Adapting to change - new business models for airlines? November 2009

There is much discussion of the need for new business models for airlines. “We have to find ways of doing things that have not been done before, without compromising on cost. There is no uniform low cost model like there was fifteen years ago”, says Alex Cruz, CEO of Vueling. "Hanging on in there and just hoping for old high–roller times to return is the road to oblivion,” confirms Willie Walsh, CEO of British Airways. But do new business models exist, or are so–called paradigm shifts nothing more than small changes to existing ways of running airlines?

Approximately 85 airlines have failed worldwide since January 2008 according to the ERA, and it forecasts that another 20 will cease operations by the end of April 2010. These numbers would be even larger if US airlines that have sought Chapter 11 bankruptcy protection, or those European airlines that have recently been acquired rather than closed down, are added.

Airlines have always seen a relatively high degree of failure: Richard Branson’s comment on buying an airline in order to change from being a billionaire to a millionaire is a standard joke used to prepare analysts, shareholders and staff for the warning that profitability is parlous.

It is a salutary thought that most of these failed airlines had alleged “excellent business plans”, often scrutinised by senior investment bankers and industry analysts. In reality many of these business plans were at best plausible but deeply flawed, if rigorously reviewed, and their acceptance was in part the result of the ready availability of credit along with the over–exuberance of aviation investors prior to 2008. Nevertheless, failure is explained as the result of unforeseen and uncontrollable events such as the economic recession, fuel prices, currency fluctuations, pandemics, the withdrawal of promised funds or undue regulatory interference. Some admit competition played a part but most claim that the airlines were well managed, and it was just unfortunate the way things worked out.

All of these factors are known to some degree by the airline managers, however, and most have been around for the last 50 years. They are complicated factors to manage but many airlines have survived similar shocks in the past. They are not the low probability, high impact ‘black swans’ as defined by academic Nassim Taleb, based upon the metaphor that until a black swan was seen in Australia in the 18th century then everyone thought it was inconceivable that swans would not be white.

Such ‘black swans’ are the genuinely unknown factors in a global market place and we see a hint of two of these in the thinking behind the quotations in the opening paragraph — i.e. what if the airline market of 2010 and beyond does not revert to the same number of people wishing to fly on air services, and what if within such a radically changed demography significantly fewer people are willing to pay premium fares?

The complexity of the future

“Glorified bus operations”

Past history suggests this should not happen, that premium passengers will return, that surviving airlines will become profitable, and that growth will resume. This has happened many times before so why not this time? There is no answer to this question, but there are doubts, and the cynicism that says airline leaders are making such statements simply in order to impose draconian cuts in staffing or cost, or to influence regulation may be misplaced. In the language of business management these questions about the future market context are complex in their nature. There are no clear answers available despite copious data sets — and airline leaders need to think in terms of a flow of events, patterns and emerging trends rather than depending upon analysis of past events as a predictor of future markets. The ‘business plan’ may become part of the problem unless it is constantly updated, and the management may also become part of the problem if it pursues narrow goals at the expense of adapting to an uncertain future. Airlines are relatively simple organisations to manage: to Michael O’Leary, CEO of Ryanair, they are “a glorified bus operation”. Skill is certainly needed to manage them well, as the delivery of services requires the completion of many quite complicated tasks that require skill. Gordon Bethune, former CEO of Continental, reminded his managers that airline operations are like a Swiss watch, in that “every part has to work if they are to run on time”.

Leadership in an airline is, however, often also complex in the nature of the problems to be addressed. In this small semantic difference, ‘complicated’ and ‘complex’ — and the ability to act differently as a result — lies one of the reasons why some airlines survive and prosper and others struggle and fail. Understanding the difference and changing leadership behaviour requires fundamental differences in the mindset of managers, and in the skills they deploy.

For complicated tasks the manager needs to be able to sense the problem, bring to bear appropriate analysis, perhaps seek expert advice and be prepared to make a decision on the relative merits of various options for action. For complex tasks the leader needs to be able to probe the uncertain nature the issue, create an environment in which alternative responses may be postulated and tried out, building upon and adapting successful lines of action and closing down the less promising.

In dealing with complicated issues clarity of thinking and decision making is important, and may lead to clear goals and accountability for execution. In dealing with complex issues dissent and a diversity of views need to be encouraged, together with a willingness to experiment. In such a potentially chaotic environment communication skills that reassure individuals and make sense of apparently disconnected or conflicting priorities become vital.

So what might this semantic difference mean in an airline context? Complicated problems may be very difficult to resolve. They may require years of training and experience and the development of high level physical or mental skills. Pilots and engineers pursue trades in which complicated tasks are routinely managed. Other roles such as system development, ground operations and human resource management also complete many complicated tasks if reservations are to be made at a good yield, aircraft loaded and dispatched, and people paid the right wages and at the right time.

