Center for Transportation Understanding the U.S. Airline Industry Wednesday, January 29,2014 Bill Yolk attended this seminar in Washington, DC that focused on: • Scope of the U.S. Airline Industry • Introducing Fundamental Economic Drivers • Overview of Key Commercial Activities • Operational Overview • The Ongoing Role of Government • Current Trends Attached is the bio of the presenter, Robert Britton, and a copy of slides used in the presentation. Feel welcome to Contact Bill if you have any questions about the material. (217) 278-9001 bvol k@ cumtd .com Eno Center lor Transportation ROBERT A. BRITTON Rob Britton is a senior advisor at the Eno Center for Transportation, and the principal of AirLearn, a consultancy that helps suppliers, partners, newcomers, and students understand the complexities of the airline industry, and provides marketing and leadership advice to a range of organizations. In 2006, he retired as Managing Director, Advertising at American Airlines, where he was part of the team that helped rebuild the AA brand after the September 11 attacks. He has spent 45 years in and near the travel and tourism industry, in a variety of roles. Rob earned a Ph.D. in economic geography from the University of Minnesota, and completed postdoctoral work at The Wharton School, University of Pennsylvania. He held staff and field positions with Republic Airlines and Northwest Airlines. Rob joined American in 1987, and worked across the enterprise, in marketing, international affairs, corporate communications, and operations. He has published over 70 articles in major newspapers and magazines, in travel-trade publications, and in academic journals. Originally a geography professor, he is now an adjunct professor at Georgetown University's McDonough School of Business, and lectures annually at more than 25 other business schools worldwide, including Kellogg, Wharton, McGill, and London Business School; he serves on advisory boards at the Global Business School Network (Washington, D.C.), and the business schools at McGill University, Montreal, and Umea University, Sweden. Rob is married to Linda, an attorney, and has two adult children and two grandchildren. They live in suburban Washington. 01.14 1/27/14 Understanding the U.S. Airline Industry: A 360° View Dr. Rob Britton Senior Adviser. Eno Center for Transportation Principal. Airleam Washington, D.C., January 29, 2014 1\irl .c;u 11 Today ' s Agenda 1. Introductions (9:00-9:20) 2. Scope of the U.S. airline industry, including contribution to other sectors (9:20-9:50) 3. Fundamental economic and financial drivers (9:50-11 :00) 4. Introduction to key commercial activities (11:15-12:30) 5. Operational overview (1 :30-2:30) 6. The ongoing role of government (2:30-3:30) 7. Current trends (3:45-4:15) B. Summary and conclusions (4:15-4:45) i\irl .l'.tlt t Introductions About you A little about me and my airline perspective What do you want to learn today? i\irl .l';lt 11 1 1/27/14 Scope of the U.S. Airline Industry Alrlxarn What Airlines Do J\ irl .l';1111 A Catalyst to Economic Development Airline services precede or facilitate the fiow of investment, information, and human capital -what we commonly call "business travel" Enable global logistics, the fast movement of high-value, perishable, or time-sensitive goods - Widening markets, especially for exports Provide the indispensable foundation for tourism, by some measures the world's largest single industry - About 40% of international tourists travel by air - lndispensible to how we interact with friends and family In short, an industry that adds enormous value to other economic sectors i\irl <";till 2 1/27/14 Contribution to U.S. GOP, 2010 Direct contribution, $206 billion (output of airlines, airports, and ground services) Indirect contribution, $169 billion, from the sector's supply chain- everything from a new Boeing to a can of Coke served on board Induced contribution of $127 billion, through spending from employees in the above two categories Tourism-related catalytic benefits of $166 billion Total= $669 billion, or 4.9% of total GDP t\irl .t'; u n Other Economic Benefit in the U.S. Airlines support 9.3 million jobs (corresponding to the categories above, for example, 2.8 million direct jobs) Significant contribution to public finance - $57.4 billion in income tax, social security, and taxes on profits - $16.6 billion in levies on travelers (taxes and fees) - $49.6 billion from the aviation supply chain - $37.3 billion from follow-on impacts t\irl.L'; ll II It's Another Grid! 1\ irl • ·ant 3 1/27/14 Fundamental Economics and Finance: : Why Is It So Hard to Make Money? The Reality Airlines for America reported that in 2012, its ten member airlines earned $152 million on revenues of $143.4 billion That works out to 21 ¢ per passenger, or a rnargin of 0.1 %! Who did better in 2012? - Apple, $41 .8 billion, margin= 25.4% - Starbucks, $1.4 