Airline disruption: it will happen in the next decade - but no one is preparing for it

The Future, in Brief

The two fundamentals of the airline industry are about to be uprooted - in tandem, as they are interrelated and, in some sense, feed off each other:

- The regulation of flying. Ownership and control rules (O&C) are being overturned steadily by a combination of "cross border joint ventures", cross border equity investments, and the rising influence of the new markets of China and Asia Pacific. Removal of O&C transforms the bilateral market access system that has lasted 70 years; and

- The selling of tickets. New (non-aviation) retailers, armed with highly specific data and the skills to exploit it, are about to take on the role of selling end to end travel, of which the airline segment is only one part. Meanwhile airlines are confined to (usually) poorly exploited data about (only) their own customers, and to infighting with intermediaries: GDS companies, OTAs, metasearch, and others.

The result: a vastly different industry where airlines become mere pipelines, and retailers become the platforms for sales.

Taking the form of 'The Great Debate', these issues will be the core of discussion at CAPA's forthcoming Airline Leader Summit at Powerscourt, Dublin, on 11/12-May-2017.

For more information please visit: CAPA Airline Leader Summit, Dublin, 11/12-May-2017 and see the end of this report.

It's not a question of whether, but of when…

With this level of surrounding and internal turbulence, does it seem likely that the airline business - governed by 70 year old regulations - will stay intact?

It defies belief that airlines will be immune from this movement. Above any other industry, airlines are captured within an arcane regulatory framework designed 70 years ago, and whose purpose was to achieve little else than protect against new entry. It is a capital intensive heavily unionised industry, and it is dominated by legacy models still focused on buying and flying expensive metal.

But at its heart the airline offering is just another consumer retail product. As such, it is just as susceptible to upheaval as mainstream retailers who have been upended by Amazon in many markets.

This report maintains that the airline industry as we know it will be unrecognisable by 2025, as fundamental features are uprooted. The process will be accelerated because of the confluence of disruption in each of the key aspects of commercial aviation: flying and selling.

Firstly, there is the advent of companies with the scope to accumulate data about every step of the travel process of hundreds of millions of travellers, together with the ability to interpret and apply it. This development will overwhelm the airlines' control of distribution. They will become little more than vehicles for transportation, much as global telecommunications links have become "pipelines" for use by any third party who wishes to access them for a price. That access is readily made through simple (and extremely data rich) "platforms" - such as the apps of Airbnb, Uber, and Amazon.

Secondly, the international market access regime, governed for over 70 years by "archaic" ownership and control rules - having protected incumbents at the same time as preventing rationalisation of the industry - that will be swamped by a combination of cross-border airline equity ownership plays and cross-border "joint ventures".

A look at the basics - fundamental, but with much baggage: Flying and Buying

To recapitulate: although airlines do now involve themselves more broadly along the supply chain, the airline industry has two essential elements:

• flying aeroplanes; and
• selling tickets.

More technically these are (1) operational and (2) marketing and sales.

There is a wide spectrum of other important airline activities, for example in international relations and industry regulation, but flying and selling are the core activities now facing disruption.

The former, operational, is unique to airlines and can engage massive governmental regulatory intervention, technical and economic. It is also highly unionised, adding to the inertia.

The marketing and sales activity has certain aspects particular to aviation, but generally differs little from any other form of retail - except that most older airlines have tended to be particularly slow at learning the art. As a form of retail, it is also rubbing up against the disruptive elements that are developing widely and affecting that function.

In the regulatory area, China will be the big disruptor as it expands into its new global role. As also will wider Asia, a region that will tilt the global balance as growth fuels innovation. Simultaneously, technology advances and the associated rise in consumer empowerment will transform the process of buying and selling tickets.

These changes are happening; we will see more impacts, and sooner than we expect.

This analysis reviews the nature and degree of disruption in each core area and what potential the future holds.

Airlines are seriously limited in their ability to market and sell

(1) They cannot enter foreign markets by conventional means

Airlines, paradoxically, don't have global market clout. They are big on brands, but here they are restricted by rules focused on their own home nations, which often limit them from entering foreign markets.

A tiny handful, like Emirates, have been able to rise above the crowd in global branding terms. But Delta, one of the biggest airlines in the world, is relatively unknown outside the US. It is trying to do something about that by buying into foreign airlines - Virgin Atlantic, Aeromexico, for example - but outdated rules prevent them from expanding seriously. That has to be frustrating, with continuing effects on their long term prospect of financial viability.

As a result of its confinement even Delta, with the largest market capitalisation of any airline (USD33 billion), is only valued at broadly the same level as Airbnb - an eight year old app, self service and with no baggage.

