CAPA Report: Technology and consumer awareness to disrupt the global aviation market

The recently launched CAPA Report has given a detailed insight into the changing dynamics of the global aviation market. One of the noteworthy assertion of the report points towards a major disruption in the current market trends, which will, primarily, be driven on the back of rising consumer awareness and technological assimilation in the process of buying and selling tickets. Excerpts of the report:


Disruption in the airline industry. It will happen sooner than we think

There are two essential elements to the airline industry: flying aeroplanes and selling (and buying) seats. More technically this can be described as (1) operational; and (2) marketing and sales. There are other important activities, such as lobbying government to limit competition, and exploiting frequent flyer programmes, but those two are the core activities now facing disruption. The former is unique to airlines, is uniquely regulated and engages massive governmental regulatory intervention, technical and economic. The marketing and sales activity has some aspects particular to aviation, but generally differs little from any other form of retail – except that most older airlines have tended to be particularly slow at learning the art. This analysis reviews the nature and degree of disruption in each core area and what potential the future holds. In the regulatory area, China will be the big disruptor as it expands into its new global role; and technology and the associated rise in consumer empowerment will transform the process of buying and selling tickets. It will happen sooner than we expect.

Addressing the ecosystem of creative disruption

The Bank of America Merrill Lynch recently identified “three ecosystems of creative disruption”: the “Internet of Things is expected to be a USD7 trillion industry by 2020, the Sharing Economy has a potential market opportunity of over USD450 billion, and local consumer On-Line Services has a potential market opportunity of USD500 billion. These ecosystems are the catalysts for creative disruption”, it argued. “They reduce barriers to entry for a new business down to imagination and the ability to maximize the ecosystem; they allow companies to improve productivity, reach new customers, introduce products and services faster than ever before; and they level the playing field between large, small and new companies, redefining competitive advantage.”

Against this scenario, airlines have remained largely un-disrupted this century, while all around them has changed. This review argues why that status quo is likely to change profoundly. It will first address the regulatory system and why that will change, in large part due to the emergence of China, and then assess the parallel and complementary role of data analytics, personalisation and consumer empowerment. 

As the two coincide, the outcome will be unexpectedly disruptive.

PART I. The undoing of bilateral airline regulation

Market entry to the airline industry remains relatively easy, with low capital needs; but market exit by incumbents is remarkable for the little that has occurred. Whether protected from destruction by power inside a sealed-off domestic market, by bankruptcy laws allowing costs to be artificially discarded, by regulatory protection internationally or by direct subsidy, the fact remains: market exit by legacy incumbents has been much more the exception than the  rule. Yet that is starting to change. The process of natural selection is slow, but accelerating.

For decades, operating aircraft was really the main activity of the industry, where engineers ran airlines. In the case of legacy airlines (that is, companies that existed prior to this century and perform full service operations), the silo nature of this operating vs selling distinction has been perpetuated across the company, much to the disadvantage of the airline, as customer relations and data analytics become increasingly important.

Economic and Safety regulation are endemic, but one is more necessary than the other 

Operationally there are, in turn, two forms of regulation: safety and related, and economic. Little needs saying in the area of safety regulation, although because of its overriding importance, safety’s untouchable halo can sometimes be a useful weapon for those wishing indirectly to impose economic restrictions – as in the case of US pilot unions opposing the operations of Norwegian International across the North Atlantic.

There they creatively argued among other things that “flags of convenience” were just around the corner (and therefore a loss of safety oversight) if Norwegian were allowed to operate from Ireland. Reality promises otherwise, but it was sufficient to send the US Department of Transportation (DoT) and Department of State (DoS) into lengthy hibernation.

It is the economic regulation that is so overweening as to be a destructive force, quite opposite to its original purpose. A main reason that an economic regulatory system established in 1945 can still exist in 2016 is the constant intrusion of nationalism. Moving from a mentality of “flag carriers” and all the nationalistic features that evokes inevitably takes time.

Legally, the foundation is in the need for bilateral approval of air services and the persistent requirement for “substantial ownership and effective control” to reside in airlines designated to operate under these agreements. 

Surprisingly, the bilateral system will change fundamentally by 2025.

Despite decades of inertia, new forces are at work, operationally and commercially that are coming together to disrupt the airline industry. From a range of sources, momentum has been building that signals the potential for a remarkable evolution in international ownership restrictions. 

