Achieving High Performance in the Airline Industry

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Recently we turned our attention to the airline industry and examined the finan-cial performance of air carriers from 2001 to 2007, a period that represented a typi-cal industry cycle of both growth and decline. The analysis focused on publicly owned companies that generated at least 60 percent of their revenues from passen-ger transport services.1 We limited our study to those airlines with an available seat kilometer (ASK) pro duction2 of at least 50 billion per year.

An exception was made for those air lines that, while not meeting the 50 billion per year ASK, had demonstrated exceptional growth during the period under review.

Importantly, we included both low-cost carriers and hub carriers in our analysis. Doing so allowed us to explore perfor-mance differences between two very different business models.

The biggest competitive differentiator for the high performance airlines is their ability to win and retain revenue during periods of both industry growth and decline. As Figure 1 illustrates, industry players achieved, on average, a compound annual growth rate of approximately 5 percent during the 2001 to 2007 cycle.

In 2003, Accenture launched an ambitious research initiative to better understand the special characteristics that distinguish high-performance businesses from their peers. To date, we have examined more than 6,000 com-panies along five key dimen sions of performance: profitability, growth, positioning for the future, longevity and consistency. Our findings confirm that high perfor-mance is definable, quantifiable and, above all, achievable. More than 500 companies have met our criteria for high performance.

Defining high performance

Figure 1. High-performance airlines significantly outperform their peers in terms of revenue growth and revenue premium.

7.87

High performerslow-cost carriers

10.09

High performers hub carriers

9.53

Rest of peer set

81.7 %

High performerslow-cost carriers

77.6 %

High performers hub carriers

77.6 %

Rest of peer set

0.10

High performers hub carriersin region B

0.07

Peer set from region B

Source: International Air Transport Association; Accenture Analysis.

Revenue growthCompound annual growth rate (CAGR %)

-6 %

Source: Accenture Analysis.

Revenue premiumYield premium ($c/RPK

3) SLF %

4

Rev/ASK ($c)5

High performers 14 %

Rest of peer set 5 %

6% Worldwide International Air Transport Association

-30 % -29 %

0.100.14

High performers hub carriersin region A

Peer set from region A

1 The 23 companies included in the peer group for the airlines industry analysis were: Air France-KLM Group, Alitalia, All Nippon Airways, American Air-lines, British Airways, Cathay Pacific, Continental Airlines, Delta Air Lines, easyJet, Iberia, Japan Airlines International, Korean Air, LAN Airlines, Lufthansa, Malaysian Airlines, Northwest Airlines, Qantas, Ryanair, Singapore Airlines, Southwest Airlines, Thai Airways, United Airlines, US Airways

2 Average seat kilometer (ASK) is a standard industry measure of airline output, calculated by multi-plying the number of seats available on flights by the distance over which the seats are flown

3 Revenue Passenger Kilometers4 Seat Load Factor (SLF %) is the ratio of revenue

passenger miles to available seat miles5 Revenue per available seat kilometer (Rev/ASK($c))

requires stage-length adjusted ASK. Data incom-plete for peer set; hence, selected comparison based on peer set of same region as high performer

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In contrast, nearly all of the high-per-formance airlines saw their revenues grow at a pace two to three times faster. High performers also excelled in securing rev-enue premiums and maintaining capital efficiencies. In fact, pre-tax return on invested capital for the low cost carrier high performers is 32 percent and 55 percent higher, respectively, than the industry average (see Figure 2).

This report based on the Accenture High Performance Business research methodology examines in greater detail the characteristics that enable the high-performance airlines to achieve these results, consistently outperform their peers and sustain their superiority over time and across business cycles, industry disruptions and changes in leadership.

Figure 2. High performers excel in revenue generation and capital efficiency thus realizing a higher margin.

11.9 %

5.3 %

7.8%

High performerslow-cost carriers

Rest of peer set

High performers hub carriers

-32 % -55 %

High performers hub carriers

1.5 %

0.4 %0.8 %

High performerslow-cost carriers

20.6 %

High performers hub carriers

Rest of peer set

7.9 %6.6 %

High performerslow-cost carriers

Rest of peer set

-45 %

Source: Accenture Analysis. All figures as 7-year average. Goodwill always included.

