How airlines have found an upside in the downturn

Toby Stokes, Ernst & Young's aviation sector leader Europe, Middle East, India and Africa, explains how the aviation industry's leading players are continuing to create growth through focused innovation and investment.

Airlines are traditionally relatively low margin businesses, hostages to the state of the global economy and the price of jet fuel. In recent years, the industry has been hit hard by both the global financial crisis and sustained high oil prices.

Business models that worked during the good times but were ultimately long past their sell-by dates are failing. Already in 2012, carriers such as Spanair, Malev and Air Australia have folded, unable to adapt business models sufficiently quickly to changed economic realities.

The situation for the industry as a whole is not about to get any easier. 

Tony Tyler, director general and CEO of IATA, earlier this year predicted a net income for the industry in 2012 of US$3.5 billion, down by almost half from US$6.9 billion in 2011.

He said high oil prices and Europe’s sovereign debt crisis hang over the industry like “the sword of Damocles”.

And yet, against this backdrop, some carriers are continuing to grow and generate profit.

At the start of this year Ernst & Young carried out a comprehensive survey of 600 senior executives at companies and corporations around the world that have performed well despite the economic downturn.

The findings of the Growing Beyond market analysis, as germane to the aviation industry as to any other, underscore the increased importance during tough market conditions of reaching customers, containing costs, inspiring stakeholder confidence and ensuring operational agility.

They also suggest that companies that increase investment – albeit with considerable focus – during a crisis of liquidity are more likely to succeed than those that merely focus on cutting costs.

During the downturn, high performing airlines have demonstrated a willingness to innovate to capture increased market share, whether through product launches or incentivisation of staff, with a marked emphasis on breaking into the lucrative emerging middle class markets of the BRIC economies.

The airline industry has not seen stability or stagnation among the market leaders during the global financial crisis; rather it has seen fierce competition amongst carriers to take the best offering to market, resulting in increased R&D and capital expenditure.

In the past 12 months, for example, the multi-million dollar roll-out of new seats has been a trend among high performers, as has the installation or retrofitting of on-board connectivity on aircraft. One Gulf carrier has even introduced on-board chefs.

In the MENA region, on-board connectivity is now offered by all of the major players: Emirates, Qatar Airways, and Etihad Airways.

In the Far East, Cathay Pacific has recently updated products across its fleet, installing brand new seating and seating concepts; for example, the introduction of a premium economy class and the redesign of business class.

And in Europe, carriers such as Virgin and Lufthansa have gone to considerable lengths to reinvigorate their offerings to premium customers with the redesign of the upper class cabin and the introduction of a new flatbed, respectively.

Seemingly counter-intuitive in a downturn, these examples are all indicative of the airlines’ desire to not only compete aggressively for international traffic, but to ensure they have not been left behind when the economic storm clouds finally part.

They demonstrate, too, top-performing airlines’ unwillingness to change strategy by placing heavy emphasis on providing lower price range products: customers prepared to pay premium prices for travel still, then, remain a cornerstone of the foundations of high-achieving carriers’ business models.

It is a strategy that is bearing fruit. IATA figures show premium traffic across the industry in February having increased by 6.3%, compared to the same month a year ago and continuing the positive trend started at the end of 2011.

Another area in which surveyed executives from high-performing companies said they placed increased importance in the corporate effort to capture market share during a downturn was staff incentivisation.

Incentivisation schemes designed to align individual goals with corporate goals and to empower staff to make decisions while utilising their ideas or their insights into customer feedback were more vital than ever before.

Successful companies, our research showed, had their staff on board, pulling in the same direction, because they felt not only incentivised financially but also part of the project. 

On the flipside, companies whose workforce cowered beneath the ever-present threat of cutbacks and redundancies were lacking in dynamism and desire to out-perform.

Perhaps the most important trend in terms of long-term customer reach identified in the Growing Beyond report was the effort being made by market-leading airlines to break into emerging BRIC economies. Between now and 2030, the number of people in the global middle class will increase from 1.8 billion to 4.9 billion, the majority of whom will live in Asia and the other high growth markets.

Etihad Airways, for example, has recently begun operations to Chengdu, an industrial city in the southwest Sichuan area of China with a catchment population of some 20 million people.

Qatar Airways, too, has recently started operating to the Chongqing in southwest China, a conurbation with some 35 million residents – more than either Shanghai or Beijing – and considerable European manufacturing activity.

These efforts to break new ground and tap new traffic flows are not limited to China; Gulf carriers in particular are making heavy investment to launch Africa routes – notably to Libya but also to Kenya, Uganda and the Rwanda in recent months.

Moreover, most high performing international carriers have shown considerable interest in launching or in operating increased services to India and South America.

The trend is emblematic of a desire identified in the Growing Beyond report, shared by high-performing corporations, to broaden their search for new customers regardless of financial downturn. 

Agility in recession is vital. The ability to change tack or to find effective ways to overcome or circumvent regulatory constraints barring or hindering access to markets was a constant in the characteristic makeup of high-performing airlines we surveyed.

Protectionist government policies designed to stop foreign carriers entering markets on an open competitive basis have long frustrated international airlines. Recently, carriers that lead the market have shown a high degree of innovation to get around constraints.

