson, 1998, pp. 17-22).

Significant changes took place after the nomination of the economic professor and also known as the ‘father of deregulation’, Alfred E. Kahn as the new chairman of the CAB (Rakowski & Bejou, 1992, pp. 15-29) / (Ben-Yosef, 2005, pp. 1-8). He had the opinion that in a competitive environment “CAB is simply not capable, to make business decisions” and that businesses will best regulate it on their own (Sheth, 2007, p. 27). In 1978 the CAB implemented the airline deregulation act to remove governmental control over routes, fares and market entry which led to a greater flexibility. This resulted in a rapid increase in competition due to an aggressive entering strategy of airlines which caused falling fare prices (Rakowski & Bejou, 1992, pp. 15-29) / (Fischer, 1997, pp. 38- 42) / (Robson, 1998, pp. 17-22). To defend their current market position, low cost carriers (LCC) and hub-and-space (HS) networks were established in the 1980s (see appendix A) (Fischer, 1997, pp. 38-42) / (Robson, 1998, pp. 17-22).

Due to such rapid changes, sustainable competitive advantage is no longer available in the hypercompetitive industry, which is described by D’Aveni. Nevertheless, to survive and maintain temporary competitive advantage, airlines began to merge or incorporate with each other at a national and international level. The effect of the merger wave was to offer a larger route network while they gained a higher market share in the highly concentrated industry (Ben-Yosef, 2005, pp. 1-8) / (Rakowski & Bejou, 1992, pp. 15- 29) / (D’Aveni, 1994, pp. 1-36).

Building alliances follows the strategy of cooperating with potential and current competitors as well as sharing procedures, such as airport facilities, flight schedules and frequent flyer programs (FFP), to save costs. Jan Carlzon (CEO of SAS Group 1981-1994) already forecasted in the late 1980s, “that only four traditional carriers will survive in the New Millennium” (Jarach, 2004, p. 38). To take a look on today’s airline industry, there are three major global alliances, Star Alliance, Oneworld and Sky Team, which cover more than two-thirds of the entire airline industry (Bartolini & Gaggero, 2012, p. 2).

The airline sector is a viable and fast changing industry. This became evident especially after the announcement of the fusion between the insolvent company American Airlines and US Airways in February 2013 (American Airlines, 2013b). They will become the biggest airline company when the merger takes place in the 3rd quarter of 2013. According to this on-going fusion, US Airways will now exit the Star Alliance to enter into Oneworld instead, which American Airlines is a member of (American Airlines, 2013a). This begs for the question, what will happen with the remaining members of the Star Alliance Group, particularly Lufthansa as the main member of Star Alliance.

Therefore, this thesis will answer the following two research questions:

Research Question 1

What is the source of Lufthansa’s competitive advantage?

Research Question 2

To what extend is the competitive advantage of Lufthansa as a member of Star Alliance influenced by the exit of US Airways as a consequence of the fusion with American Airlines?

This thesis will analyse Lufthansa’s competitive advantage within the dynamic airline industry based on a strategic analysis of its internal and external environment. An essential point is to build a temporary new advantage to be ahead of and differentiate from competitors. Thereby, it will be conducted whether interconnecting within Star Alliance can be beneficial for Lufthansa in order to reach potential customers and create a temporary advantage. Furthermore, with the help of a scenario analysis, potential future situations will be examined. This gives an outline about possible effects Lufthansa, as a member of Star Alliance, might have to face after the exit of US Airways.

Due to the actuality of this topic, this bachelor thesis will primarily be based on academic literature and the scenarios will be encouraged and underlined by a management interview given by a member of the airline industry.

Hereby a structural overview of the paper is given, allowing to follow the division of contents. This thesis is organized into two chapters. Chapter one gives an introduction into the theories used in this paper. First of all, an overview about deregulations of a hypercompetitive market will be given which is followed by an analysis of the external and internal environment of Lufthansa and its surroundings. This examination will be based on factors that influence opportunities, threats, strengths and weaknesses. Secondly, the business and corporate level strategy will be examined and will concentrate on how to build a temporary competitive advantage by integrating and building alliances. The next part explains the scenario analysis with reference to the TAIDA model.