Amazon.com, by contrast, has a market capitalisation of USD440 billion, along with a presence in most global markets - to the growing anxiety of those retail markets where Amazon is coming next.

With their natural focus on buying and flying expensive equipment, airlines fit much more comfortably, in a sense, into the role of wholesalers (of just one part of the travel experience).

So long as they are confined to national limits and regulation by O&C, they are effectively prevented from becoming truly global, or sometimes even comprehensively regional.

However, with their innovative, and often fearless, approach LCCs in Asia Pacific have skirted the O&C rules by expanding their brands across borders; "joint ventures" where the home brand - like AirAsia - finds a local equity owner who takes a majority share in that country. In this way AirAsia is able to apply its brand as a local airline in numerous markets, as well as gaining a range of operational efficiencies.

Other airlines have followed suit: AirAsia's long haul brand, AirAsia X, hubs with AirAsia; Indonesia has Lion Air; there is Vietnam's Vietjet; Singapore Airlines' (long and short haul) Scoot; Qantas' (long and short haul) Jetstar. All of these and others have established as home airlines in foreign countries. They stay within the letter of the O&C rules by being "substantially owned" locally.

Most governments, in many cases taking an approach unfettered by the inherited aviation industry rules, are little interested in the "control" element, beyond ensuring that the operations are subject to adequate safety supervision.

The Etihad example, of acquiring an array of minority airline interests across the world, was aimed at getting behind the national gateways of the long haul markets they serve; whether or not that particular example flourishes, it has blazed a trail for others to follow. Qatar Airways and its owners are pursuing a similar but different course. HNA, from China, is acquiring interests in airlines and associated interests around the world.

And, in the US, Delta has made the boldest/largest strategic cross border equity investments: in Virgin Atlantic and Aeromexico, along with smaller ones. The common theme is gaining access behind key gateways and bolstering international route strength.

These are but building blocks in what is a remorseless movement toward rationalisation. One which is gathering momentum.....

2) Mostly, airline management just does not 'get' retail yet.

Just because airlines have a product/service to sell, that doesn't mean that they are good retailers. After all, they have allowed themselves to get into a position where they mostly offer nothing more than an anonymous commodity.

It is one thing to recognise that (micro-)tablets are becoming the electronic instrument of choice, but quite another to adapt to the fact and respond effectively in the travel product offered.

The cause is not simply online competition, although that has accelerated the swift changes; it is mostly that managers have just lost sight of what their existing and potential customers wanted to buy and how.

For a generation of managers who have grown up focused on "push" not "pull", the system - and their thinking - are often out of tune with the increasingly influential role of (i) personal recommendations and (ii) mobile transparency.

Even where these features might not already have as powerful a pull as in some other retail areas, there is a rapidly growing general expectation by consumers that they themselves are, or should be, in control of the purchasing process. The consumer makes assumptions that air tickets will be no different from buying other products. This is a factor in increasing the momentum for change.

This oversight, or indeed lack of vision, in approach to the customer is not a problem unique to the airline industry; retailers across the world, often accustomed to leveraging dominant positions in their respective markets, are finding their traditional strength diluted as online sales and word of mouth influence consumer behaviour. And behemoths like Amazon spread globally.

With their systematically more sophisticated market understanding and analytics, the much larger retail companies are sweeping all before them. So global retailers and personalised data collectors are well positioned to attract airlines with the lure of large-scale sales ("part charters"). They can locate, personalise and capture enormous volumes of customers. Selling that into airlines is a simple next step - and for airlines that's a one way track.

At CAPA's recent Americas Aviation Summit Paul Pessutti, SVP and GM, Travel and Transportation, SAP, outlined this potential for airline disruption in the distribution and marketing areas as new entities employ big data to enrich the customer experience:

Paul Pessutti, SVP and GM, Travel and Transportation

Source: CAPA TV, centreforaviation.tv

Some of the key points Mr Pessutti makes:

• "The current distribution channels are going to shift. You're going to see new players in the market - SAP, google, Facebook, Apple - really get involved in the overall experience of booking and arranging travel. What enables that is the data. And the ability to provide that in a real time way."

• "Companies that have the data will be the ones who will ultimately be selling travel and capitalising on the market"

• "The airlines need to make a big investment in the customer experience… and part of that is reducing the number of intermediary steps…. But that requires innovation NOW."

• "I hope there is a role for (airline brands)...But what actually might happen if (that innovation) doesn't take place (the airlines) will simply be a brand sitting over other capabilities. We've seen this in retail and other consumer products around the world."

Right now it looks as if the companies that have the data are the ones that will ultimately be selling travel. If the airlines are going to remain relevant they will have to innovate; only the merged entities will survive.

