Volume is good but fundamentals are essential

when perusing commentary on the airline industry there is a lot of talk about passenger figures (see the previous post, for example). However, less common is the talk about yields. And even less common than that is to see discussion about the right yield and use of assets. Too many people give off the impression that airline executives are wearing blindfolds and recklessly handing out seats at ridiculously low prices to anyone and everyone. Low prices are part of the game and a worthwhile tool to stimulate demand, but the real art is the ability to maximize those ticket prices and ensure that your assets are being used effectively. If a route is flying with a high load factor and high yields should it be cut? Well, an argument could be that it should be cut if those high yield passengers will stay in the system by taking another departure on your airline or are willing to go to another airport to fly with your airline. That way the asset can be used more effectively on another route. The point is that observers of the industry need to look beyond the passengers numbers but to consider the yield and asset utilization. Nobody said this was going to be easy.

Future airline business models

With so much turmoil in the airline industry at the moment one obviously questions in what direction the industry is heading. The belief that I hold is that the industry is slowly converging and that the distinct groups that the media discusses, low-cost carriers, full-service carriers, and regional carriers, are slowly coagulating into a single group. Maybe similar to something the industry looked like prior to deregulation. These future business models will be built on the best parts from each group, maybe things such as strong online presence taken from LCCs, GDS distribution tactics from FSCs, flying your own brand and others' brands a la regionals (is Aer Lingus' and United Airlines' tie-up an omen of this?). This begs the question though, how does one know which elements to imitate (see a previous post here on how airlines change their business models).

My successfully defended PhD dissertation examined this topic. I have uploaded a presentation that explains the basics of the method and given some of the results. There are too many results to list as they are very specific, but you can see more and download the entire thesis publication here. The underlying method that was used is called Boolean algebra, which is based on the work by George Boole. It allows one to identify combinations that consistently lead to a specific outcome. In other words, which combination of business model elements always lead to a positive operating margin. The method is primarily used in political science studies, but I have extrapolated the method to business model studies and the airline industry. See the presentation for more information (the PPT file got some horizontal lines in them during the upload, sorry for the quality).

Future Airline Business Models

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The results show that there are more than just one successful LCC business model. We can see that GDS presence is a success factor, however it should be through a 3rd-party to ensure low-cost. In addition, we see that this distribution tactic should be coupled with on-lining, through-fares, or an FFP. This would indicate that LCCs in the future may expand their network by "connecting the dots." This should be done in a simple and efficient manner. Finally, we see that some LCCs can be successful with a non-standardized fleet and short stage lengths or no FFP. You can see more results in the dissertation, including what kind of business model would be successful if an LCC and FSC combined, as well as, what innovative business model change can be implemented.

The data is based on 2006 information because that was the most current information at the time of the analyses (late 2007). However, I will begin to work in more detail with the method and the data set. In the meantime I hope that it gives some inspiration to a greater understanding of the airline industry.

Segregation is slowly disappearing in the airline industry

It wasn't too long ago that large network carriers looked down upon those pesky low-cost carriers and wouldn't give them the time of day. This arrogant attitude by FSCs changed as those LCCs began to encroach on their territory and profit; it changed to one of panic. Those network carriers attempted to imitate the LCC business model but failed to really study what made a successful low-cost airline. Those high-cost carriers wrapped in LCC clothing have disappeared (Shuttle by United, TED, Song, Continental Lite, etc...). Now, it appears that these two groups have reached a consensus that both are here to stay and that it is possible to cooperate, which benefits both parties.