The starting point is with the underlying currency of the bilateral trading system: travellers. That is, ownership of market potential inside “our” boundaries and the fact that “our” travellers spend money with you. We will, so the principle is applied, give you a limited licence to exploit a little of “our” market internationally – provided you have something to offer in return. Meanwhile we will of course prevent you from operating within our domestic market. In other words, the rich and powerful call the shots – that’s mostly how international law works.

It has been called mercantilism, an elaborate description for something that amounts to a crude tit-for-tat trade. It’s only through a (very slowly) emerging rationalisation of the economic impact of aviation and of passenger convenience that even sixth freedom airlines have been granted market access – despite their lack of that trading currency. More to the point, they were “granted”that right only because it became too difficult to prevent them from exercising it. That is disruption.

When implemented, this process is called liberalisation. Sometimes it is consensual like open skies agreements. These are fragile shoots and still essentially bilateral, remaining limited by the restrictive principles of ownership and control outlined above.

The airline industry – how regulation has strangled management innovation

There can be nothing more certain than that the century old airline industry is ripe for disruption. And that it will happen, perhaps catastrophically and perhaps in the next downturn.

That it has not occurred more comprehensively already is due to a range of interlocking factors: it is nationalistic (and iconic); it is heavily regulated – from safety to commercial operations to consumer interests; it is entrenched in multiple supply chains, visible and virtual; it attracts high levels of capital investment, with major vested interests keen to retain the status quo; and, above all, it is largely lacking in the agility to think (or move) outside the box.

The latter assertion is perhaps a little unfair. There are many extremely imaginative minds in the airline business (as well as many which are not), but the ability actually to move beyond certain limits is heavily constrained by a myriad of regulation and nationalistic inertia. No other industry of its size and scope is constrained by the inability to consolidate, or is excluded from operating within foreign countries.

These restrictions impact more widely than their direct effects; they tend to strangle innovation. It is likely the sheer inertial impact of regulation that delayed the introduction of low cost carriers for so long. Restrictions on market entry internationally and the impact of market dominance in many domestic markets generate complacency and inaction; it is only the heat of competition that spurs innovation.

How obvious is it in retrospect that flying an aircraft for more than eight hours a day could dramatically lower costs? This in an industry that is burdened by capital costs; yet increasing that utilisation by 50% reduces by one third the number of aircraft an airline needs to buy.

And then, instead of the LCC exploiting its cost margin to the full, it applies a strategy that stimulates further growth; there are many features of the low cost model that are inconsistent with the strategies often-complacent or union-confined incumbents. 

Prior to the spread of LCCs, the often heard logic was that improving yields was a much more effective way of generating profits than reducing costs; all it needed was more market “discipline”. That is the sort of complacency bred by regulation and artificial barriers to entry. Certainly it is the margin that counts; but a common goal today is to strive to have the lowest, or near lowest, cost in the particular market.

Disruption in the airline industry. It is coming, faster and bigger than you think?

It is notable that airline liberalisation has scarcely been driven by overt consumer pressure. Instead it has been a handful of influential and enlightened governments who, recognising the flow-on economic benefits, have promoted aviation liberalisation in the wider national (and global) interest.

In fact, with some exceptions, airline consumers have in general received a good deal over the past 40 years, in terms of low fares and good product, a result of the combination of regulatory change and of airlines prepared to exploit it effectively. LCCs and the Gulf airlines have played a major part in that.

The consumer is becoming a major disrupter 

That said, the broader consumer movement, strongly supported by airports and by technology and sharing economy innovations, is becoming an increasingly powerful disruptive force.

Add to that the growing power of third parties who are able to aggregate travel, “personalising” it and, as we shall see later, the consumer will rule the world.

Do airline managements get retail yet? They often know the words, but do they feel it?

This is not an issue confined to the airline or travel industry. Traditional retail generally is in crisis. The cause is not simply online competition, although that has accelerated the swift changes; it is mostly that managers just lost sight of what their existing and potential customers wanted to buy and how.

For a generation of managers who have grown up focused on “push” not “pull”, the system – and their thinking – is often out of tune with the increasingly influential role of (i) personal recommendations; and (ii) mobile transparency. 

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