Alliances, in particular, have grown in popularity as a means of circumventing regulation, common in many countries, that prohibits M&A activity or the full purchase of airlines.

Alliances, often in the form of codeshare agreements, have proved an effective means by which, at low risk, airlines can generate revenues on routes to which, in some cases, they do not even fly, while simultaneously finding a way around bilateral constraints designed to restrict the frequency of their ability to operate.

Etihad Airways, the national carrier of the United Arab Emirates, has, for example, recently largely predicated its long-term business model on alliances and codeshare agreements, a strategy it believes will enable it to generate scale quickly while allowing it to maximise access to vast markets across Asia, Europe and the United States.

Emirates, too, the Gulf’s most famous carrier, has recently signed a codeshare agreement with American operator Jet Blue that it believes will facilitate considerable penetration into new US markets.

Equity deals have also seen a rise in popularity. For example, BA, American Airlines and Iberia today operate a joint venture on all trans-Atlantic routes as a result of government regulation precluding an actual merger. The joint venture is widely regarded as a ‘synthetic’ merger.

In Europe, the trend in recent years is marked with players such as Lufthansa, BA, Iberia and KLM-Air France making acquisitions as they jostle for market share.

Etihad Airways’ swoop for a 29.9% stake in airberlin, Europe’s sixth largest carrier, in December 2011, is a good example of a carrier gaining vastly increased access to large European markets at the stroke of a pen, for the cost of one mid-sized aircraft.

Agility, of course, is not only about acting quickly to find ways around barriers, it is also about ensuring operational flexibility is rapid and decision making is decentralised when it needs to be.

The Growing Beyond survey found repeatedly that high-performing airlines were those that cultivated a culture of decision making close to the ground or to regional markets. Traditionally, airlines have tended to be centralised, not devolving power to outstations.

Today, that trend is being reversed, with greater freedoms being granted to regional sales forces or regional financial controllers. The result is a markedly improved ability to react quickly to changed circumstance. 

Operational flexibility is also an enabler of speed; one that high performing airlines are achieving through, increasingly, outsourcing of procurement and ground-handling operations, or allowing revenue accounting to be undertaken by a third party in places such as India.

Effective outsourcing allows carriers to respond quickly to changing volumes and to minimise costs. The Growing Beyond survey found companies that have struggled have been those that have clung to fixed processes.

Differences in attitude to cost cutting were marked between high-performing companies and the rest. High-performing companies and carriers placed considerably less importance on reducing headcount and more on improving efficiency across the company with better processes. Their priority was about controlling costs at an optimal level that would allow them to continue with their business strategy effectively and efficiently.

Non-high achieving companies were more enthusiastic to halt or defer expenditure until business picked up.

Market leading airlines, in the MENA region and beyond, all demonstrated high levels of execution in areas such as re-engineering back office processes to improve performance, outsourcing, mastering tax efficiencies, optimising working capital, forecasting and providing decision makers with optimal market intelligence.

Ernst &Young believes it is in these areas that companies looking to improve their cost containment ability must look to make adjustments. Management must be prepared to ask itself questions such as: how confident is it that it has full visibility of cost bases and key value drivers? How confident is it that it has sufficient capital to achieve growth strategies?

Surveyed high-performing companies again and again turned out to be those in which management demonstrated laser-like focus on details and preparedness to confront brutal truths.

During a downturn, communication with stakeholders – from owners and investors, to staff and customers – takes on increased importance. Maintaining and retaining confidence is critical, not only to push through change or retain talent, but also to ensure restricted liquidity does not dry up entirely.

Winning companies, the survey showed, are communicating much better than companies that are struggling or standing still.

When third parties were asked about the relative performance of high- and low-performing companies in communicating with stakeholders, the difference was immediately apparent with 42% more respondents believing high-performing companies were communicating their current performance and forecasts to their stakeholders better than low-performing companies. Likewise, 37% more respondents said they saw better communication from high-performing companies on the issue of long-term reputation management.

It is natural for people to put their head in the sand when times are tough, or to become non-communicative. It is vital, however, that management does not allow it to become corporate practice.

The survey found that high-performing companies were markedly more prepared to talk in both broader and granular detail terms, with more coverage of non-financial KPIs, and put considerably more effort into identifying and managing risk.

Doing so was a major factor in high levels of confidence in market leading companies; confidence that ultimately will prevent talent from dusting off CVs and make investors feel sufficiently comfortable to inject liquidity.

Confidence, too, of course, is paramount for attracting customers.

The Growing Beyond survey provided strong insights into the habits of successful companies and the manner in which those companies have maintained their dynamism despite difficult market conditions.

At Ernst & Young, we believe these practices are by no means a luxury that comes with top performance; rather they are mechanisms through which excellence is delivered.

Like all best practice, they are worth considering closely, and then implementing.

Success, perhaps now more than at any time in the last 30 years, is not a matter of luck.

Success in 2012, and the ability to grow beyond the changed economic realities of modern times, is about being prepared to invest, both in people and in product, while making sure your company is optimally prepared for the future in terms of management of costs and communication to stakeholders.