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Airline strategy for sustained profitability in volatile times

admin — Thu, 29 Mar 2012 09:30:25 +0000

By: Michael Ricks, COO Oriens Advisors, Dec 2011

Despite air transport’s continued performance as one of the world’s fastest growing economic sectors, most Airlines have consistently failed to deliver satisfactory returns to their investors.
With over 1000 commercial airlines vying for passengers, an outstanding strategy is necessary to promise sustainable profits. Several airlines have been standouts over the years, each with different, but successful value propositions. Topical examples include Ryanair, Singapore Airlines, COPA and Emirates. This week we take a quick look at Southwest, often mentioned as a strategic success, but fighting to regain and retain its profit-making prowess.

Growing industry, shrinking profits

While year to year passenger volumes rides a cyclical roller coaster, the air transport sector has charted a clearly positive long-term trend. Over the past forty years, the volume of air travel has grown by a factor of 10, freight by a factor of 14. Thanks to airframe and engine improvements, a doubling of fuel efficiency was achieved. Processes optimisation and better asset utilisation have further reduced costs, with the unit cost of air travel being halved in four decades. Time to break out the champagne? More sobering news comes from IATA, namely that we can expect the industry to make only $4 billion this year on invested capital of over $500 billion. Ignoring rounding errors, that is a slim 0.8 percent return for investors. Over the past 40 years, the net-post tax profit for the industry has averaged a meager 0.1 percent of revenues.

A standout in the crowd: Southwest Airlines

Southwest Airlines is arguably North America’s most successful airline whether based upon profitability: 2010 was Southwest’s 38th consecutive year of profitability with a net income of $459 million, or passengers carried, 88 million. The strategy that let Southwest run ahead of the pack for a time: not trying to be everything to everyone, rather adhering to a simple value proposition for a select target market, positioning itself as a low-cost, high frequency, point-to-point provider of travel. Every decision must deliver that strategy (and profitability). A few examples are worth noting regarding operations, risk management and employees.

Cost conscious operations

Operations at Southwest are geared to cut cost while still delivering the core product. Taping the advantage of a homogenous fleet certainly contributed to their success, including exchangeability of aircraft, reduction of spare costs and AOG time, as well as savings in pilot, cabin crew and engineering training, plus a consistent customer experience. Flying to uncongested airports of small cities and less congested airports of large cities reduces taxi times, gate holds and in-air waiting time. Not offering inter-line connections and baggage transfer saves coordination of services with other airlines. Quicker turnaround times (2 out of three planes turned around in15 minutes vs. an industry average of 55 minutes) work expensive assets harder.

Managed risks

Business risks abound in the airline industry and represent both challenges and opportunities. In this competitive market, taking no risks would hamper growth and competitiveness. Taking calculated, managed risks can create value. The business risk turned loss-creating reality for many carriers has been (and remains) the rising cost of fuel. Ten years ago, industry wisdom held that $30 per barrel of oil was the highest price the industry could pay and still produce a profit. In the meantime, $100 a barrel is a reality that all must accept. Airlines paying spot prices for fuel had a hard time as prices went up. Southwest invested in creating capabilities in both fuel hedging and energy trading, initially a winning game. The airline has since taken some hits on its once profitable hedges, again last quarter. A conservative growth strategy, only moving into markets in which volume could be quickly increased, served Southwest well. Damned with th success of having reached the most attractive markets, recent expansion into less-dense city-pairs has been less profitable. Risk management practices musts be nimble and past results are not a guarantee of future results.

Employees are aligned with profitability and customer satisfaction

Southwest strives to treat employees as family, yet keep them working hard. The proof is in the pudding, 1,208 married couples work at Southwest. Jobs at Southwest are sought-after: Southwest received 143,143 resumes and hired 2,188 new Employees in 2010, atypically for the industry, largely based upon attitudes rather than skills. Southwest is heavily (82%) unionised. As the result of competitors succeeding in breaking union contracts as they went into insolvency, Southwest now has some the highest paid employees in the industry. Southwest’s solution is to maximise productivity, achieving what some competitors three times the staff. Southwest keeps employees on board who, in turn, please customers with warmth, friendliness, individual pride and company spirit. That has brought them in first in the American Customer Satisfaction Index 17 years running.

Can others win with this strategy?

Many have tried to emulate Southwest’s successes. Few have come close. The culprit: incremental and inconsequent change. Many competitors have implemented elements of the strategy, but retain high cost structures. Some have gotten the costs right, but have forgotten to love the customer. Over the past five years, volatile ones by any definition of the word, Southwest has delivered a post tax profit margin averaging 5.8%. One European carrier seems to have built on the low cost strategy, Ryanair, delivering an exceptional growth and profitability, but that is the subject of another week’s column.

‘Flexible Based Operations’