2015 Aviation Trends
The airline industry is hampered by slim profit margins, forcing carriers to focus on both cost reduction and revenue growth through better customer interactions.
The global airline industry continues to grow rapidly, but consistent and robust profitability is elusive. Measured by revenue, the industry has doubled over the past decade, from US$369 billion in 2004 to a projected $746 billion in 2014, according to the International Air Transport Association (IATA).
Much of that growth has been driven by low-cost carriers (LCCs), which now control some 25 percent of the worldwide market and which have been expanding rapidly in emerging markets; growth also came from continued gains by carriers in developed markets, the IATA reported. Yet profit margins are razor thin, less than 3 percent overall.
In the commercial aviation sector, just about every player in the value chain — airports, airplane manufacturers, jet engine makers, travel agents, and service companies, to name a few — turns a tidy profit. Yet it’s one of the enduring ironies of the industry that the companies that actually move passengers from one place to another, the most crucial link in the chain, struggle to break even.
That is largely due to the complex nature of the business, manifested in part by the significant degree of regulation (which minimizes consolidation), and the vulnerability of airlines to exogenous events that happen with great regularity, such as security concerns, volcanic eruptions (independent.co.uk), and infectious diseases (reuters.com). But ongoing price pressure is also a factor; the airline industry is one of the few sectors that have seen prices fall for decades. Since the 1950s, airline yields (defined as the average fare paid by a passenger per kilometer) have consistently dropped.
Given these unique circumstances, airlines must continue to focus on top-line growth because their limited profitability depends almost solely on revenue gains, while increasing productivity in order to shore up and perhaps even increase margins. The way individual commercial airlines react to and navigate several trends playing out across the globe will determine carrier performance in the coming years.
Increasing consumer expectations
People have grown accustomed to seeing significant improvements in their experiences with things they buy. Large and small products are more reliable and more user-friendly than ever before. Consider how cars have progressed even in the past decade, with upgraded safety and entertainment features, and far better handling and fuel consumption. Yet air travel has not followed this pattern. It remains for many a disappointing, grumble-worthy experience.
Air travel remains for many a disappointing, grumble-worthy experience.
Consumer disaffection is challenging for carriers to address because upgrading the “hard product” — the aircraft — is an expensive way for airlines to differentiate themselves, and the payback could be long in coming. Enhancing the “soft product” — through a welcoming and seamless customer experience across all aspects of air travel, from reservation to touchdown — is cheaper, but often more difficult to implement. Typically, such enhancements entail a wholesale behavioral and cultural shift within the organization, particularly for frontline, customer-facing employee.
Growing pressure to reduce costs and improve operational efficiency
Airlines need to make large and ongoing improvements to operate more efficiently. With few exceptions, the most successful airlines are those with the strictest cost controls. The biggest (albeit cash-intensive) lever to reduce costs lies in fuel efficiency, as jet fuel typically accounts for 40 to 55 percent of operating expenses.
Carriers with sufficient funds have been gradually modernizing their fleet to incorporate more fuel-efficient aircraft. Yet, because planes are so expensive, this approach has real value only if it is thoughtfully implemented in line with the carrier’s long-term plans for the configuration of its network, such as the programmatic expansion of certain routes over a period of years.
Cost reduction can also be achieved through enhancements in organizational structure, operating model, and work practices. In particular, legacy airlines have often built up complex processes over decades that cost far more than the streamlined processes of the LCCs.
For example, the systems that legacy carriers have in place to handle transfer passengers — how to price connections, how to handle baggage between the two flights, whether to hold a connecting flight for a few late passengers or simply rebook them, and so on — were designed when their networks were far smaller. Today, those systems have layers and layers of complexity built in, making them cumbersome and costly in many cases.
Shifting airline landscape
The rapid growth of air travel in developing markets, such as Latin America and especially Asia, is shifting the industry’s center of gravity. Middle East–based carriers such as Emirates, Etihad Airways, and Qatar Airways are taking a large slice of the formerly profitable Europe–Asia traffic from those continents’ legacy airlines.
