Turkish Airlines - Strategic Analysis

Turkish Airlines Strategy Analysis

MGT 525

Turkish Airlines Strategy Report Final Project Professor Fiona Scott Morton Yale School of Management

The following members hereby confirm that they have understood and respected the honour code

Hikmetcan Bilici

Siddharth Dixit

Anunay Sahay

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Turkish Airlines Strategy Analysis

MGT 525

1. Introduction 1.1. Turkish Airlines: Past and Present Turkish Airlines was founded in 1933 as part of the Ministry of Defense with 100% state equity. However, after the liberalization of the airline industry in Turkey and the privatization efforts of state-owned companies, the government currently owns 49% of the company, while the rest of the shares are publicly traded on Istanbul Stock Exchange1. Before the 1990s, Turkish Airlines suffered from a tarnished reputation due to frequent delays, poor customer service, and falling victim to hijackings and plane crashes. In an effort to promote Turkey and enhance Turkey’s image, the government initiated efforts to reorganize its fleet and re-vamp its management. Turkish Airlines had predominantly focused its business on the domestic market. However, as the intensity of domestic and international competition increased within the airline industry, the company decided to reorganize its operations. Its current strategies in the 21st century is proving to be strongly successful for Turkish Airlines as the company modernized its fleet, expanded its routes to service international travellers, achieved crucial alliances in the industry, and upgraded the quality of its services. Between 2006 and 2013, Turkish Airlines has seen a dramatic increase in its annual passengers, from 17.0 million is 2006 to 48.3 million passengers in 2013. Total revenues also climbed dramatically during this time period from $2.23 to $9.8 billion by the end of 20132. After the deregulation of the domestic market in Turkey, Turkish Airlines has launched several low-cost carrier brands under Anadolu Jet, Sun Express, and Northern Cyprus Turkish Airlines to compete with this segment, while positioning itself as an international player. Turkish Airlines has several hub locations in Turkey with Istanbul Ataturk Airport as its primary hub, where Turkish Technical Maintenance is also held. Due to an increase in volume of passengers to Turkey, a third airport in Istanbul is under construction, which signals more expansion and investment opportunities for Turkish Airlines, while also attracting more intense competition to the market. 1 Turkish Airlines Annual Report, 2013 2 Turkish Airlines Annual Report, 2013 2

Turkish Airlines Strategy Analysis

MGT 525

Turkish Airlines was awarded the prize for the best airlines in Europe in 2011, 2012, and 2013. Turkish Airlines, with 245 destinations, flies to more countries than any other airline. Successful government initiatives to promote tourism in Turkey, in combination with major sponsorship deals with giant sports clubs such as Dortmund, Barcelona, and Manchester United has all helped Turkish Airlines to gain visibility and customer awareness in the international airline market. In 2008, Turkish Airlines became a member of the Star Alliance Network, thereby expanding its network and partnerships with other major international carriers. Its rewards program, “Miles & Smiles”, has been successfully implemented both domestically and internationally and created further customer loyalties to the airline through its excellent rated customer service and rewards share system with the Star Alliance carriers.

2. Industry Analysis Before the deregulation of the airline industry in Turkey, Turkish Airlines enjoyed monopoly pricing as the nations’ only flag carrier. Turkish Airlines had no rivalry in domestic routes and had a low competitive landscape, as city-pairings to Istanbul for foreign carriers were not as important. By studying the Porter’s five forces, we hope to understand the intensity of the rivalry within the Turkish Aviation market. Before the deregulation, most of the air travellers consisted of people with high-income and Turkish Airlines had a reasonable supplier power in the domestic aviation industry. As Turkish Airlines was a natural monopoly and the degree of substitution was low for air traveller, the only other means of travelling was road travelling. Considering the wide geographic layout of Turkey and the amount of time consumed travelling by road, road travel was not a direct substitute for air travel by high-income population. In 2012, high-speed railway projects were completed between Istanbul and Ankara, which can be seen as a substitution for air travel. Along with the deregulation in 2003, some private chartering companies entered into the market and the degree of substitution increased as new entrants offered different networks, services and prices. The entry to market was obviously freed after the deregulation of the market, however due to capacity constraints at Ataturk Airport, the largest and busiest airport in Turkey, airlines experienced difficulty in gaining airport slots and gate positions, which are valuable resources for the airlines. Consequently, the civil aviation authority no longer permits entry due to lack of 3

Turkish Airlines Strategy Analysis

MGT 525

slots3. The ease of entry will be limited until the two current airports serving Istanbul is expanded. Additionally, there is an ongoing construction for the third airport, which will be the largest airport in the world with 150 million annual passenger capacity4. Along with the entry of new players with low-cost, differentiation, or focus strategies, the number of both domestic and international travellers rose and the power of buyers increased. As seen from the graph below, the number of domestic passengers grew approximately from 9 million in 2003 to 76 million in 2013 and the number of international passengers rose from approximately 25 million to 75 million.

