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Worth the effort?

Interlines seem like a win-win proposition for all carriers as a welcome revenue source. So why are low-cost operators wary of them?

As low-cost carriers expand into new sectors long considered off-limits and start clashing more with legacy carriers, they are inevitably starting to look at interlining opportunities. Interlines provide an important source of revenue for all legacy carriers, but all except a few low-cost carriers have so far rejected them as not worth the effort.

"They only look great on paper," says AirAsia co-founder and former Ryanair executive Conor McCarthy.

AirAsia is one of several low-cost carriers which, enticed by a new potential source of revenues, have studied interlines. But as AirAsia began looking at what was required to implement an interline agreement, it quickly became clear the extra revenues did not cover the additional costs.

"I have looked at the accounting, it's a freaking nightmare," says AirAsia's other co-founder and chief executive Tony Fernandes. "It looks sexy, but then all the other things you didn't budget for crop up."

So what is the cost of an average interline? After looking at all the variables, which make the cost fluctuate wildly depending on the airlines and airports involved, it becomes clear that computing a per-passenger average is difficult if not impossible. Fernandes says he tried, but failed, to successfully calculate the cost because he could not pinpoint the cost of certain risks such as missed connections. Several other carriers and consultants who work with them also say the cost simply cannot be accurately calculated.

"Most carriers have no clear idea what an interline cost is," says Blair Pomeroy, senior partner with Mercer Management Consulting.

Roland Berger partner Stefano Sala says in legacy carrier financial statements interline costs are spread across many different line items. The back office costs associated with interlines are combined with other costs and cannot be separated. "It's a big pot where several things will land and it's hard to separate one from the other," Sala says.

Just to implement interlines, legacy carriers have several back office functions that low-cost carriers now operate without. For example, legacy carriers must train a team to carry out exception processing, a labour-intensive process in which one carrier that sold an interline ticket bills another. The process takes at least a few months and sometimes up to one year because the initial claim is often initially rejected by the carrier being billed.

Lack of resources

Low-cost carriers do not have enough staff to dedicate a team to exception processing, do not have the resources to train staff on such complicated processes and do not have the patience to wait several months for revenue. "It takes four to eight months to put the money in the cash box. This is not compatible with low-cost carriers who want to see the cash now," says Sala.

He adds most low-cost carriers will also need to invest in new technology interfaces and establish special revenue accounting teams to implement interlines. Low-cost carriers typically use Accenture's Navitaire system for sales and distribution and revenue accounting. Sala says Navitaire is designed for airlines with point-to-point networks and is too simple to implement interlines or connections.

"The issue is not only the processing cost, which vary wildly from airline to airline, but the complexity," he says.

Fernandes agrees: "The low-cost market has worked because of simplicity."

Alex Cruz, chief executive of new Spanish budget carrier Clickair, says there are three main barriers to low-cost carrier interlines: distributing the revenues and figuring who gets how much transferring bags and dealing with late or missed connections and determining who takes legal responsibility or liability over compensation.

Cruz says all three are troublesome because "each has cost overheads" and "the last one is the toughest".

Determining responsibility is always tricky, especially when two airlines that are not exactly friends are involved. "Airline relationships aren't very strong and you are as strong as the weakest link," Pomeroy says.

In the event of a missed connection, airlines often fight over who pays for meals, hotels, baggage home delivery and a ticket on another flight, costs that are unpredictable and can quickly accumulate for long-haul passengers. Network carriers are often tempted to hold a flight for connecting passengers and their bags to avoid making such payments, but even minor delays are unacceptable to low-cost carriers that bank on quick turnarounds. For low-cost airlines the costs, while not calculable, seem to become too burdensome.

"The margin is too thin," says Sala. "The moment I hear low-cost connections I think of problems"

Pomeroy, who has discussed the concept of interlining with several low-cost carrier clients, has reached the same conclusions: "What a stupid idea it is," he says. "No one has an idea about all the hidden costs involved."

Cruz also says the concept of interlining has come up with Clickair and with several other low-cost carriers during his tenure as Accenture's chief airline consultant. But he says so far all carriers, except for a few in Australia and North America, have concluded it is not worth pursuing interlines.

