Disrupting the airline business; inertia rules

Disruptive innovation creates new markets. If things do not continue as expected, then they must follow a new path. Value creation should result for those that can take opportunities offered by disruption by innovating and managing the new path in a way that satisfies customer demand.

Much of the talk relating to disruption in the airline industry lately has centred on distribution channels and ancillary revenue. Indeed, the proliferation of the LCC business model over the past 20 years owes much to the disruptive impact of the internet as a direct distribution channel.

This, together with market deregulation (particularly in the US and Europe) allowed the disruptive new model to open up new markets. Moreover, the unbundling of the core airline product by LCCs increased the visibility of ancillary activities and stimulated the development of new revenues.

Today, however, all airlines have direct distribution channels and all talk about growing their ancillary revenues. By definition, disruption is not predictable, but the subject has become very topical and was discussed at CAPA's Airlines in Transition 2015 conference in Dublin in Mar-2015.

Many commentators refer to the customer experience as an area that needs fundamental change (for the better). The problem, of course, is that the core product - a seat on a plane - is not one that lends itself to fundamental change.

Aircraft technology can make a difference, for example quieter engines, more spacious cabins, better lighting, the improved atmospheric conditions of the Boeing 787, flat beds, thinner seating offering greater pitch (more legroom), IFE, WiFi, catering. However, it is at best debatable that these innovations are truly disruptive.

New generation aircraft technology can also have a major impact, primarily on the route network that airlines can offer, quite aside from the onboard experience. Extensions to the range of aircraft (most recently for example the 787 and A350) have also facilitated the development of longer point to point routes operated by smaller twin engine aircraft than the older large four engined monsters such as the 747 and the A340 that mainly depend on hubs.

The most significant technical innovation - in terms of market disruption - has actually been the technologically lower profile, but vitally different, arrival of extra long-haul widebody twin jets, such as the 777 and the A330. The 777 in particular, in combination with the Gulf Inc strategy (state of the art infrastructure, supportive tourism marketing), has been transformational in long-haul network operations.

These longer range twin engine widebodies have not only created new markets, but also given birth to an entirely new model. To some extent, the twins have also accelerated the development of long-haul low-cost as yet another new business model (see separate article on long-haul low-cost on page 46). The 787 has prompted LCCs such as Norwegian to enter long-haul markets. However, the lower operating costs of the aircraft alone were not enough.

Having committed to the aircraft and long-haul as a concept, Norwegian then followed an innovative path with respect to traffic rights and labour costs in order to increase its chances of success. Although it has met with significant obstacles and its profits have suffered, it is probably the first in the world to attempt to build a global point to point airline operating in markets outside its home market.

At the same time, the AirAsia brand has developed from its initial short/medium-haul point to point model to give birth to the AirAsia X long-haul brand. In turn, AirAsia X has assumed many of the features of network carriers, in particular a high proportion of connecting traffic at its Kuala Lumpur hub. Although not yet operating new generation aircraft, AirAsia X may receive the stimulus it needs to become more consistently profitable when it starts to take delivery of A350 and A330-900neo aircraft towards the end of this decade.

Arguably the greatest technological innovation in aviation in the second half of the 20th century was supersonic flight. But, in spite of it being glamorous and high profile, Concorde played only a limited part in the aviation market, with only two airlines operating just 14 aircraft in commercial service from 1976 to 2003.

Concorde was a marvel of engineering and acted as an important marketing and branding tool for Air France and, in particular, British Airways. However, Concorde was a classic example of a solution with no problem. Concorde was not a disruptive innovation creating new markets. Apart from the relatively small number of people and routes that it served, Concorde did not fundamentally change the airline industry.

More fundamental to change in the 1970s and beyond was the advent of Boeing's 747. Arriving just as the first oil crisis hit, it effectively doubled capacity (over the 707) on many North Atlantic routes, which in turn suffered from the economic downturn that higher oil prices had provoked. At the time, international air fares were cartelised, preventing overt discounting to stimulate traffic; the result was horrific industry losses, notably for PanAm, the first user. The US' main flag carrier was never the same again.

The advent of the A380 'superjumbo' has led to some innovations in onboard product, but these have primarily focused on the high end of the premium cabins. For example, Etihad's 'Residence' consists of a living room, a double bedroom and an en suite bathroom. Nevertheless, like Concorde, these kinds of product innovations are aimed at a narrow market niche and cannot be said to be true disruptions on an industry scale. Moreover, the A380 has not really opened up new markets from a network point of view, but has merely allowed airlines to serve existing dense markets with a larger aircraft.