Figure 2.1: Number of Passengers on Turkish Airline Source: Turkish Ministry of Transportation, 2003-2013 Statistical Booklet, p.41

Overall, the degree of rivalry has intensified in the Turkish aviation market for Turkish Airlines as the Company has to compete with low-cost carriers in the domestic market and large and experienced airlines in the international market.

3

Orhan, Gamze, A Study of The Strategic Responses of Turkish Airline Companies to the Deregulation in Turkey, Journal of Management Research, 2013, p.46

4 http://en.wikipedia.org/wiki/Istanbul_New_Airport 4

Turkish Airlines Strategy Analysis

MGT 525

Figure 2.2: Passenger Segmentation Source: http://centreforaviation.com/analysis/turkish-airlines-narrowing-the-strategic-gulf-part-1-112352

It can be inferred from the graph above that there has been a steady increase in the Turkish aviation market since 2004. With the deregulation in 2003, there was a tremendous growth of approximately 60% in 2004 in which Turkish Airlines was able to increase its growth and share. As there was more entry into the market, Turkish Airlines growth in the domestic market declined to 10% by 2012; along with the steep decline in the overall Turkish domestic passenger market. Along with the challenges, Turkish Airlines achieved to position itself successfully both in the domestic market and in the international market. In the next stages of our analysis, we hope to evaluate the positioning, differentiation and competitive advantages of Turkish Airlines and look into the competitive interactions of the Company in different markets. 3. Competitive Advantages of Turkish Airlines As an incumbent, Turkish Airlines had a first-mover advantage upon the deregulation of the Turkish aviation industry. As stated in our class discussion, when two or more firms compete, the winner is often the firm with the largest installed base, thereby enhancing value of networks and attracting more customers. Furthermore, Turkish Airlines was able to benefit from higher economies of scope due to its early entry. 5

Turkish Airlines Strategy Analysis

MGT 525

High quality of inflight service, brand awareness, and the safety concerns associated with competitors has helped Turkish Airlines to retain most of its existing customers and continue its price leadership. Additionally, having the biggest domestic network and seamless international and domestic passenger transit capabilities added further competitive advantages for Turkish Airlines. The low-cost operation model of Turkish Airlines while keeping the quality of services constant helped the Company to retain its leadership position. Once Turkish Airlines cut its costs, its customers started to return and lock themselves through the use of its premium loyalty card. The de-integration of its value chain has also helped Turkish Airlines to become operationally efficient and low-cost company. Through the de-integration of its maintenance, catering, ground handling, and call center subsidiaries into stand-alone companies, the stand-alone subsidiaries became more efficient and profitable. At the same time, the subsidiaries were also serving other airlines, thereby achieving a better economies and scale and lower-price reflection to Turkish Airlines5. Marketing activities of Turkish Airlines also helped to company to achieve higher brand recognition around the globe. Turkish Airlines has invested significantly to improve its brand image through the redesign of its logo, celebrity endorsements with Lionel Messi and Kobe Bryant, sports team sponsorships with Barcelona and Manchester United, and viral marketing campaigns.

