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The 16-year devolution of the U.S. airline industry is now taking place in compressed fashion in Europe. A phased, five-year deregulation of European air travel began to open the market in 1992. The industry has grown each year, yet virtually all of the subsidized national flag carriers are highly unprofitable. Upstart independents increased their market share from 40 to SO percent in only two years (1991-1993) and account for almost all of the market growth. The commoditization of prices is happening rapidly. It appears that the demise of the U.S. airline industry is being replayed, with little or no strategic learning having been transferred to Europe. With one exception.
British Airways, the world's largest international carrier, has created a business design that has allowed it to escape the downward spiral under way on both sides of the Atlantic. BA chairman Sir Colin Marshall has several things going for him. His fleet is onethird the size of the big U.S. carriers. BA has developed a unique network of strategic alliances. It has the best load factor and yield in Europe, and both are higher than those of the U.S. majors. Although BA's costs are 12.5 cents per seat mile, higher than the U.S. average, they are among the lowest in Europe. In 1993, BA had an operating margin of 5.5 percent versus an average of .4 percent for the world's 18 leading fliers.
Part of BA's network of alliances includes a risky 25 percent investment in USAir. Marshall needed an airline that could feed passengers into his North Atlantic routes. USAir has traffic in 53 eastern U.S. cities.Furthermore, the two carriers won federal approval to share flight codes in those cities. This channels USAir passengers going overseas into BA's booking system.
The other component of BA's network is strategic alliances in other lucrative parts of the world. It has purchased a 25 percent stake in Qantas Airlines in Australia, 49 percent of a new German carrier called Deutsche BA, 49 percent of GB Airways in Spain and Morocco, and 49 percent of TAT European Airlines, the leading French independent.
A key part of the BA business design is careful focus on customer selection. By targeting the international flyer, British Airways has found a way to distinguish itself from both European and American carriers. It caters to the highest end of the market, the only one in which service is paid for. BA has a low-cost position, its service is excellent, its fares are aggressively priced, and it is making a profit. The business design has one potential flaw: USAir. The carrier is in such bad financial shape that even a modest rise in fuel prices could cripple it.
Even if that occurred, industry leaders would be wise to remember the lesson of People Express: A failed business does not indicate a failed business design. If British Airways isn't the dominant global megacarrier, someone else could be.
In 1995, Crandall, Kelleher, and Marshall face a common situation. The economic incentives of the remaining players make it unlikely that profitability will return. The European market is rapidly moving through the same profit-destroying process that has played out in the United States. Customers have repeatedly shown their preference for low-priced alternatives, proving that air travel is a commodity.
Two innovative business designs have been able to create and protect their value, but their uniqueness is being threatened.
Lessons Learned: Patterns
Customer priorities have moved in one direction in the domestic air transport industry: toward greater and greater price sensitivity. The hub-and-spoke business design of major U.S. airlines has delivered tremendous utility to the increasingly price-sensitive customer segments. What that business design has failed to do is recapture value for the airlines themselves. The regional, point-to-point business design, exemplified by Southwest Airlines, has been more successful at value recapture. However, recent margin erosion at Southwest raises the question of whether any business design can create sustainable profit and value growth in a hypercompetitive industry characterized by high fixed and negligible marginal costs. The only certain beneficiaries of Value Migration in the airline industry have been the customers.
Paradoxically, the regional airlines represent an opportunity for the beleaguered national carriers. To minimize the fixed-cost portion of their operating systems, regionals like Southwest have avoided building infrastructure, such as maintenance units and computer reservation systems. Troubled national airlines have identified these low-fixed-cost operators as a new customer set: AMR is now earning significant profits as an outsourcing provider of management and reservation services.
Another route to profitability may be a service-oriented international business design. British Airways has targeted international business travelers and built up a network of global alliances to offer them a seamless, high-service experience. Impending deregulation and sharpened competition in the European market will test the ability of the BA business design to continue to capture sufficient value.
Lessons from the evolution of the airline industry are that a major external event such as deregulation will create new customer segments and new opportunities for innovative business designs. Entrants will experiment and implement them. Since changing the course of a large corporation is difficult and time-consuming, incumbents should increase their flexibility to cope with nontraditional competitors by maintaining a portfolio of different business designs. When one design begins to attract value, it should also begin to attract commensurate investment to serve as a platform of future value growth.
Finally, when customers indicate a product or service is a commodity, even a successful business design will be profitable only as long as it presents a unique choice. People Express lost its edge when American matched its fares. If Southwest doesn't develop the nextgeneration business design, it will lose its distinction to the local carriers.
Replaying the Game
The airline chess game also illustrates the enduring power of institutional memory. In this case, conventional strategic behavior was exacerbated by a big case of industry-think versus customer-think. There was very little serious customer-think. All the majors responded to deregulation, to Southwest, to People's-to each otherin the same way...