Innovation has always been difficult in the airline business. The basic airline product is uniform throughout the industry, and any incremental change by one carrier is usually taken up by its competitors quickly - if it is successful. To survive and stay ahead of their competitors, airlines are constantly looking for fresh ideas.

Four panaceas for survival are now unfolding - removing intermediaries, managing the customer, advancing the product and creating the 'virtual airline'. Thinking management has each of them on the radar screen but with varying degrees of intensity and currency. However, while these panaceas make sense from an airline point of view, it remains unclear how customers will react to them.

'Removing intermediaries' refers to travel agents and includes direct and electronic distribution, restructuring and consolidation of travel agency commissions and electronic ticketing. The theory is that savings in the cost of selling airline tickets will be retained and translated into stronger margins.

The second panacea is 'customer management'. Many airlines have now woken up to the fact that their hidden asset is their customer. If they can capture information about their customers and use modern data warehouse technology and direct marketing techniques effectively, they will be able to redesign products to suit target customers, resulting in improved yields. The essence lies in the belief that customers can somehow be 'captured' and become the 'property' of airlines through the clever use of loyalty programmes and technology. However, it is unclear how customers will take to the notion of being 'captured'!

The third panacea is 'product advancement', which is occurring in the form of network extension and service upgrades, usually through codesharing alliances. Progressive airlines in Europe and the US see the attractive margin as being obtained from 'not otherwise carried customers'. With an extended network and advanced origin and destination yield management systems, an airline can improve its capacity allocation and pricing to capture more revenue. At the same time, many airlines are enhancing their service features in the expectation of higher yields.

But are codesharing alliances and service upgrades what customers really want and are they prepared to pay for them? Some market research suggests there are better ways of satisfying customer requirements.

The fourth panacea is 'virtualisation'. Outsourcing will, its proponents declare, result in radically improved performance since the airline will concentrate on what it knows best, while managing a range of relationships with suppliers that are specialised in their own areas of competence. Again, it is uncertain how airline customers, suppliers and other stakeholders might react. Selling direct

During the 1970s and 1980s, airlines achieved significant results from owning CRS and developing the travel agency distribution channel, particularly for business tickets. Selling costs fell from about 20 per cent of revenue down to as low as 10 per cent for a time. However, sales and distribution costs are now back up to 20-25 per cent of revenues for many carriers.

Yet powerful new technologies are available in the form of low-cost personal computers, network computing, the Internet and multiple user interfaces. The CRSs, now evolved into global distribution systems (GDS), have developed into powerful independent groups, servicing travel agencies rather than their owner airlines and giving airlines less cost control.

As a result, airlines are looking for a new solution aimed at getting their product directly to customers by using new information and communication technology. In the perhaps ambitious view of Julius Maldutis of Salomon Brothers, more than half of all US air tickets will be sold via direct channels, bypassing travel agencies, by the turn of the century.

The Internet is rapidly becoming standard technology for electronic commerce and has emerged as the standard used by nearly all on-line service providers, including Prodigy, Microsoft Network and CompuServe. Developments in telecommunications and mobile telephony have meant that interfaces have evolved dramatically. Providers of on-line services, including travel information and fulfilment services, can reach customers through a PC, network computer or personal digital assistant. The customer can be reached at home, at work, at play, or indeed when shopping, or in a travel agency with kiosk-type products.

Progressive airlines are developing their own systems either as a front-end to the GDS or as independent channels to reach their customers. GDS will no longer be the dominant reservation channel for business travel. Airlines will also focus more on the leisure traveller.

Airlines are progressively shifting their attention and investment towards the direct channel, using their own proprietary technology to develop an offering that is tailored to their target customers. In parallel, however, the airlines will give some support to independent travel agents. Survivors among travel agents will link themselves closer to selected airlines, using their proprietary systems - becoming more like car dealers than full-range agencies, supported by their airline supplier.

GDS will need to decide whether they are serving the interests of airlines or travel agents. In any event, they will have to adapt their product offerings and technology to remain in the game.

Ticketless travel cuts the travel agent out of the sales process altogether. It can save airlines a fortune - each ticket can cost up to $8 to issue, let alone the cost of travel agency commission.

There is much conjecture on whether the consumer will have an appetite to adopt this new technology. The young affluent middle classes have taken to new technology, and surveys by CIC Research suggest that they are interested in making their travel bookings and fulfilment through the Internet, once they are happy that the transaction is secure. But most consumers seem to show a resistance to booking their travel directly themselves.

