Aviation Strategy Analysis What is the future of the European flag-carrier model? uropean aviation is beginning a process of trolled both carriers, had undertaken a disastrous Emajor restructuring. The competitive land- conglomerate strategy (code-named "Hunter"), scape of 2005 is likely to look quite different than withdrawing assets from Swissair and investing Aviation Strategy that of 1995. Serious flaws have developed in the them in independent airlines in other countries or is published 11 traditional business model followed by the major in separate service businesses. Swissair, Sabena times a year by carriers, and the future viability of that business and Crossair were separate operating companies Aviation model and those airlines has been openly ques- and were not directly exposed to the losses or lia- Economics tioned. bilities of the other airlines and service compa- at the beginning of the month This article is designed to provide a frame- nies. work for the better understanding of several ques- Network Management for Swissair and Editor: tions: Sabena (senior management for the two airlines Keith McMullan • What drives competition between the major had been combined in 1999 but remained sepa- European carriers? rate from the holding company) knew that both Subscription • Why some European hubs have been more carriers were in a highly vulnerable position, given enquiries: profitable than others? the industry-wide profit declines and the obvious Julian Longin Tel: +44 (0) 20 • Why the profitability of these carriers (as a failure of the outside investments. Airline man- 7490 5215 group) collapsed long before September 11? agement also knew that fleet decisions that SAir • What business models might provide a basis for Group had imposed on the airlines would reduce Copyright: profitable operation in the future? future profitability by hundreds of millions of dol- Aviation • What path is industry consolidation/restructuring lars. The fleet decisions had been driven by con- Economics All rights reserved likely to follow? glomerate objectives (including the development Discussions of airline business models, of an aircraft leasing company) and without any Aviation demand segmentation and detailed traffic flows real reference to whether the aircraft could be Economics can sometimes seem a bit dry and academic. The operated profitably within the Swissair or Sabena Registered No: data and analysis presented here was originally networks 2967706 (England) developed in 2000, in the decidedly non-academ- Assuming (heroically, as it turned out) that the Registered Office: ic context of two airlines whose survival was high- airlines could somehow be reorganised indepen- James House, LG ly uncertain. dently of the SAir Group conglomerate invest- 22/24 Corsham St The challenge facing Swissair ments, Network Management undertook a major London N1 6DR internal study in 2000 to address two questions: VAT No: 701780947 and Sabena in 2000 • Could either Swissair or Sabena survive long ISSN 1463-9254 In 1999, Swissair had a minus 4% profit mar- term, given competitive changes across Europe? The opinions expressed in gin while Sabena had a minus 6% margin, a bit • What future business model and short-term this publication do not nec- essarily reflect the opinions below AEA averages, after having earned small changes would give the greatest chance of sur- of the editors, publisher or contributors. Every effort is profits the previous two years. These declines vival? made to ensure that the mirrored downward profit trends among airlines This article will outline one view of the com- information contained in this publication is accurate, but across Europe. Both airlines were financially petitive and profitability issues facing all of no legal reponsibility is accepted for any errors or healthy, in the sense of having strong positive Europe's large airlines, as seen from the per- omissions. cash flow, easily meeting all current obligations spective of these two struggling mid-sized carri- The contents of this publica- and having much of their networks earning fully- ers, based on data available at the time (1999- tion, either in whole or in part, may not be copied, allocated profits. Although no national airline in 2000) of the study. It is not intended to provide a stored or reproduced in any Western Europe had ever failed before, both car- complete discussion of the events leading to the format, printed or electronic, without the written consent riers were destroyed and liquidated within eigh- of the publisher. teen months. By Hubert Horan; Questions and comments to SAir Group, the holding company that con- [email protected] September 2002 Aviation Strategy Analysis demise of Swissair or Sabena. While the specific recommenda- EUROPEAN BUSINESS MODELS MID 90s tions developed for the two carriers two years ago are of no more than Charter historical interest at this point, the question of what drives hub prof- • Narrow focus on one itability in Europe, and the viability O&D demand segment Flag 1st of competing business models • Limited fleet/marketing Div remains highly