Pre-tax ROIC6

EBITA7/Revenue

Revenue /Invested capital

6 Return on invested capital (ROIC)7 Earnings before interest, tax and amortization

(EBITA)

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This was certainly evident in the 2001 to 2007 industry cycle. Following several years of healthy profitability in the 1990s, the terrorist attacks of 2001 and the SARS virus scare of 2002 and 2003 con-tributed to a dramatic reversal of for-tune—profitability plummeted as did stock performance. The airlines’ weak capital returns were apparent when gauged against not just other industries, but also other players in the aviation sector. When compared to airports, catering companies, aircraft manufac–turers and other sector players, airlines’ return on capital employed (ROCE) was, on average, 140 percent lower.

Accenture’s research has confirmed several trends that are reshaping the industry today and will affect growth strategies for years to come. These trends include:

Industry consolidation The 2001 to 2008 period saw a number of hub airlines—especially in the more mature EU and US markets—move to fortify and expand their home market positions by merging operations with other carriers. Looking ahead, we believe the trend of industry consolidation will continue and force many average per-formers to partner with former rivals or develop niche go-to-market strategies.

Fuel price volatility Fuel prices rose throughout the period of the Accenture study, averaging $72 per barrel by 2007. Airlines responded to fuel cost pressures by improving their efficien-cies—not just in fuel usage, but also in other areas such as labor productivity and distribution. Today, a reduction in demand for oil offers some fuel-price relief for air-lines. However, experts predict another mid-term fuel price rise in the coming years. In this environment of extreme price volatility, airlines will be challenged to maintain—and, if possible, expand—their efficiency initiatives.

Airline industry overview

The airline industry, as a whole, operates in an environment of perpetual cyclicality. Periods of strong demand and modest profits are routinely followed by equally long—and usually deeper—periods of weak demand and economic instability. In this roller-coaster environment, achieving profitability is, at best, a zero-sum game.

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Over-capacity The industry is bracing for a glut of new aircraft that were ordered in record num-bers beginning in 2005. Specifically, most airlines are awaiting delivery of two major aircraft types: the 500-seat Airbus A380 geared for ultralong-haul, intercon-tinental travel between major hubs, and the 200-seat Boeing 787, which will be the first aircraft of its kind to enable intercontinental traffic to and from medium-sized cities. The delivery of both types of aircraft will potentially transform long-established leisure and business travel traffic flows and create a tremen-dous surge in capacity, which is likely to accelerate price competition and place massive downward pressure on yields and profitability. In this environment, effec-tively using and managing aircraft capac-ity will be critical.

Of course, the full effect these trends might have on the industry will depend largely on the length and depth of the current global recession. While an upswing in passenger traffic and aggressive cost management initiatives have produced modest gains in profitability in recent years, the economic downturn is neutral-izing these gains. The International Air Transport Association expects 900 million fewer airline passengers over the next five years and year-to-year industry growth is expected to hover around just 2 percent before returning to an average growth rate of just 5 percent in 2012.

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Accenture’s ongoing High Performance Business research has revealed that top companies in all industries share a “competitive essence,” made up of three building blocks of high performance: • Marketfocusandposition• Distinctivecapabilities• Performanceanatomy

It is high performers’ mastery of all three building blocks that enables them to exploit economic cycles and continue to thrive. Aligning and renewing the building blocks are what ultimately position the leaders for long-term success.

For airlines, we identified seven charac-teristics that distinguished the high-per-formance businesses (see Figure 3).

Figure 3. The success of the high-performance airlines is based on strong market focus, a set of distinctive capabilities and a performance-oriented culture.

DistinctiveCapabilities

Operational excellence• Maximize aircraft productivity• Take advantage of cost base flexibility

Non-passenger revenue generation• Strengthen cargo contribution• Access ancillary revenue sources

Demand/capacity fit• Leverage multihub strategies• Synchronize demand and capacity

Financial freedom of action• Secure superior cash reserves• Sustain low gearing

Market Focus & Position

Revenue growth premium• Outgrow competition• Win and retain premium passenger segments

Superior market penetration• Dominate home market• Establish a strong local operational presence

Performance Anatomy

Leadership culture • Win and retain best talent• Re-think existing organizational structures

The building blocks of high performance

Market Focus and Position

Results in better decisions

DistinctiveCapabilities

Results in better practices

Balance, Aligment and Renewal

Performance Anatomy

Results in better mindsets

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High-performance businesses know when and where to compete. In the airline industry, this means proving market dominance in two key ways—by generating more revenue and by penetrating markets more successfully than your competitors.

