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Disruption in the airline industry. It is coming, faster and bigger than you think: Part 2

It is notable that airline liberalisation has scarcely been driven by overt consumer pressure. Instead it has been a handful of influential and enlightened governments who, recognising the flow-on economic benefits, have promoted aviation liberalisation in the wider national (and global) interest.

In fact, with some exceptions, airline consumers have in general received a good deal over the past 40 years, in terms of low fares and good product, a result of the combination of regulatory change and of airlines prepared to exploit it effectively. LCCs and the Gulf airlines have played a major part in that.

Ironically, consumers and the EC and US DoT/Congress have instead ridden political waves to introduce “consumer protection” rules that often do more harm than good – for example the flawed rules on both sides of the Atlantic and elsewhere punishing airlines for delays, even where weather or ATC/airport or other issues are to blame.

Part 1 of this report appeared at Disruption in the airline industry. It will happen sooner than we think: Part 1

The consumer is becoming a major disrupter

That said, the broader consumer movement, strongly supported by airports and by technology and sharing economy innovations, is becoming an increasingly powerful disruptive force.

Add to that the growing power of third parties who are able to aggregate travel, “personalising” it and, as we shall see later, the consumer will rule the world.

Do airline managements get retail yet? They often know the words, but do they feel it?

It is one thing to recognise that (micro-)tablets are becoming the instrument of choice, but quite another to adapt to it and respond effectively.

This is not an issue confined to the airline or travel industry. Traditional retail generally is in crisis. The cause is not simply online competition, although that has accelerated the swift changes; it is mostly that managers 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 – is 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 are, or should be, in control of the purchasing process. The consumer makes assumptions that airlines will be no different from buying other products. This alone does not disrupt the system, but it does increase the momentum for change.

This shortcoming 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.

It is often hard for airline managements 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, Gulf carriers and new entrants, accommodating and influencing intermediary activities, not to mention externalities like oil prices, volcanoes, terrorism and pandemics.

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, 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 ultimately it is the empowered consumer which 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 – something 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 (CAPA is one of them!); B2C consumers are equipped with the information to see into the market – and the tools to get what they want. And if they are prevented for what they consider unnecessary reasons, they will make their concerns felt vocally 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 longstanding fundamental problem of the airline industry, one which underpins many of the consumer-airline problems which arise – creating, impliedly or explicitly, unrealistic expectations. Overpromising and under-delivering. Whether they be inflight misbehaviour or service shortfalls, or simple “ripoffs” – an expression only too often used where fare complexity traps unwitting consumers – are endemic.

The new consumer empowerment serves to emphasise the growing disconnect between passenger expectations and reality. Or perhaps it was always there, but where airlines were once able to, 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 entry generally have illustrated the options which can be possible. Combined with their access to undreamt 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”.2  Data and its use are now beginning to dominate the conversation.

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

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

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 discreet 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 optimization have become increasingly better, faster, and smarter, creating an even greater need for a new solution.”

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 effectively in revenue management.

And even then, the airline only has access to its own database – a relatively tiny cross section of its 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 for two reasons; firstly because the company estimates trips will become much larger than its basic business – which itself is now valued at around USD30 billion (almost as much as Delta, the world’s most profitable airline). That’s a lot of money for an eight year old app.

But the forecast is more important in the airline disruption context because Airbnb and others are able to project this growth on the back of their cutting edge data science technology

Airbnb for example has in its short life 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 doesn’t 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.

Fellow accommodation online travel agent group Booking.com in Jun-2016 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 USD75 billion. Its data analytics are cutting edge and all-encompassing.

Then there is Amazon, valued at USD370 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 (also valued at about USD370 billion), whose Facebook Messenger reaches nearly a billion monthly active users (and is reshaping democracy!) – we haven’t even got to Uber, valued at nearly USD70 billion or Google (USD530 billion market cap) yet...

These are each massive ventures, mostly children of the 21st 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 teeth and gaining personalised insights into consumer behaviour.

Messaging functions show how the future can look

Messaging functions such as Facebook's WhatsApp or China's WeChat - which now enables travel bookings - illustrate how every word spoken can be used to capture consumers. A private conversation where people discuss a football match can translate into an offer of travel and accommodation for the game. And WeChat can book it all.

For an airline, 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, 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 or investing in metal or bricks. That’s not how they operate – they leave that to others – but they will be pulling the strings.

And to the future. One consistent strain in the four rounds of airline industry disruption over the past 40 years has generally been the confluence – not always coincidental – of four features:

In each case the disruption was the outcome of market conditions that had become unsustainable. Their time had come.

The four common features, present to a greater or lesser extent have been:

A technical step change;

A new form of operational innovation by some airlines;

A change in the regulatory structure; and

A change in the way the airline retail product is distributed.

