Mid-sized airlines face crucial decisions as they focus on which strategies and management tactics to adopt. Sara Guild reports from an Airline Business conference on the future of medium-sized carriers. The greatest profit potential for medium sized carriers lies in a direct attack on the strategic weaknesses of the global carriers. Yet most mid-sized carriers tread a less dangerous path, avoiding direct competition by operating in niche markets, replicating the larger carriers' operations but with lower costs, or taking refuge through close links with a larger airline. So said Rupert Duchesne and Henry Schlee from Mercer Management Consulting as they outlined these alternative strategies for survival at the Airline Business 'Challengers to the Major Airlines' conference in London.

Duchesne and Schlee advised that the way to obtain a real return on investment was to exploit the structural weaknesses of the majors' large networks by offering low-cost, no-frills service such as Southwest's, or by focusing on superior service at similar prices, as does Virgin Atlantic.

It is the costs of large hubs and vast networks, which require cross-subsidy of economy by business class, shorthaul by longhaul, and early booking by late booking, that leave the majors open to exploitation by the mid-sized carrier, said Schlee.

For example it is difficult for the majors to compete directly with Virgin Atlantic, with its high quality service confined to longhaul routes. In a more hybrid form, Emirates represents a medium sized carrier that has attacked the weakness of the majors through high quality service, offering perks such as limousines in specific markets for first and business class passengers.

Group managing director Maurice Flanagan put forward the argument that in fact the small to medium sized carrier had the cost advantage. 'Beyond a certain size, economies of scale in our business go into reverse,' he said. Lufthansa with 216 aircraft has a cost per ATK of US 72 cents, whereas Emirates with 15 aircraft is at 42.4 cents.

Duchesne suggested that the alternative strategies had less potential. Niches could be profitable but suffered from limited growth opportunities, while sheltering under the wing of a major or replicating the majors' features at a lower cost are unlikely to generate more than average profitability.

The key to a successful niche strategy is to exploit more than one niche, said Steve Forte, vice president marketing and sales of Italy's Meridiana, which expanded from its strong seasonal traffic base in Sardinia into a second niche, Florence. This has enabled the carrier to reduce its Sardinian traffic from 70 per cent of the total to 55 per cent.

Portugalia has adopted a dual niche/confrontation strategy, beginning with domestic services and expanding to include Lisbon-Madrid in competition with TAP Air Portugal, but then moving to secondary European routes without competition. Operating income in 1994 was $66.2 million, up 22.4 per cent on 1993, reported general sales manager Francisco Bordalo. And although the carrier has yet to break into the black, the net loss of $241,000 in 1994 was greatly reduced from the $3.6 million loss of the year before.

Brad Burgess, managing director of CityFlyer Express, argued that the 'sheltering under a wing' strategy, in his case in the form of a franchise arrangement with British Airways, benefited both the carriers and the customer. From its franchisor CityFlyer gains instant recognition with the British Airways brand, and although Burgess argued franchising does not discourage competition, competitors are sure to think more carefully about taking on the BA brand than they would another regional carrier.

The deal provides valuable feed and gives access to BA's frequent flyer programme, an otherwise costly marketing tool. 'A different sort of benefit that franchising has brought us has been the ability to maintain our independence. For a small regional carrier to survive, some form of alliance with a major is virtually essential,' said Burgess. Finally, it has produced a big improvement in CityFlyer's results. In 1994, the first full year as a franchisee, CityFlyer made £632,000 ($399,613) on turnover of £25 million, compared to 1993 when profits were £144,000.

But not all mid-sized carriers are in a position or have the inclination to attach to a larger airline. Instead many opt to replicate a major's network, offering quality service and similar frequencies at a lower price, and using alliances and frequent flyer programme links. One example is British Midland, which is expanding its network to challenge the global reach of British Airways through codesharing alliances, of which it now has eight.

With disquiet in the industry about codesharing, British Midland managing director Austin Reid announced an initiative to produce a code of conduct in consultation with other carriers. Reid said the 'code' would insist that a codesharing deal must increase the range of choice and competition, must be clear and transparent, and must be fully explained to airline staff in order for them to advise passengers. 'Codesharing is vital for the mid-sized airline. It can enhance revenue and can help mid-sized airlines to compete against the majors, and to take traffic from competitors,' said Reid.

