With a common focus on cabin service, unique culture and premium revenue optimization, Delta Air lines and LATAM Airlines Group alignment might be after all a better fit for both carriers.
Global stock markets, American Airlines, Oneworld alliance members and the aviation community were caught by surprise with the announcement that Delta Air Lines will buy a 20 percent stake in LATAM Airlines Group. In 2019, LATAM was planning to make a significant milestone by getting the approval of two major Joint Business Agreements (JBA).
The first planned JBA was between LATAM and American Airlines. The second was between LATAM and International Airlines Group (IAG), which controls European airlines British Airways and Iberia. But the plans did not go through. Should they have been approved by authorities, these JBAs will have helped the airlines to enhance revenue sharing for both passenger and cargo, further integrate their networks, provide enhanced connectivity opportunities, increase aircraft utilization and offer more non-stop flights with shorter connecting times while enabling its passenger to access 400+ destinations.
Likewise and for a long time, LATAM has been strengthening its ties with Oneworld alliance partners to pursue a deeper relationship in order to reap strategic network, scheduling, revenue and cost containment benefits among others.
But why did Delta and LATAM decide to join forces and what are the key benefits for each?
Because of the importance and potential of Latin American air travel demand -- and the race to position to capture that growth.
LATAM serves a large world area with perhaps little traffic when compared to other world regions by volume such as Asia Pacific. Boeing's 2018-2037 Commercial Market Outlook shows South America to represent 6 percent of world traffic while Asia Pacific, for example, accounts for 30 percent followed by Europe and North America with 27 percent each while other areas account for 10 percent.
However, Latin America shows the highest growth potential with 7 percent RPK growth. In comparison, the world average RPK growth is less than 5 percent. Moreover, when considering mature markets such as Europe and the US, they stand at 3.6 percent and 2.8 percent respectively. Therefore, Latin America is a small but key market to be positioned in.
The number of flights per capita is an important metric to ascertain market stimulation potential. Based on World Bank data, New Zealand stands at 3.4 flights per capita, the US is at 2.6, and the UK at 2.3. For example, Chile stands at 0.98 while Brazil - the largest market in South America and the sixth-largest domestic passenger market in the world - stands at 0.46. Therefore, the potential to stimulate demand remains high in Latin America. This is, in fact, one key reason why Chilean LAN Airlines decided to partner with Brazilian TAM Airline in Y2012 to create LATAM Airlines Group.
This observed potential and LATAM's dominant positioning in the region and its strong footprint in Brazil is what caught the interest of Delta. Initially, Delta partnered with GOL Airlines to take advantage of Brazilian feeder traffic. Being LATAM the second largest player in Brazil with operations in 45 airports, operating a strong route network with an average of 560 daily domestic flights with a clear hub strategy were enough attributes for Delta to join forces with LATAM.
Besides, unit revenues are expected to continue improving in Latin America principally from revenue enhancement opportunities in Brazil as its economy continues strengthening resulting in both improved traffic and premium revenue through higher fares. These will translate to additional connectivity for Delta.
Looking at other regional markets in Latin America, LATAM domestic passenger operation includes flights by LATAM Argentina, LATAM Chile, LATAM Colombia, LATAM Ecuador, and LATAM Peru, totaling more than 1,000 flights per day. The airline is the market leader in Chile and Peru, with close to 60 percent market share in each. However, a few years ago its participation was close to 80 percent but due to ULCC penetration in those markets, the airline has been losing ground and is facing reduced profitability due to fare competition. In Argentina and Colombia, LATAM is the second-largest player followed by Ecuador where it is the third.
In terms of seat capacity share and considering South to North America markets in 2018, American Airlines shows 22 percent share while LATAM has 20 percent and United 10 percent. On the one hand, this shows that Delta will be able to reap important traffic, revenue and branding benefits from the region based on LATAM's strong seat share positioning. Likewise and when considering seat capacity share, South America to European markets Air France/KLM stands at 21 percent, IAG 18 percent and LATAM 12 percent. On the other hand, LATAM will be able to reap important traffic and revenue benefits in those markets based on Delta SkyTeam members strong seat capacity share in those markets.