billion, margin= 10.5% - Ford , $5.7 billion, margin= 4.2% ;\irl .l'.tl t l Problem 1: Old Airlines and New Ones Fifty years of invasive government regulation created these two types - During this era, all (older) airlines had similar costs, thus there was little incentive to control them - VVllen costs went up, airlines asked regulators for price increases Established airlines have structural and other disadvantages compared to newer carriers (LCCs) Management decisions also added complexity and increased expense - Airlines did this because there once was revenue to justify the added expense - but no longer Air! r;u 11 4 1/27/14 Apples-to-Apples Unit Cost Comparison U.S. Cents{¢) per Ava liable Seat Mile 2012 2011 American 17.01 17.18 Delta 17.24 16.68 United 20.30 20.00 US AJrways 16.49 16.36 Frontier 10.64 13.46 JetBiue 11.02 10.84 Southwest 9.80 9.43 Virgin America 12.49 12.51 Source: U.S. Department ofTra nsportation: stage-leng th adjusted, fro m the I.IIT Airline Data Project Problem 2: Little Supplier Competition Almost everywhere in the world, airlines now compete vigorously in open domestic markets But supplier markets tend to be imperfect, with few firms or entities - labor unions: monopoly providers at many air1ines - Monopoly infrastructure providers, usually government - Airframe, engine, and component manufacturers - Large oil companies - Others: caterers, GDS providers Some think this is the largest structural problem, more important than age A irl.L'.ll ll Problem 3: High Fixed Costs Fixed expenses are typically 70-80% of total - These include aircraft leases or payments, airport rents , and much of labor This drives a classic law of microeconomics - A firm will pursue any activity that covers all variable expense and makes even a small contribution to fixed costs Each of these decisions is economically rational by itself, but not at the company or industry level Every airline, new or old, wants to fly the asset, because a plane earns no revenue on the ground 5 1/27/14 Problem 4: Calibrating Supply and Demand Demand varies temporally (by time of day, day of week, season) The product is perishable, like bananas at supermarkets You cannot shrink to survive - Airlines cannot reduce costs quickly or commen surate with re venue de creases - Labor costs "average up" in a seniority system Has market entry, once impossible, now become too easy? And why is market exit so rare? Is another basic problem aircraft production? ;\irl .e;u n Problem 5: Huge Capital Needs Aircraft- the basic productive assets- are expensive - One Boeing 777 costs US$160 million; a 737 is $70 million - Large airlines have large neetsl The industry is simultaneously capital intensive, labor intensive, and energy intensive - In contrast to manufacturing industries, traditional tradeoffs among these are costly, and take a long time - The 737-800 example: from three pilots to two, and three engines to two , but over a 30-year time hori zon In an industry that cannot generate profits, who will supply all the capital? - Since inception, the industry worldwide has produced a cumulative loss J\ i rl .l'.lll l Problem 6: Government Influence No other industry has been -and remains- subject to as much government influence over key aspects of the business - The legacy of domestic economic regulation - A double standard in many markets between old and new firms - Infrastru cture on the ground (runways and airports, wh ich are a shared responsibility) and in the air (ATC) - Enormous lax burdens, which you pay in ticket prices - Excessi ve operational regulations - Outmoded restrictions on foreign ownership - Continued regulation of internati onal aviation We will return to this topic later today 6 1/27/14 Problem 7: Little Brand Preference Fifty years of government regulation helped commoditize the industry in consumers' minds And there's little genuine product differentiation in competitive markets - The essential flying experience has been the same for decades - New companies with differentiated products have typically failed Three recent factors perpetuate this commodity aspect - Tran spare nt pricing on the Internet, and the rise of meta search providers - The rise of low-cost carriers like Southwest and Ryanair, vlith their very simple customer propositions - Alliances that sell each other' s services as their own (codesharing) Frequent-flyer programs have been the best way to address this commodity problem Airl .t·;u n Key Commercial Activities f\irl.eam Key Airline Commercial Functions Network planning and scheduling - How to decide where to fly -where to put productive assets - How to transform a network plan into a working schedule Pricing and revenue management - Selling the right seat at the right time at the right price - Hint: airlines don't use a dart board or a Ouija game! Sales and distribution - Channel strategy Promotion - Frequent fiyer programs, advertising, P.R.