Disruption Phase 1 - Sixth Freedom operations

Phase 1, across the 1970s, was on the back of the arrival of Boeing’s jumbo jet, the 747, which changed the economics of the industry, while injecting new needs for market planning and revenue management. It allowed the upstart Singapore Inc with its young flag carrier to emulate the sixth freedom model established by KLM and the Dutch; this quickly spread through Asia.  The established flag carriers felt this was improper, as they “owned” that traffic.

At a marketing and sales level this unwelcome development was enabled by the erosion of IATA’s price fixing and enforcement, making it difficult for the incumbents to prevent under-the-table sales of sixth freedom tickets. Thus disrupted, the regulatory system adjusted to reality.

Disruption Phase 2 - Liberalisation meets ultra-longhaul

Phase 2 involved the coincidence of ultra-long haul widebody aircraft with liberalisation under the spread of open skies agreements; combined with the vision of the Gulf states, Emirates and the other carriers, the power of the GDSs across the world opened up new markets. Now the geography of the Gulf and the range of the new aircraft was such that almost any two points on earth could be linked with one stop. That was the basis, but it took vision and innovation to make it work.

Initially the scale of this disruptive force was limited, but as it became clear that the model worked, so the European hub airlines became more concerned. The beginning of their hub dominance was about to be disrupted.

Disruption Phase 3 - LCCs

Phase 3 had a similarly disruptive impact, this time on short haul markets. Again it was liberalisation within the EU that opened the door to new entrant LCCs establishing a whole new level of efficiency; this was assisted by the emergence of a more strongly competitive manufacturer in the short haul aircraft market, provoking aggressive pricing.

But, although LCCs had started operating in Europe in the 1990s, it was only when the power of the internet and direct selling became widespread that the movement really flourished.

Of the four ingredients however, two have become pre-eminent. Overcoming the hurdle of ownership and control restrictions in a way that can allow some form of rationalisation of the industry; and applying the personalisation potential derived from consumer data are the next frontiers in the inevitable disruption of a geriatric industry.

As these two strains merge – the regulatory and the retail – the airline industry is heading rapidly for a magnitude and form of change that is hard to predict, except that it is likely to be vastly more extensive than most expect.

Disruption Phase 4 - Ownership and control provisions are relaxed and the third party data princes take control

Phase 4 means ownership and control provisions are relaxed, perhaps significantly. While this may not be a multilaterally consensual conclusion, it will result from the coming together of market power exercised by a new force, China, with the tacit support of a range of participants keen to invest outside their national boundaries. We have already witnessed some of the preliminary ingredients of this movement, with cross-border JVs, a growing number of cross-border equity investments and numbers of immunised JVs with all the characteristics – on a market by market basis – of merger.

Applying the rules rigidly is not something that governments have to do. They have the power but not the obligation to do so, and whether they exercise that power will come down to a practical decision on what is in the national interest. Just as the wider economic interest has forced some relaxation of access rules, so the ownership rules will bend.

However, the more complex and novel level of disruption comes from outside. The third party data princes are lining up to take over the role of “owning” the consumer. Airlines may have some part to play in that new future, but will not be as the dominant parties.

The Four Phases of Aviation Disruption

Technical Innovations

Operating environment

Regulation

Sales and Marketing

1940s - 1960s

  • Multiple union strength evolved in complex operating and admin companies
  • Boeing 707s arrive
  • 737s arrive
  • Strict – entry, capacity, frequency, pricing, routes all tightly controlled. Rigid ownership and control (O&C) rules applied
  • Passenger origin established as the “currency” for bilateral trading. Dominated by “flag carriers”
  • IATA fixes global prices – and enforces them
  • Tight control of third and fourth freedoms, a little fifth
  • Major airline disputes over free sandwiches and in-flight movies on North Atlantic
  • Manual, personal, direct sales and high street airline offices. Travel agents gradually intervene. 
  • No pricing flexibility
  • Typical load factors around 50%
  • Economy class grows rapidly after jet operations begin
  • Interlining organised through IATA agreements

1970s

  • 747s arrive
  • First oil crisis and economic downturn
  • Pricing challenges as 747s add large amounts of capacity and weak global economy suppresses demand
 

PHASE 1

SIXTH FREEDOM DISRUPTION

 
  • Many airlines break ranks, with “illegal” price discounting
   
  • Most established airlines fight strongly against allowing this “abuse” of bilaterals
  • US domestic deregulation; US begins to liberalise bilaterals for countries which allow  market pricing (“routes for rates”)
  • Breakeven load factors grow as competition forces real prices lower
  • American Airlines establishes a computer reservations system (CRS)

1980s

  • Airbus begins production of A320s
  • US CAB terminates ATI for IATA’s price fixing
  • US pursues international liberalisation and establishes first “open skies” agreements
  • First Chapter 11 reorganisations of US airlines
  • International hub and spoke operations evolve
  • Various airline groups establish CRSs; allows them to market more widely, still through travel agents
  • Competition authorities force transparency on CRSs, consolidation begins

