Stockholm School of Economics Institute of International Business Master Thesis, 10 credits “FLYING HIGH” or The Successful Take-off of airBaltic Abstract This is a case study of a Latvian airline airBaltic that despite the tough characteristics of the airline industry has been able to grow steadily and compete side-by-side with the aggressive low-cost competitors. We explore how the company has managed to transform from a full service airline with a home base in a small and unrecognized destination to a competitive hybrid carrier that is able to follow the industry price pressure by simultaneously expanding its route network and uncovering the hidden potential of the market. The main purpose of this thesis is to indentify the critical factors behind the successful development of airBaltic. During the two stage analysis, based on Porter Five Forces and Resource Based View of Strategy, we have identified several success factors. The Rolling stage with its weak market competition, government support and strategic partnership with SAS formed the competitive base for airBaltic, and allowed the company to meet the fierce competition during Take-off stage which came with substantial market changes and required flexibility and solid base of experience in order to be able to compete with the aggressive low-cost carriers. The route network developed during the Rolling stage served as a strong weapon for airBaltic in this competition. We believe that our thesis will give researchers additional insight of how reconciliation between outside-in and inside-out perspectives in strategy formulation can be reached, and inspire managers of small regional airlines to use their potential and follow the market changes. Keywords: airBaltic, “Open Sky”, outside-in perspective, inside-out perspective, resources and capabilities, airline industry. Authors: Zane Zilberga 80342 Vita Kasparjosta 19599 Advisor: Dr. Peter Hägström, Associate Professor IIB Opponent: Irina Aseeva 80347 Presentation: January 10, 2008, 13-15 Table of Contents 1 Introduction .......................................................................................................................... 3 1.1 Background ..................................................................................................................... 3 1.2 Purpose ............................................................................................................................ 4 1.3 Contribution .................................................................................................................... 4 1.4 Outline of the Thesis ....................................................................................................... 5 2 Methodology ......................................................................................................................... 6 2.1 Research Method ............................................................................................................ 6 2.2 Case Selection ................................................................................................................. 7 2.3 Delimitations ................................................................................................................... 8 2.4 Data Collection ............................................................................................................... 8 2.5 Quality of Research ....................................................................................................... 10 3 Theoretical Background .................................................................................................... 13 3.1 Industrial Organization ................................................................................................. 13 3.2 Five Forces of Competition Model ............................................................................... 14 3.3 Resource-Based View of Strategy ................................................................................ 18 3.4 Competitive Advantage ................................................................................................ 21 3.5 Knowledge-based View of the Firm ............................................................................. 25 4 Case Description................................................................................................................. 26 4.1 Key Facts about Latvia ................................................................................................. 26 4.2 Latvian Airline Industry ................................................................................................ 27 4.3 airBaltic ......................................................................................................................... 30 5 Analysis ............................................................................................................................... 37 5.1 The Rolling Stage ......................................................................................................... 38 5.2 The Take-off Stage ....................................................................................................... 44 6 Conclusion .......................................................................................................................... 53 7 Further Research ............................................................................................................... 56 8 References ........................................................................................................................... 57 9 Appendix ............................................................................................................................. 60 2 1 Introduction This section presents the background of the thesis topic and explains to the reader why this phenomenon is interesting to study. The purpose of the thesis is briefly formulated followed by a description of how the thesis contributes to the research area. Finally, the thesis outline is presented in order to facilitate the reading process. 1.1 Background Airline industry has always been attracting a great deal of attention of researchers and practitioners due to its particularity. It is an industry characterized by cyclical nature, very thin profit margins, tight regulations and fierce competition. Huge capital investments are required in order to ensure a sufficiently steady foundation for the start of the business. Recently the European airline industry has been experiencing several challenges that have turned around the market trends and changed the prevailing business practices of the operating airlines. One of the most important challenges faced by the European airlines is the “Open Sky” regime which since 2004 has created a single unified large market for air transport consisting of the twenty-five member states of the European Union plus Iceland, Norway and Switzerland. In 2007 two more countries joined the EU, and the unified market now encompasses twenty-seven member states. As a result, both traditional legacy carriers and low-cost airlines have been lumped into one big bowl, and the competition has intensified to a large extent. The low-cost airlines are making a big pressure on the traditional airlines by constantly lowering ticket prices and intrusively penetrating the market with ever new routes. Despite the threatening description of the industry, there are several airlines that have discovered the secret survival algorithm and been able to successfully compete in the market. Furthermore, even seemingly inexperienced and small airlines have found the right place on the earth and fearlessly come up against the “big brothers”. Obviously, a curious question arises: What lies behind their success? What is the magic formula of success in such a thankless industry? We got impressed by airBaltic. A new airline started its operations in Latvia in 1995 and wakened a market that had fallen asleep during the early years of Latvia’s independence. By gradually accumulating the market knowledge and learning from the experience of the well- 3 known Western airlines, airBaltic revived the market and attracted interest of foreign airlines to Riga as an interesting destination. Although being a relatively small and new airline in the common EU airline market, airBaltic has an advantageous niche which allows it to enjoy the benefits of the rapid economic growth in the Baltic States and to adapt to the changing business practices brought in by an increasing amount of competitors. We consider airBaltic as a success story and as an example of how a small airline can find an advantageous niche in the market and gain the largest market share in Riga airport by constantly expanding its route network and the number of passengers. By gradually accumulating its strengths, airBaltic has been able to successfully deal with such a rapid turnaround of the industry as happened in 2004. Critical factors behind the successful development of airBaltic are identified with the help of both outside-in and inside-out theoretical perspectives. We have an ambition to integrate the Five Forces of Competition Model with the Resource-based View of Strategy in order to see that the company’s strategy is a reconciliation of its internal factors and the external environment. We believe that our thesis will be of interest to both researchers dealing with analysis of external and internal environment of a company, and practitioners engaged in the airline industry. For the former, we want to