Indian air carriers have their hands full as the rapid growth in domestic air travel adds to the strain on the country’s aviation infrastructure and rising fuel prices cut into profits.
The pressure is telling: Last month, India’s biggest domestic airline, Jet Airways, reported its first loss in five quarters despite carrying more passengers. Competitor SpiceJet, too, is hurting from higher energy costs, reporting that its net profit in the October-December quarter dropped 23% year-on-year.
Beyond these pressing issues, however, lies one of the biggest operational challenges that airlines confront: how to manage complexity. For most carriers, their effectiveness in managing complexity spells the difference between profitable growth and declining profits.
This problem looms large in the airline industry. For most other consumer purchases—everything from shampoo to autos—typically one-third of customers buy on price, one-third on quality and one-third on brand. But airlines have long been an anomaly. Bain and Co. research shows 85% of all leisure passengers buy tickets based primarily on price. Business passengers buy largely on price and schedule— and only about 15% are loyal to a brand when the competing price is close.
This hypersensitivity of air travellers towards price puts pressure on carriers to differentiate from the competition by adding more services that passengers value. Many airlines prefer to offer these additional services over cutting costs, as it is easier to do. But this can backfire: With each new service, an airline risks increasing the complexity of its operations, which can send costs spiralling out of control. In our experience, companies can reduce costs by as much as 35% and increase sales by up to 40% by mastering the “innovation fulcrum”—the point between service variety and operating complexity.
Selected services—at a price: Some international airlines are now discovering that by offering a no-frills base fare and adding back optional services for which passengers are willing to pay, they can give customers what they value while keeping operating costs in check and improving growth.
Australia’s Virgin Blue is the master of the innovation fulcrum. The low-cost carrier offers the lowest possible base fare, but charges extra for everything from food to seats in the front or exit rows, which it has renamed the “Blue Zone”. For example, on flights between Sydney and Perth, travellers can pay Australian dollars (A$) 15 extra (around Rs560) for movies or A$30 extra to sit in the roomier Blue Zone seats. Its Velocity loyalty programme is also simplistic, offering passengers six points for every dollar spent. Such programmes are helping the carrier, Australia’s second biggest airline, attract high-value business customers. Last year, it launched its premium economy section for passengers ready to pay more than for regular economy, offering them two wider seats abreast with a table in between. But like other airlines, Virgin Blue has been affected by high fuel costs: It reported in February its first-half profit fell 8.8% to A$113 million.
Find new revenue streams: For its part, American Airlines discovered a way to create a new revenue stream while improving seat management. For a $25 fee, US and Caribbean passengers without a fully refundable ticket can purchase the right to confirm a seat on an earlier or later flight on the day of departure. It’s a convenience for passengers. And for the carrier, the service solves multiple problems: It ensures a particular seat is filled, gives the airline advance notice for reselling seats that are vacated, and opens up seats for people who will pay higher fares. The offering has been a notable revenue generator.
Other airlines in different countries are innovating speciality services without increasing complexity. El Salvador’s TACA airlines has branded itself as the baggage-friendly carrier. After reducing labour inefficiencies and boosting operating margins, the airline found it still needed to generate additional revenues to stay afloat. The solution: Adding a service that was highly valued by its customers. Many of its passengers are US residents, bringing excess baggage to family or friends in Latin America. Travellers told the airline they were willing to pay extra to stow them aboard. While many carriers refuse to take odd-sized or overweight baggage, TACA now welcomes those objects—for a fee. Combined with the cost-cutting, the new policy has helped TACA’s profits rise to make it one of the most profitable airlines in the Americas. TACA’s strategy may interest Indian airlines which often have to deal with passengers carrying excess luggage.
With these new business models, airlines are hoping to establish a distinctive brand, one that makes passengers less price-conscious.
That is the success of Hertz, the car rental company with the largest market share worldwide, despite the fact its prices are often the industry’s highest. Hertz has found the balance between offering desired extras without adding major costs and complexity. It provides covered parking lots, locations close to the airport, and the perception that its employees speed customers through the rental process. This has helped build Hertz’s phenomenal branding success that saw its fourth quarter net profit double to $81 million on greater car rental revenues
Airlines can achieve such results, too, and cope with the impact of rising fuel costs by stripping their services down to the bare bones and then carefully adding back those services—and only those services—that customers want and are willing to shell out for.
Ashish Singh is managing director of Bain & Co., India. Dave Emerson is the head of Bain & Co.’s Global Airline Practice. Nikhil Raghavan is a manager in New Delhi office.
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