In the past I have spoken about how the business models of LCCs, FSCs, and regionals are converging. This will mean that we will see more and more cooperation between the different types of carriers, just as the announcement by WestJet of Canada and Air France/KLM of, well, France and the Netherlands. These "two" (two in quotations because I see Air France/KLM as one carrier, but they are still cruising around in two liveries) will enter into a code-share agreement by then end of this year or early 2010. In addition, they will look into interline agreements and FFP tie-up, technology permitting. This appears to be a strategic attempt by both carriers to capitalize on a partner's advantages. WestJet has a strong foothold in the Canadian market, which is an attractive feed to Air France/KLM who are up against Air Canada in trans-Atlantic flights. WestJet, on the other hand, can potentially get more traffic due to passengers wanting to fly to Europe. The challenge brand-wise is ensuring that passengers who hop off in Canada and transfer to a WestJet flight don't expect AF/KLM first-class service. This has always been one fear of entering into agreements between FSCs and LCCs. However, if they make this transparent to the passenger it should be acceptable. In addition, many LCCs actually have a more attractive short-haul product compared to the short-haul product on FSCs. Technology will also play an important role here. Integration of IT systems that allow a seamless and low-cost experience to the customer is vital. A tie-up that is challenged technologically and has added expense goes against the entire concept of the agreement.

This will be interesting to watch and if others will follow suit in other parts of the world. In addition, the agreement and WestJet and Southwest may have just gotten a whole lot more interesting.

Open Sky has done just that

It looks like the Open Sky agreement between the US and EU has done just that, opened the skies. Sir Richard Branson has just announced that Virgin Atlantic plans to operate a pure business class airline from European centers across the Atlantic, click here. Opposed to Eos, Maxjet, and SilverJet this venture will have the backing of the Virgin group and they can certainly capitalize on that. The challenge is not to dilute the Virgin Atlantic offering out of the UK. The service level is already quite high near the nose of the aircraft, although I am excited to see what innovative ideas they conjure up for this venture.

What are airlines saying around the world?

A portion of my PhD studies is to question how airlines change their business models and why they are changing. A survey was sent out to every scheduled passenger airline in the world earning more than $5 in revenue. I got a response rate of 21%. The results were very interesting and show that airlines do indeed innovate their business models, but they are also heavily reliant upon imitation of their competitors, especially those in other groups. Below is a PowerPoint presentation of the results. Take a look at it if you want to learn how airlines create value for their customers, what activities they are changing and why, and who executives turn to for inspiration.

Fly for what?

Well, seems like spring is in the air since new airlines are popping up left and right. I don't know if they are rose buds or weeds, only time will tell. Here is another one, Fly for Beans. I wouldn't recommend investing in this venture either. I remember reading that JetBlue was struggling to come up with an appropriate name for their airline. The founder was favoring calling the airline IT, and had many creative ideas on how to capitalize on the name (one was luggage tags called schlep IT). Apparently someone stressed that such a name doesn't instill confidence among passengers. I would nominate this as another one of those company names. Do I even have to mention it, Fly for Beans is basing its business model on the low-cost theme.

A palette of colors

Apparently someone has conjured up a new airline, FlyPink, which is aimed at the female traveler who demands luxury, click here. This is unbelievable and I doubt the business plan is routed in reality. Short, weekend-based travel trips for girls being flown in pink planes, getting served pink champagne, and pampered in the departure lounge is the target market. I am doubtful that much research has been done into this scheme. Reminds of me BackPackerExpress, the attempt at low-cost, long-haul aimed at young backpackers. Needless to say, that airline never took to the skies either. If airlines that offer champagne in first class with global networks are struggling to earn a profit, while marketing themselves to both men and women, I doubt this airline can break the code to do so. I did stress that airlines need to find a niche to capitalize on to flatten out the descent into commoditization, but this is not what was meant.

A new way to fly...maybe

Eclipse Aviation has recently beefed up its order books with yet another air taxi order, this time from ETIRC Aviation which ordered 120 of the jets with options on another 60. Eclipse now has 2,700 orders and options for their innovative product, and approximately 1,700 are from air taxi firms. 1,400 of those 1,700 are from DayJet alone! Those are impressive numbers and shows that there certainly is interest in supporting such air taxi services. There is only one problem, the economics of success are deceptive and it will be a real struggle to create a viable enterprise out of such a venture. As Richard Aboulafia notes in his blog, if there are 10,000 air taxis by 2020 that produce 21 billion ASMs that will only replace 1.2% of the planned ASMs in 2020. That sure isn't a capacity dent. Then of course there is the cost of transportation. Today most passengers can fly nearly everywhere in the US, on low-cost airlines, network airlines, regional airlines, "commuter" airlines. Then there are those that can afford their own private charter. Granted this can sometimes take you to closer where you want to go, but that convenience comes at a price. As you can see in the slide below the cost of using the service of an air taxi is going to far outweigh that of an airline.