Revenue growth premium Being keenly focused on growing your year-to-year market revenues at a faster rate than your rivals. Our research con-firms the strength of the low-cost busi-ness model. Ryanair and easyJet, for example, both earned revenues at a rate of three times the industry average. But, more surprisingly, so did LAN, demon-strating that impressive revenue growth could also be achieved under the hub business model. LAN’s secret? Success-fully going after an underserved market—namely, short-haul passengers who tradi-tionally opted for alternative, cheaper modes of transportation and exploiting competitors’ weaknesses. With a new network model for its short-haul fleet, LAN slashed its prices by 30 percent and, overnight, made short-haul air service more accessible and affordable to South American consumers. The strategy paid off. Since launching the program—dubbed, appropriately, “a new way to travel”—LAN has welcomed half a million new custom-ers each year.

Besides attracting impressive passenger numbers, it is important to clearly dem-onstrate your superior ability to access and sustain a high share of premium passengers. For example, comparing Lufthansa to its European peers and Cathay Pacific to its Asian peers, both companies achieved a 30 percent advan-tage in revenue per ASK and they did so while operating their network at an industry-average overall seat load factor.

Superior market penetration Significantly strengthening market share position is another characteristic of high performance. Cathay Pacific, for example, expanded its market share at its Hong Kong hub by 15 percentage points to cap-ture a dominant market share of 48 per-cent. LAN has achieved at least a No. 2 position for intercontinental and short-haul flights in each of the South Ameri-can markets it has entered.

Achieving dominant home-market posi-tion is due, in large part, to a strong local operational presence. Ryanair, which does not offer connecting flights like hub car-riers do, bolstered its market share by establishing new operational bases—and the corresponding direct flights between those bases. Over the past 10 years, the airline has increased its number of bases from two to 27. Today, the airline owns a 27 percent share of the European low-cost carrier market.

For their part, Lufthansa and LAN extend their market reach by placing hub opera-tions in key catchment locations that attract more passengers. LAN, through organic growth, established dedicated hubs in each primate city in South America upon its market entry. In Europe, Lufthansa acquired Swiss International Airlines, Austrian Airlines and Brussels Airlines, adding Zurich, Vienna and Brussels hub operations to the established Lufthansa network. Both airlines use their multihub networks as a competitive advantage.

Market focus and position

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Accenture’s research has consis-tently shown that high-performance businesses in all industries differen-tiate themselves with hard-to-repli-cate ways of working. In the airline industry, our research revealed that mastery of four broad capabilities is essential.

Operational excellence High aircraft productivity—for both long- and short-hauls—is a key factor in achieving cost advantages. The high performers among the hub carriers out-perform their peers by 15 percent (14.3 block hours per day compared to 12.3) on intercontinental flights. They have also been able to successfully imitate certain components of the low-cost network structure within the hub business model, thereby closing the average gap of two block hours per day between low-cost carriers and the peer set by 50 percent. Lufthansa, for example, introduced a net-work design at its non-hub Hamburg base that mimicked low-cost carriers‘ point-to-point model with dedicated aircraft, reduced turn-around time and a minimal number of overnight stays away from Hamburg.

While hub carriers might be able to mimic low-cost carriers when it comes to imple-menting programs that improve aircraft productivity, there is little they can do to match the low-cost carriers‘ cost flexibil-ity advantages. Ryanair and easyJet, for example, both have a much higher share of variable costs, which means they can more effectively control their capital

flows and more quickly respond to market fluctuations. The most important variable cost is labor. Only about half of their workers are full-time employees with unlimited employment contracts. The remaining workforce—comprising con-tract workers or employees on fixed-term contracts—can be scaled up or down as needed to meet changing market demands.

