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Mid-air turbulence: Solutions for LCC leadership

Last month we outlined how low-cost carriers are waking upto a new reality, facing many of the same troubles as their legacy competitors. In short, they are facing the growing pains of not being so young anymore. Their leaders are responding in three primary ways: by getting together, playing the waiting game or changing their model.

GET TOGETHER

A natural response to threat is to adopt a strength in numbers approach, and that is precisely what many budget players have done.Although this has taken several forms,mergers and commercial alliances have emerged as a favourite. Canada's WestJetand Mexico's Volaris have established codeshare and marketing agreements with Southwest Airlines,allowing the latter to virtually expand geographically, something it has been loathto do directly. AirTranand Frontier Airlines have also established a broad-based marketing agreement to take advantage of geographically complementary networks.

On the acquisitions front, easyJet bought BA's budget arm Go and GB Airways; FlyBe has absorbed BA Connect; Air Berlin purchased Deutsche BA and LTU in Germany; and Ryanair has made multiple attempts to buy Aer Lingus. Mergers are also rife, with Sterling and Maersk Air joining forces in Denmark, Air Deccan and Kingfisher coming together in India, JetStar Asia merging with ValuAir in Southeast Asia and, most recently, Clickair merging with Vueling in Spain.

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The word on the street is that the next area to watch for consolidation activity is the over-served Mexican marketplace. Avolar and Almahave already failed and others - InterJet, VivaAerobus, and Volaris - are poised to combine in some shape or form.The Mexican ‑government, historically reluctantto see competition disappear, is now seriously contemplating allowing the merger of Aeromexico and Mexicana along with the latter's budget subsidiary, Click Mexicana.

Whether such combinations are simply the low-cost extension of an otherwise consolidating airline industry, or the normal shakeout one would expect in an industry with too many participants, is not clear.Regardless, the effect is the same: fewer budget players - and those that remain looking and feeling more like larger carriers.

THE WAITING GAME

Several low-cost airline leaders have concluded that the safest response to the troubled times is to "hunker down"and stay out of the spotlight.Despite having recently added some new flights to Boston, Virgin America has curtailed network growth for the foreseeable future, preferring to be a survivor than another failed low-cost that suffered from over-expansion.JetBlue has deferred or cancelled aircraft deliveries, while Frontier has sold aircraft and returned leased examples early while in bankruptcy protection.Even the historically robust Ryanair has lightened up on the throttle, recognising that there may be a cliff at the end of the runway.

Though getting into a foxhole while bombs fly overhead could well be a sound business strategy and the one most likely to ensure survival, it goes against the grain of the low-cost model for several reasons.

Firstly, it means little or no growth, the fuel of the low-cost fire.But this somewhat mutes budget players'dynamic and entrepreneurial nature and with that comes the loss of certain cultural and organisational traits, which low-costs have historically leveraged.It also means investment horizons and liquidity timelines for founders and private equity investors are extended, often leading to frustration and impatience in the boardroom.

CHANGE THE MODEL

Certain budget carrier leaders have responded to deteriorating market conditions by adapting their business models.Faced with converging competition from both other budget players and more efficient legacy carriers, several have started introducing amenities and product differentiators.Others have resorted to more traditional business practices, such as third-party distribution or loyalty schemes.Butthese add-ons often cost money and serve, in the long-term, to erode profitability.

The evolution of traditional low-costs has perhaps spawned a new segment: "new world carriers", such as JetBlue and Virgin Blue.The leadership of these carriers believe the answer lies not in the purist approach, but in offering differentiating product characteristics while holding true to doctrine on operational efficiency.It is quite conceivable, given the strong convergence trend, that most budget players will migrate into this new world space.Airline industry consultant and former Virgin Blue executive David Huttner believes that "over time, you'll likely find very few carriers at either extreme end of the product spectrum.Staying true to the low-cost model requires an incredible amount of discipline to say 'no'."