And what does an airline offer its customers? Frequent departures, an integrated network, global reach, etc. Right now DayJet only has operations planned for Florida. Of course, that will expand as the fleet grows. But the air taxi is promising a maximum 30 minute wait for your flight. It all sounds great but I was not able to find anything about price on the site. I will admit that the concept is novel, it has the theoretical potential to be a radical innovation in the air transport industry, I am concerned about the economics of it though. We'll have to watch and see what happens, both in the US and Europe.

Air Asia X goes with Airbus

FlyAsianXpress, the long-haul brand of Air Asia, has confirmed an order for 10 A330-300s. It appears as if the world's leading LCCs are going to seriously attempt long-haul operations, with JetStar and Ryanair getting into the mix too. FlyAsianXpress had evaluated the 777 but delivery positions were not acceptable, which is related to Ryanair's O'Leary stating that his airline would wait a few more years before confirming an order as demand is currently high and driving prices up. In the meantime, FlyAsianXpress plans to have 25 A330s on the ramp within the next five years.

Southwest eyeing unbundling

Southwest Airlines may be eyeing unbundling some of its services in a bid to achieve its 15% annual earnings growth, which may not be possible through ticket sales alone. The airline did trial assigned seating in the summer of 2006 in select cities and got mixed customer reviews. In addition, the airline has stated that it won't have a reservation system that can handle assigned seating until 2009. The airline has portrayed an image of the customer-friendly airline that does not charge for such services, even poking fun at rivals who do so. However, it may have to change its offerings if it wants to continue its growth pattern. The challenge is identifying those services that customers value and are willing to put cash on the table to purchase.

Ryanair comtemplating across the pond operations

I had to check the publication date on Flight International's recent article, "Ryanair boss Michael O'Leary plans launch of transatlantic no-frills airline with fleet of 50 Airbus 350s or Boeing 787s," click here, and make sure that it wasn't an April Fool's joke. It seems to be geniune enough considering it is dated April 11th.

Apparently, O'Leary and his team are looking at launching a trans-Atlantic subsidiary to the US following the recent Open Sky agreement. It would link with Ryanair's 23 bases in Europe with a handful of secondary airports in the US: Baltimore, MD; Providence, RI; and Islip, NY. The operation would be a separate entity from Ryanair and would not offering connecting services for passengers. O'Leary makes the point that they want to avoid complexity in the business model. Keeping activities simple and uncluttered allow for easier adjustments and trials. The operation will most likely utilize A350s or 787s and will be purchased near the end of the decade when they expect the demand to soften and prices to come down.

The article does not mention continuing on inside of the US. However, with Tony Ryan's investment in Allegiant and that airline's statement that it wants to be a Ryanair look-a-like, that may be something in the works. Of course, cross-Atlantic low-frills flying is not new to aviation. Laker's SkyTrain, People Express to London, or even Icelandic Air's former backpacker image. However, all these airlines are now defunct (except Iceland Air, however its image has certainly improved from its earlier days). There are various explanations for their failure, however Ryanair has something they didn't: passenger feed from all of the EU. People Express did have its US feed, however the CEO, Don Burr, did state that distribution strategies of People Express' competitors helped to undermine the airline. Ryanair is operating in the age of the Internet and doesn't have to fight with competitor-owned GDS'.

No one can say that the airline industry sits still for very long.

Cater to the business fliers

First they were in the GDS, then they were out, and now they are back in. JetBlue appears to have a wavering love of the business flier. Business fliers like to book at the last minute and therefore put more money on the table for a seat. However, they also demand more perks, which add costs. Now JetBlue has announced that the airline is researching offering refundable tickets for higher fares. They want to be able to reserve the greater pitch aisle seats at the front of the plane for those corporate fliers, see here.