Non-passenger revenue generation The hub carrier high performers generate approximately 60 percent more cargo-related revenues than the peer set. By professionalizing their belly cargo capa-bilities, these players are able to lower their break-even seat load factor by an average of 6 percentage points. Low-cost carriers, by their business model, do not provide cargo services. Yet they have gone far beyond traditional airline passenger ticket sales and demonstrated a notewor-thy ability to access additional revenue streams related to the customers’ travel experience such as the sale of bus and rail tickets, hotel reservations and onboard sales of beverages, food and merchandise. In doing so, Ryanair, for example, has added $ 360 million (US$486 million) to its 2007 total reve nues.

Demand/capacity fit Hub carrier high performers excel at balancing the demand for their services with their capacity to deliver these ser-vices. The simplest—and most efficient—strategy to achieve a prosperous demand/ capacity fit involves a single hub, located in a large catchment.

For example, Cathay Pacific uses this approach to take advantage of a profit-able long-haul operation that requires only a small feed network. LAN has recently extended the Cathay Pacific model with an international multihub approach that operates several hubs in various South American primate cities, all linked together to form a multihub net-work.

Multihub models require clear hub roles and strategies to avoid internal over-capacities. Lufthansa demonstrates the value of such thinking. Its main hub in Frankfurt serves as a 360-degree hub with worldwide coverage. The airline’s acquired hub operations in Zurich, Brussels and Vienna are (or soon will be) sized to the local catchment demand.

Financial freedom of action As mentioned earlier, the airline industry is highly cyclical. Managing through eco-nomic downturns is key. In this regard, high-performance airlines also distinguish themselves by adopting different strate-gies according to their business model (see Figure 4). Hub carriers demonstrate a strong capital basis by operating at a gearing level that is nearly a quarter of that of their peers. High performers among the low-cost carriers, in contrast, rely on high cash reserves. For example, Ryanair’s cash reserves equal the size of the com-pany’s annual sales. These reserves serve as a buffer against economic downturn and a source of future growth.

Figure 4. High-performance airlines enjoy financial freedom to act.

High performers hub carriers

Source: Accenture Analysis.

Average gearing 2001–2007(debt /equity ratio)

US peersNon-US peersHigh performers low-cost carriers

x3.8

3.5

0.91.7

30.5

Source: Accenture Analysis.

Average cash reserves 2001–2007(cash/revenue ratio)

Peer SetHigh performers

16%

42%

Distinctive capabilities

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Accenture’s research has identified performance anatomy as the third building block of high performance. Performance anatomy refers to the unique way companies manage common business elements rela-ted to culture, leadership and the work force. Among high-performance airlines, performance anatomy is driven by a leadership culture that not only places a premium on win-ning and retaining the best talent, but also encourages innovation and promotes entrepreneurship among teams.

In terms of talent management, LAN has launched a number of initiatives to attract promising young candidates to join the company, build skills among existing workers and provide selected employees the financial support necessary to pursue outside training and education. To retain the best people, the airline even provides scholarships to family members of employees for vocational training courses.

When it comes to creating a culture of innovation and entrepreneurship, no one in the airline business does more than easyGroup, the owner of the easy brand. Formed in 1995, easyJet was the first of many easy companies currently in exis-tence to adhere to a common principle: the fewer frills a product or service has, the cheaper it will be. Today, there’s easy-Internetcafé, which has grown to become Europe‘s largest chain of Internet cafés. There’s easyBus, which offers a low-cost

express minibus service between central London and Gatwick, Stansted and Luton airports. Their no frills super budget easy-Hotel has operations across London and in select European and Middle Eastern countries. There’s even easyPizza, a deliv-ery-only pizza company launched in 2004. The easy model for success is any-thing but. It’s about more than creating a different business. It is about transferring best practices and enabling the whole group to evolve and improve efficiency and customer satisfaction. It is also about having strong and visible leaders who act as a brand and value symbol to workers.

Performance anatomy

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The immediate future for airlines will be shaped largely by how well they cope with the current econom-ic crisis. Accenture believes that high-performance businesses will use the current economic downturn to their advantage. That is, they will use this time of instability and flagging revenue to capitalize on their competitors’ weaknesses. The most successful carriers will do four things right:

Manage growth High-performance airlines teach that winning and retaining revenue growth premium has been the major strategic objective for multihub and low-cost carriers in years past. Yet, with the mid-term industry outlook, achieving profit-able growth will be harder than ever. Passenger traffic is expected to decline. Fuel costs are expected to rise again above the early-2009 level. Emissions trading schemes will be introduced, placing new and additional pressures on a carrier’s bottom line.