It's often hard for airline management to focus on this core retailing activity

There are so many other "core" activities to deal with: lobbying with government; complex labour relations (pilot unions can seriously constrain an airline's policy options); network planning; treasury functions and aircraft buying and leasing; IT functionality (insourced or outsourced); coming to grips with fast changing markets disrupted by LCCs, responding to Gulf carriers and new entrants; accommodating and influencing intermediary relationships; not to mention myriad externalities like oil prices, volcanoes, terrorism and pandemics.

All the while hemmed in with massive safety and security regulations.

One factor making exploitation of retail so difficult is the powerful and shifting role of intermediaries.

For some years now airlines have complained loudly about the way GDSs, online travel agents, and metasearch have reduced the buying process to one of commoditisation, where the only driver is price. In the airlines' eyes this is compounded by the significant charges levied by GDSs on every air segment sold; the airlines are locked into multi-year deals with them and, in turn, GDSs lock in travel agents, making for a near-perfect inertial system.

And the GDSs themselves, often labouring under the weight of old technology and confronted by online competition, are struggling to support their airline clients by providing the ability to display and promote features other than price, as well as to allow them to sell ancillaries online.

But while the airlines and their intermediaries are busily squabbling violently within their walls, the barbarian hordes are massing outside.

Ultimately it is the empowered consumer that drives the greatest disruption of all

The most significant disruption that has occurred to date in the aviation and travel industry (and retail generally) is the shift in behaviour of consumers. The app-empowered consumer is more knowledgeable today, leveraging greater transparency, wanting direct control and unwilling to accept arcane rules that have governed airline operations for decades. And when they behave as business travellers they demand to be rewarded and treated with some recognition of the value they bring to the airline - a recognition that airlines are rarely able to deliver.

In short, consumers have been liberated (and captured) by technology. Small businesses are able to compete in global markets in ways that would not have been possible 15 years ago; B2C consumers are equipped with the information to see into the market - and with the tools to get what they want. And if they're prevented for what they consider unnecessary reasons, they will make their concerns felt loudly through social media outlets.

For an industry which has so often relied on opacity to extract greater benefits, transparency can hurt. Many airlines are now aware of this new consumer power and they are making all the right noises, talking of the need for personalisation and understanding the customer.

Yet very few airlines are actually doing anything effective to implement the words they are using; they know they need to, but rarely have the instruments to convert words into action.

And here lies a long-standing fundamental problem of the airline industry, one which underpins many of the consumer-airline problems that arise - creating unrealistic expectations. Overpromising and underdelivering. Whether those outcomes be inflight misbehaviour, service shortfalls, or perceived "ripoffs" (an expression often used where fare complexity has trapped unwitting consumers) - they are endemic.

The new consumer empowerment serves to emphasise the growing disconnect between passenger expectations and reality. Or perhaps it was always there; but whereas airlines were once able to overpromise ineffectually, consumers' ability to complain is now a much more powerful antidote.

The consumer's ascent to power has coincided with diversification and disruption of the airline product

LCCs, the Gulf carriers, long haul LCCs and new entries generally have illustrated the options that exist. Combined with their access to undreamt-of levels of handheld technology and social media access, consumers have genuinely achieved a position where they can influence the system. That influence, as noted above, is minimal in the regulatory environment, but is rapidly growing in all sorts of practical areas.

Artificial Intelligence, virtual reality and the use of portable technology have the potential to change travel distribution profoundly over the next 10 years, according to the London School of Economics (LSE) in a 2016 study entitled: "Travel distribution: the end of the world as we know it?"

Based on an industry survey, it suggests that "Gatekeepers, 'mega meta online travel agencies', and artificial intelligence may fundamentally disrupt the future of travel distribution".[1] Data and its use are now beginning to dominate the conversation.

And it's not just distribution of course; it's the airline business itself which is in the firing line.

Airlines may struggle to come to grips with big data, but the prospects of large, older airlines achieving serious value are few

It will not be for want of trying - although many senior managements remain reluctant to make the necessary (major) commitments in cost and corporate restructuring necessary to achieve results.

Burdened by a silo-oriented organisational structure and an absence of the right analytical minds and systems, airlines are in an unequal race with third party information aggregators to capture their own market.

As one provider described it recently, "an airline with 500 daily flights can have up to 500,000 discrete data points that potentially need to be monitored by a revenue management system. But today's revenue management systems rely on limited technology platforms that were built with a threshold of handling only one fifth of the volume of complex data that exists today. In addition, advances in data management, processing power, and forecast optimisation have become increasingly better, faster, and smarter, creating an even greater need for a new solution."[1]

Getting the data into a form that is capable of analysis and then developing the opportunity and systems to exploit it are achievements well beyond the likely capabilities of today's airlines. These need to focus on the user experience, digesting vast amounts of data - then to exploit the data to apply it effectively in revenue management.