The Middle East carriers are highly dependent on connecting traffic, because their home markets are limited by the smaller population of their region. Yet their unique geographic positioning — most of the world’s population is within eight hours’ flying time — means they are able to capture a disproportionate share of long-haul market growth.
Similarly, LCCs continue to experience above-average growth rates for the industry, particularly in emerging economies with many first-time fliers. Worth noting, however, is that LCCs also increasingly face rising customer expectations, especially in mature markets. These carriers will need to find the right balance between making investments to improve the experience they offer and maintaining their cost advantage.
And consolidation will play a role in the industry as well. To a large degree, the industry’s low margins are driven by its fragmentation, and the resulting overcapacity in many markets. Still, U.S. carriers have been able to improve their financial performance dramatically, primarily through bankruptcy restructuring and a series of major mergers.
In response to these trends, we believe that airlines must take several specific measures to remain competitive.
Get to know your customers better. As is true in other industries, understanding individual customers’ preferences and consumer-related activities is essential to delivering personalized service and targeted offerings. However, airlines must evolve beyond their reliance on existing loyalty programs, which can generate significant customer data (such as spending patterns through an airline-branded credit card) but don’t automatically lead to real insights about travel behavior and choices.
In most cases, carriers need to invest in more advanced customer analytics. And technology alone is not enough; airlines must also rewire their organization and processes to embed customer service into their organizational ethos. For example, at each point of interaction between the passenger and the airline — looking up flights, booking, check-in, boarding, and in-flight experiences — airlines can capture richer data about customers’ preferences, and constantly seek to exceed their expectations.
The benefits of greater customer knowledge and, hence, intimacy are an improved passenger experience and targeted offerings, such as proactive recommended flights to a passenger’s preferred destinations. As a result of such an approach, airlines gain a greater chance to generate ancillary revenue, and — through loyal customers — a higher percentage of sales coming through direct channels (rather than through online travel sites, which take a cut of revenue). This approach will also allow full-service carriers to unbundle existing products and charge fees for specific aspects of the trip, such as fast-tracking security lines or advance boarding, without alienating customers and putting their premium positioning at risk.
Use digitization to reduce operating costs. Airlines must also use new technology internally to streamline their operations and reduce costs. For example, systems that can enable real-time resource planning and allocation drive greater utilization. Tech-enabled engines can notify maintenance and operations centers of performance issues while an aircraft is still in the air, and request that a replacement part be waiting when it lands. Such measures can reduce downtime and greatly improve performance, driving down costs while also bolstering passenger satisfaction through more frequent on-time arrivals and departures.
Cut the fat, not the muscle. In reducing expenses, airlines must determine not only how far to cut, but also where to cut. A critical part of the process is identifying the set of essential capabilities that differentiates them from their rivals in the view of customers. In many cases, those capabilities may require renewed investment. Yet management needs to be ruthless in cutting costs in all other areas that are not relevant to safety, reputation, branding, or customer value.
Airlines need to cut costs in areas not relevant to safety, reputation, branding, or customer value.
Partner strategically. Finally, because the legal frameworks of bankruptcy restructurings and consolidation in the United States are not applicable in most other markets, and government regulation will continue to limit much consolidation, airlines should continue to seek partnerships that can complement and even improve what they do best, as well as close glaring gaps. In most cases, these partnerships will be more targeted and synergistic than the traditional alliances that now dominate. Those alliances allow route sharing on a broad basis, but they aren’t tailored narrowly enough to allow airlines to strategically fill in specific gaps.
Qantas, which was already part of the oneworld alliance, recently forged such a targeted partnership with Emirates. Qantas did not have the traffic to fly profitably to multiple cities in Europe, yet that was a significant demand among its loyal customer base. Emirates, by contrast, had sufficient demand to access a large number of destinations in Europe, but it did not have a loyal base of local customers in Australia. The new partnership gives Qantas access to many more destinations in Europe, and it gives Emirates access to an extremely loyal base of customers.
The airline industry has long struggled with margins, but the current growth phase in most markets, coupled with evolving technology and customer preferences, offers a real opportunity. By adopting the measures described here, carriers can forge better relationships with customers, cut costs selectively, and improve their financial performance in a sustainable way — either alone or with the right set of partners.