Managing Strategic and Financial Risk in Airline Expansion: the Case of Ethiopian Airlines1
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Managing Strategic and Financial Risk in Airline Expansion: The Case of Ethiopian Airlines1 Aly Verjee Master of Studies (MSt) Candidate, Department of Politics and International Studies University of Cambridge 1 The author selected this topic in December 2018. On the morning of 10 March 2019, Ethiopian Airlines flight ET302 from Addis Ababa to Nairobi crashed six minutes after take-off. All 157 passengers and crew aboard were killed. As of the time of this essay’s submission, the accident’s cause remains unknown, and the long-term implications for the company uncertain. While this paper does not address the management of operational risks of airlines, ET302 reminds us that this dimension is all too real, and that there can be potentially devastating consequences. Condolences are offered to the families, friends, and colleagues of the passengers and crew of ET302, and to all associated with the airline. 2019 Cambridge - McKinsey Risk Prize Bio-sketch and Photo Page Student Name: Aly Verjee Email contact: [email protected] Title of Submission: Managing Strategic and Financial Risk in Airline Expansion: The Case oF Ethiopian Airlines I am a candidate for the degree: MSt International Relations Bio-sketch (Approximately 150 words) I am a candidate For the Master oF Studies degree at the Department oF Politics and International Studies, researching the psychology oF international mediation. ProFessionally, I primarily work as a political analyst of contemporary African politics, Focusing on eastern Africa. I am currently a senior visiting researcher at the United States Institute oF Peace in Washington, DC, and a Fellow oF the RiFt Valley Institute. I previously served as deputy and then acting chieF oF staFF to the Former president oF Botswana, Festus Mogae, in his capacity as chairperson oF the Joint Monitoring and Evaluation Commission, which oversaw the 2015 peace agreement in South Sudan. During the 2013-15 South Sudan peace talks, I served as a senior advisor to the chieF mediator, the Former Foreign minister oF Ethiopia, and Former chairman oF the board oF Ethiopian Airlines. I have also served as the European Union’s chieF political analyst for election observation missions in Tanzania, Zambia and Sudan. 2019 Cambridge - McKinsey Risk Prize Declaration Form Student Name: Aly Verjee Email contact: [email protected] Title of Submission: Managing Strategic and Financial Risk in Airline Expansion: The Case oF Ethiopian Airlines Number of words of submission: 4809 I am a candidate for the degree: MSt International Relations Academic Institution/Department: Politics and International Studies (Polis) Declaration I conFirm that this piece oF work is my own and does not violate the University oF Cambridge Judge Business School’s guidelines on Plagiarism. I agree that my submission will be available as an internal document For members of both Cambridge Judge Business School and McKinsey & Co’s Global Risk Practice. If my submission either wins or receives an honourable mention For the Risk Prize, then I agree that (a) I will be present at the award presentation ceremony 20-21 June 2019, (b) my submission can be made public on a Cambridge Judge Business School and/or McKinsey & Co websites. This submission on risk management does not exceed 10 pages. Aly Verjee (Electronic Signature) Please include this declaration Form aFter the cover page oF your paper submission. “If you want to be a millionaire, start with a billion dollars and launch a new airline.”2 A maxim in commercial aviation is that airlines almost always lose money.3 Some analysts go as far as to argue that the global industry has collectively never turned a profit.4 Whatever the accuracy of the overall accounting, it is clear that commercial aviation is an industry in which it is difficult to thrive; Adam Pilarski describes it as a sector that “seems to violate the most basic principles of economics and business.”5 History is replete with examples of failed airlines, many of which were once profitable enterprises (e.g. Pan Am, Trans World Airlines (TWA), Swissair, and most recently in the UK, Monarch and Flybmi). According to industry executive Robert Martin, since 2001, there have been at least 301 airline company failures worldwide.6 And of all the aspects of the airline business, expansion is one of the riskiest. Again, the industry’s history demonstrates that airline expansion risks, and often overextends, the fundamental strengths of the business. However, despite the many pitfalls, most airlines do explicitly seek to expand. Therefore, identifying – and then managing and mitigating – the risks of expansion is essential if a growth strategy is to succeed. This essay addresses the case of what was, for nearly