The airline has the disadvantage that it only has access to its own database

This is a relatively tiny cross section of an airline's potential market, with no ability to look into consumers who haven't travelled or booked with them, or along the whole travel chain.

Take the "sharing economy's" Airbnb for example. It is eight years old. It has recently expanded into corporate travel and into "trips". Trips are add-ons, or side trips such as a city tour or boat ride (each with high margins).

This sounds minor, but it is important: because the company estimates trips will become much larger than its basic business - which itself is now valued at around USD30 billion. That's a lot of money for an eight year old app.

The forecast is more important in the airline disruption context: Airbnb projects growth from its cutting edge technology

The company has accumulated an enormous stockpile of data on its users and is able to convert that to useable information. It is becoming a data analytics company. It has the data, it has the technology and it has the human resource skills needed to leverage the opportunity. It is aiming to provide that holy grail that airlines talk of: door to door service and beyond. As with its accommodation product, Airbnb owns no real estate or infrastructure.

It does not have to carry the risk of buying billions of dollars of heavy metal. It is simply an app; an app with comprehensive coverage and deep insights into who the passenger is and what he/she needs. This is compellingly attractive. In short, it is capturing the customer.

Airbnb is hardly alone. In Jun-2016 the fellow accommodation online travel agent group Booking.com released two "data insight" tools designed to help its nearly one million hotel sites to improve their revenues.

By delivering such a wide range of personalised data, the OTA offers something the individual hotels cannot ever dream of accumulating or applying. These offerings are irresistible in the short term, but they come at a high price - they accelerate the suppliers' dependence on the data. Booking.com's owner, Priceline, is valued at USD85 billion. Its data analytics are cutting edge and all-encompassing.

Then: Amazon, valued at USD440 billion, with its Amazon Web Services

Like Airbnb and Booking.com, Amazon has become a data analytics company, armed with modern technology, human skills and one of the most comprehensive databases in the world. It uses these to sell product, but constantly accumulates an overwhelming database of consumer behaviour. More importantly, it has the capability to apply it.

And Facebook (valued at about USD410 billion), reaching half the world's consumers; we haven't yet even got to Uber - valued at nearly USD70 billion - or google (nearly USD600 billion market cap).

These are each massive ventures, mostly children of the 21^st century (google is the elder, at 20 years) employing banks of tech geniuses. Aviation is only one of many targets on which they are sharpening their focus and gaining personalised insights into consumer behaviour.

Even with a willing management and the ability to fund a few billion dollars' worth of investment (that narrows the field significantly), it would take at least two years for even the most innovative airline to achieve "personalisation" on a useful scale. Some are trying, with tech labs and the like, but even the best pale into insignificance when faced with the scope and scale of the major analytics aggregators.

So these third party data hegemonists are able to offer a growing array of "solutions" to the providers, all the while strengthening the reliance of their hotel, airline and other clients.

It is not hard to see where this leads. By the end of this decade the control of the distribution process, and of the customer, will be in the hands of the data analytics companies.

That does not mean they will be doing all the heavy lifting. That's not how they operate - they leave that to others - but they will be pulling the strings. They will be the platforms, while the airlines become the pipelines.

What can airlines do to prepare for this disturbing future?

Come along to the CAPA Airline Leader Summit, Dublin, 11/12-May-2017 and hear some of the world's leading airline CEOs, key government officials and leading industry minds review the challenges and look for solutions. Over 30 airlines are represented.

And above all, participate in the debate. (If you have any comments on the arguments raised above, please forward them to info@centreforaviation.com.)

The Proposition: This House believes international airline operations will be thoroughly disrupted by 2025

John Byerly will oversee a full scale debate on the demise or otherwise of ownership and control rules, between:

For the Proposition: Rigas Doganis and Barry Humphreys

Against the Proposition: Ulrich Schulte-Strathaus and Albert Muntane Casanova

John Byerly Consultant John R Byerly	Rigas Doganis Chairman European Aviation Club	Barry Humphreys Chairman BKH Aviation	Ulrich Schulte-Strathaus Managing Director Aviation Strategy & Concepts	Albert Muntane Casanova SVP Aviation Research DVB Bank SE

This will be followed by a full programme over two days covering the topics raised above, with fascinating discussions and intriguing outcomes.

[1] Sabre's Product Marketing Manager, Jade Owens, Nov-2016.

[2] Travel distribution: the end of the world as we know it? - an LSE study commissioned by Amadeus, Oct-2016.