As discussed, in the 21st century it is difficult to create truly disruptive innovations in the onboard experience. A seat on a plane is still a seat on a plane and sitting on one for long periods of time has not changed very much in decades. Aircraft speeds have not altered significantly since the advent of commercial jets, but the divide between rich and poor has grown, in aviation just as in national economies. Life in the unbundled economy cabin is today much more confined and cabins are full where a 60% load factor used to meet needs. (The premium classes meanwhile live in relative luxury, cosseted in luxurious lounges, lying flat inflight, provided with gourmet meals and the best wines, with widescreen television.)

Perhaps this is why there is now so much attention on the economy customer's experience before the flight - distribution - and on the ways in which the customer experience can be enhanced by offering a wider range of products and services (before, during and after the flight) - and ancillary revenues.

A typical and important feature of disruptive new business is that disruptors tend to go directly to the consumer. This was always one of the core attributes of LCCs (the airlines that have been the greatest sources of disruption over the past couple of decades) and, on the whole, it still is. They were the first to take advantage of the internet to sell tickets directly to the consumer, bypassing travel agents and GDS entirely. This was a highly disruptive innovation. Before long, all airlines used direct channels for at least some of their ticket sales.

Paradoxically, in recent times, a number of LCCs have disrupted their own approach to distribution by returning to third party sales channels. In Europe, easyJet led the way by signing deals with GDS and TMC organisations in order to reach more business travellers. Others, such as Ryanair, have followed suit.

The internet also provides others with a means of reaching consumers. New third party businesses such as online travel agencies (OTAs), price comparison sites and broader web-based businesses such as Google now offer consumers a relatively easy way to research and book their travel options.

Mobile apps have taken direct distribution a step further by putting everything that a passenger needs to make a booking into the palm of his or her hand. Ryanair Chief Marketing Officer Kenny Jacobs summed this up at Airlines in Transition 2015: "Mobile has put the customer more in control of what they want to do". This gives airlines, and any consumer-facing business, the opportunity to build a closer and more intimate relationship with its customers. Combined with Big Data, which can provide detailed information on all aspects of consumer behaviour and preferences, the potential is enormous.

Until relatively recently, a customer could only have direct access to the full range of an airline's product and services - its inventory, its onboard offer, its ancillary services - through its own website. Third parties such as GDS' and travel agents could not display the same range of content beyond the core offer of flight schedule and seating. Simply put, the different information technologies that contained all the content could not always communicate with each other.

This has now been addressed by developments such as Travelport's Merchandising Platform, which offers rich content via GDS for airlines (and other travel companies). IATA's new distribution capability (NDC) also aims to facilitate the development of IT standards in this area.

Ancillary revenues include two broad categories. First, there are revenues derived from the unbundling of what was the core airline product into optional features such as onboard catering, seat allocation and bag check.

Second, most airlines now also offer a range of travel-related services such as insurance, hotels and car hire. It is not always clear to what extent ancillary activities really provide new revenue streams, rather than merely re-allocating them to a different ledger. This is a particularly fuzzy question regarding the unbundled features of the core airline product.

Moreover, the sale of additional travel-related services is generally not separately reported and its contribution is hard to assess. Where there is some evidence, it seems that revenue coming from additional services is not huge. For example, easyJet now reports revenue in two categories: seat revenue, which includes everything connected with the onboard product, and non-seat revenue, which is all the revenue from partner services. In its FY2014 accounts, non-seat revenue was just 1.5% of easyJet's total revenue. In FY2011, when easyJet last reported ancillary revenue, including everything other than the purchase of a seat, this was 21% of revenues as a category.

It is obviously too simplistic to extrapolate this to all airlines, but it suggests that the vast majority of ancillary revenue comes from unbundled product features. It is certainly possible that successful marketing strategies and yield management of ancillary revenues can increase them, but this adds to the feeling that at least some significant proportion of such revenues is not entirely new.

Against this background, and in view of the typically very small profit margins in the airline industry, any genuine new revenue activity is highly prized. This is all the more so if that activity comes with little additional cost. Hence the current fashion among many in the airline industry, and many more circling outside it, to talk up the potential for airlines to develop their retail skills.

