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Published: October 25, 2010

 
 

The Airlines’ Global Dilemma

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 — Etihad, Emirates, Qatar Airways, and Turkish Airlines, among others — 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. Locations like Dubai are quickly becoming global megahubs. Most of these startup airlines are private companies, so information about the cost of operations is hard to come by. But given that employee strikes are illegal and collective bargaining unheard of in the Gulf States, it’s easy to see the cost disadvantage the legacy carriers face.

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. For instance, Lufthansa in-sources most operations at Frankfurt and Munich, its major German hubs, but outsources these activities at less-trafficked sites where it does not have critical mass. During the current travel recession, carriers with the most diversified operational holdings — besides Lufthansa, Emirates, and American Airlines — have consistently outperformed their direct competitors.

However, many airlines realize that they can’t compete with outsourcers like Amadeus Inc. in airline information technology or General Electric Company in heavy maintenance, and thus can find no compelling reason to keep these activities in-house. 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. Instead, they’re more like basic supplier contracts between a single airline and a provider.

Existing global alliances may offer a pathway for sharing some of these activities that should be outsourced in a way that makes a real difference to the carriers’ bottom lines. These partnerships, which include familiar names like SkyTeam, Star Alliance, and Oneworld, took shape in the 1990s when it became clear that international mergers would be a nonstarter for a long time. They were formed under the clunky sobriquet “code sharing,” which means one airline tickets a partner’s flight as if it were its own, thus extending each network’s reach and, in the process, boosting airline revenue. Although air transport regulators are casting an increasingly wary eye on route-to-route ventures, they have begun loosening antitrust enforcement on these global alliances. Such à la carte “antitrust immunity,” for example, allows partners’ marketing departments to share information about each airline’s passengers. The next level of alliance synergy that airlines may be able to tap in the coming years to improve corporate performance could include joint parts and materials procurement, shared information processing, and cooperation on new product development. 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.

 
 
 
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