Figure 3.1: Turkish Airlines market positioning

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Orhan, Gamze, A Study of The Strategic Responses of Turkish Airline Companies to the Deregulation in Turkey, Journal of Management Research, 2013, p.55

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Turkish Airlines Strategy Analysis

MGT 525

All of this growth, both organic and through alliances has been matched by significant progress in terms of service quality. Skytrax, the global organization that ranks airline quality, has given Turkish Airlines a host of awards in recent years. These include recognition in 2011, 2012, and 2013 as Europe’s Best Airline, Southern Europe’s Best Airline and best Economy Catering6. 4. Domestic Positioning and Competitive Interactions As explained by Porter, companies usually focus on three different types of strategies. The strategies are outlines as cost-leadership, differentiation, and focus7. Upon the entry of new players into the Turkish aviation industry, new players chose one of the options outlined above, as it is very difficult to implement two strategies under one firm. As seen from the table below, the industry has six players besides Turkish Airlines and each airline seems to be strategizing on one topic. The strategic competitive tools for players are based on network, quality of service, and price8. In order to map out the cost/quality positioning of Turkish Airlines amongst other players, we will be studying the competitive tools of other players relative to Turkish Airlines. Most of the new entrants followed a low-cost business model, thereby targeting the low and midincome population of Turkey. Along with cost leadership, the entrants relied on its hub-andspoke networks and popular city-pairings for high utilization rates and operational efficiencies. Because offering a single fare is not competitive, such airlines adopted yield maximization pricing systems and adjusted their prices in accordance to Turkish Airline prices, as Turkish Airlines is the clear dominant player and price maker9.

6 Turkish Airlines Annual Report, 2013, p.7 7

Orhan, Gamze, A Study of The Strategic Responses of Turkish Airline Companies to the Deregulation in Turkey, Journal of Management Research, 2013, p.37

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Orhan, Gamze, A Study of The Strategic Responses of Turkish Airline Companies to the Deregulation in Turkey, Journal of Management Research, 2013, p.46

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Orhan, Gamze, A Study of The Strategic Responses of Turkish Airline Companies to the Deregulation in Turkey, Journal of Management Research, 2013, p.46

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Turkish Airlines Strategy Analysis

MGT 525

Figure 4.1: Current state of the operational airlines

Other entrants such as Atlas Jet offered better in-flight services to its customers and mainly competed on the service tools. At the same time, the Company still offered prices that are higher than low-cost carriers, but the prices were not as high as Turkish Airline’s prices. Atlas Jet also chose to focus on its network and look for destinations where the average income is higher. Pegasus Airlines entered the market in 2005 as another low-cost carrier. However, the Company differentiated itself by focusing on its network and by choosing Sabiha Gokcen Airport, Istanbul’s second airport, as its hub location. Just like other airlines, Pegasus was also utilizing yield management systems for pricing. Additionally, the Company acquired IzAir, which has its hub in Izmir. With this acquisition, the company seeks to differentiate its network and serve markets with different city-pairings10. SunExpress, in which Turkish Airlines has 50% equity, offers services from Antalya, Izmir, and other popular cities to Istanbul’s Sabiha Gokcen Airport. The reason why the Company is using Sabiha Gokcen Airport is basically to be in direct competition with Pegasus Airlines in Sabiha Gokcen Airport. SunExpress offers low-cost seats with additional value-add services on demand so the company is flexible in meeting different customers perceptions and budgets. As a strategic response to low-cost carriers, Turkish Airlines focused on lowering its costs whole maintaining the same level of quality for its customers. In 2003, Turkish Airlines has decided to grow its fleet and made a credible capacity commitment to the industry whilst keeping the other

10 Orhan, Gamze, A Study of The Strategic Responses of Turkish Airline Companies to the Deregulation in Turkey, Journal of Management Research, 2013, p.51

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Turkish Airlines Strategy Analysis

MGT 525

resources stable excluding the cabin and crew 11. Turkish Airlines achieved to keep its costs stable while improving productivity. Additionally, Turkish Airlines decided to vertically de-integrate its ground operations such as handling and catering. This move has given the other parts of the value chain efficiency, as they were able to serve other companies and achieve economies of scale while Turkish Airlines was able to focus on its operations and outsource service for lower costs. Yet, Turkish Airline’s most impactful reaction to the deregulation of the market was the launch of Anadolu Jet, a low-cost sub-brand of Turkish Airlines. Although Turkish Airlines was keeping its position on the cost/quality curve through its efficiencies and image, these strategies were not enough to tackle competition in the market place, as there was a significant price competition with the entry and the low-cost business models of entrants. Anadolu Jet, with its hub operations in the capital city of Ankara, offered its passengers a lowcost flight with the structural advantages of Turkish Airlines and its geography. Anadolu Jet was able to integrate its network to Turkish Airlines for domestic passengers with international flight connections. Furthermore, Ankara is a highly populated city located in the center of Turkey, with its hub and spoke network, Anadolu Jet was able to offer low-cost and efficient city-pairings to its passengers.