THE DRIVE TO ZERO

Whereas the tendency among some budget carrier chiefs has been to go more mainstream, the purists have actually gone the other way.Recognising that the primary driver behind low-cost success is low fares and market stimulation, certain players have declared that "zero pricing"is their ultimate objective.

Foremost among them is Ryanair.Already known as the price leader in Europe (and perhaps the world), Ryanair has publicly declared its desire to get its fares consistently down to zero via cross-subsidy from other revenue streams and advertisers/sponsors.To make that model a success, leaders will not only need to hone their purist cost management and avoidance skills, they will also need to get equally effective at ancillary revenue generation and third-party sponsorships.

Allegiant Air, the relatively new Las Vegas-based low-cost has implemented a business model predicated on substantial ancillary revenue generation and it appears to be working well, allowing the airline to profitably link secondary US cities, with poor direct air services, to major leisure destinations. Garry Kingshott, chief executive advisor of Philippines budget carrier Cebu Pacific, sums it up nicely: "The next phase of low-cost development is to continue to play the price leadership game, to drive market stimulation, ultimately with zero fares and ancillary revenue."

LEADERSHIP CONVERGENCE

Perhaps unsurprisingly, alongside marketplace and business model convergence, we have witnessed a convergence of sorts in the area of leadership talent.Historically, low-cost carriers touted themselves as the "non-airline"airlines, preferring to employ leadership talent from outside the industry, unburdened with legacy thinking.

Virtually all the prominent low-cost carrier founders or drivers, with the exception of David Neeleman's JetBlue, were newcomers to the industry: Clive Beddoe (WestJet), Tony Fernandes (AirAsia), Herb Kelleher (Southwest), Michael O'Leary (Ryanair) and Stelios Haji-Ioannou (easyJet), to name a few.But a close examination of the leadership teams of many of today's players reveals a large number of big airline transplants.

Notable examples include ex-JetBlue Airways president Russ Chew (American Airlines),JetBlue Airways executive vice-president, commercial Robin Hayes (BA), Ben Baldanza (US Airways) as chief executive of Spirit Airlines and David Cush (American) as chief executive of Virgin America.Gol, the successful Brazilian low-cost is replete with airline executives from defunct Brazilian legacy carriers such as VASP.Even successful JetStar was nurtured under Alan Joyce, an Aer Lingus alumnus from the days prior to the Irish carrier's low-cost transformation.

Such a tendency is not surprising.Whether they stay true to the pure play low-cost business model or not, budget carriers are, after all, airlines with many of the same operational, commercial and financial issues.As they grow, those issues become meaty and more complex, and proven industry experience is often required to manage them.

Virgin Blue chief commercial officer Stefan Pichler concurs:"In the beginning, a lot of low-costs had an entrepreneur as their leader.Those entrepreneurs had a clear vision and were good at building up a business.But as soon as a business starts growing rapidly, an entrepreneur must become a leader and many are now struggling with that.That's because, at a certain stage, it is not about managing a vision but managing complexity.A lot of entrepreneurs can't do that."

TOP LINE FOCUS

The past half-decade has witnessed a low-cost functional excellence shift from operational to commercial.Historically, perhaps the most sought-after role was that of chief operating officer who was the "guru"of operational efficiency and likely the internal "cost czar".The operations function at Ryanair, for example, has spawned many low-cost evangelists who have gone on to launch or manage other budget operations around the globe.

But with low costs becoming a staple not only among budget carriers, but also many legacy carriers, the battle ground has shifted to the top line: the commercial agenda.Recognising the diminishing returns on cost reduction, and also the substantial upside on ancillary revenues and improved revenue management, low-cost chief executives now place a big premium on top flight chief commercial officers.Securing creative and innovative commercial executives, and teams who can win in the guerrilla warfare of the low-cost battle ground will, in our view, become increasingly important in the years to come.