Another competitive tool, the frequent flyer programme, represents a dilemma for mid-sized carriers. South African Airways' senior general manager Nic Vlok said the carrier relaunched its Voyager scheme as it was vital to have 'a relationship with a critical mass of customers that prefer your airline.' With 200,000 members and links to American Airlines' programme and hotel and car rental partners, Vlok said the annual revenue from the sale of mileage to partners and fees from them was $2.5 million, covering the cost of operating the programme. The FFP was one element in SAA's financial turnround; the carrier forecasts a profit of $35 million in the year ending 31 March 1995.

However, Emirates group managing director Maurice Flanagan expressed scepticism about FFPs. It was vital to 'keep it simple', staying away from sub-brands, global alliances and frequent flyer programmes, he said. 'I believe there is a risk of airlines being stampeded into serious unnecessary expense and the administrative complexity that goes with it,' said Flanagan. He described the distribution of miles as a 'slippery downward slope,' and he advocated selective loyalty programmes, such as giving a free economy class ticket for future use when a first or business class ticket is purchased. Emirates does this on certain routes such as London-Dubai.

In outlining the path he has followed to prepare Kenya Airways for partial privatisation later this year, managing director Brian Davies emphasised the need for good management and freedom from political interference. Staff motivation and financial incentives to enable employees to benefit from a restructured, commercialised entity were crucial. Davies put all 2,700 staff through a training programme in 30 days, producing immediate service improvements which helped Kenya Airways to increase traffic and turn a profit of $7 million in 1994. 'Investment in training was the best spend we have made,' said Davies, who also stressed that a foreign airline alliance with equity investment was necessary for the carrier's survival.

A presentation by Sky Magary, president of United's West Coast shuttle, proved that good managers will need to be aware of the major players' response to mid-sized carriers.

Magary showed that, with team work and ingenuity, a major player has the resources to create a viable alternative to compete head-to-head. Through a rethink of work practices, requiring changes in union rules and government approval of new operational measures, Shuttle by United has cut turnround times to 20 minutes to emulate Southwest. 'We have succeeded in producing a product that can permanently compete from a cost standpoint with any new entrant in the marketplace,' said Magary. From the beginning of April Shuttle will be operating 378 daily departures to 16 west US coast city pairs, in a market which has already seen exits by American Airlines and USAir.

Durable new entrants

As many Europeans wonder if the US new entrant phenomenon can be repeated, Sam Buttrick, senior vice president at PaineWebber, pointed out that, even though only three of the 24 US jet operators that began in the 1980s survive today, a small number of durable new entrants can make a big difference. 'There has been a large number of small failures and a small number of large successes,' said Buttrick. 'Two or three will prove the exception, but they will also be of exceptional consequence, as we have witnessed with ValuJet.'

This time around Buttrick predicted that things will be different for three good reasons. New entrants now can look to Southwest as the mentor, there is a real advantage in having low costs, and United States government departments are more willing to act if the majors become too aggressive.

Most speakers agreed that some form of government intervention was crucial to ensure that mid-sized carriers were given adequate access to markets and protection from unfair competition by the majors.

John Coleman, director of the office of aviation analysis at the US Department of Transportation, said: 'We are committed to levelling the field to new entrants.' While the Department of Justice's antitrust laws are the first line of defence, predatory behaviour is notoriously difficult to prove. 'The Justice Department . . . must prove that pricing is below marginal or average variable cost. But it must also prove that successful predation would create a sustainable monopoly so that losses incurred by the predator in driving out a competitor could be more than offset by future monopoly profits.' However, Section 411 of the Federal Aviation Act, which is administered by the DOT, is more flexible as it does not require the sustainable monopoly aspect to be proved.

Frederik Sorensen, director of air transport policy at the European Commission, said that Commission actions added up to a clear policy to safeguard the right of mid-sized carriers to compete in a fair market with equal opportunities. He pointed out that the Commission's efforts included the ground handling directive, an independent review of CRS operations, the forthcoming review of slot allocation procedures, and possible legislation on codesharing.

The Commission's antitrust rules on the abuse of a dominant position had been used. Although predatory practices were hard to prove, the rules should act as a deterrent.

In his summary, the conference chairman Alastair Pugh said that well managed, cost conscious mid-sized carriers, offering excellent value products, clearly could compete successfully against the majors. 'The most sustainable advantage that can be achieved by mid-sized carriers is to lever against the higher costs and wider product range of the majors.' However, in some markets, especially those situated in Europe, 'the air transport jungle almost demands protective strategies' - either cooperating with or avoiding the majors. And for most carriers which do compete head-on with the majors, a protective regulatory regime is essential.

Source: Airline Business