Air­line busi­ness: Cut-throat com­pe­ti­tion

BOTH FULL SER­VICE AIR­LINES AND LOW-COST CAR­RI­ERS ARE SEEK­ING TO PRO­VIDE GREATER DIF­FER­EN­TI­A­TION BE­TWEEN THE PROD­UCTS THEY OF­FER

The Jakarta Post - Magazine - - Contents -

The world’s air­line com­pa­nies are facing more in­tense com­pe­ti­tion, which could force them to cut air fares to be­low the mar­ginal costs of pro­vid­ing ser­vices in or­der to be able to sur­vive.

The net­work legacy (full ser­vice) air­lines around the world have en­coun­tered a rev­enue prob­lem with the emer­gence of low-cost car­ri­ers (LCCs) as a for­mi­da­ble com­pet­i­tive force. It has also be­come clear that net­work air­lines have fun­da­men­tal op­er­at­ing costs and pro­duc­tiv­ity dis­ad­van­tages com­pared to their low-cost ri­vals.

The dif­fer­ences in the cost struc­tures be­tween net­work legacy air­lines and LCCs re­flected sub­stan­tial dif­fer­ences in the pro­duc­tiv­ity of both air­craft and em­ploy­ees.

One of the big­gest chal­lenges in the air­line busi­ness is the cut-throat com­pe­ti­tion. Some CEOs of LCCs be­lieve that cut­ting prices to rock bot­tom is the only way to win com­pe­ti­tion.

Hav­ing the low­est price is the only means to in­crease mar­ket share and be­come a dom­i­nant player in the mar­ket. These cost lead­er­ship tac­tics do not come from a rev­enue man­age­ment strat­egy, but are some­times cre­ated from the top as a preda­tory way to dump com­peti­tors.

Air fares be­low op­er­a­tional costs have caused losses, which in the long term could kill air­line com­pa­nies. Low­er­ing prices as a weapon to de­te­ri­o­rate the mar­ket in or­der to kill the com­peti­tor means no one will win.

Healthy com­pe­ti­tion will ben­e­fit cus­tomers sub­stan­tially. Stronger in­dus­try per­for­mance cre­ates lower in­dus­try costs and ef­fi­cien­cies, which in turn are passed through to the price of the tickets.

In this equa­tion, LCCs tend to op­er­ate in a “point-to-point” man­ner to min­i­mize air­craft ground times. Shorter ground times re­sult in higher air­craft uti­liza­tion rates, in con­trast to the hub-and-spoke net­works of the largest legacy air­lines.

LCCs also have im­ple­ment­ing sys­tems and op­er­at­ing pro­ce­dures based on safety cri­te­ria and rev­enue man­age­ment strate­gies. As a re­sult, LCCs have been able to achieve air­craft uti­liza­tion rates more than 45 per­cent higher than what legacy car­ri­ers achieve for the same air­craft type. This con­trib­utes to 35 per­cent lower air­craft op­er­at­ing costs per unit.

Tourism has been a key in­dus­try in the LCC equa­tion. Due to the nature of LCCs, their key fo­cus has been on leisure trav­el­ers and tourism. They play a big­ger role par­tic­u­larly in con­nect­ing small cities, iso­lated is­lands and re­mote re­gions to the big cities.

Both net­work legacy air­lines and LCCs are seek­ing to pro­vide greater dif­fer­en­ti­a­tion be­tween the prod­ucts they of­fer, en­hanc­ing the travel ex­pe­ri­ence and es­tab­lish­ing cus­tomer loy­alty to a spe­cific air­line rather than view­ing the prod­uct as a com­mod­ity.

Net­work air­lines and LCCs are in­creas­ingly com­pet­ing over ser­vice by in­vest­ing in tech­nol­ogy to en­hance their web­sites, up­grad­ing their fleets and air­port lounges and pro­vid­ing the types of ser­vices and on­board ameni­ties that con­sumers may value.

By in­tro­duc­ing new tech­nol­ogy, in­clud­ing mo­bile ap­pli­ca­tions, air­lines make it eas­ier than ever to pur­chase tickets, but in this area there are some third par­ties (on­line ticket ven­dors) that are able to book higher rev­enues than those made by car­ri­ers, which have spent a lot of money buy­ing air­planes. It is more or less like Google, which has larger rev­enues com­pared to the telecom­mu­ni­ca­tions op­er­a­tors that spend a lot of money build­ing the in­fra­struc­ture.

They use the in­fra­struc­ture be­long­ing to air­lines to cre­ate prof­its. The dan­ger will come if this kind of com­pany be­comes a su­per-hub sell­ing tickets to cus­tomers, be­com­ing hege­monic pow­ers to dic­tate the prices and prof­itabil­ity of the air­line with­out shar­ing risks and rev­enues.

Ef­forts by net­work legacy air­lines to re­duce costs have also been a key fac­tor in the im­proved fi­nan­cial per­for­mance of the air­line in­dus­try. In US, ex­perts found that bankruptcy re­struc­tur­ing dur­ing the last decade played a key role in en­abling net­work air­lines to re­duce costs.

The bankruptcy process of Delta Air Lines and Amer­i­can Air­lines present an ex­am­ple of how net­work air­lines can cut their costs by ne­go­ti­at­ing con­tracts and pay con­ces­sions with their la­bor unions. Through bankruptcy they can re­struc­ture and do per­son­nel re­duc­tions.