In the second chapter, the theory will be discussed and applied to the airline industry and Lufthansa, in reference to the theoretical framework of the first chapter. In the concluding part of the paper, possible future scenarios will be outlined and complemented by the opinion given by an expert from the airline industry in order to identify potential challenges for the competitive advantage of Lufthansa.

2. Theoretical Framework

In the theoretical framework, the strategic management analysis will be explained with the aim to identify a firm’s competitive advantage in a hypercompetitive industry and to describe how to develop future scenarios.

2.1. Strategic Management Analysis in a Hypercompetitive Industry

The preliminarily point for a strategic management analysis is to understand the industry, its environment and a firms unique core competencies (Porter, 1980, pp. 6-7). Strategy describes the way to achieve competitive advantage, based on a set of assumptions and hypothesis which is supported by a company’s vision to inspire and give faith in the short and long-term (Barney & Hesterly, 2006, p. 5) / (Drucker, 1994, pp. 95-105). “Firms obtain sustainable competitive advantage by implementing strategies that exploit their internal strengths through responding to environmental opportunities, while neutralizing external threats and avoiding internal weaknesses” (Barney, 1991, p. 99) with the so called SWOT analysis.

Figure 1: SWOT Analysis

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Source: Barney, 1991, p. 100

2.1.1. Hypercompetition

In order to understand the dynamic industry environment, the concept of Hypercompetition needs to be examined first. Globalization is the increase in availability of information, the access and change of technology, shapes competition among firms and industries dramatically. Only these firms, which built innovatively on their core competencies, jump to the next stage to restart the cycle as winners. This outlines, that sustainable competitive advantage is no longer available in dynamic industries due to rapid changes which lead to a constant pressure to disrupt the status quo, while creating a series of new and temporary advantages (D’Aveni, 1994, pp. 1- 36).

Developed by Rich D’Aveni, Hypercompetition theory describes this aggressive competition with the term ‘dynamic strategic interaction’ based on four areas: ‘cost and quality’, ‘timing and know-how’, construction and destruction of ‘strongholds’ and the neutralization and accumulation of ‘deep pockets’ (D’Aveni, 1994, p. 1).

The first characteristic, ‘cost and quality’, focuses on minimizing costs or maximizing sales volumes to gain higher profits. This generic strategy, developed by Porter, will be analysed later on in the course of the business level strategy discussion (D’Aveni, 1994, pp. 39-70).

The second advantage, ‘timing and know-how’, includes the importance of developing, offering unique resources and knowledge to establish additional value for the customer and to be able to charge more while maintaining a monopolistic situation. This will be explained in the internal analysis by reference to the resource based view (D’Aveni, 1994, pp. 71-113).

If a firm is able to create entry barriers, this is indicated in the third distinctive capability, ‘strongholds’. Distinctive capabilities are organizational strengths, which pursue firms to follow a strategy more effectively and efficiently than competitors do (Barney, 1986, p. 794). With the help of Porter’s five forces, the barriers of entry will be described in the external analysis (D’Aveni, 1994, pp. 114-151).

The last stage, ‘deep pockets’ measures firm’s financial resources to overcome an economic downturn which can be influenced by politics, or the geographic region and is outlined in the macro analysis of the external environment in more detail (D’Aveni, 1994, pp. 152-178). Achieving these four characteristics by building temporary advantage and disrupting the status quo, this can be addressed by the ‘New 7-S’s’ framework (superiors stakeholder satisfaction, strategic soothsaying, positioning for speed, position for surprise, shifting the rules of competition, signalling strategy intent, simultaneous and sequential strategic thrusts) with three critical factors (vision, tactics and capability) (D’Aveni, 1994, pp. 235-254), which is outlined in the following figure.

Figure 2: D’Aveni Hypercompetitive Model ‘New 7-S’s’

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Source: D’Aveni, 1994, p. 248

The ‘New 7-S’s’, have four major goals to understand and follow a dynamic strategic interaction on a long-term basis in a hypercompetitive environment. An advantage is to disrupt the current situation, by moving first, to the next stage of the cycle. The second benefit helps to empower employees throughout the company and identifies customers by gaining an in-depth knowledge in this field. Third, by following an aggressive strategy, the superior will gain a greater market share while weakening the competitor’s position. Finally, launching innovative and unique products in constant pitches are sources of competitive advantage (D’Aveni, 1994, pp. 249-250).