System improvements

An added degree of complication arises when one part of the total system fails as a result of factors such as the intervention of weather, an aircraft arriving late from maintenance, check–in staff being absent through sickness or the predicted no–shows resulting from the overbooking algorithm all show up. Procedures are in place to react to these situations and in many airlines – especially the good ones – the motivation and energy among staff noticeably increases as they react to the problems that arise. The precision of a Swiss watch is to be admired but for many people a little bit of change and challenge, on occasion, reminds them (and others) that what they do, however small an activity, has a purpose. For managers a constant drive is to simplify the levels of complication through system improvements which translate into clear processes for every person to follow. Most airline management training therefore emphasises the importance of understanding the value and logistical chains and the need to resolve problems in the best interests of the overall system – and the delivery of the brand promise to the customers. “Do not export the problem” to the next function was a key principle when Air Canada was going the extra mile or Jan Carlson was reminding airline staff at SAS that they transported people not passengers.

For complicated problems there is usually an answer, sometimes a ‘right answer’ but always a ‘best answer,’ based on previous experience and looked at from the overall system perspective. The answer may be difficult to find, and it may take a lot of time and effort but there is an answer. Hence most passengers and cargo are transported according to the terms of the fare agreement and the expectations of the purchaser, and very nearly all aircraft take off and land safely — millions of them every day.

For complex problems, however, there is no right or even best answer. There is only a range of options, each of which may provoke new and unknowable responses which may lead to the need for more decisions to which there may not be a right answer. Welcome to the world of airline leadership.

Currently airline managers are becoming aware that their industry may need ‘new business models’ — i.e. a change of basic philosophy, market positioning or business structures – and not just more of the same in terms of cost cutting, marketing or the manipulation of yields. In fact there is some concern that cost cutting per se may lead to the failure of some current airlines because it removes the capability of the airline to compete effectively in the future. Royal Dutch Shell paid the price for a similar approach in the oil downturn of the 1990s when it saved operating costs by reducing its exploration and project management capability and then struggled to find sufficient skilled and affordable staff 10 years later when the market opened up. Shell had the financial muscle to recover; some airlines may not.

21st century breakdown

So why might ‘new business models’ be required? Or is this another convenient label to describe another of the sort of transitions regularly made by airlines over the last 50 years? There are still serving airline managers who remember IATA inspectors fining them because their sandwiches were larger than the agreed industry standard. One EU country put the sales manager of an Asian airline in prison in the late 1970s because he sold discounted tickets. Revenue accounting functions were still processing millions of ticket coupons by hand in the 1980s. ‘Hub and Spoke’ was still new fangled thinking in the Europe of the 1990s, and CRS systems were but starting their journey to the world of GDS and Web2 in a similar timeframe. Low cost airlines were still being predicted to fail at the millennium with McKinsey among others pointing out that they could only penetrate 30% of the market at most; and not so long ago ‘blue skies’ and ‘open skies’ were associated with weather reports rather than with a belief that countries would actually agree to such liberalisation. New business models may be required because in this decade some of the forces for change are not about the industry and the way it manages itself – as all the above examples are. Some of the likely changes result from external factors such as globalisation, environmental protection and security. The new business models may therefore need to be driven by views of transportation in the 21st century, not by views of the competitive position of airlines at the moment. This is complex. Complex to look through the dark glass of the future and make reasonable predictions, and complex to communicate the emerging change of vision and sense of purpose and direction to staff who are still trying to keep aircraft flying ‘like a Swiss watch’ and with fewer resources.

Theodore Levitt’s observations on the failure of the US railroads in the 1970s may be salutary for some. Railroads did not fail because passenger and freight demand declined (demand actually increased) – they failed because they allowed others to fill the need as they concentrated on being railway companies rather than transportation companies and allowed others to enter the market with more appropriate approaches.

Current airline leaders are facing a world in which globalisation is not just about aviation markets. Three areas — from many — that illustrate what makes the current airline leadership task so complex are the new geo–political orientation, the drive to constrain further environmental pollution and the growth of the web generation. These are complex not only in themselves but because they also interrelate.

The emerging geo–political orientation is not more of the same – arguments over market access, inward investment, and fair competition. These are complicated but known issues. An example of what is not known is how a world in which some or all of the BRIIC countries (Brazil, Russia, India, Indonesia, and China) will develop and the role that may be played in these by air transport. This is not just about sheer size and local market dominance. For example will there be a replacement of current international travel nodal points by such as the Gulf states?

The development of the massive new airports and facilities in Abu Dhabi and Dubai are indicative of this. It is possible that these will become the new global hubs – replacing the under–invested, constrained and possibly increasingly ill–placed European airports. If so this will not be because of the airports and their geography – although with a resurgent Asia the history of the ancient silk–routes is a useful pattern to consider – but more to do with their aggregation of business and trading facilities, supported by infrastructure, legal and taxation systems that attract commerce and residents. Such a growth over the next 10 years could fundamentally change international air route structures, the required composition of fleets, and the role of air transport within a new global economy.