The perceived opportunity here is not just for airlines to sell onboard products and travel-related services, but also to combine their Big Data-derived knowledge of passenger preferences with passengers' inflight down-time to try to sell them a full range of other products and services. The advent of inflight WiFi is a key enabler of this move towards airlines becoming online retailers.

The vision put forward by some is that passengers will relax into their seat, log onto their smart phone, laptop or perhaps the airline's onboard WiFi-enabled IFE system and then happily fill the flight by ordering all those products that they do not normally have time to think about. Purchases will then be collected at the destination, on return, or to be delivered while the passenger is travelling.

What's more, say the 'airlines as retailers' visionaries, the carrier's knowledgeable IT system will present the browsing passenger with just the product they wants, based on the intimate details of their lifestyle and buying behaviour it has gathered from the many "touch points" in the airline-passenger relationship. It may even pique the passenger's interest ahead of the flight with an email (or other communication, presumably app-based) making tailored "customer-centric" suggestions.

This may be appealing to some passengers, but, equally, it may not. For a start, it is unlikely to gain any traction on short-haul flights. Even on long-haul, those who do not like to use flights to catch up with work may continue to prefer to sleep, read, or use the airline's inflight entertainment system.

Moreover, many people do not appreciate being sent another stream of un-requested communications, whether from the airline, or, more annoyingly, from third parties. Airlines will need to be mindful that, for perhaps a silent majority, the concept of 'customer-centric' does not need to stray beyond providing the passenger with safe, comfortable and on-time passage from origin to destination.

Nevertheless, this does raise another area of potential for disruptors to innovate, namely in providing passengers with a genuinely door-to-door service. Stitching together all the elements of a journey, including surface transfer via multiple modes of transport and accommodation needs, through a single point of contact is a genuinely value added service.

Even if converting airlines into genuine retailers may not be imminent, Ryanair's Mr Jacobs said at Airlines in Transition 2015, "aviation has not used customer data as well as it could". This brings undoubted opportunities for airlines to do better and to provide customers with a better experience across the full spectrum of their interactions.

However, apart from the ongoing and not insignificant technological challenges, the big question is who benefits from innovations in distribution and the generation of new revenue streams? Will it be the airlines, or will it be the suppliers and other third parties that are swarming around them to offer the skills necessary to facilitate the innovations? Which suppliers?

Google has made a series of high profile moves into the travel industry, although its attempts to be all things to all people have not met with universal praise. Cartrawler, Chief Technology Officer, Bobby Healey told Airlines in Transition 2015 that he does not believe Google will take over travel. "They have done a poor job with their meta search," he said, arguing that, they lead from an engineering point of view, but not from a customer point of view. Nevertheless, he conceded that Google could "acquire their way" to a solution, but also warned that Facebook and WhatsApp could "completely kill" Google's travel plans.

For Sabre Airline Solutions, VP Marketing Solutions Stan Boyer, it is not a question of whether it is Google, Facebook or WhatsApp that succeeds in travel. "The bigger question airlines need to ask themselves is do we want that to happen as an airline?" If not, said Mr Boyer, airlines should then be asking what they should do to prevent it, or even if they can prevent it. "It truly is about the data and about the customer. If you're not pairing those two together in real time, then you are missing the opportunity and opening up the door for someone else who knows how to work the data and can get to your customer.", he said.

easyJet is an example of an airline that recognises this threat and which has made great strides in developing digital platforms to provide a better customer service. Although Ryanair has a strong history of innovation, doing more than any other airline (certainly in Europe) to simplify and democratise air travel, it started to fall behind in this area.

Now, however, its new Ryanair Labs operation seeks to close the gap on easyJet and then to take a lead in developing digital technology, without adding cost. Nevertheless, Ryanair's Kenny Jacobs said at Airlines in Transition 2015 that technology companies would play a bigger role, although he predicted that life would get harder for OTAs.

The likes of easyJet and Ryanair may be ahead of many airlines in their approach to innovation, but it seems that most of the disruption in these areas is coming from IT service providers and other third parties.

Not unnaturally, these suppliers are doing it to serve their own bottom lines. Of course, in the best examples, both the airline and the supplier should benefit. But they can only really do that by ensuring that the passenger truly benefits too.

Even then, the financial history of the airline industry, which has never been able to hold onto margin improvements (with only a very few exceptions), tells us what seems to be an undeniable truth. Relentlessly, airline passengers demand more for less. And they get it.