Chris Tarry

1
Is sustainable profit an unrealisable dream?

• Chris Tarry
• Stockholm
• 19th November 2003

2
Agenda

• Industry background issues
• Structural changes and consequences
• Managing the responses
• Conclusions
• Final thoughts

3
General Strategic Objectives

• Survive
• Compete
• Prosper
• BUT
• How does the industry match up

4
Global airline industry Performance
Source ICAO
5
Airline traffic and capacity trends
Source ICAO
6
Passenger load factor trends
7
Break even load factor trends
Break even load factor ((op cost x traffic)/(op
rev x capacity))
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Long term industry trends
Source ICAO/CTAIRA research
9
International operating economics
Data IATA
10
The source of profit
Data IATA
11
Long term US yield trends in a mature market
Source ATA
12
European Airlines Trends Europe
Source AEA
13
European Airlines Trends North Atlantic
Source AEA
14
European Airlines Trends Far East
Source AEA
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Forecasting issues traffic and real GDP
Data IMF, ICAO
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Nominal GDP and airline revenue
Source IMF/ICAO
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The search for a turning point USA
Source Pollingreport.com/ATA
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Industry Outlook

• Still an exceptionally tough environment
• Unsupported profit may not be possible before
  2005/06
• Airlines still need to achieve structural cost
  reduction

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Structural changes and consequences
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Terminology

• Low cost airline
• Low fare airline
• New model airline (NMA)
• Traveller
• Customer
• Business traveller
• Travel policy
• Compliance
• Product
• Commodity
• Marketplace
• Value for money
• ROI

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Product issues

• What constitutes the product offer?
• The flight?
• Flexibility?
• Timing?
• Frequency?
• Airport attractiveness?
• On board service?
• On ground service
• It depends
• Each of us (and our employer) will value and
  price the attributes differently

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Market segmentation - The UK example

• Mainline
• British Airways
• Virgin
• bmi British Midland
• Lower Cost
• easyJet
• Low cost
• Ryanair
• Charter airlines
• More widely, segmentation is also possible
  between geographic region, maturity of market and
  market type

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Market segmentation - International

• Regional limited long haul network (Finnair)
• Supra-regional extensive long haul network
  (Lufthansa)
• Intra-regional cross- border but not long haul
  (easyJet)
• Global hub and spoke global reach (Singapore,
  Emirates)

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Industry life cycles

• What happens ?
• Slowing growth rate
• Changing consumer behaviour in maturing
  markets
• Decline unless there is change and
  re-invention

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What are the constraints to change?

• Management?
• Labour?
• Capital?
• Infrastructure?
• Regulation?
• In reality a combination

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Airline industry life cycles

• Is maturity and decline the only option?
• Does structural rigidity mean an inability to
  change?
• Has the managerial prerogative at some
  airlines been ceded?
• Is the fundamental and necessary change
  impossible?
• Are the costs of change too high?
• Will there be further exits?
• Opportunities for segmental new entrants

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If traffic alone is not the route to profit, what
is?

• A need for
• The right cost base
• The best revenue stream
• The appropriate level of assets
• There is not a one size fits all template

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Mainline airlines - what needs to be done?

• Reduction of structural excess supply
• Differentiation of increasingly commoditised
  products
• Addressing the gap between customer and the
  traveller
• Reacting to changing market structures
• Structural reduction of cost
• Improvement of shareholder returns
• Also important to keep a sense of perspective

29
British Airways Productivity measures
Source Company reports
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British Airways Total measurement
Data British Airways
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New entrant airlines
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Changing markets - The new entrant formula

• Supply led growth
• High utilisation
• High density seating
• Low distribution costs
• Simple fare structure

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The London area experience
Source CAA
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London and the Southeast

• Main focus of NMAs
• Rich travel market and incumbents initially
  pressured
• Significant fight back by incumbents
• Signs of market maturity

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The Mainline fight back

• With a focus on
• Price discriminators
• Quality discriminators
• Now able to offer more options
• Business to Full fare Economy
• Full Fare Economy to Restricted Economy
• Fundamentally changed rules of engagement

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Mainline fight back (2)

• Fare structure simplification
• Easier internet booking process
• Raising awareness of value proposition
• Exportation of new fare structures

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Fare trends 2002
Source American Express
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The UK in an intra-European context
Source American Express
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A snapshot of marketplace changes (1)
Source British Airways
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A snapshot of marketplace changes (2)
Source British Airways
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Potential effects on the NMAs

• From the mainline airlines response
• Fall in average fare
• Rise in break even load factor
• Pressure on earnings growth
• Stock market reaction when go-go stocks go ex

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Limits to growth exist even for NMAs

• Markets are not infinite
• Risk of over-dependence on journey price
  elasticity
• Need for a reason to travel even if the ticket is
  free
• Increasing importance of other trip
  determinants
• Relationship between income and travel

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UK Maturing markets? (1)
Source CAA
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UK Maturing markets? (2)
Source CAA
45
UK Regional traffic trends (1)
Source CAA
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UK Regional traffic trends (2)
Source CAA
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Industry Consolidation
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Consolidation issues

• The degree of concentration in an industry
  reflects the extent and nature of competition
• based on Douglas Needham The Economics of
  Industrial Structure 1970
• Competition and market maturity are not evenly
  spread
• So is consolidation the answer to the
  industrys problems?

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Putting it in context

• What are the problems of the mature and maturing
  airlines?
• Too much capacity
• Too much cost
• Not enough profit even in the best times
• Will these be solved by consolidation?
• Not in the absence of other actions
• Is the industry capable of managing the necessary
  change?
• Not a good track record in this area

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Conclusions

• Permanent change in the operating environment
• New business models needed
• Without continuing change the industry will not
• Achieve adequate profitability
• Attract new capital
• Key challenge remains the management of change

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Two final thoughts

• Progress is a nice word but change is its
  motivator and change has its enemies
• Robert Kennedy
• More of the same is not an option
• Chris Tarry

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