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(originally published by Booz & Company)


The Big Squeeze

4. Apply “less is more” ideas by taking a lesson from low-cost carriers. Using techniques reminiscent of Japanese manufacturing, successful discount carriers have continuously improved and found new ways of reducing costs. Decrease the number of aircraft types, thus saving on maintenance, training, and staffing. Reduce aircraft turnaround times, thus increasing aircraft utilization. Simplify and automate ground services. Streamline labor arrangements. In these ways, low-cost carriers get in more flights per day than traditional carriers and keep to their schedules, resulting in less overtime and fewer airport penalties. Overall, LCCs have a 40 percent operational cost advantage over traditional network carriers. But what can the traditional carriers do to reduce cost?

Typically, traditional carriers have only gone part of the way, by focusing on the costs that are directly determined by their existing business model and processes (such as reducing overhead expenses, improving systems and infrastructure, renegotiating labor contracts, and automating ground operations). But often, carriers neglect to look at cost items that are driven by their overall strategy. Costs driven by aircraft complexity, passenger services, and the operational footprint across the existing network are key levers that legacies need to pull to achieve the low costs of their competitors.

5. Take advantage of merger opportunities. Our research suggests that airlines can save 5 to 10 percent of their total costs by merging with a similar-sized airline. For example, the Air France–KLM merger demonstrates, with €525 million ($722 million) in realized synergies to date, that substantial cost savings can be achieved through strategic mergers. By 2011, Air France–KLM expects to enjoy cost savings of up to €1 billion ($1.4 billion), driven mostly by consolidated network management, capacity swapping and schedule coordination, and lower cost in aircraft purchasing and maintenance. A carefully thought-out acquisition strategy can also help fill gaps in service and branding, creating a stronger airline that’s better aligned with the strategies we’ve suggested.

Airlines in a New Era
What might a new airline look like once it has escaped no-man’s-land? It will be a much more flexible, agile enterprise, with multiple brands that can meet customer and routing needs quickly, effectively, and cheaply. Qantas is perhaps the best example. Originally established as a competitive response to the entry of low-cost carrier Virgin Blue into the Australian domestic market, Qantas’s discount carrier Jetstar offers both domestic and international low-cost travel, targeting the leisure customer segment with a lower-cost operating model. Leaving these segments to Jetstar, parent company Qantas has focused on the higher-end business and premium customers. With such pronounced segmentation, Qantas’s operating profits have risen to nearly AU$700 million ($546 million) in 2005 from AU$344 million ($193 million) two years earlier.

The new operating model that we recommend involves significant changes that go against the long-held industry dogma that a single airline operating model can be all things to all customers. It will require airlines that are now highly centralized to meet tough organizational challenges: managing separate process streams for differentiated customer service levels, managing decentralized business units focused on segment products and services, and coordinating different businesses to get the greatest cost efficiencies — for example, by maintaining economies of scale in aircraft purchasing and maintenance.

The challenges are tough. As Rod Eddington, former chief executive of British Airways, famously quipped: “Changing airline culture is like trying to perform an engine change in mid flight.” But as profits are stripped away by competitors, not changing that culture can be even more risky and can end in a crash landing.

Author Profiles:

Chris Manning ([email protected]) is a vice president with Booz Allen Hamilton based in Sydney. He leads the firm’s work in the global airline industry and the Australian private equity business. His work to date has been focused on the areas of strategy, particularly customer-back market/growth strategies, and organizational change.

Stephan Gross ([email protected]) is a senior associate with Booz Allen in Munich and the marketing director of the firm’s work in the global transportation and aviation industries. He specializes in major transformation and turnaround initiatives for public and private transportation organizations and operators, including large privatization and deregulation projects in Europe and the Middle East.

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  1. Brian Graham and Timothy M. Vowles, “Carriers within Carriers: A Strategic Response to Low-Cost Airline Competition,” Transport Reviews vol. 26, no. 1 (January 2006): Looking at different ways of establishing low-cost operations as a response to changed market forces, the authors describe the potential drawbacks and success factors of developing a new carrier model within an existing legacy carrier’s business model. Click here. (Registration required.)
  2. JayEtta Z. Hecker, “Commercial Aviation: Despite Industry Turmoil, Low-Cost Airlines Are Growing and Profitable,” Testimony Before the House of Representatives Subcommittee on Aviation, Committee on Transportation and Infrastructure, June 3, 2004: Summarizes the General Accounting Office’s findings regarding the measures taken by airlines to reduce costs and improve revenues and balance sheets. PDF Download.
  3. Hagen Lindstädt and Bernd Fauser, “Separation or Integration? Can Network Carriers Create Distinct Business Streams on One Integrated Product Platform?” Journal of Air Transport Management vol. 10, no. 1 (January 2004): In looking at the ideal organizational design for airlines, the authors argue that separating operations is the best approach. PDF Download.
  4. Chuck Lucier, “Herb Kelleher: The Thought Leader Interview,” s+b, Summer 2004: The cofounder and chairman of Southwest Airlines explains why an airline’s employees are the key to a profitable business. Click here.
  5. Chris Manning and Stephan Gross, “Airline ‘No Man’s Land’”: The Crisis Faced by Traditional Hub Carriers and How to Escape It,” Booz Allen Hamilton white paper, April 2007: The article on which this Leading Idea was based takes a closer look at the evolution of the airline industry. PDF Download.
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