Despite the world's march towards segmented, global markets over the past decade, the airline industry remains dominated by national players. But the established carriers may soon face a choice - do they plan to help change the market or risk becoming marginal players?
Given all the talk about the need for consolidation, it is almost tempting to assume that it is actually taking place in the airline industry. The truth is that progress has been all but absent over the past decade.
Though the 1990s marked a period of rapid globalisation for most other industries, the basic shape of the airline business has remained largely the same, with most major carriers still stubbornly locked within their national markets. As is starting to become apparent, this has left the established players with an increasingly dated one-size-fits-all business model, which looks unlikely to carry them through the next decade as it moves relentlessly towards segmented global markets.
The reasons for the failure to globalise are well rehearsed. It is true that a mix of ageing regulation and politics has set hard limits on merger and acquisition activity, especially for those carriers burdened with carrying their national flags. But as established players have discovered to their cost in other industries, such barriers can rapidly become irrelevant once global market forces come to bear. And there is no evidence to suggest that air transport can remain insulated from these forces, nor that their increasingly smart customers are prepared to wait patiently for regulatory change.
Nor is there any hard reason why it has to be existing players who own the relationship with the customer. Plenty of others within the travel chain have the ability to bundle up and remarket the airline product on a global basis if established players are not ready or able to take the initiative. Some of the old certainties are already being tested. Witness the new generation of low-cost operators and online travel agencies that have started to work around the old roadblocks, often hopping across traditional market boundaries with relative ease. If the traditional carriers are less flexible, then it has as much to do with where they have come from as with the regulatory constraints over where they are allowed to go.
All industries share some common evolutionary stages, each with their own demands. As with all evolutionary processes, the key is to adapt and survive. The process is typically kick-started by the discovery of a new technology. A handful of visionary pioneers put the pieces together to prove that it can fly. Entrepreneurs then set about turning a bright idea into a marketable product. Next comes a phase of investment and expansion as money floods in to what promises to be a high-growth new business sector. After the initial explosion, the technology matures to the point where further advances become expensive and yield incremental improvements rather than the dramatic step changes of the early development days. That technology curve is as true of the automotive industry, which took a century to mature, as it is of the Internet, which took a decade.
As the product enters the mainstream and nearly everyone has access to the same technology, so the emphasis shifts from invention and towards the need for better production processes and economies of scale. The advantage goes to those companies with sufficient scale to dominate their surrounding markets and with the volumes to lower unit costs and invest in the business. That in turn has tended to promote the emergence of national champions, capable of supplying a complete range of products, albeit within the natural protection of their home market.
Aviation has been little different. It started a century ago with the first powered flight, moved through the early days of commercial aviation and on to the dawn of the jet age. Since then the pace of technology has slowed. Aircraft have continued to become more efficient but, since the end of the 1970s, improvements in size and speed have come in increments. As aerospace veterans are fond of pointing out, Concorde is still the world's only serving supersonic passenger jet.
By the 1980s, more reliable technology and better processes allowed airlines to extend the offer of air travel to a mass market. The consolidation that followed has centred on the race to dominate "home" markets. Almost everywhere, the survivors have eaten or killed off sub-scale local rivals.
The next phase of evolution centres on the trend towards global market access, which has been playing out everywhere else over the past decade. Its roots lie in the opening up of world trade and the free flow of capital in the late 1980s. The subsequent consolidation has, however, been more than just a search for global economies of scale. In part it is a response to the changing relationship with customers. In the days of dominant national champions and closed markets, power lay with the supplier. As barriers fall and new choices emerge, so it shifts to the consumer, now also armed with access to a free flow of global information. Despite some lingering attachment to flag-carriers, consumers have shown few misgivings about leading this charge towards buying global brands.
Many markets, from banking and brewing to automotive and aerospace, have already seen the emergence of a handful of truly global players, with the scale and reach to serve a full range of market segments around the world. The airline industry has yet to join them.
