Restructuring: Cutting to fit

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Restructuring is a delicate operation which many airlines are being forced to undergo. Boston Consulting Group executives Martin Koehler, Pedro Esquivias and Raj Varadarajan explore how customisation of this painful process pays off.

Most airlines are struggling for survival. The severe drop in demand and the volatility in oil prices have compounded the industry's structural problems of overcapacity and increasing market fragmentation. Still, despite the roller-coaster environment of the past decade, a few airlines have consistently managed to create value for shareholders.

One distinguishing feature of these top performers is their ability to relentlessly reduce costs without endangering the fundamentals of their business. In fact, they have taken advantage of industry instability and accelerated pursuit of their strategic goals. Not an easy task. But in our current economic climate, managing costs is imperative. As one senior airline executive told us: "If you want to survive in the airline industry, you have to insist on trimming unit costs by at least 5% a year." Another was even more definitive: "Cost cutting is a necessity. It has to become a daily routine, like brushing your teeth."

Yet airlines often come up short in their attempts to shrink costs. Sometimes it is because they do not communicate the urgency for change powerfully enough - not only to unions and other employees, but also to external stakeholders. Companies also run into trouble because their cost reduction programmes are poorly designed: either they are not linked to the business strategy and hurt the company's competitive position in the long term, or they are not ambitious enough, focusing on easy fixes, rather than what is most necessary. And we have often seen programmes suffocate from lack of senior involvement. Leaders must walk the talk if they expect the organisation to go along.

 (c) rex features
 © Rex Features
But perhaps the biggest reason why cost-reduction efforts fail is because the execution is less than rigorous. It is not unusual for enthusiasm to run high at the outset, but six months in momentum can slow to a crawl as the organisation struggles with unclear methodologies, misaligned budgets and ambiguous metrics. The programme needs to be carefully tracked and strict success targets established.

Consider the experience of one European airline. It spent half a year designing an efficiency programme that involved most of the organisation. But five months after kick-off, managers were arguing about whether the firm was on track to achieve its goals. The enormous effort seemed headed for oblivion. What went wrong? It turned out that the company had focused almost all of its attention on what needed improving, but neglected to devise a method that held people accountable for achieving specific, clear-cut targets. Measures are one of the most important parts of a well-designed cost reduction programme.

ENSURING SUCCESS

Develop a powerful story reinforcing the need for change. Enlist your most persuasive and articulate people to construct a narrative with vivid, powerful analogies and images which describe the current situation and future potential. The aim is to elicit support as well as nurture a sense of urgency for those going through the cost-reduction programme

Turn weakness into an advantage. An external crisis, such as a take-over attempt or a liquidity crisis, can bring people together. Rather than downplay these events, use them to rally the troops

Establish processes for people to opt in to the change. Give people the sense that they are choosing to change, rather than having change forced upon them

Insist on a precise, data-driven approach in all conversations. Be relentless in shifting the discussion to facts and away from unsubstantiated fears. Paint a graphic picture of what "business as usual" would mean

Reverse the burden of proof from top-down "why we have to cut costs" to bottom-up "how we will cut costs"

Establish a system for rigorous programme management. Make prerequisites and the details of the cost cutting programme clear to all parties and ensure that the company budget reflects the impact of the cost reduction programme

Ensure that management leads by example. Management must provide the model for cost cutting by rigorously managing the programme and demonstrating that it is willing to work as hard as everyone else. It must also ensure that the interdependencies between teams and critical paths are clear to everyone concerned. To create buy-in, the very people who design programmes should be assigned to implement them.

Based on our experience with dozens of cost-cutting efforts, we recommend a three-step process which begins with accurately assessing the company's starting position. This information can then be used to select the right model, paving the way for relevant measures to be implemented.

There are three issues to consider in accurately assessing a company's starting position. The first is the need for cost reduction. One airline we worked with settled on an aggressive 20% cost reduction target after careful analysis showed this was the only way to face lower-cost competition. It knew that it had to change and it was able to define precisely how much change was necessary.

The second consideration is potential for improvement. This includes not only the difference between current and desired cost performance, but also an assessment of the company's ability to deliver. For instance, it might save considerably by changing to newer generation aircraft, but will early lease contract termination incur significant penalties?

Moreover, facing the hard facts about where a company stands in relation to its competition is not always easy. We have found that airlines tend to underestimate the superiority of their competitors' cost performance and overestimate their capacity for improvement. To be as objective as possible, we believe it is critical to use a comprehensive database that contains benchmarks across multiple cost variables. Given the highly interrelated nature of airline operations and cost buckets, prior experience in delivering cost reductions in each variable is also critically important.

