One traditional company after another — manufacturers and service providers alike — is facing a vexing problem: Their business models have become so complex that it is harder and harder to generate profits. Over the years, these companies have added layers of product and process complexity to their business models in order to grind out incremental returns. Although each incremental decision can usually be justified on its own, the aggregate revenue benefits often fail to compensate for the overall costs of complexity.
| “The airline business model — essentially designed to take anyone from anywhere to everywhere, seamlessly — was a great innovation, but it is no longer economically sustainable in its current form.” |
No companies illustrate this predicament more vividly than the large U.S. hub and spoke airlines. Their business model — essentially designed to take anyone from anywhere to everywhere, seamlessly — was a great innovation, but it is no longer economically sustainable in its current form. Indeed, they are now tied to massive physical infrastructure, complex fleets of aircraft, legacy information systems, and large labor pools.
While the big carriers face a future of red ink, low-cost carriers like Southwest Airlines and Jet Blue are prospering by exploiting a huge cost-of-operations advantage. According to Booz Allen Hamilton analysis, low-cost carriers spend 7 to 8 cents per seat mile to complete a 500 to 600 mile flight, whereas the large airlines spend closer to 15 or more cents.
The Cost of Complexity
Surprisingly, only some 5 to 10 percent of this 2 to 1 cost differential between the traditional and low-cost airlines can be attributed to the extra “frills,” such as in-flight meals and entertainment and other amenities, that the hub and spoke carriers offer. Instead, the pace and the complexity of operations associated with maximizing revenue within the traditional hub and spoke business model account for some 65 percent of the gap. Consider the big airlines’ burdens that low-cost carriers avoid:
- Flight schedules structured predominantly to attract high volumes of low-yield connecting passengers, which causes congestion, long aircraft turnaround times, and poor utilization of physical assets and personnel;
- Labor-intensive business processes capable of providing seamless connections to anywhere in the world that accommodate, and partly encourage, last-minute seat assignment changes, upgrades, and itinerary modifications; and
- A distribution system tailored to selling tickets across the globe and to providing the largest customer base possible to maximize revenue through the yield management system.
By the end of 2000, these factors, combined with expensive labor agreements and rising fuel prices, placed the large airlines in one of the most difficult cost vises in the industry’s history. Boom-period pricing was required for hub and spoke airlines to break even. But the recession and bear market put an end to that option, as did the wide-spread presence of low-cost carriers, which operate a much simpler but still attractive service at significantly lower prices.
| “According to Booz Allen Hamilton analysis, low-cost carriers spend 7 to 8 cents per seat mile to complete a 500 to 600 mile flight, whereas the large airlines spend closer to 15 cents.” |
