When Atlanta-based Delta Air Lines announced a partnership with London-based Virgin Atlantic on 11th December last year, it marked an important shift in the transatlantic market dynamics. The deal for 49% of Virgin Atlantic that had been previously owned by Singapore Airlines, purchased in 2000 for £600 million (US$965 million), worth US$360 million, will expand connection opportunities for Virgin frequent flyers in the United States through Delta’s hubs, and on the flip side for Delta flyers in the form of long-haul connections beyond London Heathrow as well as to a few regional destinations in the United Kingdom (UK) that were included in the carve-out of London Heathrow slots after the purchase of British Midland Airways (bmi) by International Airlines Group (IAG). Additional benefits for passengers and frequent flyers include reciprocal lounge access at Delta SkyClubs and Virgin Atlantic Clubhouses, and other reciprocal benefits in earning and spending miles in the respective frequent flyer programmes. The two carriers will also launch a full “joint venture” partnership covering the combined 31 flights per day between London Heathrow and the United States on which Delta and Virgin Atlantic will share all revenues and expenses equally.
Virgin deal strengthens SkyTeam’s position at London Heathrow
Perhaps the most benefit of the deal will be the one that is least financially quantifiable; the added strength that this move provides to SkyTeam in the transatlantic and London markets. While Virgin Atlantic will remain independent of any alliances in the near term, longer term the status quo of a Delta/Virgin Atlantic joint venture cannot survive. For instance, Delta, Air France-KLM, and Alitalia already have a highly lucrative joint venture partnership in place for transatlantic flights, which includes Delta’s services to London Heathrow. In fact, most of Delta’s London Heathrow flights utilise slots leased from Air France-KLM as Delta only owns enough slot pairs for 2 daily flights by itself.
Now that Delta’s Heathrow flights are also subject to the joint venture with Virgin Atlantic, it raises several questions for the broader SkyTeam JV. If Delta right now is making more profits than Virgin Atlantic, then post Delta-Virgin, the SkyTeam JV will lose some of its profits, because its share of Delta’s LHR profits is cut. And depending on the specific language in either JV, SkyTeam might actually be precluded from some of the revenue at Heathrow.
In the long run, this sort of arrangement and uncertainty is not sustainable and thus it is likely that Virgin Atlantic will join SkyTeam and its transatlantic joint venture in the not too distant future. If and when it does so, it will dramatically rebalance the current market structure in the London market.
As of today, at London Heathrow which is the only relevant airport for business travel in London, SkyTeam has a 6.5% share of capacity, while Star Alliance holds around a 19.4% capacity with oneworld holding a dominant 58% capacity share at the airport. The addition of Virgin Atlantic, especially with the 12 new slot pairs it received from International Airlines Group (IAG), will push SkyTeam’s capacity share northwards of 12.5%. While this is still below that of Star Alliance, it makes SkyTeam much more competitive for frequent flyers and business travellers with a large London travel component. The incremental value and extra revenue to SkyTeam in that case can number in the tens of millions of dollars every year.
Another way to measure the impact of Virgin Atlantic on the Heathrow market is to look at the slot share of each JV – this gives an idea of the limits on each alliance’s transatlantic market share in Heathrow, the maximum potential market share available for each alliance if they increase capacity or shift slot allocation amongst member airlines. oneworld leads this category with 5,088 slots available, Star Alliance is second with 836 slots available, and SkyTeam is at a distant third with just 501 slots. However, when Virgin Atlantic is added to the SkyTeam mix, the alliance instantly takes over Star Alliance’s second place with 973 slots.
For Virgin Atlantic, Delta deal provides desperately needed capital
The deal is attractive for Virgin Atlantic – firstly, it provides the long-haul carrier specialised in Atlantic-crossing with an important source of capital as well as additional feed in its ongoing fight against a resurgent British Airways. The major benefit will come in transatlantic markets, where more than 70% of Virgin Atlantic’s overall capacity is deployed. However, despite the airline’s strength in key business markets from London and key leisure markets from around the UK, it slipped to a net loss of £80.2 million (US $129.7 million), the third time in the carrier’s 28-year history. Thanks to the partnership with Delta, Virgin Atlantic will become much more attractive for London-based frequent flyers. Delta currently offers 2 flights per day between London and Atlanta, 1 flight to Boston, 1 flight to Detroit, of which the Detroit service typically jumps to 11 weekly or double-daily in summers, 1 flight to Minneapolis-St. Paul, and 3 flights to New York John F. Kennedy International Airport (JFK). The key flights are in the New York-London market, where American and British Airways have 15 daily flights, whereas Virgin Atlantic has just 6 daily flights. With the Delta partnership, that figure jumps to 9, and while this is not comparable to the number of flights offered by BA and its transatlantic immunised joint venture (JV) partner American Airlines (AA), it is nevertheless a big leap forward.
