MIAMI By most measures, the global airline alliances are as robust as ever. Star Alliance, oneworld, and Skyteam now comprise 62 member airlines, which represent more than 50% of global capacity and generate more than $380 billion in revenue annually.

At this point, the alliances have collectively sown up most of the full-service carriers in desirable markets across Europe, North America, and Asia-Pacific. Thus only Latin America and the Middle East remain as significant markets where alliance penetration lags among full-service carriers, whereas the African aviation market still isn’t developed enough to justify a widespread alliance membership.

Meanwhile, the biggest threat to alliance hegemony in recent years was the rise of the Middle East Big 3 carriers (Emirates, Etihad, and Qatar Airways) as well as Turkish Airlines’ new prominence in serving intercontinental traffic flows. However, Turkish Airlines continues to embrace its Star Alliance membership and Qatar Airways has settled into oneworld nicely.

So on the surface, the alliances appear to be in great shape. But fault lines are emerging.

Alliances provide a lot of value

Alliances can be thought of as a way to gain some of the benefits of cross-border airline mergers without running afoul of the legal prohibitions against such mergers in most of the countries or geographic regions around the world. Airline mergers generate synergies, both through eliminating redundant costs and by generating revenue from a combined network and sales presence. However, since most countries require airlines that operate origin and destination networks at their airports to be majority owned by citizens, the only way for carriers such as Thai Airways and Ethiopian Airlines to recognize those types of synergies is through some sort of cross-border alliance.

On the cost side, savings are generated through a variety of measures, including co-locating member airlines at airports and sharing facilities such as gates, premium lounges or even terminals (i.e. London Heathrow).

Simultaneously, alliance members generate revenue synergies by coordinating schedules, code sharing, recognizing partner frequent flyer programsand allowing reciprocal earning and redemptionand enacting block space agreements, which allow airlines to block out a set number of seats on their planes for partner carriers to sell. There are also intangible benefits such as increased customer and corporate contract retention due to the increased network presence offered by alliances.

And despite their imperfect natures, these partnerships drive a lot of value for members. In a large alliance like Star Alliance, the annual revenue contribution (excluding benefits specifically from joint venture partnerships amongst alliance members) can range from a few million dollars annually for smaller members such as Aegean Airlines to hundreds of millions of dollars each year for a behemoth like United Airlines.

On a route-specific level, benefits can be even more stark due to increased feed. For example, American Airlines feeds more than a hundred passengers per day onto one world partner Cathay Pacific’s flights between Los Angeles and Hong Kong in each direction. No doubt a factor that drives Cathay’s ability to offer four daily flights on the city pair.

A tangled strategic web

However, there is a sense that the alliances are getting unwieldy, with members frequently finding themselves at cross-purposes with one another. In particular, oneworld has a tangled set of partnerships that call into question the future for some of its members. For example, American Airlines has close ties (including anti-trust immunity [ATI]) with Qantas, British Airways parent International Airlines Group (IAG), and Japan Airlines, as well as strong ties with Cathay Pacific. Japan Airlines also has anti-trust immunity and close ties with IAG.

However, cooperation between Japan Airlines and Cathay Pacific or Qantas is non-existent. Additionally, Cathay Pacific and Qantas have entered into head-to-head combat over Qantas’ proposed Jetstar Hong Kong operation which in turn would see Qantas partner with Skyteam member China Eastern to offer low-cost competition at Cathay’s primary hub at Hong Kong.

Cathay Pacific also has close ties with Star Alliance member Air China (in which it holds a reciprocal equity share), that likely detracts from its contribution to oneworld. Separately, Qantas and IAG used to have deep ties and ATI on the Kangaroo route, but Qantas ditched IAG in favor of unaligned Emirates while IAG has gotten closer with Emirates’ rival Qatar Airways, who now owns 9.99% of IAG. And to top things off, while Qatar Airways is an actual member of oneworld, American Airlines seems to prefer partnering with its unaligned rival and fellow MEB3 carrier Etihad.

There are similarly tangled strategic webs of conflict amongst Star Alliance and Skyteam members, and what this all points to is the fact that the global airline alliance may no longer be the optimal partnership strategy for airlines today.

Given the constant evolution that airline products, networks, and market conditions undergo, it may actually make sense for airlines to instead opt for a patchwork system of weaker (code share and interline agreements) and deeper (joint ventures and/or equity stakes) partnerships with a targeted set of airlines.

Joint venture or bust

Code shares, while they lack some of the cost synergies of alliances, are nothing to sneeze at. Look no further than Alaska Airlines’ more than $850 million in code share revenues resulting from its “Swiss neutrality” system of partnerships. On the other end of the spectrum lie anti-trust immunity and joint ventures, which allow for deep ties that effectively enable cross-border mergers without violating the legal terms of bilateral agreements.