2.1.2. External Analysis

The global competitive environment is determined by the external environment, by identifying opportunities and threats of a company within its broad business environment, the surrounding industry and market. It defines relationships on the macro and micro level.

Macro environment

The macro level describes the broad or far environment, which can be analysed with the STEEPLED analysis. This tool identifies the social, technological, economic, environmental, political, legal, ethical and demographical factors, which can influence the current or future performance of a business (Narayanan & Fahey, 1986, pp. 58- 173).

Micro environment

The micro level refers to the competitive, or also known as the near environment, which analyses the attractiveness of an industry by identifying the threats faced by a firm in the relationship with its customers, suppliers, competitors and the government. In 1980, Porter established the five forces framework to develop the competitive intensity and profitability of an industry according to the bargaining power of buyers and suppliers, the intensity of competitive rivalry and the threat of new entrants and substitutes (Porter, 1980, pp. 3-33).

Figure 3: Porter’s Five Forces Framework

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Source: Porter, 1980, p. 4

The completeness of this model has been argued among experts and also whether, it is considered too abstract and analytical, especially in fast changing industries. However, this will not be considered in this analysis (Grundy, 2006, pp. 213-229). Furthermore, in a hypercompetitive industry, the point of creating entry barriers is essential to gain or lose competitive advantage. Entry barriers can be divided into the followings stages: economies of scale, product differentiation, capital requirements, switching costs, access to distribution channels and cost advantage (Porter, 1980, pp. 3-33).

2.1.3. Internal Analysis

The internal environment includes all factors within an organization that shapes their tangible and intangible resources as a source of competitive advantage. Examples for tangible and intangible resources are outlined in table one. Therefore, it is rather important to identify first, the controlled resources and capabilities of a company (McLoughlin, 2010, pp. 99-112) / (Wernerfelt, 1984, pp. 171-180).

The resource based view (RBV) is an economic theory which identifies the strengths and weaknesses of a company and evaluates with the aid of the VRIO analysis (value, rarity, imitability and organization) whether these fulfil the criteria to earn above average returns through building a temporarily competitive advantage (Barney & Clark, 2007, pp. 69-72). Beginning with the resources, these are classified as the main inputs into a firm’s process, which have to be heterogonous and not perfectly imitable (Barney, 1991, pp. 111-112) / (Peteraf, 1993, pp. 179-191). The next step is to turn these resources into value adding activities to represent firm’s competencies. Also, dynamic capabilities are important as “the firm’s ability to integrate, built and reconfigure internal and external competences to address rapidly changing environments” and exploit organizational learning (Teece et. al, 1997, p. 516). Dynamic capabilities are also known as tangible and intangible resources.

Table 1: Types of Tangible and Intangible Resources

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Source: Valentin, 2001, p. 55

The last step is to identify the organization’s core capabilities, which should be unique and rare in order to differentiate from competitors which complete the basis for building competitive advantage. Prahalad and Hamel (1990, p. 82) stated that core competences are “the collective learning in an organization, especially how to co- ordinate diverse production skills and integrate multiple streams of technologies” to add value to the customer.

2.2. Building Competitive Advantage

A firm has a competitive advantage in a market if it produces at lower costs while matching a firm’s core competencies and opportunities, which are analysed in the internal and external analysis described above (Peteraf, 1993, pp. 179-191). “Today’s competitive advantage may become tomorrow’s albatross unless strategies attune themselves to change in underlying conditions” (Christensen, 2001, p. 105). On the one hand, Dyer & Singh (1998, pp. 660-679) described four main sources of competitive advantage. The sources focus on offering relation-specific assets, knowledge-sharing routines, complementary resources and capabilities and effective governance. On the other hand, Christensen (2001, pp. 105-109), sets economies of scale, economies of scope, vertical integration and non-integration as the source of competitive advantage. In this thesis building competitive advantage will be explained on the basis of the business strategy, which focuses on how to compete in a single business or industry and corporate strategy, with the focus on how to compete in several operating businesses (Barney, 1986, p. 793).

