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GROWING THE AIRLINE BUSINESS: WHERE LIES THE DISCONNECT?

GROWING THE AIRLINE BUSINESS: WHERE LIES THE DISCONNECT?

MAGAZINE ARTICLES / PARADIGM

MAGAZINE ARTICLES / PARADIGM

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MAY

MAY

2018

2018

Growing the Airline Business: Where Lies the Disconnect?

Growing the Airline Business: Where Lies the Disconnect?

As you know, Airline Profits has one key message. And that is the need to rethink the airline business from the ground up. In fact, we went even further by presenting a business model in Airlines for Business, the first volume in the Airline Profits Book Series. This article discusses a significant disconnect when it comes to the air transport industry.

Lifecycle of Innovation

First of all, does innovation has a lifecycle? From our perspective, it does. And Simon Wardley a passionate guru on value chain mapping presented that notion very well. Typically, innovation usually comes about in the form of a product, then goes through different stages over time. Here they are:

1.       Product Stage

2.       Customization stage

3.       Service stage

4.       Commodity stage

5.       Utility stage

 

1.       At the product stage, innovation is in its infancy, so standardization is not possible yet. There are still many aspects to be figured out. In this phase, it will be costly to produce; it will be priced accordingly at a much higher point.

2.       At the customization stage, there is a better knowledge of the product. Therefore, there is at least a primary differentiation between the core features and the optional features which can be customized. In this phase, it may cost a bit less to produce. However, the need and the extent of customization will often dictate a more or less higher price point. That is mainly because each customized unit will naturally be unique.

3.       At the service stage, the level of understanding of the original product is much more significant. Moreover, a better way of delivering that product seamlessly, the infrastructure and the teams or systems required have been identified and put in place. In this phase, the cost of production is much lower. However, pricing would largely depend on the level of quality and the consistency in which one delivers the experience. There still may be the possibility of customization, and that will undoubtedly drive the price point up.

4.       At the commodity stage, customers have widely adopted the product, and the cost of production is even lower than that of the initial product. Furthermore, the raw material that would go into the production is most readily available. And because it costs much less to produce at that point, the sales price will be much lower. And that, in turn, will attract even more customers. Another essential characteristic of the commodity stage is the fact that, there are many manufacturers or providers of the given product or service. And that too will be an important factor in driving the pricing down.

5.       At the utility stage, the product is not only widely spread, but the vast majority of the target market adopted it and are using that as an everyday product. In fact, it would be difficult to live without having or using such a product or service. There may be one or more providers or manufacturers. However, the need for mass production ensures an economy of scale, which commands a lower price point. In this phase, even more so than in the commodity stage, not only is the cost of production meager, but the volume of sales is much higher, because of the regular consumption of the product or service.

 Is Air Transport a Service or a Commodity?

Having covered the lifecycle of innovation, this is a fundamental question worth considering.

Well, the answer is either or both. Why? Firstly, the basic airline business model, which is still in effect today widely across the airline industry, is mainly selling seats. And as someone put it so well, beyond having a seat, the residual value of a commercial flight is nothing more than the souvenir of the travel experience. Therefore, air transport is a service.

Secondly, the pursuit of market share, meaning volume, and the subsequent price wars do position air transport more as a commodity than a service.

Where Lies the Disconnect?

So referring to the previous section, from an innovation perspective, commercial air transport is still at a service stage, because the cost of production is still relatively high. And as a rule, airlines operating expenses are mainly driven by the price of jet fuel.

At the same time, the pricing of air services, which is mostly driven by price wars do place air transport into the commodity stage.

There wouldn’t be any real issues with that if the financial performance of the air transport industry were good enough. Unfortunately, this is not the case in most instances. As we have seen in recent years, exceptional airline performance depends strictly on how abnormally low oil price may be. That is another way to suggest that the airline industry is at the mercy of market forces well outside of its control. Another point to underline here is the fact that the so-called outstanding or record performance is not necessarily that extraordinary compared to other less vital industries.

 

What Could Be Done About It?