It is instructive to look back over a decade of the Airline Business top 100 financial rankings. The groups that led in 1990 are virtually identical to those that were top in 2000. All bar one of the top 10 reappear a decade later - and that despite some big currency swings and a major recession in the intervening years.
Only four of the top 50 carriers have disappeared from the ranking over the decade and they are the usual suspects: Pan Am, Canadian, Eastern and Australian Airlines. These were all notable victims of unfinished national consolidation. It seems that more leading carriers have been driven to bankruptcy by cross-border competition in the past six months than in the past decade. Conversely, the top half of the table for 2000 includes only three passenger carriers that were not already in the top 100 ranking a decade earlier. All are products of the growth in Asia, including Emirates, Asiana and China Southern.
Moreover, the world market share of the largest airline group has remained unchanged at around 5% of industry revenues. The top 10 carriers together account for just over 40% of the market. Compare that with the sweeping consolidation in other sectors. The top 10 automotive manufacturers command an impressive 80% of the world market and the bulk of that is in the hands of only three major groups. Even in the traditionally fragmented brewing sector, a recent spate of consolidation has left ten giants with close to half the world market.
Airlines have responded after a fashion with the formation of alliances, the largest of which account for around 20% of the world passenger market. But alliance members still jealously guard their brand identities and customer relationships. Mergers could go on, but they remain a distant prospect.
The signs suggest this industry has yet to step up to the challenge of addressing new global markets. Its preoccupations still rest heavily on supply-side issues, driven by measures of process efficiency, asset utilisation and volume growth, not to mention an obsession with consensus and standards.
On the customer side, consumers have seen little change in the travel experience over the past decade. On the basic measures, block times have got longer and punctuality worse. In aggregate, there are still too many carriers crowded into the middle ground, offering largely the same range of products and services. The net result has been some punishing market-share battles and a steady erosion in yield. Allowing for inflation, yields have declined in real terms at an underlying rate of more than 5% per year during the past decade.
Commoditisation is a growing risk and has already been seen on short-haul services. The industry's net margins, which have peaked at a mere 3%, are more reminiscent of a volume commodity business than a brand-conscious service sector. Despite the effort put into the cabin, it is hard to see much real differentiation between the mainline carriers. It is a truism that what everyone else does too cannot count as a differentiator. In fact, the proposition put together by new online intermediaries, exemplified by the blind auction model of priceline.com, relies on the assumption that airlines are all basically the same and the only thing that matters, certainly to leisure customers, is price.
Such positioning could be crucial as the newly global markets continue to evolve. We are moving towards a world in which traditional market boundaries begin to blur. No longer are markets defined by the products they deliver (hotel rooms, hire cars or airline seats, for example) but by their relation to the customer (the travel experience). The choice for traditional players at this point is where they aim to sit along the value chain. At the top will be global retailers and arrangers who own the brands and the customer relationship; below are the producers who supply the capacity; in between are supply-chain managers handling information and logistics.
It is not clear who will end up dominating in each of these roles. In the retailing model, for example, some producers have been able to create differentiated global brands that give them pricing and distribution power. In other cases, however, the power has shifted in favour of the major retail combines. Even a sector as production-led as automotive has seen manufacturers invest in broader "lifestyle" propositions in order to avoid ceding the customer relationship to middlemen and dealers. In financial markets there is a growing division between those that provide the retail brand, whether through store cards or Internet banking, and those institutions that manage the services.
Such reshaping has still to occur in the travel market, but there is no reason in principle why a travel arranger such as an American Express should not wrest brand loyalty away from individual suppliers of airline seats or hotel rooms.If airline groups wish to retain their power, they will need to start doing those things that underline their difference from the herd and find some new basis for segmentation. They will certainly have to update the old models based around the economics of national markets.
Along the way, a few simple tests should establish whether the airline industry is reaching the next stage on the evolutionary ladder. Genuinely different customer value propositions will start to succeed, global players will begin to emerge without the need for broad marketing coalitions and the craving for consensus standards and industry solutions will recede. Perhaps most telling of all, it should become possible for a non-airline company to emerge as a real competitor.
Source: Airline Business