This little blurb is just another sign that the traditional classification of airline business models are blurring. JetBlue, a low-cost airline in the daily literature, is emulating more and more the traditional airlines in the market. This is necessary since JetBlue is realizing it can't offer all those perks at the lowest fares in the market. It has two options, shed costs and dilute its offering, but that will strip the airline of its charm, or attempt to capture more business fliers at higher yields. Eventually, traditional carriers will imitate LCCs more and more and the models will not be easily distinguished in the future.

777s for Virgin Blue

Boeing has just scored the sale of six 777s for Virgin Blue's foray into the long-haul market. This contract is worth more than US$ 2 billion for Boeing and may just usher in the long-haul LCC business model...sort of. I have not seen any news on the configuration plans for the airline. Currently Virgin Blue is shopping for US routes and prefers to bypass the Hawaiian islands and head straight for the mainland. It will be interesting to watch this development, along with Virgin America's conditional go-ahead from the US DOT.

Pay for your ticket...and your bags

Observers of the airline industry have noted that Ryanair took the Southwest Airlines business model, dehydrated it of all its frills and now have an airline that is focused on moving passengers from A to B, even more so than Southwest, and that Ryanair may actually become a copied model in the future. While Southwest has had operating margins hovering near 10% or less, Ryanair can brag with margins consistently above 20%. Rumors have it that some US airlines are looking at the Ryanair model, such as Allegiant and Skybus. However, Spirit Airlines has decided to take one step closer to the Ryanair model. Click here and you can read their About Us page about their plans for charging for all checked baggage. Their business class service will cease to exist, while the more spacious seats up front will still be available. In the future passengers can pre-pay for their checked luggage. This is not the first time such a model has been implemented. People Express utilized this concept as well. It will be interesting to see how the consumer reacts. It might just be that future students of the industry will note how the Ryanair-model has influenced a new breed of airline.

CPAs are not an untouchable model

The financial media often portrays the regional airlines in the US as untouchable darlings due to their capacity purchase agreements with major carriers. The lore is that these agreements insulate the regional airline from common industrial turmoil because expenditures are covered by the major partner. These small jet providers however are bound to the major partner, through good and bad. It is the contracting airline that holds all the cards in this relationship; if a provider can't fulfill their end of the bargain there is always someone else in the market that can. Small jet provider management is responsible for ensuring it holds up their end of the bargain, and hopefully they can do it for less than the major is paying per departure. The consequences of this inaction were witnessed in early 2001 when Delta Air Line's SJP, Comair, went on strike. Delta's passenger feed provided by Comair was crippled and Delta learned a valuable lesson: don't leave all your eggs in one basket. Soon Atlantic Southeast Airlines were in the picture and complementing Delta's passenger feed. Other majors in the industry began exploring diversification options. Of course, there is also Atlantic Coast Airline's refusal to subject itself to United Airline's CPA demands, and ACA's attempt to go-it-alone as Independence Air.

Now, Express Jet, which is the former wholly-owned subsidiary of Continental Airlines and operates as Continental Express is feeling the pain. Express Jet were unable to meet the demands of Continental's new CPA and were ordered to return 69 aircraft to Continental, who then planned to contract another partner to provide passenger feed (the SJP business model does not always own the aircraft, they are leased from the major partner). Express Jet could opt to keep the 69 aircraft and lease them from Continental at higher rates, however there was no need for them in the Continental network. So, the question now is: What does Express Jet do with 69 aircraft? Well, some other major may want a new feed partner, however Express Jet has a hard time competing with the major SJPs out there, SkyWest, Republic, and Mesa. Then there is the option of shifting the airframes to Europe where Express Jet has a subsidiary attempting to bring CPAs across the Atlantic. This is not going so well as the majority of major airlines in the EU wholly own or have large equity investments in their regional airlines. So, Express Jet has now started a corporate division. This division will be stocked with 10 aircraft that are being refitted to better suit passenger needs. That leaves up to 59 airframes without a home at the moment.

The SJP business model is not a sure-fire win for stakeholders. Look at the turmoil that Comair, Mesaba, and Pinnacle are going through. While this business model appears to be protected from industry challenges, it may only be truly successful if diversification is possible. Those SJPs that operate for numerous carriers in the market are the most adept at surviving a downturn in the economy.