2.2.1. Business Level Strategy

The business level strategy is “concerned with strengthening the company’s market position and building competitive advantage in a single business company or a single business unit of a diversified multi-business corporation” (Barney, 1986, p. 793). With the three generic strategies, developed by Porter, the industry performance can be evaluated whit the aim to create additional value for the buyer. Nevertheless, to follow any of these strategies, an overall commitment and support of the organization is essential for an effective implementation (Porter, 1980, pp. 34-46).

Figure 4: Porter’s Generic Strategies

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Source: Porter, 1980, p. 39

Firstly, if a company follows the cost leadership, it means that it offers products and services at a lower price in comparison to all its competitors. This might also be influenced by the sources of cost advantage. Secondly, firms can also offer industry wide unique products and services as distinct capabilities and charge these at a higher price in order to gain competitive advantage. This level of uniqueness requires that firms contribute a perceived value to their customers by differentiating their products and services from rival ones. Finally, the focus strategy concentrates on a particular segmentation of products and services, geographic regions or individual buyer groups. Moreover, by setting the focus on a specific target, firms are able to narrow their field and offer their individual products at a lower cost level (Porter, 1980, pp. 34-46).

2.2.2. Corporate Level Strategy

The corporate level strategy, “establishes an overall game plane for managing a set of businesses in a diversified, multi-business company” (Barney, 1986, p. 793). There are various corporate strategies, to gain competitive advantage in the long run.

The first strategy combines operational strengths and franchise marketing or operations (KPMG International, 2013, p. 21) / (Hanlon, 2008, pp. 94-106). The second possible strategy is to enter an earnings share agreement. Such combined services or also called joint ventures which are written agreements to collaborate towards a particular aim and share all losses and profits (KPMG International, 2013, p. 21).

Another possible way is to make direct investments to obtain a voting or controlling right in another company in order to expand services and gain influence in other markets (KPMG International, 2013, p. 20). Outsourcing is also a way to cut costs, while shifting activities to other external companies. In addition, with interline and code- sharing agreements a firm is able to coordinate uniform services. Here, the operating company operates all services and the marketing company only offers this provided service to the public (KPMG International, 2013, p. 20) / (Hanlon, 2008, pp. 94-106). Furthermore, with an M&A, organizations can combine similar synergies with partners and act as one company (KPMG International, 2013, p. 19) / (Iatrou & Oretti, 2007, p. 118). The last option is to expand a company’s network with a strategic alliance (Walter & Barney, 1990, pp. 79-86). A network is “any collection of actors that pursue repeated, enduring exchange relations with each other and at the same time lack a legitimate organizations authority to arbitrate and resolve disputes that may arise during exchange” (O’Connell & Williams, 2011, p. 172).

This thesis will only discuss the effects of strategic alliance in a hypercompetitive industry, where firms combine its core competences and skills to build a network and increase its market share to join competitive advantages (Smith, Carroll & Ashford, 1995, pp. 7-23).

A strategic alliance is an inter-firm cooperation with a long-term perspective to combine all assets and capabilities to work towards a common interest with the intention to enhance competitiveness and performance for all members (Iatrou & Oretti, 2007, pp. 75-87) / (Oum, Park & Zhang, 2000, pp. 30-37) / (Bartolini & Gaggero, 2012, p. 3) / (O’Connell & Williams, 2011, p. 172). Alliances can be built with vertical or horizontal integrations. Vertical integrations can be divided into forward and backward integrations. Whereas forward integration acquires firms along the distribution chain, firms acquire its suppliers with a backward integration. If firms adopt other companies or activities with a similar production and services, this is known as horizontal integration (Mowery, Oxley & Silverman, 1996, pp. 77-91) / (Chan et. al., 1997, pp. 199-221). Advantages and disadvantages of building alliances in general are listed below.

Table 2: Advantages and Disadvantages of Building a Network

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Source: own illustration adapted from Dyer & Singh, 1998, pp. 660-679 / Gonzalez, 2001, pp. 47-510 / Mowery, Oxley & Silverman, 1996, pp. 77-91

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