relevant. • Network ubiquity • Home market dom- The classic "flag-carrier" inance business model Flag 3rd • Multiple market Div segments The two classic European air- • Mixed fleet/prod- line business models were the Flag uct/marketing for "flag-carrier" model, which was 2nd Div diverse markets designed to operate at a large scale and serve a very broad range of potential customers, and Note: Market shares based on ASKs the "Charter-carrier" model, which was designed to only serve a specific, narrow Lufthansa followed in Frankfurt. demand segment. The flag-carrier model, best European aviation will always represented by Lufthansa's Frankfurt hub-based network, was adapted by almost every scheduled be highly fragmented airline from Portugal to Finland, and has five key European air travel demand has always been features: extremely fragmented due to heterogeneous • Domination of travel demand from the carrier's national markets, huge disparities in disposable home market; income levels and market sizes, strong distinction • Service to multiple, diverse demand segments between leisure and business destinations, and (business/leisure, domestic/intra-Europe/ inter- wide disparities in transport alternatives. It is continental, home market/sixth freedom) to max- unnatural for any one business model to become imise total travel volumes; the overwhelming standard across such a hetero- • Large US-style hub operations in order to aggre- geneous marketplace. The central position of the gate demand from dispersed markets; flag-carrier model was heavily influenced by reg- • A mixture of different aircraft sizes in order to ulatory and aeropolitical constraints and has maximise the frequencies offered; and already begun to break down. Airlines such as • Significant marketing infrastructure (such as Ryanair are attempting to develop new leisure ori- worldwide sales and distribution) and systems ented markets (Stansted to Rimini or Biarritz) out- complexity (yield management, airport opera- side of the traditional charter model, while tions) to efficiently serve the diverse markets. easyJet and others are developing more busi- Charter carriers aggregated demand via spe- ness-oriented O&Ds while avoiding the compre- cialised pricing, packaging and distribution, and hensive scope and infrastructure intensity of the organised operations around larger single-class traditional flag-carrier model. Where demand is aircraft with lower unit costs, and only served highly fragmented, it is normal for companies to O&D markets that fit into this approach. experiment with new or modified models, and it As late as 1995 the central strategy question should be possible for multiple, overlapping busi- for European airlines was scheduled versus char- ness models to successfully serve different seg- ter. Once a airline chose the "scheduled" path, it ments. then pursued every logical source of demand in Airline business models are demand driven, order to maximise traffic volumes and scale. Smaller markets produced smaller airlines, but not cost driven they all followed the same business model that Because of the fragmented demand base, the September 2002 Aviation Strategy Analysis The First Division market size advantage most critical strategic issue for any airline is net- work ubiquity versus a narrow focus-the decision There is a marked difference in the size of the to serve multiple, diverse traffic flows or to con- local revenue base between the four First centrate on one specific market segment. Cost Division hubs and the ten Second Division hubs. structures must be then carefully tailored to the The CDG market is three times larger than target market, but it is dangerous to segment air- Zurich, Brussels or Munich, while Heathrow is six lines on the basis of concepts such as "low cost". times larger, and these gaps would be even larg- There is no such thing as a "high cost" business er if one considered total London/Paris demand model. Classic charter carriers avoid many of the instead of the airport level demand. This size branding, CRS, and hub airport costs that British advantage of the ASK capacity operated by the Airways and KLM must bear, but as a result they First Division hubs mirrors the differences in the cannot efficiently serve more diverse scheduled underlying revenue bases. This is in marked con- markets or scale their operations to a large net- trast to the US hub environment where origin work size. Ryanair's approach achieves low costs market size gaps between the top tier hubs on Stansted-Ireland routes but would be uncom- (Atlanta, Dallas, Chicago) and second tier hubs petitive on Heathrow-Austria routes. Airlines (Houston, Denver, Pittsburgh, Philadelphia) are under any business model will fail if they add too much smaller. This also explains why new much capacity relative to their target markets, or entrants using 140-seat aircraft have had suc- cannot keep costs in line with what those markets cess developing networks of large O&D markets will pay for. ex-London, and much less success at Brussels, Three segments within the "flag-carrier" Munich or similar cities.