Ba - Iberia After Nearly Two Years

BA - Iberia

After nearly two years of negotiating, British Airways (BA) and Iberia completed their merger in the spring of 2010 (Arnott, S., 2010). By 2011, the combined entity earned an operating profit of €190 million. The profit was attributed to improved U.S. business due to a partnership with American Airlines, and strong group buying power that helped control jet fuel expense (Rothwell, S., 2011, 1). The combined entity is known as International Airlines Group (IAG) and has pledged to grow further, something that combined with the operating benefits has added to its share value (Rothwell, S., 2011, 2). When the merger was first proposed, the two airlines noted that there were synergies to be won, and that the combined entity would be better able to thrive in the current difficult market conditions (Werdigier, J., 2009). The success of the merger can be attributed in part to a good understanding of the market forces in the airline industry and how the merger helped improve the two airlines' ability to respond to those market forces.

Porter's Five Forces model is a tool that can be used to explain a firm's pricing power within its industry. The five forces are supplier power, buyer power, threat of substitutes, threat of new entrants and intensity of rivalry (QuickMBA, 2010). In the airline industry, supplier power is low to moderate. The size of airlines gives them bargaining power over most suppliers. The two biggest expenses are labour, over which the airlines have strong pricing power and fuel, over which the airlines have only limited pricing power. They can hedge and perhaps gain some economies of scale, but ultimately airlines are forced to adjust to jet fuel prices that sometimes fluctuate strongly. The airline industry is highly competitive. Holiday-takers are not usually price-takers, although business passengers and trans-ocean passengers are more likely to be price-takers. On many routes, there is a high risk of substitution from various forms of land transport, or even from travelling to different destinations. On long-distance routes, however, the threat of substitutes is significantly lower. The threat of new entrants is high. The airline industry has seen many startups enter the business in the past 20 years to challenge the established carriers. These new competitors are challenging both the low end of the market (Ryanair, EasyJet) and high end (Emirates, Etihad). The intensity of rivalry is strong among firms in the industry, due to high fixed costs and a high number of players competing for a finite number of highly lucrative routes. Overall, the pricing power for firms in the industry is only moderate as the result of these factors. The combined IAG has greater power over its suppliers, which helps to drive down costs, and better control over trans-Atlantic routes in particular, which helps to improve revenues.

The PEST analysis can also help to understand the characteristics of the external environment. The first aspect is the political environment. Airlines are heavily regulated, and this adds to the cost structure, but these costs are universal to all airlines operating in the EU. There are some political dimensions to landing rights as well, as many national carriers have exclusivity over the most desirable airports. When airlines combine, they gain better access to more key airports through their alliance. The economic environment was challenging at the time of the merger (Werdigier, J., 2009), providing incentive for firms in the industry to merge in order to improve their bargaining power over suppliers. The economic environment for European airlines with a Trans-Atlantic and continental focus remains weak as the economies of both Europe and North America are subject to slow recovery. The social environment remains strong. Economic considerations aside, people still love to travel. The latent demand for air travel is still strong, even if purchases decline somewhat. The technological environment is relatively stable in the airline industry today. There is continuous innovation in flight technology, but it is largely incremental at this point, with no major new technologies revolutionizing air travel. This benefits airlines -- there are also no major new technologies on the horizon that are threatening the basic business model of airlines either. In general, the external environment is favourable for airlines; while there are challenges, those challenges are by no means insurmountable. Given the prevailing conditions, industry consolidation is a good option for improving bargaining power and control over key routes.