While anti-trust immunity and joint ventures (JV) often go hand-in-hand, they are technically separated (ATI must precede a JV). ATI essentially allows two airlines to hold in-depth business conversations about things like pricing, coordinating of schedules, and the like in a way that would normally violate antitrust laws (hence the name anti-trust immunity).

A JV goes a step beyond, and allows the two carriers to act as if they were a single airline for certain portions of their respective network (i.e. Trans-Atlantic flights or flights between the United States and Australia), jointly making capacity, schedule, and pricing decisions while sharing revenues, costs, and profits from the services covered by the JV. Not all grants of ATI result in a JVfor example Delta and Korean Air have ATI, but have not agreed upon a Joint Venture agreement… yet.

Joint Ventures are better for airlines than normal code share or blocked space agreements because they allow for the explicit coordinating of schedules, sharing of revenues/costs, and (in a more cynical sense) the blatant control or reduction of capacity and thus increase in fares and profits in previously competitive markets.

For the moment, JVs are usually only allowed between countries or regions with open skies bilateral agreements allowing free entry, which is why the U.S. airlines have the most JVs. But as more and more countries opt for open skies, the prevalence of Joint Ventures will only increase, and will be even bigger business than alliances or code shares.

The numbers behind the Joint Ventures versus Alliance Equation

By any measures, the numbers involved in Joint Ventures dwarf those driven by alliance membership. For example, when Air India, a mid-sized carrier by global standards, joined Star Alliance, it projected revenue increases of $130-150 million annually, driven largely by the strategic import of the Indian market. Additionally, Eva Air, a similarly sized carrier in a less important market (Taiwan) only managed to generate $80-100 million in annual revenue gains from alliance membership.

Meanwhile, the aggregate revenue figures included in JVs is hugean estimated $7 billion annually for the oneworld JV anchored by American and IAG, and $10-11 billion for the SkyTeam JV including Delta, Air France-KLM, and Alitalia. The Trans-Pacific Joint Ventures are smaller, but still handle billions of dollars in revenue and hundreds of millions of dollars in profits, while the smallest JVs are cross-border ones for short-haul flights (i.e. Delta-Aeromexico, which was projected to handle $1.5 billion in combined revenues). However, in order to assess the true financial impact of JVs, merely summing the revenues of flights covered within the JV will not suffice.

Instead, the better number to assess is how much each Joint Venture contributes to the profits of member carriers – measuring the actual benefit for Joint Venture members. These figures are much smaller, for example the Delta-Air France JV generates about $200 million in annual incremental profits for the atlanta-based carrier, while American and IAG each generate $240-250 million apiece from their Joint Ventures.

Even when the JVs are scaled down like this, the value to member airlines dwarfs that of alliance membership. At a 20% profit margin (i.e. in the top 1% of all airlines worldwide), the annual incremental profit from alliance membership is no more than $60-70 million for carriers like American, Delta, United, or IAGand each of their JVs returns several times that annually.

The equity alliance(s)

An even deeper form of cooperation is for one airline to buy an equity stake in another carrier, ranging from small ticket purchases such as Delta’s purchase of a 3.5% stake in China Eastern to its acquisition of a 49% stake in Virgin Atlantic. The smaller equity stakes tend to be about securing partnerships in critical airline markets (Qatar Airways’ stake in IAG is of this type), while the larger stakes enable the acquiring airline to exert significant strategic control. For some airlines such as Delta, the equity stakes function independently as a mix of those two functions in various geographies around the world.

But for others, such as Etihad Airways, the equity stakes may well function as a new, more attractive alliance structure. Over the last 5-6 years, Etihad has purchased large equity stakes in financially troubled carriers around the world such as Alitalia, airberlin, Jet Airways, Air Seychelles and Virgin Australia. In doing so, it has deepened the cooperation among all of these airlines while gaining substantial strategic leeway to reshape their networks in any manner it sees fit.

So Etihad, with its equity alliance, has come closest to achieving the initial goal for alliances of a cross-border merger in all senses of the word except the legal one. And it would not be surprising to see other carriers building similar equity alliances. For example, IAG may certainly invest worldwide once it completes its strategic acquisitions within the EU. And Delta, who has steadily slipped away from the Skyteam fold, may well do the same with its own set of equity investments.

The future of the global alliance is questionable

All of these factors, particularly the feasibility of Joint Ventures change the viability and necessity of global alliances in the airline industry. At the same time, the alliance system isn’t necessarily going to fall apart immediately. Over the short run (the next 5 years or so), the alliance system is probably secure, given how much inertia it has (including lots of joint investments that will induce member airlines to fall for the sunk cost fallacy). But on a longer run timeline, its survival will depend on how much further the tangled strategic web among member airlines develops, and whether the inevitable joint ventures and equity purchases occur within, outside, or across alliance lines.