Marketing the Airport When the Network Air Carrier Model is Broken Mike Tretheway Vice President

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Marketing the Airport When the Network Air
Carrier Model is Broken Mike TrethewayVice
President Chief EconomistInterVISTAS
Consulting Inc.

• 9 June 2003

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Meltdown of the Network Carrier Business Model
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• "The airline business model - designed to
  take anyone from anywhere to everywhere,
  seamlessly - was a great innovation, but is no
  longer economically sustainable in its current
  form.
• recent Booz Allen Hamilton Inc. report

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• "At the heart of the problem is the business
  model which full service carriers have used to
  generate revenues for five decades."
• Robert Milton, CEO Air Canada

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Full Service Network Carrier (FSNC)

• High connectivity product
• connectivity superior to rail product

Change rail carriersChange stations
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Full Service Network Carrier (FSNC)

• High connectivity product
• superior to rail product
• Highly flexible product
• Ideal for business travel
• multi-stop itineraries
• ability to change plans at last minute
• could transfer from one carrier to another
• in flight and airport amenities offered

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Full Service Network Carrier (FSNC)

• Costly to provide
• significant investment in systems
• significant investment in infrastructure
• carrier systems
• airport systems

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Full Service Network Carrier (FSNC)

• Not all travelers needed this product
• many only needed point to point, return, with
  limited need for flexibility
• Assumed economies of scope exist
• cheaper to jointly provide network service and
  simple point to point service
• although in late 40s, charter carriers offered
  simply, low cost service
• CAB regulated their services out of existence

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Division of the Market

• Markets have grown
• Markets were deregulated
• Specialist carriers emerged offering simply
  product
• The low price offered has attracted the
  travelers who do not need the superior network
  product
• The loss of these has undermined the network
  carriers economies

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Moving Backward Up the Cost Curve
Unit cost after loss of simple pax
Unit Cost with all pax
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Meltdown of the FSNC model

• Loss of simple pax to LCCs
• Upward pressure on unit costs
• Widening fare gap
• causing business travelers to choose simpler
  product at a much lower price
• Example Vancouver-Ottawa
• Y class 1700 one way
• J class 1950 one way (a good value)
• M class 1200 one way
• LCC 350 walk up

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The LCC Business Model
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Net Profit as of Revenue1993-2001

• Average Min (93-00)
• SW 8.9 6.1
• NW 2.4 -4.4
• AA 1.9 -9.5
• DL 1.9 -8.4
• UA 1.1 -13.1
• CO 0.0 -17.1
• US -2.2 -24.1

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The Low Cost Carrier

• Carriers with highest market capitalisation
• US Southwest (more than all others combined)
• Canada WestJet (3x Air Canada)
• Europe Ryanair
• Australia
• Virgin Blue valued at 500 million from
  investment by Branson of 40 million

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LCCs Today
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The LCC business model

• A successful model
• for shareholders
• for passengers
• for communities
• Not a fad
• SW is 30 years old, has aged labour force

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Low Cost Carrier Model (LCC)

• Ryanair
• no connectivity to other carriers
• no connectivity to its own flights
• limits on luggage
• pay for a glass of water
• A highly successful business model

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Impact on Traffic
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Airline Market DynamicsWestJet Route Market
Stimulation (1996-1998)
500
400
300
200
100
0

• Two year growth rates

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Ryanair Planned Yield Decline

• Ryanairs business plan calls for constantly
  declining yields
• To further stimulate the market
• yield drop stimulates market more the
  proportionately
• Allows further economies, supporting lower unit
  cost

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Moving Backward Up the Cost Curve
Unit cost after loss of simple pax
Unit Cost with all pax
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Ryanair Surviving 911 etc.
This wedge allows carrier to surviveload factor
drop of 20 percentage points
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Where Ryanair Cuts Cost

• Use Secondary Airports
• Standarised low weight Fleet
• Point to point services
• Max fleet utilisation
• Cheap product design no connections
• No frequent flyer program
• Non-participation in alliances
• Minimize aircraft capital outlay
• minimize personnel costs

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Ryanair Culture

• DRIVE COSTS DOWN !!To sustain competitive
  advantage
• corporate ethos of ongoing and rigorous cost
  reduction
• e.g., employee salaries linked to profits
• staff costs declined from 17.5 to 16.4
• large portion of pilots compensation in shares
• marketing/distribution costs
• declined from 11.8 to 5.8 of costs
• Replace landing fees with incentives

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Ryanair Tough with Airports

• Replaced Rimini Italy with Ancona Italy
• one hour drive south
• Had built Rimini to 70,000 pax
• daily service from London Stansted
• Airport Management
• Here we have the spectre of misguided airport
  management and board seeking to break its
  contract with Ryanair.

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WestJet

• Fleet of 90 aircraft planned
• Will end 2003 with 40 aircraft
• Serves 26 cities
• Indicating it will start service to US
• first cross border low cost carrier service
  outside the European Economic Area

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WestJet

• By 2000, WJ was ready to go nation-wide The
  carrier began its pan-Canadian expansion plans in
  early 2000, with the opening of a service to
  Hamilton, ON. Hamilton is an attractive airport
  due to its low costs, lack of congestion and
  relative proximity to Toronto, which is 45 miles
  away. The airline subsequently set out to build
  Hamilton as it eastern hub.