Aviation business models defined

Business models within industries are sometimes challenging to identify and categorize, and the airline industry is no exception to this rule. Many scholars and journalists attempt to create simplified classifications of the airline industry, which ignores its complexity. Hopefully, this blog will provide some clarification.

There are three types of airlines in the world: passenger, cargo, and a combination of the two. A passenger airline is Ryanair, while a cargo airline is FedEx, and a combination is Northwest Airlines. Pure passenger airlines are not as common because there is money to be made in moving cargo. Many low-cost carriers (more on those later) are pure passenger airlines, which is a conscious decision to avoid extra expense and complication. Cargo airlines are simply that; they only move cargo around. Combination airlines are very common and they move both passengers and cargo, which may consist of mail or freight from shipping companies or freight forwarders.

Most readers are more familiar with passenger and combination airlines, even though they may not be aware that their clothes are sitting in the same cargo hold as their Christmas package being sent from grandma. So, we will focus on these two types of airlines and lump them together under the nomenclature passenger airlines. We will use this term since it is the one most are familiar with.

Passenger airline can be further segmented according to scheduled and non-scheduled. Non-scheduled passenger airlines are, for example, Condor. Scheduled passenger airlines are Emirates or Aloha. The common passenger airline business models are as follows:

• Network carriers (they also go by other names: legacy carriers, flag carriers, incumbents, hub-and-spoke carriers) such as British Airways
• Low-cost carriers (they too have other names: point-to-point carriers, new entrant carriers, value for money carriers, low-fare airlines) such as Air Asia
• Regional carriers (this is a common term for both airlines that operate in a specific region or those that provide feed traffic to larger, network carriers, but I will provide another term for these particular carriers) such as Air Greenland
• Small Jet Providers (this is term coined by consultants at The Boyd Group to describe those carriers that lease capacity to larger airlines, which many call regional carriers; this term has worn out its usefulness since small jet providers now operate aircraft that can fly more than half the continental US) such as SkyWest
• Charter carriers (this category is relatively small in the US and much larger in Europe; they commonly offer both integrated, comprehensive package deals or seat-only sales to popular tourist destinations) such as Condor
• Business aviation (this is a category some scholars include in their analyses of airline business models, however I do not consider this business model segment with the realm of the airline industry, I merely include it here to ensure you that I have considered its implications; the value proposition and target market of this segment does not warrant a threat towards airlines and should be considered a separate business model, on par with passenger, cargo, and combination carriers) such as NetJets

Most literature discusses four business models for passenger airlines (remember, this is both pure passenger and combination airlines), however I have added a fifth category, the small jet providers (remember, I do not consider business aviation in this category, it was merely mentioned to discuss its relevance). Regional is a term that was carried over from the historical US classification of airlines according to annual revenue (source: http://ostpxweb.dot.gov/aviation/airlineclassifications.htm).

• Major airlines: > $1 billion in revenue
• National airlines: $100 million - $1 billion in revenue
• Regional/commuter airlines: < $100 million in revenue

These classifications are little outdated as the large US "regional" carriers have revenue in excess of $1 billion and operate aircraft that are much larger than those previously; you can hardly deem an Embraer 195 a "puddle jumper." With the introduction of small jets (Bombardier and Embraer) and the technological advances in these aircraft, regional airlines have now grown into large companies that operate hundreds of aircraft and no longer fly to destinations a short hop from a large airport. Small jet providers operate with a unique business model of capacity purchase agreements (CPAs) that essentially is a capacity and crew lease to a larger airline on a long-term basis. This is similar to a wet-lease, however the partnership is more integrated and long-term.

Within these 5 business model categories there are many sub-categories. It is not appropriate to assume that all airlines within one category have the same business model. Many low-cost carriers actually operate a hub-and-spoke model (for example, Frontier and Air Tran) while some resemble to a greater extent a point-to-point operation (Ryanair). Some network carriers have begun to adopt aspects of the low-cost model (SAS with the removal of ticket restrictions and now offering one-way fares). A small jet provider (Independence Air) transitioned from a CPA agreement to a low-cost carrier with a hub-and-spoke network; this model eventually failed but it is an example of a business model transition. There are many more detailed examples, however I hope that you get the gist of the airline business model classifications and the dangers of attaching rigid aspects to each that are inappropriate.