Typically, we can look at the issue at hand from two different angles, but it has to be identified and agreed as being a real issue first. The reason being that many airline CEOs still avoid the discussion and tend to suggest that there is no way for them not to engage in price wars. And that is where a lose-lose approach to the business is undermining the industry’s ability to sustain itself and provide a decent return on investors’ money. It is also the place to highlight that some industry leaders and influencers have proclaimed that the air transport sector has turned itself around for good. We only hope that that is indeed the case and not just some wishful thinking.

With that said and provided that airline CEOs do identify a disconnect as we have exposed in this article, there are two options available to be considered.

Option 1: Revert to the Service Stage.

As covered at earlier in this article, the service stage will entail that air carriers charge fees in line with the service provided. One must consistently deliver quality and customization of the service in such a way that customers willingly pay in exchange for high perceived value. In such a case, airlines should focus more on competing based on product or service differentiation. We have covered that in Airlines for Business, in case you want more details about our perspective on the topic of differentiation of airline offering.

 

Option 2: Push to the Commodity Stage

The second option is to advance into the commodity stage.

The main characteristics of the commodity stage are:

  • Multiple providers
  • Low cost
  • Low pricing.

That would entail that air travel would become more commonplace in such a way that a vast majority of people would choose that over other means of transportation. Another consequence of such positioning would be that pricing rather than product differentiation would be the primary competitive driver (as it is already today). That implies though that more open sky partnership would be there to allow more connectivity between various destinations around the world. The other implication would be that more modern infrastructure is in place to support such growth and expansion of air service. The need for current infrastructure would not necessarily be limited to air transport. Other means of mass transportation, such as road, railway, and maritime sectors would require similar improvements to handle the flow of traffic to and from airports.

Besides, it may take a few decades to get there. That is not only due to the substantial investments that would be required to attain an acceptable level of efficiency. It also hinges upon the time necessary to build such infrastructure, because it certainly couldn’t be done overnight.

Furthermore, another significant constraint is the shortage of qualified and licensed personnel. Without such an enabler, all the investments in modern infrastructure would prove useless.

Conclusion

In the early part of the 20th century, an innovation came about: the invention of a heavier-than-air, powered and controllable airplanes. Then followed just about a decade later, yet another change: a scheduled air service between the towns of St. Petersburg and Tampa, both in Florida. As we have considered in this article, this second innovation just like the first one has gone from the product stage, the customization stage to the service stage. For instance, scheduled air service is now available worldwide, while airplanes can be rented or leased. And while none of this two innovations have entered the commodity stage, airline pricing has in fact pushed scheduled airlines into the commodity stage. And that could have been true except that this stage of affairs does not reflect the real cost of airline operations. Thus, the air transport industry which is so vital to the world economy appears to enrich every other link in the commercial aviation value chain, except itself. The only time, air carriers make decent profits is when oil prices are abnormally low. And while the last few years seemed to be good years for many airlines, the profit margins and the average yield per passenger tend to suggest that airlines still have a long road ahead before attaining financial sustainability. 

Suggesting that there is a disconnect that the airline industry needs to resolve before it can benefit from its tremendous contribution to the world economy, would be an understatement. The challenge lies mainly in the reluctance of many industry leaders to recognize that they are engaged in a losing game, then to identify the necessary steps to address the issue. Until such a time, it would be a detrimental mistake to leave things just the way they are and merely hope for the best.

As you know, Airline Profits has one key message. And that is the need to rethink the airline business from the ground up. In fact, we went even further by presenting a business model in Airlines for Business, the first volume in the Airline Profits Book Series. This article discusses a significant disconnect when it comes to the air transport industry.

Lifecycle of Innovation

First of all, does innovation has a lifecycle? From our perspective, it does. And Simon Wardley a passionate guru on value chain mapping presented that notion very well. Typically, innovation usually comes about in the form of a product, then goes through different stages over time. Here they are:

1.       Product Stage

2.       Customization stage

3.       Service stage

4.       Commodity stage

5.       Utility stage

 

1.       At the product stage, innovation is in its infancy, so standardization is not possible yet. There are still many aspects to be figured out. In this phase, it will be costly to produce; it will be priced accordingly at a much higher point.