The environmental agenda may also be at a tipping point. Despite the hype it is unlikely that the December conference in Copenhagen will change the world. There is, however, a growing public perception that aviation is not a good environmental civilian through the emissions it puts into the atmosphere or through noise pollution. In this environment the planned carbon emission trading scheme, taxing airline passengers, and imposing additional night time bans are but a few of the challenges airline leaders face. In this arena airline leaders have to manage complex stakeholder issues and in multi–actor environments. Having newer aircraft and achieving higher load factors does not advance the argument against curtailing flights per se. Improved efficiency is unlikely to prove a sufficient answer to perceived pollution, as the hydro carbon industry has found to its cost in the last 10 years — and that industry has infinitely more political clout than airlines.

The challenge of the web

So airline leaders may need to radically rethink flying within the emerging environmental parameters, and recognise that in Europe the regulation may well be much tougher than the rest of the world. Whether this is ‘fair’ depends upon where you come from — it is a relative term, and as BA’s Bob Ayling found out some years ago in dealing with the European Commission, having the best argument does not necessarily mean achieving the best outcome. Web2 (and soon Web3) raises quite different issues. Most airlines have now caught up on the transformation that genuinely web–driven distribution offers. The elements of choice and comparison have now been joined by an enhanced ability to move more tasks onto the passenger (such as completing check–in and printing boarding cards) and the concurrent ability to market and sell ancillary services. These are on the cusp of fundamentally changing many marketing and ground handling functions. Web2 also offers other opportunities, however. As companies have reduced corporate travel in response to the current recession they have also experimented with new generation tele–conference systems such as Telepresence (Cisco) and Halo (HP). These are very different to previous teleconferencing tools in look and feel. These offer companies genuine choices as to whether to fly or not. As Giovanni Bisignani, director general of IATA, said in Washington in September it is not at all certain that premium travel passengers will return in large numbers as the economic recession eases.

The “net generation” (essentially anyone under 31 years of age, although some older people also ‘get it’) is also quite different in views on travel. This generation has grown up living in virtual worlds and sees no reason not to transact all business virtually. The many entrepreneurs of China do not see the need to travel – why should they? Their businesses are operating well enough through web–enabled technique. This generation is also exceptionally demanding of web communications – they want freedom of choice, customisation, and the ability to scrutinise the quality of the goods and services they receive and corporate integrity of the companies they do business with.

Complicated versus complex

Ironically Ryanair scores highly on all these dimensions – including the last – as it does “what it says on the tin”; certainly delivering no more, but crucially no less than what is offered. Legacy airlines face a more difficult challenge as they try to increase ancillary revenues at the same time as presenting higher fares as added–value to the passenger. Airlines, as with other businesses, also face the challenge of making social networking – in which feedback on all aspects of perceived service is shared instantly on the web – a positive and not a negative experience. The days of a sales representative talking a key agent or corporate account around are largely gone in many markets – the holders of these posts are likely to be under increasing pressure form direct user communication within their organisations, and on sites such as Facebook and the new phenomenon of Twitter. So airline leaders face a number of complicated and complex challenges. They need to address the former to keep the airlines going, but they also need to address the latter if they are to prosper in the future. The skills to deal with each are not complementary and it is not easy to learn, think and act strategically when under fire. It is also not easy to maintain clear direction and story lines for staff, especially if the implications of the story are fewer or different jobs. Not maintaining such story lines, however, is the stuff that industrial disputes are made of. Reducing cabin crew yet improving service; removing airport services but still improving capabilities to cope with unforeseen disruption; opening up more transparent distribution whilst significantly improving yields and profitability; increasing flights at the same time as reducing environmental impact and waste — all are examples of the adaptive challenges needed to progress complex problems. They are adaptive challenges because the need is to make sense of patterns and incomplete data, and to build capabilities from resources available, or to create new resources.

As Charles Darwin said “It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is the most adaptable to change.” In an airline world it would be a mistake to follow the much later and misquoted passage about “the survival of the fittest” implying survival is about size, or financial, market, or brand strength. The key is how leaders ensure their airlines constantly adapt.

A more modern re–statement of Darwin’s theory was made to a select committee in the UK Houses of Parliament in 2005 — not a place necessarily associated with adaptability. But the quote was not from a politician. It was from a director of Tesco, a very successful supermarket chain. When asked what the strategy of the company is, she replied: “It depends upon how well we do, how our customers feel about it, and what the competitors do.” Here is a clear statement of a leadership belief that success requires constant adaptation, not a static business plan. A similar approach may well be required by the leadership of many airlines over the next few months and years.