Airlines: a new operating model

by

Tom Hansson
hansson_tom@bah.com

Dr. Jürgen Ringbeck
ringbeck_jurgen@bah.com

Dr. Markus Franke
franke_markus@bah.com

Airlines: A New Operating Model
Providing Service and Coverage Without the Cost Penalty

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Airlines: A New Operating Model
Providing Service and Coverage Without Cost Penalty
Once again the global airline industry is in crisis, and industry icons arefighting for survival. Already, there have been high-profile bankruptcies in both the U. S. and Europe, and there is significant risk of more to come. The scene is reminiscent of a decade ago, when the airline industry struggled through the last recession and the aftermath of the Gulf War. There are too many airlines and too many hubs operating in a competitive environment where exit barriers arehigh. Market forces and bankruptcy protection ensure that distressed capacity does not disappear; instead it comes back, potentially at a lower cost level, threatening to trigger price wars that drive still more airlines into bankruptcy. Only this time, the situation is worse. Financially and structurally, the U.S. airline industry is in more dire straits than it was a decade ago, and the competitivesituation in Europe is much more unstable as traditional pricing discipline breaks down. The big difference is the impact of Low Cost Carriers (LCCs). Ten years ago, the LCC threat in the U. S. was limited to a regional carrier, Southwest Airlines, and some underfunded start-ups. Europe was not threatened at all. Today, LCCs, operating at half the cost levels of traditional network carriers,threaten to undermine the whole hub and spoke (H&S) system. Clearly, a new business model is needed that eliminates the structural cost penalties of the H&S model while retaining its key service and coverage attributes… urgently in the U. S. and soon in Europe. Today’s problems are not merely cyclical; they are structural and, as such, demand a structural solution. The objective of this Viewpoint isto evaluate the nature and causes of this industry crisis and to propose a potential solution, drawing on experiences from other industries that have undertaken fundamental business model transformations. An Unstable Industry Structure In the U.S. the gap between costs and revenues has never been wider, and September 11 is only part of the reason. “Industry-leading” labor agreements and rising fuelprices in 1999 and 2000 drove costs to such a high level that only boom-period pricing could offset them and allow the industry to break even. While post– September 11 restructuring has reduced capacity, it has had only limited impact on unit costs. Meanwhile, prices may be reverting toward historical trend levels following the longest—and arguably the most intense— economic boom in recordedhistory (see Exhibit 1). Business travelers, in particular, are no longer prepared to pay the high fares tolerated in the late 1990s. Indeed, both corporate and individual travelers are asking for lower prices, high frequencies, and simpler, more efficient service.

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An Unprecedented Cost-Revenue Gap Has Opened in the U. S.

Unit Revenue and Cost Trend (U.S. Industry)
0.16
Centsper Available Seat Mile (c/ASM) (Adjusted to 2001 Dollars)

0.15 0.14 0.13 0.12 0.11 0.10 0.09 0.08
CASM decline: 1979–1992: 1.5%pa RASM decline: 1979–1992: 1.8%pa

Unit Revenue (RASM) Unit Cost (CASM)

Unprecedented cost-revenue gap, started before 9/11 Poor Outlook for Q3/Q4 2002

CASM increase: 1993–1998: -1.0%pa RASM increase: 1993–1998: +0.6%pa

Source: Company Financial Statements,Back Associates, Booz Allen Hamilton Analysis

In Europe, the crisis has been less pronounced, but unrelenting price competition is putting cost levels under pressure. Airline pricing structures are collapsing as industry incumbents address the threat of low-cost competitors and defend their market positions. In fact, this market is beginning to look like the U. S. market in the early ‘90s,...