Figure 4.1: Price Quality frontier set by Turkish Airlines

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Orhan, Gamze, A Study of The Strategic Responses of Turkish Airline Companies to the Deregulation in Turkey, Journal of Management Research, 2013, p.54

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Turkish Airlines Strategy Analysis

MGT 525

Based on the value map analysis above, we can see that all airlines are plotted on the indifference curve and segregated themselves through their network, service, price, as well as differentiation strategies. Turkish Airlines is clearly the leading quality provider of services with its price leadership while Onur Air, Pegasus, and Anadolu Jet are following a low pricing strategy with lower quality of services. Atlas Jet has positioned itself in between the low-cost carriers and Turkish Airlines. Post-deregulation of the domestic aviation industry seems to be based on price competition under the auspices of Turkish Airlines. By expanding its capacity, Turkish Airlines made a tough commitment. Since products are not differentiated enough to justify the price difference for the price-sensitive travellers. Upon capacity expansion, Turkish Airlines focused on its utilization rate while keeping the service quality constant and lowering prices. See graph below for illustration purposes of Cournot and Bertrand best response function adjustments.

Figure 4.2: Competitive responses of Turkish Airlines signifying commitment

5. International Positioning and Competitive Advantages Turkish Airlines is, and has been, benefited from its main operation hub in Istanbul. Istanbul’s strategic location in linking the East to the West has offered a natural uniqueness in the Aviation industry. Being able to reach to 55 countries within 3.5 hours substantiates the attractiveness of the location12. The strategic location of Istanbul translates into three main competitive advantages for Turkish Airlines against its competitors such as Etihad and Emirates.

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http://www.turkishairlines.com/tr-TR/kurumsal/faaliyet-raporu/2011/en/m-1-9.html

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Turkish Airlines Strategy Analysis

MGT 525

The first main advantage is to be able to offer flexible route planning to destinations that are within 3.5 hours. This flexibility offers last minute adjustments to the plane size. For example, if a scheduled flight from Istanbul to Paris is under booked, the trip can be allocated to a smaller body plane, thereby lowering the costs associated with the flight and increasing the average revenue per customer. The second advantage that is associated with location is the increase in the volume of transit passengers. Since there are limited number of flights from Northern Europe, Northern Africa, and Middle East to long haul destinations such as North America, South America, and Asia Pacific; Turkish Airlines is able to link passengers from neighboring countries to its long haul flights. The Star Alliance network further increases the number of transit passengers from neighboring countries as well as from countries such as U.S.A. and Singapore. Going further, the company seeks additional high-transfer potential destinations for growth. However, Turkish Airlines is also aware of the fact that operating just as a network carrier is not aligned with their vision to become a leading airline operator not only in Europe, but also in the World. Therefore, Turkish Airlines is also focused on improving and growing its operations as a service carrier.

Figure 5.1: Airway operations of Turkish Airlines – the expansion story

The third advantage is the increase in the visibility of Turkey as a Tourism destination. The influx of passengers to Turkey for Tourism has benefited Turkish Airlines as Turkish Airlines was the most preferred carrier to Turkey. 11

Turkish Airlines Strategy Analysis

MGT 525

Figure 5.2: Efficiency increment in Turkish Airlines Operations Source: Turkish Airlines Annual Report, 2013, p.5

6. International Expansion In the Company’s international growth success, several strategies such as adding new routes, having cost leadership, sponsorships, and its strategic alliances have played a big role. When adding new routes, focusing on potential high transit passenger markets is very well aligned with Turkish Airline’s international business model. Additionally, balancing both short haul and long haul flights and optimizing the frequency of its flights in its network to reduce passenger transit time and increase customer quality has strengthened Turkish Airline’s position. In its expansion to high-transit markets, Turkish Airlines successfully identified potential opportunities in Africa and Far East. The international growth mainly came from regions outside Europe, however, the international-to-international transfer, meaning the use of the Turkish hub only as a facilitator between two countries has risen significantly from 4.4 million in 2009 to 11.6 million in 201313. The international-to-international transfer area is where Turkish Airlines is in direct competition with other premium Middle East airlines such as Etihad, Emirates, and Qatar Airways. As seen from the graph below, Turkish Airlines is on par with Emirates in terms of international passenger numbers in 2012.

