Thomas C. Lawton is a visiting professor at Dartmouth's Tuck School of Business.
The lethal cocktail of economic recession, high oil prices, currency instability, and a drop in demand for expensive seats has hit the international air transport industry hard. Budget carriers aside, airline companies traditionally make most of their money from business and first class passengers, and commercial cargo. Air freight volumes have declined and premium seat occupancy has slumped as the air transport industry has been rocked by corporate cutbacks and a decline in consumer spending. Once dominant companies such as American Airlines have been forced to seek the relative protection of chapter 11 bankruptcy to restructure their costs and debt. This has prompted many to question how certain airlines will survive.
The other reality that the recession has highlighted is the need for many long established companies to get their cost bases in order and ultimately transform into more efficient and adaptable organizations. In this respect, there are many parallels between the automotive and the air transport industries. Former "national champions" such as General Motors and American Airlines face an uphill struggle in the face of strong and fractious unions, large legacy and structural costs, generous pay, and conditions that are often not in line with industry norms. Unlike their younger, leaner, and more agile budget airline competitors, mature airlines (also called legacy, flag carrier, or full service carriers) like Alitalia, American Airlines, and Olympic Air have largely failed to get control of their costs.
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In contrast, budget carriers like Southwest Airlines are founded on the principle of streamlining costs so as to maintain low prices. Cost consciousness is at the core of their corporate cultures and central to their market successes. Take the example of Malaysian-based AirAsia. Founded in 2001 by former music executive turned entrepreneur Tony Fernandes, AirAsia focused on ensuring a very low cost structure as a cornerstone of its business model. Today's its costs are the lowest in the industry and it is the largest and most profitable budget airline in Asia.
The unstoppable growth and expansion of budget airlines across the globe leads many observers to ponder the future of legacy carriers. Willie Walsh, chief executive of International Airlines Group (the holding company for British Airways and Iberia), has already made his decision. He sees a structural shift in the industry, away from high fixed costs and the reliance of legacy carriers on price neutral premium traffic. He faced these same challenges as the boss of Irish flag carrier, Aer Lingus, where he managed its transition from a state-owned, high service, money loser to a publicly listed, lower cost, and regularly profitable company.
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Struggling airline companies do not usually lack talented managers or expert advice. When you speak with those working in and for these businesses, you realize that they fully recognize what needs to be done and, often, how to do it. The challenge in many countries is to first remove the dead hand of the state and allow flag carrier airlines to operate on a truly commercial basis. Second, it is key to facilitate debt restructuring and legacy cost reduction, particularly the crippling pension obligations. Finally, these companies must clarify their strategic market positions. For instance, if you choose to fly from London to Athens, what is Olympic Air's customer value proposition relative to easyJet or Aegean Airlines? For many passengers, this is no longer clear.
For some airlines, mergers or acquisitions are the preferred options. In the United States, Delta bought Northwest Airlines and United Airlines merged with Continental Airlines. Already the results are clear, as these leaner operations have seen a return to profit in 2011, despite the fragile U.S. economic recovery. In Europe, the integration of Air France and Royal Dutch Airlines, and more recently, British Airways and Iberia, offer a compelling logic and a rational structure. The Air France-Royal Dutch deal was configured to maximize cost savings, retain loyal customers, and focus on profitability. Europe continues to have more airlines than it needs and further acquisitions or cross equity deals are likely. The nature and origin of partners may evolve, as cash-rich and growth-focused Middle Eastern airlines such as Emirates Airlines, Etihad Airways, and Qatar Airways look to expand their market reach. These companies employ a growing number of pilots, cabin crew, and managers from around the world, making them truly global in culture and context.
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Legacy airlines everywhere have to wake up to the new reality. Many still refuse to do so or are hampered by governmental or military demands that are divorced from commercial exigencies (as is the case in many developing countries). However, some carriers, such as Aeroflot, Air Canada, and All Nippon Airways, faced up to market conditions several years ago. These success stories provide some indication of how mature airlines can remain competitive and forge their own strategic pathways in this era of budget airline dominance. Their strategies were based on six principles of successful turnaround: new leadership that sets and communicates a clear vision and set of objectives; a focus on cost efficiencies and profit maximization; no compromise on quality of customer service; membership in an alliance network; regional consolidation, often through mergers and aquisitions; and investment in staff training and improved communications, both internally and externally.
Together, these six activities provide a powerful set of principles and practices that can be weaved together into a successful turnaround strategy. With or without recession, air transport competition is intense across the world and legacy airlines have struggled to adapt to cost pressures, increased customer expectations, and new competitor threats. Some have successfully managed this transition, providing a ray of hope for legacy airline managers everywhere and illustrating how not only to keep pace with but move ahead of budget airlines and other new entrants in the struggle for passengers, markets, and profits.
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