CULTURAL DAMAGE

The change in leadership working its way through low-cost leadership ranks may have unintended secondary effects. Perhaps most important among them is culture.Beyond better fundamentals (cost, simplicity, newness), budget carriers have also historically enjoyed the benefits of their entrepreneurial and employee-centric cultures.Those cultures have normally been established and nurtured by visionary founders who appreciated that employee engagement and commitment is worth as much, if not more, as a 5% edge on unit costs.Southwest's legendary efficiency and customer loyalty are both the clear product of a culture that works for all involved.

So, what happens to low-cost culture when the team at the top changes?Can "imports"be realistically expected to fully internalise and become advocates of a culture they did not help shape?Is it realistic considering they did not participate in the rapid growth start-up phase of the airline and its associated entrepreneurship and camaraderie?Likely not.

Conversely, can budget carrier owners, often private equity firms, plausibly expect the founders and teams that drove unbridled growth in a spirit of optimism and opportunity to now dispassionately address the harsh realities that their carriers face?Can they be as effective at reducing headcount as they were launching new routes?Likely not.

There appears to be an increasing level of impatience among private equity investors with their investment's leadership teams.While they were willing to see through a few bumps in the road on the glorious upside, they now appear much less inclined to give management the benefit of doubt in more troubled times.This suggests a more fundamental question - is private equity the best vehicle to support the budget sector or is there a growing mismatch in investment horizons?

With the passage of time and major environmental changes, it is inevitable that low-cost leadership and culture evolve, drawing them nearer to the mainstream. But there are a few exceptions where the culture and its core benefits are jealously guarded and protected as sources of competitive advantage.David Huttner, says: "The cost culture of Ryanair is owned and advanced by the CEO who has been a constant at the carrier.Equally, WestJet has done a very good job of not losing its culture as it has grown to become a major player in the Canadian marketplace.To ensure that, leadership has to live the culture, from top to bottom, every day."

Stefan Pichler agrees: "We at Virgin Blue still have our culture as it was from the first day.But this has a lot to do with the fact that our founding CEO is still on board, and he lives the same culture every day.When you change your CEO, you will often get a new culture as that person does tend to bring new senior management into the organisation."

Low-cost mergers present additional cultural challenges.Alex Cruz, Clickair chief and future CEO of the merged Vueling-Clickair, shares the challenge in merging two different low-cost cultures:"It's a big and difficult task.We appreciate that it shouldn't be culture A or culture B that survives but instead that A+B = C and that we need to sell employees of the combined entity on a new culture, C."History has proven that successfully managing an airline merger is a monumental task with uncertain outcome.Having to define and propagate a new culture as an effective blend of two others makes it even that more complicated."

A NEED TO LEAD

The past few years have presented low-cost carriers with the challenges of a lifetime.Not only must they deal with a myriad of business issues, they must also tackle the hard reality of hitting full-fledged adolescence, if not adulthood.That life cycle transition comes with its share of aches and ills. Now the challenge for low-cost airline chiefs is to lead: to provide clear, unambiguous - and likely bold - direction to their organisations.If there is a time for creativity and innovation, it is now.

While the low-cost community is considered an off-beat and innovative bunch, adopting and implementing a low-cost cookie cutter model from abroad - be it Southwest, JetBlue, or Ryanair - is not true innovation.

The turbulence these leaders now face requires fresh thinking, the kind that brought the first low-cost carriers, and their first major derivatives, into existence in the first place.The executives who provide that, and find smooth cruising altitudes quickly, will undoubtedly reap the rewards.

About the authors:

Michael Bell, who previously spent six years with McKinsey, co-leads the global aviation practice of executive search specialist Spencer Stuart. Email: MBell@SpencerStuart.com

Thierry Lindenau is Brussels-based regional co-ordinator for Europe, Middle East and Africa at Spencer Stuart's global aviation practice. Email: TLindenau@SpencerStuart.com

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