The third - and ultimately decisive - consideration is the credibility of the case for change. Cost cutting is hard work. The extent to which a company is willing to put itself through pain will depend on how compelling a case for change it can make. More importantly, aggressive goals require strong cases.

As previously noted, many cost-reduction efforts fail because the necessity for change has not been communicated persuasively or because employees do not "buy it". In our experience of meeting with union representatives to discuss cost reductions, we are often surprised at how little information they have about the company's competitive position and how eager they are to learn about what needs to be done. Greater business transparency, such as benchmarks comparing cost performance against competitors or cash projections of current operations, can help convey urgency and win company-wide buy-in.

Once a company has accurately measured the situation, it can then identify the most suitable cost-reduction model. This choice depends on potential for improvement and the credibility of its case for change, which will point to one of four approaches: incremental change, re-engineering, hardball negotiation or transformation.

INCREMENTAL CHANGE

Sometimes the potential for change and desire to push it is low, for instance at a state-owned carrier, where the government has no appetite for radical transformation and the company lacks relevant expertise and resources. In such cases, incremental change offers the most sensible approach. It calls for picking your battles carefully. Key initiatives might entail optimising purchasing by bundling purchases or changing suppliers, increasing the use of technology or reducing catering and in-flight costs. Although the amount saved will be relatively modest, conflict will be minimised.

But sometimes incremental change is not sufficient to maintain a sustainable position in the long term. In a recent project, our client's management team initially advocated a moderate cost reduction programme to face the traffic slowdown, believing this would suffice as it had done in prior crises. But our analyses indicated that the magnitude and duration of the recession, and increasing low-cost competition arising from the liberalisation of some of its core markets, put the company at risk of a liquidity crisis in the short term. Therefore, incremental change would have been insufficient and a more radical transformation was initiated.

RE-ENGINEERING

When there is high cost savings potential, but making the case to stakeholders would be tricky, re-engineering is often the best approach. Many improvements can be made without requiring significant changes to labour contracts or negotiations with other stakeholders. This involves looking at all elements of the operation and assessing the potential to redesign processes or redeploy assets more efficiently - for instance, reducing the time an aircraft spends on the tarmac or cutting the need for check-in counters by promoting the use of online check-in.

Re-engineering an operation is a fairly complicated undertaking, requiring a high degree of technical skill and discipline in implementation. In this respect, it is essential to understand interdependencies across the operation and the risks of destabilising the work flow.

HARDBALL NEGOTIATION

When a company feels it has a strong case for change, yet it lacks the appetite to pursue a total transformation, skilled negotiating will increase the potential for success in areas such as outsourcing, headcount reduction, wage freezes and supplier discounts. But the potential for conflict is high and senior management should actively participate in the negotiation process. It will require extremely experienced negotiators who can evaluate different options objectively and drive hard bargains, yet preserve a good working relationship with stakeholders over the long term.

TRANSFORMATION

Incremental change, re-engineering, or negotiations can only take you so far. Sometimes a total transformation is needed. Companies that have identified strong opportunities for cost improvement, have the desire for aggressive cost reduction and are able to develop a compelling story for cost savings are candidates for transformative change.

This means redesigning the commercial model to strengthen the company's competitive position and optimise critical cost areas, such as fleet, crew, maintenance, handling, IT and sales and marketing. It involves the whole organisation and a wide range of skills, but above all senior management must be directly involved and lead the change.

Selling the plan to key stakeholders is also crucial, essential and no small challenge. One of our clients described it as "switching engines while you're flying".But the pay-off is potentially very high: a leaner, more flexible and focused organisation that is responsive to customers, achieves greater productivity with less capital investment and operates with an engaged workforce which understands the importance of continuous improvement.

The importance of choosing the right cost-reduction model cannot be overestimated. But success also depends on the commitment of a company's stakeholders. Change on any level is difficult, but especially so in uncertain times when economic forces outside of the business are producing considerable stress. That is why strong leadership throughout the change process is absolutely imperative. The challenge that airlines face is indeed higher than ever. But we believe that strategic restructuring will accentuate the competitiveness of successful airlines - and vice versa. Thus, the virtue of continuous cost cutting will accelerate the overdue reshaping of the industry.

  • Martin Koehler is a senior partner and managing director of Boston Consulting Group's Munich office. He leads the firm's Aviation, Travel and Tourism sector. Pedro Esquivias is a partner and managing director in the firm's Madrid office. Raj Varadarajan is a partner and managing director in the BCG Dallas office.