13 Turkish Airlines Annual Report, 2013, p.5 12

Turkish Airlines Strategy Analysis

MGT 525

Figure 6.1: Passenger increment distribution a.) Overall increment Source: Turkish Airlines Annual Report, 2013, p.6; b.) Comparative increment in Airline traffic between Turkish Airline and others. Source: http://centreforaviation.com/analysis/turkish-airlines-narrowing-the-strategic-gulf-part-1-112352

Turkish Airline’s cost leadership has also been reflected to its customers, thereby giving an additional advantage in comparison to its international competitors. Especially, the expected marginal price sensitivity of passengers from Middle East and Africa will offer Turkish Airlines in a more competitive position.

Figure 6.2: Cost Sensitivity analysis for low cost carriers. Source: http://centreforaviation.com/analysis/turkish-airlines-narrowing-the-strategic-gulf-part-1-112352

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Turkish Airlines Strategy Analysis

MGT 525

Furthermore, the brand awareness of Turkish Airlines through its sponsorships, celebrity endorsements, media coverage, as well as quality awards form Skytrax has attracted millions of passengers. Partnerships and Agreements played a key role in the international expansion of Turkish Airlines. As stated in its annual report: “The company will support its organic growth through strategic collaborations with other airlines in its targeted markets as called for in its growth plan. In this way, it will also strengthen its standing as a global network carrier while increasing its opportunities to provide better service in other territories.” 7. Future Outlook Turkish Airlines is not only a carrier on its own but also an active player in the lower end of the market via its subsidiaries such as Anadolu Jet and SunExpress. This strategy helps Turkish Airlines focus on the core business and continue its full service role. By expanding its business in Eastern Europe, Middle East and Far East, Turkish Airlines is enjoying increasing revenue and profits and the market is definitely appreciating the strategic moves as one can judge from the share price demonstrated in the chart below:

Figure 7.1: Turkish Airlines Stock Price (THYAO) 14

Growth opportunity is supported by the booming economy in Turkey, a country with a population of 75 million people. National air travel demand is growing, helping the strong financials of the company. Turkey is investing its national transportation and liberalizing its policies, which will make it a more important spot for tourism.

14 http://www.google.com/finance?q=thyao&ei=G6B2VPmlEMmQqwH36oDoDQ 14

Turkish Airlines Strategy Analysis

MGT 525

One of the most important competitive advantages the company has is the geographic location of the company. Istanbul, located only 3 hours difference to 50 countries, gives a unique advantage, making the city an international flight hub.15 In terms of financials, it has a significant rise in its revenue and profitability figures and more importantly a cost advantage over its rivals. In terms of EBITDAR margin, Turkish Airlines has achieved an 18% EBITDAR margin, well above the industry average. Another important factor that supports the strong financials is the revenue-expense profile of the company. The strength of euro over USD is a major contributor of the growth starting from 2009. Strong dominance in the domestic market and the ability of charging premium is also a core advantage for the company. We have seen in the value chain analysis, Turkish Airlines is also spreading the risk and raising the barriers for entry by holding the subsidiaries in technical maintenance, catering services, fuel supply and ground services. Recently, the Company has signed another joint venture in which, Turkish Airlines started the production of the first Turkish airline seats16. Star Alliance membership gives it a brand recognition advantage and the ability to charge premium. On the other hand, aggressive expansion strategy should be evaluated with a bit of caution as the network synergies will take time to replicate when expanding into regions such as Africa, Far East and Australia. The requirement for the new fleet for expansion may also bring a drain on the strong financials of Turkish Airlines. The expansion policy will also have an impact on utilization rate of the fleet and Cost per ASK. As stated in the class, large financial liabilities can stiffen price competition as airlines have a fixed capacity, perishable product, and the ability to sell future demand. Turkish Airlines is unquestionably one of the rising stars in the region, enjoying profitable growth and compelling expansion opportunities. The competition with Gulf competitors will be fiercer going forward. Overall however, Turkish Airlines appears very well positioned and ready to manage the risks that it will face during its expansion period and maintain its growth position and strong financials. 15

http://centreforaviation.com/analysis/turkish-airlines-narrowing-the-strategic-gulf-part-1-112352

16 Turkish Airlines Annual Report, 2013, p.9 15