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 / Fall 2005 / Issue 40(originally published by Booz & Company)


Format Invasions: Surviving Business’s Least Understood Competitive Upheavals

Airline Invasions: “Barbarians” at the Gates

One of today’s harshest format invasions is roiling the airline business. An alternative business format — low-cost carriers with a point-to-point production model, exemplified by Southwest, Ryanair, and JetBlue — is challenging the traditional “hub-and-spoke” format of incumbents. The challengers have designed their operations around the relatively simple requirements of moving passengers directly from one city to another. The hub-and-spoke incumbents, in contrast, are configured to provide effective passenger connections and to maximize revenue from their networks. The challengers build volume through price-led market stimulation of their point-to-point routes, creating passenger connections as a by-product. The incumbents build volume by offering synchronized services “from anywhere to everywhere.”

The cost differences are huge: The challengers have a 40 to 50 percent cost advantage, a result of 20 to 30 percent higher utilization of aircraft and crew, more than twice the ground personnel productivity, and less than half the overhead cost per enplaned passenger. Critically, this is not the result of unionization or differences in pay scales. Southwest Airlines, for example, is unionized; with stock options and benefits factored in, it pays its employees more than many of the U.S. hub-and-spoke carriers.

Neither can the cost differences be attributed to bare-bones and low-quality service. Although challengers like Southwest and Ryanair began by attracting price-sensitive customers traveling short distances, they have steadily extended their service offerings. They now feature longer flights, connections for passengers and baggage, and better on-board services (JetBlue has 24-channel TV screens for each passenger). As a result, challengers have doubled their share of U.S. domestic passengers, to 30 percent today from 15 percent in 1992. (European discounters are rapidly moving along the same path.)

In his book Seeing What’s Next: Using the Theories of Innovation to Predict Industry Change (Harvard Business School Press, 2004), Clayton Christensen questions the ability of these new-format airlines to replace the hub-and-spoke incumbents. While conceding that low barriers to entry make them a continual threat to incumbents’ profitability, he adds, “Because there is not asymmetric motivation, disruptive discounters are unlikely to transform the industry.” But we see a different pattern emerging. Having capitalized on the recent cyclical downturn in airline travel to gain market share, the challengers are permanently changing the pricing level in the industry, and are poised to become the dominant format. Today, some 80 percent of U.S. domestic passenger trips occur between cities that can comfortably support nonstop service. For the traditional hub-and-spoke airlines, there is no place left to hide.

The incumbents have responded by cutting costs, increasing efficiency, and adapting selected elements of the low-cost carrier model, such as “smoothing out” (more effectively scheduling arrivals and departures) at hubs. They have also created smaller “airlines within airlines,” such as Shuttle-by-United (and, recently, Ted), Continental’s CalLite, and US Airways’ MetroJet. However, their costs are too high to allow them to compete in the low-fare market, because they retain significant elements of the hub-and-spoke business format. Overall, the incumbents’ countermeasures have had little effect, because their basic business format — the fundamental cause of their cost disadvantage — remains largely unchanged.

The only viable strategy for the major hub-and-spoke airlines is to adopt the essential elements of the point-to-point production model as quickly as possible. This does not mean eliminating first-class service, on-board food, frequent-flyer lounges, or even connections. In fact, reducing service levels might well be counterproductive, as the challengers will gradually add these service features without losing their fundamental cost advantage. Instead, it means adopting the challengers’ scheduling approaches and ground-operations concepts, and simplifying overhead structures accordingly, reflecting the fact that the vast majority of passengers really only want to travel between points A and B. This will involve massive transformation programs — completely redesigning how operations are carried out and displacing tens of thousand of workers. The new format, however, could save the larger incumbents billions per year in costs and allow them to compete effectively in the new equilibrium that will emerge as the new business format replaces the old one.

—B.S., T.H., N.H.

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  1. Clayton M. Christensen, Scott D. Anthony, and Erik A. Roth, Seeing What’s Next: Using the Theories of Innovation to Predict Industry Change (Harvard Business School Press, 2004): A theory of disruptive success that partly, but not completely, meshes with the format invasion concept.
  2. Jeff Ferry, “Flextronics: Staying Real in a Virtual World,” s+b, Winter 2004: A Singaporean contract manufacturer emulates Toyota’s innovations. Click here.
  3. Victoria Griffith, “Welcome to Tesco, Your Glocal Superstore,” s+b, First Quarter 2002: Of the s+b retail case studies, the most relevant format-renewal example. Click here.
  4. Tom Hansson, Jürgen Ringbeck, and Markus Franke, “Flight for Survival: A New Business Model for the Airline Industry,” s+b, Summer 2003: More detailed view of the airline format invasion and its cost consequences. Click here.
  5. Art Kleiner, “The Next Wave of Format,” Deeper News, 2001: Manifesto about Internet and media formats as socially created, not technological, innovations. Click here.
  6. William Leach, Land of Desire: Merchants, Power, and the Rise of a New American Culture (Vintage, 1993): Early 20th-century format invasions among department stores, fashion merchandisers, and investment banks.
  7. Chuck Lucier, “Herb Kelleher: The Thought Leader Interview,” s+b, Summer 2004: The cofounder of Southwest Airlines explains the strategy underlying his airline’s cost advantage. Click here.
  8. Costas Markides and Paul Geroski, “Colonizers and Consolidators: The Two Cultures of Corporate Strategy,” s+b, Fall 2003: Cultural change for enabling resilience among incumbents. Click here.
  9. James Womack and Daniel T. Jones, Lean Solutions: How Producers and Customers Achieve Mutual Value and Create Wealth (Simon & Schuster, 2005): Wholesale Toyota-inspired manufacturing and service redesign.
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