While the majority of European fliers to these cities are likely to be SkyTeam frequent flyers already, Virgin Atlantic could pick up some incremental UK-based frequent flyers to these cities, and benefit on routes not covered by a future SkyTeam joint venture such as Mumbai, Dubai, Accra, Cape Town, Johannesburg, Lagos, Nairobi, Shanghai, Sydney, or Tokyo. It could also pick up incremental frequent flyers from oneworld and Star, which would improve performance on its other long-haul routes as well. Another factor in making Virgin Atlantic more attractive to London-based frequent flyers is the enhanced connectivity in the US – Virgin Atlantic will offer a service on which its frequent flyers could easily connect to hundreds of secondary and tertiary destinations around the US, which makes it more attractive. While these gains are likely to be small individually, the boost of several additional frequent flyers and business trips, or potentially even a few corporate contracts, when aggregated is significant – it could cross US$40 million per annum per Aspire Aviation’s estimates, which in an industry with tiny profit margins is a major improvement.
That said, the deal will not materially improve the connectivity of Virgin Atlantic at London Heathrow. In the near term, with Virgin Atlantic operating from Terminal 3 and Delta operating out of Terminal 4, very few connections are likely to be scheduled through Heathrow, as they would necessitate passengers to clear immigration and then re-clear security. Delta would prefer to route its connecting passengers through SkyTeam partner hubs in Amsterdam and Paris, albeit the connection experience in Paris is generally regarded as one far from seamless. Even after Delta relocates to Terminal 3, connectivity will be far from optimal. The majority of African and Asian flights depart between 8-10 pm at night. Meanwhile, all of Delta’s Heathrow flights arrive by 12:00 pm, which makes anything except Cape Town, Shanghai, and Tokyo an unbearably long connection. With ample service on Delta metal to both Tokyo and Shanghai, Cape Town is the only logical connection. And while Delta could use US morning departures to improve connectivity by swapping slots with SkyTeam partners, the market indicates that the only commercially viable timing for origin and destination (O&D) on flights to Europe are US evening departures. As the passengers connecting to Virgin Atlantic’s destinations are likely to be lower yield, Delta is arguably better served through connections in Paris or Amsterdam where the long haul economies of scale make low-yield connections more economically feasible. In terms of connecting from Asia/Africa to the US, the connectivity is mixed. Hong Kong, Cape Town, Johannesburg, and Sydney all connect well onto Delta’s US network, though the rest of the network only connect well to New York. Therefore while there will be some incremental connectivity improvements, the Delta Air Lines deal will not create much meaningful financial synergy for Virgin Atlantic.
In terms of changes, it is unlikely that Virgin Atlantic will add or augment to any current Delta hubs outside of New York JFK. Delta might make the second summer flight from Detroit daily and add frequencies at Atlanta or Minneapolis. In the longer term, as Virgin Atlantic brings on Boeing 787-9s of which 15 examples are on order and potentially Airbus A380s of which 6 are on order, it might use some of SkyTeam’s slots to expand services to Africa or Asia, maybe even Latin America. That is a major potential for expansion, although this may be more than 2-3 years away at the earliest.
With regards to the effect on competitors, British Airways is hurt to some degree by any improvement at Virgin Atlantic, but effects will be muted in scale. At the end of the day, British Airways has more than 350 peak day departures from London Heathrow, including more than 80-90 long haul ones – the new Virgin Atlantic-Delta tie up will have just 31 long haul flights and 9 short haul flights after 3 of the 12 new slots Virgin Atlantic gained from the bmi slot carve-out were returned when Virgin could not secure rights to serve Moscow. Still, as European short-haul flights continue to face pressure from low-cost carriers (LCCs) and Iberia faces the dual threat of increased labour antagonism and a collapsing Spanish economy, any threat to IAG’s cash cow of London Heathrow long-haul routes is troubling.
For Delta, the benefit is first and foremost to improve its access to the lucrative transatlantic market. It too will be able to pick up incremental frequent flyers, business travellers, and corporate contracts in cities such as Miami, Los Angeles, Chicago, San Francisco, who will in turn increase their Delta flying within the United States. Delta can also tap into Virgin Atlantic’s existing frequent flyer and corporate contract base for connections onwards into its US network. The move also helps with Delta’s access to regional destinations in the UK; specifically Glasgow, Edinburgh, and Aberdeen, none of which are currently served by Delta. While KLM does a strong job of connecting the regional UK, these connections are much more efficiently done through London Heathrow. And the biggest benefit will come in the lucrative New York-London market. Tripling the frequency on the most important route for New York-based business travellers will make Delta infinitely more attractive and competitive. It also represents a big step forward in Delta’s so called “Win New York” strategy. The strategy, which includes a new domestic hub at New York LaGuardia, and airport upgrades at both LaGuardia and JFK where the existing terminal is being torn down and replaced, is aimed at reducing the edge held by market leader United in the all-important New York market.
As with Virgin Atlantic, the market-specific benefits outside of New York will not be large. But when the small effects are added up, once again it makes up a large annual figure; perhaps as much as US$100 million per annum. For a purchase price of just US$360 million, the deal will likely pay off for Delta, especially in a long-term strategic sense. And it continues Delta’s overall international strategy of linking up with foreign carriers to fill network holes that it easily cannot. For example, in order to reduce SkyTeam’s weakness in Latin America, Delta invested in Aerolineas Argentinas, Aeromexico, and Brazilian low-cost carrier (LCC) Gol to increase feed in the region. It also launched a joint venture for Australian flights with Virgin Australia. In the coming months, Delta will likely expand this strategy even further as it looks to fill holes in its international network.