1990s

  • Global downturn
  • KLM-Northwest ground-breaking hub-to-hub alliance on the North Atlantic
  • Liberalisation spreads as economic value of aviation becomes more central to government strategy
  • EU Single Aviation Market established
  • Airport Privatisation spreads
  • Frequent Flyer Programmes expand
  • Typical load factors for legacy carriers increase to 70%-80%

PHASE 2

GULF CARRIER DISRUPTION

Ultra-long haul aircraft arrive

  • Long haul network planning reshaped
  • Three GDSs emerge from the previous CRSs and sold off by airlines; pricing transparency grows

2000s

PHASE 3

LCC DISRUPTION A320-737 competition reduces prices

  • LCCs in Europe and Asia Pac.

  • Ryanair, easyJet expand, AirAsia begins

  • Short haul disruption begins in earnest

  • Online, direct sales start to disrupt distribution channels

Environmental pressures grow

  •  US majors go through Chapter 11 bankruptcy
  • Quasi-mergers among European majors
  • Fuel price crisis
  • Global Financial Crisis
  • EU External Aviation Policy allows the EU to negotiate bilaterals as a bloc
  • Despite no open skies, LCC X-Border JVs in Asia Pac. avoid some of the O&C control, allowing pan-regional growth for LCC groups
  • Airports with financial bottom lines influence the regulatory conversation
  • Economic benefit policies adopted by many governments
  • Some cross-border airline equity investments
  • US-EU Open Skies agreement
  • Industry load factors push into 80% levels
  • Transparency of pricing becomes much greater
  • Branded Global Alliances aim at global marketing

2010-2014

787s, A350s etc

Ultra-long haul, thinner routes, disrupting network hubs

 
  • EU-US multilateral agreement

  • Closed, anti-trust immunised JVs on the North Atlantic

  • Cross-border airline equity investments accelerate

  • OTAs and Metasearch expand, helping commoditise sales

  • Third party information aggregators intrude into travel - Google, Facebook, Amazon, Booking.com, Airbnb...

  • Big data becomes a buzzword

  • Consumer empowerment/self-management expand rapidly

  • Mobile usage skyrockets

2016-2025

PHASE 4

CHINA + 

BIG DATA TRANSFORMATION

  • China much more powerful in global aviation
  • Ownership & Control lines blur as Chinese airline and travel investment spreads
  • Virtual airline operation becomes more widespread as third parties dominate retail
  • Distribution changes fundamentally
  • 3rd parties, much more adept at aggregating, interpreting and using big data, dominate marketing and sales
  • Consumers control markets through direct access tools

Amid this storm of change, what can airlines do to protect their positions?

In the near term, inevitably, deeper bilateral partnerships with other airlines will be paramount. These will be designed not only with today’s needs in mind, but provide a foundation in what will be a very different world in the 2020s. For these relationships could well develop into the equity quasi-mergers of the 2020s, as ownership and control rules become more pliable.

But even more importantly, if airlines are to retain relevance in the overall supply chain, they will also need to forge deep associations with this other channel of disruption, at the marketing and sales/retail end of the spectrum. Equity and otherwise, they will probably be with the same data organisations that are fomenting their disruption.

Many airline managements will remain focused on the traditional airline role of flying aeroplanes

They will see this as the tail wagging the dog, ignoring the main business of the industry. There will always be a role for these enthusiasts, but that role will be more about being servant than master.

There is also the alternative; perhaps to invest, either independently or with outside groups, in developing much more sophisticated big data skills. That will be expensive and time consuming and, unless it extends to the whole travel supply chain, will not effectively compete with the larger data analytics groups. They will be useful, but will not stem the tide.

Moreover, even embracing the travel industry implies increasing marginalisation. For much of the world, travel has simply become one of a range of consumer options, interchangeable and competing with buying a new laptop, going to dinner with friends, or going to a football match.

Understanding the holistic nature of consumer behaviour through analysing its own data is well beyond the range of airlines. The massive new aggregators live and die on that data and will not be slow to exercise their power.

Innovation, thinking outside the box, will be critical. That will need management boards with different profiles, and new managements, who understand more about retail and data than about buying big boys’ toys. Even just the debate itself will be a powerful disruptive force.

Flying aeroplanes will always be a vital science, but it is not the scientists who rule the world; they merely provide the means to a larger end.

This is a lightly modified version of a report which appears in CAPA's Airline Leader journal, Nov/Dec-2016


2. Travel distribution: the end of the world as we know it?, an LSE study commissioned by Amadeus, Oct-2016
3. Sabre’s Product Marketing Manager, Jade Owens, Nov-2016

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