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WestJet Break Even Load Factor
Does not have decline in BELF found at
Ryanaironly 10 point gap
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Southwest
10 point gap until 2001
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JetBlue
8 point gap
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Break-even Load Factors
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Future Market Shares
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Traffic share of LCCs

• US
• 24 of passengers
• 12 of aircraft
• 11 of ASKs
• 9 of revenues
• growing -- many aircraft on order
• Canada
• WestJet growing to 90 jet aircraft vs. Air
  Canadas 250-
• plus other LCCs

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Future Growth

• Fleet expansion plans
• easyJet - 240 firm options
• WestJet - 94 firm options
• Ryanair - 150 firm options
• Jet Blue - 90 firm options
• Southwest - 430 firm options

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Future Growth

• LCC Expectations
• VB from 18 of seat capacity to 30
• LCCs 40 share of US RPMs by 2020
• 2002 18
• 1995 11
• WJ 40 annual growth
• Ryanair 30 annual growth
• Southwest 8 annual growth
• will surpass AA by 2013

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Future Share of FSNCs

• US currently
• 20-25 of passengers carried by LCCs
• These carriers will grow
• to 40?
• FSNCs plan to convert some capacity to quasi-LCC
  format
• to 5-20?
• Hence FSNC may be
• 40-60 of market

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The FSNC business model

• An amazing product
• high connectivity and convenience
• built a global industry
• facilitated economic growth
• But
• not everyone needs to buy the package
• hence, no longer financially successful
• But there continues to be a role for FSNC ...
  They will not disappear

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Changes needed to the FSNC

• Market share will be reduced
• consolidation will be necessaryif rising unit
  cost is to be avoided
• outside of USconsolidation will need to cross
  borders
• perhaps reduced to 50 of market

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Changes needed to the FSNC

• Will need to reduce costsand redefine service
• labour and supplier cost reductions
• Wages and productivity
• but 25 cost reduction will still leave LCCs with
  25 cost advantage
• will need to sell the value added service

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Conversion of FSNC capacity

• Air Canada - prior to restructuring
• Tango operates 20 aircraft
• Zip to operate 20 aircraft
• 16 of Air Canada fleet converted
• Carriers goal convert 40 of capacity to LCC
  format (or quasi-LCC)

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Conclusions

• LCC model
• here to stay
• will serve 50 of market, higher for domestic
• success requires low cost, especially low
  airport cost
• airports must seek pax based value
• Returns will moderate but not disappear
• Only a few LCCs will be successful

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Conclusions

• Full Service Network Model
• Destined for a major drop in share
• 40-50 of traffic
• but 70 of revenues
• Will re-invent
• somewhat lower costs
• reduced service levels
• reduced network
• conversion of capacity to new formats

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Airport Marketing
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Target LCCs

• The expanding market segment
• They are seeking lower cost
• high fleet productivity
• secondary airport may have effect of reducing
  fleet requirement by 10 by rapid turns
• reduced landing fees
• marketing incentives

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Airport Incentives

• Canada common practice to discount landing fees
• airport earns other pax related revenues
• parking, food/beverage/retail, advertising,
  PFC/AIF
• Europe pay the airline
• Charleroi pays Ryanair for service
• long term contracts

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Airport Incentives

• Travel banks
• reduces risk for air carriers
• while saving airport from charge of price
  discrimination
• 1-3 million common amounts
• 1.5 million 4000 per day
• equivalent to 15-25 passengers per day

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Airport Incentives

• Dual airport marketing
• pooling incentivesfrom both airports on a route
• offers the carrier a significant advantage

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Airport Incentives

• Marketing Commitment
• avoids discriminatory pricing
• local promotion of route
• assist with spoke end marketing
• cash and non-cash marketing
• non-cash airport advertising
• non-cash media relations campaign
• cash joint media advertising

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Dont overlook FSNCs

• Restructured FSNC is like a new carrier
• many routes will be reassessed
• hub locations could be reassessed
• downsizing
• hub buster routes
• US Airways placing large order for RJs

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Dont Overlook FSNCs

• They are learning the incentive game from the
  LCCs
• The future must include greater pax-driven,
  non-aeronautical revenues
• PFC/AIF
• food/beverage/retail
• parking
• advertising, web site traffic

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Market to Regional Carriers

• There will be a significant shift of national
  capacity to regional carriers
• more relaxed scope clauses
• Regional carriers may make more independent
  decisions as to where they flight and what routes

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Develop Insight on FSNC strategy

• FSNCs emerging as new carriers with new operating
  models and products
• The Airport Marketer must develop sources of
  intelligence on individual carriers and how
  their corporate strategies are shifting

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Professional Airport Marketing

• Carriers need scientific presentations
• Define catchment area appropriate for the carrier
• LCCs have 3 hour drive range
• FSNCs may seek smaller catchment areas to
  differentiate the value of their product
• what is yield and market share potential -- QSI
  modeling

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Thank You !Mike TrethewayInterVISTAS
Consulting Inc.604-717-1801Mike_Tretheway_at_InterV
ISTAS.comwww.InterVISTAS.com