What is the business model?

Academics are beginning to delve deeper into the issue of business models since the first major breakthroughs were made in the late 1990s. Timmer is commonly attributed with bringing the term to light in 1998 with his article, Business Models for Electronic Markets. More recent additions include Afuah's 2004 book, Business Models: A Strategic Management Approach, as well as, a wealth of articles, such as Hedman & Kalling, The Business Model Concept, or Magretta's seminal Why Business Models Matter.

Its importance is widely accepted, even if its definition and understanding are not. The main components of the model include:
1. Value proposition: What is it that a company brings to the market, and what benefits do customers gain from utilizing a company's product and/or service.
2. Target segment: Which customers are the primary users. The value proposition and the target segment must coincide, in other words, your target market should value your offering.
3. Activities: This aspect of the model is what the majority of people describe as a business model; it is usually the most visible and the part of the model that can be relatively easily adjusted.
4. Network: The network describes how a company's partners, suppliers, customers and others all interact with the business model.
5. Competitive strategy: How does the chosen model compare to others in the industry? What advantages and disadvantages does it provide over competitors, and how easily are these eroded?
6. Finances: At the end of the day it is always necessary to do a financial analysis to test the financial sustainable of the business model. This aspect reviews revenue streams and associated costs, and hopefully results in positive figures.

It is imperative that companies realize that business model elements coexist in balance with each other in successful companies. If business model innovation only focuses on one element the balance may be upset, and the remainder of the model may require adjustment to ensure long-term sustainability.

A recent survey by IBM pinpointed that CEOs are paying more attention to business models than in the past. They indicated that business model innovation is a core element of long-term success. Business model innovation refers to a company's dynamics when it comes to adjusting, or changing, their business model to better suit their current market or enter entirely new markets. Examples of business model innovation includes the transition of IBM from an OEM manufacturer to a consulting firm or Apple's transformation from computers to business and consumer electronics.

Business model innovation is beginning to appear more and more in the airline industry. Aer Lingus' transition from a national, full-service network carrier to a low-cost carrier. Aer Lingus was struggling with Europe's largest low-cost carrier, Ryanair, right at its door step and needed to take drastic steps to avoid permanent damage. Today, the carrier is achieving positive financial results and preparing for an IPO. JetBlue has gone against the traditional low-cost carrier grain and aggressively targeted business travelers. The business model that is necessary to target that market segment is different from targeting leisure travelers. Business model innovation is imperative in today's fast-paced business world, and we will be seeing many more innovations within the airline industry in the coming years.

The importance of business models...in any industry

There are some industries that are profitable and others that are less profitable. However, within any industry there are the upper echelon of successful companies, the middle-road, and the laggers. The question that many observers attempt to answer is: Why are some companies successful and others less successful? Sometimes it is access to specific assets, a patented technology, or an important network. Much research is beginning to indicate that a company's chosen business model has an enormous impact on its level of success.

The aviation industry, as a whole, has its fair share of sub-industries. There are full-service carriers, low-cost carriers, charter airlines, regional carriers. Within these sub-industries there are a range of business models. I will follow conventional wisdom and tend to focus on full-service and low-cost carriers as these are the most visible to the general public. Most research indicates that there are two types of business models in the scheduled-passenger industry, full-service and low-cost, however this is an over-simplification of the industry. There are many low-cost airlines that do not adhere to the conventional definition or follow the supposed low-cost airline business model, while the same holds true for full-service carriers. Numerous distinct business models are sprouting up across the globe within these two aviation sub-industries. Some passengers are flying with true low-cost carriers, such as Ryanair, some with low-cost carriers offering a slightly greater level of service, such as JetBlue, some with full-service carriers offering less-than-ideal full-service, many North American carriers, and finally others are flying with carriers that set the standard in service offering, such as Singapore Airlines. The business models are really a continuum stretching from pure low-cost to pure full-service, and the spectrum is populated from one extreme to the other.