2.       At the customization stage, there is a better knowledge of the product. Therefore, there is at least a primary differentiation between the core features and the optional features which can be customized. In this phase, it may cost a bit less to produce. However, the need and the extent of customization will often dictate a more or less higher price point. That is mainly because each customized unit will naturally be unique.

3.       At the service stage, the level of understanding of the original product is much more significant. Moreover, a better way of delivering that product seamlessly, the infrastructure and the teams or systems required have been identified and put in place. In this phase, the cost of production is much lower. However, pricing would largely depend on the level of quality and the consistency in which one delivers the experience. There still may be the possibility of customization, and that will undoubtedly drive the price point up.

4.       At the commodity stage, customers have widely adopted the product, and the cost of production is even lower than that of the initial product. Furthermore, the raw material that would go into the production is most readily available. And because it costs much less to produce at that point, the sales price will be much lower. And that, in turn, will attract even more customers. Another essential characteristic of the commodity stage is the fact that, there are many manufacturers or providers of the given product or service. And that too will be an important factor in driving the pricing down.

5.       At the utility stage, the product is not only widely spread, but the vast majority of the target market adopted it and are using that as an everyday product. In fact, it would be difficult to live without having or using such a product or service. There may be one or more providers or manufacturers. However, the need for mass production ensures an economy of scale, which commands a lower price point. In this phase, even more so than in the commodity stage, not only is the cost of production meager, but the volume of sales is much higher, because of the regular consumption of the product or service.

 Is Air Transport a Service or a Commodity?

Having covered the lifecycle of innovation, this is a fundamental question worth considering.

Well, the answer is either or both. Why? Firstly, the basic airline business model, which is still in effect today widely across the airline industry, is mainly selling seats. And as someone put it so well, beyond having a seat, the residual value of a commercial flight is nothing more than the souvenir of the travel experience. Therefore, air transport is a service.

Secondly, the pursuit of market share, meaning volume, and the subsequent price wars do position air transport more as a commodity than a service.

Where Lies the Disconnect?

So referring to the previous section, from an innovation perspective, commercial air transport is still at a service stage, because the cost of production is still relatively high. And as a rule, airlines operating expenses are mainly driven by the price of jet fuel.

At the same time, the pricing of air services, which is mostly driven by price wars do place air transport into the commodity stage.

There wouldn’t be any real issues with that if the financial performance of the air transport industry were good enough. Unfortunately, this is not the case in most instances. As we have seen in recent years, exceptional airline performance depends strictly on how abnormally low oil price may be. That is another way to suggest that the airline industry is at the mercy of market forces well outside of its control. Another point to underline here is the fact that the so-called outstanding or record performance is not necessarily that extraordinary compared to other less vital industries.

 

What Could Be Done About It?

Typically, we can look at the issue at hand from two different angles, but it has to be identified and agreed as being a real issue first. The reason being that many airline CEOs still avoid the discussion and tend to suggest that there is no way for them not to engage in price wars. And that is where a lose-lose approach to the business is undermining the industry’s ability to sustain itself and provide a decent return on investors’ money. It is also the place to highlight that some industry leaders and influencers have proclaimed that the air transport sector has turned itself around for good. We only hope that that is indeed the case and not just some wishful thinking.

With that said and provided that airline CEOs do identify a disconnect as we have exposed in this article, there are two options available to be considered.

Option 1: Revert to the Service Stage.

As covered at earlier in this article, the service stage will entail that air carriers charge fees in line with the service provided. One must consistently deliver quality and customization of the service in such a way that customers willingly pay in exchange for high perceived value. In such a case, airlines should focus more on competing based on product or service differentiation. We have covered that in Airlines for Business, in case you want more details about our perspective on the topic of differentiation of airline offering.

 

Option 2: Push to the Commodity Stage

The second option is to advance into the commodity stage.

The main characteristics of the commodity stage are:

  • Multiple providers
  • Low cost
  • Low pricing.