"It's damn hard, particularly the legal part," Cruz says.

Often the exceptions involve budget carriers that are owned or partly owned by legacy carriers. For example, Australia's Jetstar now interlines with owner Qantas on its short-haul domestic and new long-haul international flights.

Jetstar acknowledges interlining does add cost and that this cost is almost impossible to calculate, but says its arrangement with Qantas makes it worthwhile. Jetstar considered following the traditional low-cost model of not interlining with any carrier, but concluded in a pre-launch study that the revenue benefits outweighed the costs, which included hiring additional workers to transfer bags and acquiring a lost-baggage tracing product.

"The commercial benefits exist. A sound percentage of our customers are interline customers and we see clear commercial benefits in interlining with our parent Qantas," Jetstar says.

Jetstar is looking at codesharing with outside carriers, including Japan Airlines. Rival Australian budget carrier Virgin Blue already codeshares with United Airlines and Virgin Atlantic and has an interline agreement with domestic turboprop operator Regional Express.

Budget model

The co-chief executive of South African low-cost carrier Kulula, Gidon Novick, says Virgin Blue's interline agreements should be a model for other budget airlines because Virgin Blue makes it clear to customers it will not be responsible for missed connections. "Virgin Blue has an interline light relationship. They limit responsibility," Novick says. "It's one project we'll look at, but it could be the cost is not worth the revenue."

Kulula envisages interlining with foreign carriers that operate into South Africa and are not already aligned with British Airways and the BA franchise that Kulula parent Comair operates in South Africa.

In the USA, independent budget carrier JetBlue also says it is talking to several potential interline partners, but has yet to complete any deals. The proposed interlines with international carriers would feed JetBlue's New York JFK hub.

JetBlue is already one of only a handful of low-cost carriers that transfer bags and passengers between their own flights - others include ATA Airlines, AirTran Airways, Air Berlin, Southwest Airlines and Virgin Blue. In fact, ATA and Southwest already codeshare. Low-cost carriers that already have the ground infrastructure and technology to offer connections can more easily implement interlines than other budget carriers, although the other barriers, including legal, still must be overcome.

Clickair carries the code of its part-owner Iberia on some of its point-to-point services. So far it has refused to interline or connect with Iberia because of the complexity involved, but Cruz, while reluctant, says interlines involving low-cost carriers will happen and are unavoidable. "I am hesitant, but I don't say 'no' forever. There could be a time when we might do it," he says. "It's one more thing that brings in revenue."

While some low-cost carriers are studying interlines, especially as more expand into long haul, most seem to have ruled them out. Ryanair chief executive Michael O'Leary refuses to sell other low-cost carrier tickets on his website, yet alone interline with them. "We won't get distracted," he says.

AirAsia will not even interline with new sister carrier, long-haul operator AirAsia X. Fernandes says Fly Asian Xpress (FAX) tried to meet a Malaysian government request to interline with Malaysia Airlines (MAS) after Fernandes set up FAX last year to operate turboprop routes relinquished by MAS, but says it proved too difficult to implement.

Instead Fernandes says the future is website cross-selling and passengers will "interline naturally" by buying their own combination of low-cost tickets from an airline website that also sells tickets on other budget airlines. "They will do it on their own," he says.

"What we're talking about is passengers making their own connections," adds McCarthy. "There are complexity problems with interline agreements."

Are interlines even worthwhile in the legacy carrier world? On the surface interlining seem like one of the few remaining advantages legacy carriers enjoy over low-cost players. But when looking deeper at interlines and what is involved, perhaps the lack of interlines is one of the several advantages low-cost carriers have over legacy competitors.

Pomeroy says carriers must go through complicated interline negotiations "for a minuscule amount of people". In January Northwest Airlines ended about 50 interlines with carriers that had not implemented e-ticketing. A year ago Air Canada terminated about 150 of its 350 interline agreements as they were unprofitable. Pomeroy says other legacy carriers would make the same conclusions if they examined interlines closely: "Nobody ever thinks: is it more trouble than it's worth?"

Alex Cruz of Clickair, Tony Fernandes of AirAsia and Gidon Novick of Kulula are among the 90+ chief executive interviews on our website, visit www.airlinebusiness.com




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