The Airlines’ Global Dilemma
Airlines were global before much of the business world knew global existed. As early as 1919, international travel quickly became the most romantic, highest-margin segment of the airline industry, and it remains so today. Given their rich international experience, you might think the major Western airlines would be well positioned to take advantage of globalization, now that other industries have caught up to them in seeing the profitability possibilities of worldwide commerce. But that’s not the case; in fact, unlike for virtually every other industry, for the traditional airlines, globalization is not an opportunity, but their gravest threat.
As auto, chemical, and pharmaceutical companies have demonstrated, today is a perfect time for international consolidation to better scale resources around the world. For large international airlines, such mergers and partnerships could go a long way toward significantly cutting costs by reducing competition, using the workforce and planes more efficiently, and reconfiguring route networks to make them less redundant. But these global transactions are not yet in the cards. There are many challenges and obstacles, such as regulation restrictions, to a fully globalised future for these carriers. But if these carriers want to continue to survive and thrive, these are issues that must be overcome.
The Challenges: Regulation Restrictions and Crowded Airways
Most countries puts strict limits on foreign ownership, in the U.S. no more than 25 percent of voting shares can be owned by non-American equity holders. Because of these restrictions, international consolidation is effectively precluded for most large carriers, so they have to make do with local mergers. Those kind of linkups will help drive down costs in mostly saturated markets but do little to position the airlines to take advantage of potential growth in rising markets like India and China. “Ownership restrictions are just one set of leftover nationalist regulations that traditional carriers are forced to grapple with. Equally disconcerting and difficult to navigate are the sometimes inconsistent—or at least illogical—policies that governments impose in many countries,” said Fadi Majdalani, Partner Booz & Company.
At the same time that the legacy carriers struggle with navigating their international presence, the airspace itself is getting more crowded. New international players from the Middle East and nearby countries are emerging as a real threat with tangible advantages. Capitalized with government funds, running virtually tax-free, equipped with freshly built fleets of standardized aircraft, operating out of sparkling new airports, staffed with non-union workers, and offering top-notch service, these carriers are aggressively pursuing new economy-class fliers while skimming the business-class cream. They’ve been particularly successful at luring customers from traditional carriers on long international routes linking the developed world with emerging markets, especially between Europe and Asia. Indeed, Emirates is now the world’s seventh-largest airline, while Etihad and Qatar Airways are offering five star products and services.
“In the last decade, the global aviation sector has witnessed a steady increase in passengers and revenue, and emerging markets have seen even faster growth. In the Middle East: From 2005 to 2009, revenue passenger kilometers for the overall industry experienced a compound annual growth rate of 4 percent; in the Middle East, by contrast, the sector grew at 13 percent,” said Alessandro Borgogna, Principal Booz & Company.
Learning to Cope: Pipe Dreams and New Commitments
Up against these new international challengers, and with rock-bottom-price discount carriers driving down yields in home markets, how can legacy carriers cope in an industry that for them will remain part protectionist, part globalized, for years to come? To begin with, while recognizing that there is no perfect business model for the airline industry, these carriers must commit to developing the optimal model for the markets in which they compete.
Airlines actually are conglomerations of several separate types of operations; these might include air service, maintenance, ground handling, and catering, among others. Although the outsourcing of functions such as aircraft maintenance, repair, and overhaul (MRO) has become routine, to one degree or another many airlines are still managing many of the other activities. For some airlines and when business conditions are particularly difficult, the steadier cash flow and reduced overhead from managing ancillary activities like IT, food distribution, and MRO in-house as shared services could be a smart strategy. Yet more times than not, the outsourcing deals don’t provide the anticipated results, because the agreements tend not to be particularly well thought out, lacking strong incentives for cost improvement, for example.
Thus far, though, these moves remain a pipe dream, in part because antitrust regulators are still giving immunity only gingerly, but also because consensus among all alliance members is difficult to achieve. Until these alliances can routinely produce improved returns and greater efficiency, airlines should consider more bilateral and multilateral sharing arrangements that don’t involve an entire group of airlines but achieve synergies on a smaller but still significant scale. This, in effect, turns their linked routes into a virtual airline and could point the way toward realizing the types of sharing programs that are harder to coordinate in the big alliances.
“In addition, the major airlines must finally commit to remaking themselves and develop the capabilities they need to compete in their complex business environment. The airlines have faced this challenge for a long time, but too many remain burdened by incoherence between their strategic direction and the operating model and capabilities required to succeed,” said Borgogna.
Although nationalistic politics have militated against serious cross-border consolidation in the airline industry, the economic forces of globalization are unlikely to allow preservation of the status quo in perpetuity. “Over the next decade, the chances of major changes in political attitudes toward international airline mergers are high enough that every major player in the industry must prepare for them. Expertise in merging diverse cultures will become a crucial competitive challenge,” said Majdalani.
Integrating two companies is tough enough within the same country. International mergers only up the ante. Even same-continent pairings can present difficulties: such as merging very different work ethics. In addition, airlines must be prepared to handle the complexity created by mergers in such activities as management of ground operations and maintenance of different types of planes. Politics might protect the industry for now. But airlines that fail to anticipate a fully globalized future risk grounding themselves. Imagination and creativity enabled them to take flight and cross the oceans nearly a century ago. Now the large, established carriers must dig deep to apply those same traits again.