Also, with record aircraft deliveries expected in the next few years, price competition will surely become more intense. The infusion of record-capacity of A380s in the Middle East and smaller B787s with the potential to establish more point-to-point intercontinental ser-vices between medium-sized cities will transform traditional hub traffic flows. Against this backdrop, high performers will be those that dominate their home

markets, create the right balance between demand and capacity, build a competitive culture and effectively pursue secondary revenue sources.

Excel in customer relationship management Many airlines believe that transporting passengers to their destinations safely and serving food and beverages along the way is all that is needed to generate cus-tomer loyalty. This extremely limited approach to customer relationship man-agement does little to drive customer loy-alty—even in the best of times. With air-lines facing stiffer competition and a global economic downturn, prudent cus-tomer-centric investments in marketing, sales and distribution are critical, as is understanding passengers’ needs and preferences along the entire value chain of travelling—from pre-book planning to services upon arrival.

Looking ahead

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The immediate future for airlines will be shaped by how well they cope with the current economic crisis. Over the long-term, however, we believe those carriers that demonstrate the characteristics presented in this report will continue to achieve high performance. In short, the manner in which they build market focus and position, distinctive capabilities and performance anatomy will ultimately separate the high-performance airlines from their peers.

Accenture believe there is tremendous opportunity for airlines to strengthen their customer interactions, given that customer relationship management in the industry, as a whole, has seen little advancement since the introduction of the frequent flyer programs in the 1990s. Those airlines that learn how to access, analyze and use customer data beyond frequent flyer enrollments will be well placed to improve customer loyalty, cap-ture others’ customers and build new markets around the world.

Supercharge their efforts to achieve operational excellence Amid the steady stream of challenges associated with cyclicality, intense com-petition and high capital costs, carriers have become used to activating and fol-lowing a standard set of temporary crisis measures to deal with ordinary economic downturns. Today’s global recession is anything but ordinary. Normal tactics that have been used to achieve or main-tain operational excellence will no longer

suffice. Drastic action is needed. Efficien-cies must be achieved wherever possible. Costs must be cut by, at minimum, 10 percent, and business models must be designed with long-term sustainability and adaptability in mind. To achieve these goals, airlines will need to examine every opportunity to optimize their costs. Out-sourcing non-core activities and imple-menting innovative lead-buyer programs are just two concepts that should be con-sidered.

Focus on sustainability In the coming years, sustainability will be more than a cost issue; it will be a com-petitive lever. An airline’s CO2 emissions, reported with bookings, will play an important role in consumers’ purchasing decisions. This is because customers increasingly prefer to support companies that demonstrate a commitment to envi-ronmental, economic and social sustain-ability. Along with customers’ perceptions, regulatory requirements will soon prompt airlines to take action. The European

Union, for example, is looking to reduce CO2 emissions by 46 percent by 2020. As part of this EU initiative, all flights to and from Europe will require emissions trading scheme (ETS) certificates beginning in 2012, with ever-greater CO2 reductions expected there after. In this environment, ETS certifi cates will hold as much com-petitive importance as airport slots. An airline’s growth will depend, largely, on how well it navigates a path toward sus-tainability.

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About Accenture Accenture is a global management consulting, technology services and outsourcing company. Combining unpar-alleled experience, comprehensive capa-bilities across all industries and business functions, and extensive research on the world’s most successful companies, Accenture collaborates with clients to help them become high-performance businesses and governments. With approximately 177,000 people serving clients in more than 120 countries, the company generated net revenues of US$23.39 billion for the fiscal year ended Aug. 31, 2008. Its home page is www.accenture.com.

ContactsFor more information on achieving high performance in the airline industry, please contact: Guido HaarmannGlobal Managing Director, Airlines+49 89 93081 68617guido.haarmann@accenture.com

Peter BaumgartSenior Manager+41 79 540 5303peter.baumgart@accenture.com

Marcus FrommSenior Manager +41 44219 5940marcus.fromm@accenture.com