sixty years, a small, mostly unremarkable, state-owned airline, in an aviation market more commonly associated with war and poverty, and its rise to become its continent’s largest and most profitable airline, and one of the most rapidly growing worldwide: Ethiopian Airlines (call sign: ET), founded in 1945. In a little more than a decade, Ethiopian increased more than six-fold the number of passengers it carried (see Fig. 1). Ethiopian is now Africa’s biggest airline by passenger traffic, growing even in years that saw a decline in air traffic on the continent.7 Fig. 1: Ethiopian Airlines traffic, in millions of passengers, 2005-18. Ethiopian Airlines Passenger Traffic, 2005-18, in millions 10.6 7.6 6.91 7.39 5.92 4.64 3.73 2.8 3.15 1.56 1.76 2.1 2.5 05/06 06/07 07/08 08/09 09/10 10/11 11/12 12/13 13/14 14/15 15/16 16/17 17/18 2 Richard Branson, founder of Virgin Atlantic, Virgin Australia, Virgin Nigeria, and Virgin America airlines, circa 2001. 3 To memorably quote Omar Fontana, the founder of airline Transbrasil, “there are three ways to lose a lot of money: slow horses; fast women; and airlines. But you know, they’re all a lot of fun.” 4 “Five Reasons Why the Airline Industry Will Never Be Profitable,” Faculty of Law, McGill University, 2011. https://www.mcgill.ca/iasl/files/iasl/ASPL614-Five-Reasons-Airline-Never-Profitable.pdf 5 A. Pilarski, “Why Can’t We Make Money in Aviation?” London: Routledge, 2007. 6 “BOC Aviation CEO Update,” CAPA Low Cost Long Haul Global Summit, 4-5 Oct 2018, https://centreforaviation.com/analysis/video/boc-aviation-ceo-update--the-need-to-understand-everything-about-airlines- from-their-business-model-and-management-team-through-to-liquidity-and-the-competitive-market-882 7 W. Davison, “Ethiopian Airlines Profit Rises 12 Percent in 2014-15,” Bloomberg, 7 March 2016. 1 In 2008, rival South African Airlines (SAA) carried three times as many passengers as Ethiopian. Ethiopian now carries almost twice as many passengers as SAA.8 As shown in Fig. 2, Ethiopian now dwarfs its competitors by industry metric revenue passenger kilometres (RPK), increasing its share from 11% in 2005/6 to 35% in 2016/17.9 Fig. 2: RPK share, major African airlines, 2005/6 and 2016/17 RPK 2005/06 RPK, 2016/17 Ethiopian Airlines 11% 11% South African 9% 11% Airways 17% 35% EgyptAir 19% 48% 19% Royal Air Maroc 20% Kenya Airways Further demonstrating its significance, Ethiopian recently overtook Emirates and its mega-hub Dubai in the number of international transfer passengers carried to Africa.10 Today, Ethiopian Airlines is the largest African airline group by revenue and ranks 52nd globally, ahead of better-known Finnair (55th), Malaysia’s Air Asia (58th), and US Hawaiian (59th), and on par with the UK’s Virgin Atlantic (46th), Alitalia (48th), and Air India (50th). By the available seat kilometres (ASK) industry metric, Ethiopian is comparable to Taiwan’s China Airlines, but with much more rapid growth: a 20% increase in ASK year on year (see Fig. 3), with dramatic growth in destinations served and fleet siZe (see Fig. 4).11 Fig. 3: ET Growth in ASK and RPK, 2005-18 Fig. 4: ET Destinations and Fleet Size, 2004-19 60 140 50 120 40 100 30 80 20 60 10 40 0 20 0 04/05 05/06 06/07 07/08 08/09 09/10 10/11 11/12 12/13 13/14 14/15 15/16 16/17 17/18 Available Seat kms (bn) 04/05 05/06 06/07 07/08 08/09 09/10 10/11 11/12 12/13 13/14 14/15 15/16 16/17 17/18 18/19 International Destinations Fleet Revenue Passenger kms (bn) 8 “Ethiopian Airlines 2015 outlook: more rapid expansion as it Becomes Africa’s largest airline,” CAPA Centre for Aviation, 13 January 2015, https://centreforaviation.com/analysis/reports/ethiopian-airlines-2015-outlook-more-rapid-expansion-as-it- becomes-africas-largest-airline-204559 9 RPKs are the numBer of revenue passengers carried multiplied By the distance flown. 10 O. Mohammed, “Ethiopia overtakes DuBai as top feeder of air traffic to Africa,” Reuters, 29 NovemBer 2018. 11 ASKs are the airline’s available seats multiplied By the distance flown. Data adapted from the FlightGloBal World Airline Rankings, 2014-2018, and Ethiopian Airlines annual reports, 2004-16. 2 Ethiopian’s success was far from inevitable; managing the risks of expansion was key As recently as 2013, aviation experts Heinz and O’Connell argued that African carriers, including Ethiopian, were “being severely threatened by Gulf based carriers that are continuously strengthening their footprint in Africa.”12 Even more recently, based on 2015 data, industry analyst OAG reported that “African aviation punches below its weight,” a description in which it did not exclude Ethiopian.13 Yet the data suggests Ethiopian has risen above its peers and is competitive even when going head to head against industry giants.14 However, focusing on profits and growth does not explain the company’s success, nor how the risks of failure were overcome.