Looking at revenues in the region, Delta derived only 7 percent of its revenue from Latin America while 71 percent comes from its US domestic operation, 16 percent from Atlantic operations and 6 percent from Asia as follows:
By having a more solid footprint in Latin America, Delta can optimize its revenues. Its CEO expects the LATAM partnership to bring US$1B in revenue growth over the next five years.
As both, Delta and LATAM have been running consistent and solid operations with mid to upper 80s load factor, have strong brand with a growing loyalty base and an embedding culture resulting in strong focus on soft spec and its key focus on employees, I expect under a number of high-level assumptions ran and a conservation scenario that Delta revenues in Latin America could reach 10 percent to 12 percent of total passenger revenues. Likewise, LATAM will be able to reap important economic benefits from Delta and its partners in South America to European markets.
Under this partnership, both airlines can commercially coordinate joint sales and marketing efforts, collaborate on airport facilities and many other cooperation arrangements including airport lounge access, airport ground handling, maintenance services among others that most likely will be pursued in a value-based phase approach.
On the one hand, direct and immediate benefits for the airlines will include important passenger options in terms of non-stop flights, shorter connection times and greater passenger flexibility and autonomy in terms of frequencies and scheduling choices.
By YE2018, LATAM had over 30 million members in its frequent flyer programs (an increment of almost 10 percent from the previous year) with 15+ million LATAM Pass members and 15+ million LATAM Fidelidade members. Overall, the potential to trade miles for airplane tickets from one carrier to the other will be fully explored. Delta loyalty travel award revenues increased US$243M to $2.6B in Y2018 reaching almost the whole amount Delta collects in revenues from Latin America passenger services. An impressive number.
Moreover and under the other revenues category, Delta loyalty program revenue relates to brand usage by third parties associated with Delta co-branded credit card reached US$1.5B in Y2018. These are the key differentiator and core competitive strategies Delta fully exploits to its advantage and is are areas where LATAM might be looking forward to further optimize revenues and overall profitability.
On the other hand, indirect benefits and synergies in terms of network management will include the possibility to operate thinner traffic destinations which would be unprofitable for a standalone carrier. Furthermore, other indirect benefits will include business optimization in a number of areas and hopefully more market penetration through competitive pricing and micro-segmentation that could push premium revenues to the next level.
Air and foreign travel followed by immersion or experiential travel continue driving growth, building and growing a highly personalized, high-margin loyalty and service revenue stream portfolio to push forward higher consumer spending and revenue per passenger might provide that extra premium revenue for both airlines in order continue battling the region/world many challenges including increments in jet fuel prices, headwind from unfavorable foreign exchange rates, labor strikes, ULCC expansion and others.
Enhanced premium revenue through seat mix, upsell and customer satisfaction have been driving Delta's top-line revenues in the last few years. From a product standpoint, Delta has created a core competitive advantage through a multi-class product segmentation that has assisted to diversify its revenue stream. Today, Delta larger portion of revenue is now generated by a more diverse, higher-margin revenue stream for both revenue premium tickets and loyalty program services which each has almost double in the last 7 years as follows:
LATAM’s new fare segmentation on all domestic markets was executed in Y2017 and was a late move when compared to other full-service carriers. In addition, fare segmentation in all international routes was completed just last year. LATAM's new sales model allows passengers to choose among four fares categories with differentiated options for bags, seating and flexibility for travel date changes. In contrast, Delta has pioneered a distinct travel experience model with clear value propositions that enable customer choice. For example, Delta One, Delta Premium Select, First Class and Delta Comfort+ include varying premium amenities and services while main cabin and basic economy allow varying levels of pre-travel flexibility. To ensure premium revenues and to align a seamless travel experience, this will be a key area of collaboration and catch-up for LATAM.
Delta uses a retail-oriented, merchandised approach to distribution with well-defined and differentiated products to passengers. Its model is based on a number of merchandising initiatives implemented across its distribution channels that allow passengers to better understand its product offerings, making it easier to buy products they desire while increasing revenues per passenger and travel experience satisfaction. Its merchandising effort is most effective in Delta's digital channels where customers can compare all product options in a single, easy to understand display as tested. A number of these products are known to yield a high margin from 35 percent to 100 percent+.