Net­work and low-cost air­lines are also pur­chas­ing new air­planes, as ev­i­denced by new air­craft or­ders from Garuda, Lion Air and Sri­wi­jaya in the case of In­done­sia. Pas­sen­gers may ben­e­fit from these new planes. They are qui­eter and of­fer en­hanced en­ter­tain­ment op­tions and other in-flight ameni­ties. Some air­lines, for ex­am­ple, of­fer flat-bed seats, pre­mium econ­omy seats, faster Wi-Fi and larger over­head bins.

Air­line rev­enues have also been sup­ple­mented by the growth in an­cil­lary fees for op­tional ser­vices. These in­clude fees for ser­vices that were pre­vi­ously in­cluded in the air­fare, such as checked bags, early board­ing, seat se­lec­tion and meals and such new ser­vices as Wi-Fi ac­cess. An­cil­lary fees have been ben­e­fi­cial for air­lines by en­abling them to col­lect rev­enues that are re­lated to the costs im­posed by in­di­vid­ual pas­sen­gers.

Some air­lines are also waiv­ing cer­tain fees, such as bag fees, to in­crease cus­tomer loy­alty to their brand. Net­work air­lines also are mar­ket­ing their abil­ity to of­fer trav­el­ers ac­cess to more global des­ti­na­tions through ex­panded net­works. For cer­tain pas­sen­gers, some air­lines are in­tro­duc­ing pre­mium ser­vices such as limou­sine pick-up at the gate.

The global air pas­sen­ger mar­ket is build­ing strong mo­men­tum in 2016. The in­dus­try out­look is im­prov­ing as the global econ­omy con­tin­ues to re­cover. The fall in oil prices strength­ens the up­turn. Global pas­sen­ger traf­fic in Jan­uary was 7.1 per­cent higher than in the same month in 2015.

Ca­pac­ity is in­creas­ing and is ex­pected to move ahead of de­mand growth in 2016. Yields, how­ever, con­tinue to de­te­ri­o­rate amid stiff com­pe­ti­tion. The strength­en­ing in­dus­try per­for­mance to­day is be­ing driven by lower oil prices, which dropped to an av­er­age of US$55 per bar­rel in 2015 and is pro­jected to fur­ther fall to $51 per bar­rel in 2016, giv­ing air­line prof­its a boost.

Av­er­age global fares in re­ported US

dollar terms fell by around 12 per­cent in 2015. The strong ap­pre­ci­a­tion in the US dollar seen over the pe­riod ex­ag­ger­ated the down­ward trend in air­fares. Ad­just­ing for the cur­rency ef­fect, nom­i­nal global fares were ap­prox­i­mately 4 to 4.5 per­cent lower than in 2014.

Com­pet­i­tive pres­sures within the in­dus­try and the de­clines in oil prices seen around the end of last year and into 2016 are likely to trans­late into fur­ther de­clines in fares. While we see air­lines mak­ing about $25 bil­lion in af­ter-tax prof­its in 2015, it is im­por­tant to re­mem­ber that this is still just a 3.2 per­cent net profit mar­gin, al­though ef­fi­ciency gains by air­lines are il­lus­trated by record high load fac­tors of 80.6 per­cent in 2015, ta­per­ing slightly to 80.4 per­cent in 2016.

“Cre­at­ing a 3.2 per­cent net profit mar­gin does not leave much room for a de­te­ri­o­ra­tion in the ex­ter­nal en­vi­ron­ment be­fore prof­its are hit,” said Tony Tyler, IATA’s director gen­eral and CEO. Al­though the in­dus­try story is largely pos­i­tive, there are a num­ber of risks in to­day’s global en­vi­ron­ment.

The rapid growth of the global air­line in­dus­try and the con­tin­ued threat of ter­ror­ist at­tacks, like what hap­pened in the Brus­sels air­port, re­cently made safety and se­cu­rity is­sues crit­i­cal to ev­ery air­line and ev­ery pas­sen­ger in ev­ery air­port. For the air­lines, the new se­cu­rity pro­ce­dures have in­creased op­er­at­ing costs and in­duced more se­cu­ri­tyre­lated flight dis­rup­tions and de­lays.

Air­lines around the world are en­coun­ter­ing a grow­ing wave of lib­er­al­iza­tion, if not out­right dereg­u­la­tion. Air­lines are facing com­pet­i­tive pres­sures, both from new en­trant low-cost air­lines and re­struc­tured legacy car­ri­ers, and the need for ex­panded avi­a­tion in­fra­struc­ture, both air­ports and air traf­fic con­trol, is of par­tic­u­lar im­por­tance to the emerg­ing economies of the world. Like in In­done­sia, where much greater rates of de­mand growth are fore­cast for both air­line pas­sen­gers and cargo.

In other re­gions, a chal­leng­ing sit­u­a­tion is grow­ing into a new threat. There is a new avi­a­tion power emerg­ing in the Mid­dle East com­pris­ing three car­ri­ers of sig­nif­i­cance: Emi­rates, Eti­had and Qatar. These car­ri­ers of­fer all of the com­forts that the world elite car­ri­ers pro­vide. They serve hun­dreds of im­por­tant world des­ti­na­tions from their

JAKARTA

An­tara Fly­ing low: A Lion Air air­plane gets ready to land at the Ngu­rah Rai In­ter­na­tional Air­port in Denpasar, Bali. Lion Air Group has es­tab­lished sub­sidiaries in Malaysia and Thai­land to tap into the grow­ing mar­ket in South­east Asia.

JP/Djemi Am­nifu

Airstrip: Pas­sen­gers walk to a wait­ing air­craft at DC Sau­dale Rote Air­port in Baa, Rote Ndao re­gency. The air­port can only ac­com­mo­date ATR and Twin Ot­ter air­planes.

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