The first generation of direct channels, Minitel in France and Teletext in the UK, have developed customer acceptance for simple transactions and for purchase of last-minute deals. New proprietary systems to be launched on the Internet will be much more user-friendly and provide the scope for airlines to sell high-value, high-margin products, enabling travellers to customise their requirements. Business travel has a high frequency and high transaction cost, allowing providers to amortise development investment fast. It is likely that a wider and increasing proportion of the population will be prepared to shop directly for travel.

From the mega-chains like American Express and Carlson Wagonlit to the large national agencies and the independents, travel agents will have to respond by developing products and services that add value to the travel experience, both from the customer's and supplier's perspective.


Customers as assets

Customers are now being perceived by progressive airline management teams as assets. The segmentation of an airline's customer base into categories - such as young family, old, adventurer or sporty - has now evolved into 'segment of one marketing', whereby every customer is potentially a segment. Here, the supplier develops a purchasing and behavioural profile of each regular customer, enabling it to target each individual with customised offerings.

The 'segment of one marketing' process requires four sequential steps:

* Target the customer by developing case history profiles for each regular client and assessing the life-time value of that client. For example, a back-packing student flying to Tibet may not be perceived today as a high-yield customer, but the life-time value of this customer may be very high given that the student may develop into a executive with large purchasing power.

* Develop the means to retain the customer's loyalty.

* Match the product creation to these target customers through customer management and product development programmes.

* Align the most appropriate distribution channel to the target markets. For example, it would be more appropriate to target the young middle classes through direct marketing and the Internet.

New data warehousing software and associated smart systems allow carriers to exploit customer databases from different sources within their own organisations and from alliance partners, and to marry profiles and purchasing and travelling habits to elements in their product database. These systems allow a real-time capability to package for an individual customer a destination, a budgeted price, and product components such as flight, car hire, hotel bed and entertainment. Customer management could accelerate disintermediation, threatening the tour operator as well as the travel agent.

Until now, efforts at customer retention have focused on loyalty and frequent flyer programmes providing financial inducements or other benefits. But frequent flyer programmes have evolved to the point where their loyalty-generating capability must be questioned. Of the 45 million members of airline loyalty programmes worldwide, most belong to between two and four programmes, demonstrating that the customer is not so much loyal to the airline as to the schedule.

Unawarded miles are becoming a liability to airlines and initiatives to make miles taxable are accelerating. Many corporations are now obliging employees to transfer their personal miles to the corporation, which will be much less loyal than the individual.

Other suppliers' customers have been linked into airline loyalty programmes, but if customers earn points by using the telephone or by spending money in a supermarket and cash in those benefits on an airline, how does that make the customer loyal to the airline?

The irony is that airlines are giving away benefits to their most captive customers - the frequent business travellers who, in most cases, are motivated by the convenience of the schedule and the quality of the product and service offering. The real challenge is to come up with an effective infrequent flyer programme able to capture the loyalty of regular but infrequent travellers, particularly on leisure travel, and to convert them into life-time customers. In the end, loyalty programmes may be abandoned once their loyalty-generating capability has become too confused.


More speed, more speed

Airlines are refocusing on their core product and services as the distinguishing feature. Potential airline customers look at two elements of an airline's offering. The core product is determined by the route network, schedule and type of aircraft. This is accompanied by a range of service features, such as seat configuration and comfort, in-flight services and services offered on the ground before and after each flight.

Freddy van Gaever, managing director of VLM Airlines in Belgium, says the basic customer requirement should be obvious. 'Spending years at college is not necessary to know that people fly for speed!' He recently went on to say: 'Every other form of transport is becoming speedier. But 60 years ago, the businessman was travelling from downtown London to downtown Paris in three hours - much the same time as it takes today.'

By and large, travellers prefer the fastest route if the price is right. Obviously, travellers have different speed/price ratios which may vary according to the nature of their trip. The speed of air travel is predominantly a function of the core product. Customers choose the airline that operates from their origin to their destination, and they are most likely to select nonstop flights before connecting flights, and on-line connections ahead of interline connections. Airline service features also affect the speed of travel and thus influence customer satisfaction - for example, airport access and the speed of check-in, boarding, deplaning and baggage delivery.

North American passengers want a fast, hassle-free core product. Studies by J D Power & Associates, the prominent airline market research firm in North America, show that on-time flights, aircraft condition and schedule - all elements of the core product - are the major contributors to flight satisfaction. When you add check-in performance, 60 per cent of customer satisfaction is derived from factors that constitute the speed of the airline product.

European passengers have similar requirements but they value comfort more than their counterparts in North America, according to a recent OAG survey. Schedule makes a higher contribution to flight satisfaction in Europe than in North America, probably because European passengers have fewer choices for getting from origin to destination.