Relating to LATAM, its ancillary revenue strategy includes change and cancellation fees, excess baggage weight, 1st bag charges, seat selection, upgrade bid and LATAM+ seating or the first 6 rows of its high- density aircraft. Although a late follower, its ancillary revenue strategy has increased more than 50 percent since the implementation of the airline new sales model in Y2017 that has allowed the airline to personalize its offering while allowing passengers to benefit from lower fares. I expect this to be another key area both airlines will continue working on to reach the typical ancillary revenue average of 10 percent of total revenues for a full-service carrier model.
The use of biometrics to speed up the boarding process will be a key initiative for both airlines. Pilot programs of facial recognition have been successfully executed in the Carrasco airport in Montevideo, Uruguay. In addition, Atlanta International airport is today the first facial recognition biometric terminal for international travelers. Therefore and as Delta is perceived to be a leader among global airlines in this regard, this will be a key area to jointly explore leaner business processes and lower headcount in order to reduce CASKs and overall costs.
As both airlines continue facing competitive and cost pressure in all markets, they also need to further reduce the number of Full Time Employees (FTE) per aircraft, a key metric in the airline business. As of YE2018, LATAM shows 129 FTE per aircraft from 162 it had by YE2014 which shows solid progress in headcount reduction. In contrast, Delta mainline operates with 102 FTE per aircraft or 27 employees fewer than LATAM by YE2018. When looking at Delta's total fleet number of 871 by YE2018, this is almost 24,000 fewer employees. Assuming an average of USD60K per year and 1.3x labor benefits, this amounts to US1.9B. In an initiative to reduce cost under this partnership will be jointly work on digital technology procurement especially for drop off bag machines. By mutually working on a number of cost containment strategies and further pushing a number of digital processes and strategies, a leaner workforce structure can be achieved. For example, LATAM goal to expand self-services to roughly 30 airports in 2019 need to be further enhanced.
Furthermore, LATAM has tested successfully a number of augmented reality applications through its app pioneering, for example, one of them that allows passengers to find out if their carry-on baggage is within the limits allowed on board. This technology uses only their phone’s camera and is offered for Android and iOS devices. By YE2019, biometric identification will be available for LATAM passengers in at least six airports but further work is needed in this area to improve profitability and margins.
Digital transformation will be a key investment area for both airlines under this partnership. It will support operations and provides tools to employees not to mention that technology is a core competitive advantage these days that can deliver more personalized service, further enhancing the customer experience and strengthening their brand and competitive position.
Other areas for both airlines to work under this partnership should include, end-to-end travel experience, cabin interior investment, synergies of a joint frequent flyer program that focuses on CRM, data analytics, high margin products and a unified value proposition, among others.
In terms of unique culture and people, both Delta and LATAM for many years have consistently run probably solid operations with strong brand recognition and a growing loyalty base which has been possible by their focus on employees and its culture resulting in a strong soft spec and unique competitive advantage. A number of these soft specs include great cabin services, unique culture and just as simply as staff friendliness which is not that common today in the airline business among others. That is exactly why (and besides other points discussed in this article), LATAM alignment with Delta is a better fit than with its previous predecessor.
But both airlines need to work hard to extract the full benefits of this partnership. One the one hand, Delta is interested in pursuing high yield traffic opportunities in Latin America and benefit from extra connectivity in key markets such as Brazil among others while working with a player that is well-positioned in terms of market dominance, unique culture, branding and a leader in soft specs.
On the other hand, LATAM is interested in pursuing enhanced South America to Europe connectivity and building a stronger high margin and premium revenue portfolio among other initiatives to improve profitability.
Finally, both airlines are uniquely positioned to meet growing regional and world demand to build end-to-end travel experiences focusing on experiential travel opportunities and a combination of personalization, technology and high margin products as passengers today are increasingly looking for connections not only to brands but also people, places, and cultures.
René is an International Consultant, Advisory Board Member and Chairman of the Aviation Festival Americas Miami event held each year in Miami, FL. with more than 1,000+ air transportation professionals. He manages a number of global consulting projects with key focus on revenue optimization, cost reduction, business restructuring, strategic planning, and commercial strategy. He is an IATA and Airport Council International instructor. In addition, he is a regular contributor to a number of air transportation magazines in Canada, USA, Europe and Latin America. He can be reached through his LinkedIn page.
René previously wrote about United Airlines and CRJ550 jet.