That would entail that air travel would become more commonplace in such a way that a vast majority of people would choose that over other means of transportation. Another consequence of such positioning would be that pricing rather than product differentiation would be the primary competitive driver (as it is already today). That implies though that more open sky partnership would be there to allow more connectivity between various destinations around the world. The other implication would be that more modern infrastructure is in place to support such growth and expansion of air service. The need for current infrastructure would not necessarily be limited to air transport. Other means of mass transportation, such as road, railway, and maritime sectors would require similar improvements to handle the flow of traffic to and from airports.

Besides, it may take a few decades to get there. That is not only due to the substantial investments that would be required to attain an acceptable level of efficiency. It also hinges upon the time necessary to build such infrastructure, because it certainly couldn’t be done overnight.

Furthermore, another significant constraint is the shortage of qualified and licensed personnel. Without such an enabler, all the investments in modern infrastructure would prove useless.

Conclusion

In the early part of the 20th century, an innovation came about: the invention of a heavier-than-air, powered and controllable airplanes. Then followed just about a decade later, yet another change: a scheduled air service between the towns of St. Petersburg and Tampa, both in Florida. As we have considered in this article, this second innovation just like the first one has gone from the product stage, the customization stage to the service stage. For instance, scheduled air service is now available worldwide, while airplanes can be rented or leased. And while none of this two innovations have entered the commodity stage, airline pricing has in fact pushed scheduled airlines into the commodity stage. And that could have been true except that this stage of affairs does not reflect the real cost of airline operations. Thus, the air transport industry which is so vital to the world economy appears to enrich every other link in the commercial aviation value chain, except itself. The only time, air carriers make decent profits is when oil prices are abnormally low. And while the last few years seemed to be good years for many airlines, the profit margins and the average yield per passenger tend to suggest that airlines still have a long road ahead before attaining financial sustainability. 

Suggesting that there is a disconnect that the airline industry needs to resolve before it can benefit from its tremendous contribution to the world economy, would be an understatement. The challenge lies mainly in the reluctance of many industry leaders to recognize that they are engaged in a losing game, then to identify the necessary steps to address the issue. Until such a time, it would be a detrimental mistake to leave things just the way they are and merely hope for the best.

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Left wing of an airborne modern aircraft. Photo Credit: CC0 Creative Commons

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Copyright © 2015-2018 Airline Profits, All Rights Reserved.

Copyright © 2015-2018 Airline Profits, All Rights Reserved.

Destined for Aviation Leaders and Influencers, Airline Profits is the first aviation magazine devoted to improving airline effectiveness and profitability. 

ISSN 2368-7800 (Print)

ISSN 2368-7819 (Online)

Destined for Aviation Leaders and Influencers, Airline Profits is the first aviation magazine devoted to improving airline effectiveness and profitability. 

ISSN 2368-7800 (Print)

ISSN 2368-7819 (Online)

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ABOUT KOFI SONOKPON

ABOUT KOFI SONOKPON

Managing Editor of Airline Profits, the  first aviation magazine devoted to airline effectiveness and  profitability, Kofi Sonokpon has nearly 25 years of experience in  aviation. Kofi holds an IATA sponsored Master of Business Administration  (MBA) in Air Transport Management from the John Molson School of  Business at Concordia University in Montreal. An aviation expert and  thought-leader, Kofi Sonokpon is also a speaker, trainer and the author  of an innovative book series intended for the 21st century airline,  namely Airlines for Business and  Airlines for Technology. An  accredited media delegate to the 39th Triennial Assembly of ICAO, Kofi  Sonokpon is the host of Airline Profits Executive Interviews where he  discusses various issues and solutions with aviation industry leaders  and experts.

Managing Editor of Airline Profits, the  first aviation magazine devoted to airline effectiveness and  profitability, Kofi Sonokpon has nearly 25 years of experience in  aviation. Kofi holds an IATA sponsored Master of Business Administration  (MBA) in Air Transport Management from the John Molson School of  Business at Concordia University in Montreal. An aviation expert and  thought-leader, Kofi Sonokpon is also a speaker, trainer and the author  of an innovative book series intended for the 21st century airline,  namely Airlines for Business and  Airlines for Technology. An  accredited media delegate to the 39th Triennial Assembly of ICAO, Kofi  Sonokpon is the host of Airline Profits Executive Interviews where he  discusses various issues and solutions with aviation industry leaders  and experts.

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