Customers in both markets place high importance on the speed of check-in. When an American Express survey asked business travellers what they hated most about airline services, 53 per cent said early check-in, while 31 per cent cited the slowness of security clearance and passport control.

The most significant initiative most airlines are making to enhance their product is the formation of codesharing alliances to extend their route networks to serve more of the origin and destination travel needs of more customers. At the same time, service upgrades are proliferating. There are showers and limos on arrival, phones and faxes in flight, shopping malls on the ground and soon in the air, plus gambling and other forms of entertainment. Is this what customers are demanding? Do they realise that they paying for these service upgrades in one way or another? Are they really willing to do so?

Many passengers say they are not interested in codesharing or the service upgrades that have no impact on speed. Typical comments are: 'Hub networks have meant pointless, time-consuming connections for the convenience of an airline' or 'There is no such thing as a seamless codeshare connection'. Carlson Wagonlit research suggests that 'Over 75 per cent of travellers would travel on 'no frills' flights within Europe' and that '64 per cent would not use in-flight business facilities' such as phones and faxes. Boeing points out: 'What contributes most to making a flight memorably pleasant? An unoccupied adjacent seat.'

Codesharing offers a wider network of destinations, but it has developed a bad reputation because some partners simply share their codes without doing much to adjust their schedules, and passengers feel they are being misled about who does the flying. Alliances will only be beneficial for customers if airlines move away from codesharing and towards complete mergers.

Many customers have no interest in the kind of service upgrades many carriers are offering. They would much rather have improvements on the ground that contribute to a faster travel experience. The growth of the no-frills, point-to-point carriers supports the assertion of Toby Joseph of Carlson Wagonlit, who says: 'Added value may not be what travellers and corporates want . . . we are likely to see more 'basic' products which focus on speed and efficiency.'


Virtual realities

Many airlines are examining comprehensive outsourcing and disposal strategies as they seek to meet demands for earnings growth amid an increasingly competitive environment. At the extreme, Virtual Air, Inc would undertake itself only those activities that define its product, develop its brand, manage contractors and optimise cash flows. It would determine the routes, schedules, aircraft types, prices, incentives, distribution channels, service features, standards and contract suppliers. After all, today's highly regarded and most profitable airlines, like British Airways, Cathay Pacific, Singapore Airlines and Southwest are leaders in these areas.

This airline would also 'insource' activities needed to maintain critical knowledge and 'ownership' of customers (such as distribution) and customer contact will primarily be at points of communication and sale.

Virtual Air would have few or no fixed assets. All flying, ground and support activities involving large, unionised workforces would be outsourced to existing specialists or new entrants. Some suppliers may be today's airlines operating as franchisees.

In a more likely scenario, 'near virtual airlines' will retain a little more than the minimum requirements. Each airline will make its own choice of insourced versus outsourced customer-contact activities to fulfil management's vision and self-image.

Technology will be a primary instrument for displacing rather than outsourcing activities such as customer management, electronic distribution, airport processing and maintenance.

Still, activities requiring large workforces or non-branding skills will be outsourced, especially where efficient external markets already exist (such as IT, engineering and maintenance, ground handling, catering, training, accounting, reservations, and perhaps even flight operations). Undoubtedly, some airlines will boldly outsource their way to virtuality, but the wise will tread cautiously.

While customers like the low fares which outsourcing helps to make possible, last year's rash of accidents raised customer concerns about contracted maintenance, pilot training and airport security. These are now influencing people's choice of airline. For example, Iapa in the US is receiving more enquiries from passengers about the maintenance practices of specific airlines, and Carlson Wagonlit reports a significant rise in requests from customers about the type and age of aircraft they will fly.

The leading carriers may be ready for Virtual Air, but first they will have to deal with many complex issues:

* Is there a competitive marketplace for outsourcing to provide scale economies and quality levels?

* Are these airlines skilled at managing a plethora of contractors?

* Will airlines or customers really benefit from lower costs from outsourcing?

* Are our regulatory authorities ready and able to police the virtual airline and all its suppliers?

* Are customers willing to agree that virtuality will give them a better deal?

The biggest challenge for Virtual Air is that the activities which determine some two-thirds of customer flight satisfaction would be outsourced to contractors, leaving Virtual Air with responsibility for only one-third of the activities that are most important to customers. Clearly, this will carry major risks.

Only time will tell whether these panaceas will be routes to salvation. However, it is clear that airlines must take into account their customers when implementing these innovations. The successful carriers will enter into an open and serious dialogue with customers, employees, suppliers and trade partners to explain why change is necessary and how survival requires fundamental reappraisal of practices and attitudes.

Source: Airline Business