The Airline Industry: Challenges in the 21st Century

185 Pages·2009·4.93 MB·English

by  Alessandro Cento (auth.)

The Airline Industry
Alessandro Cento
The Airline Industry
Challenges in the 21st Century
Physica-Verlag
A Springer Company
Alessandro Cento
KLM Royal Dutch Airlines
Via Modigliani 45
20090 Segrate (MI)
Italy
[email protected]
ISBN: 978-3-7908-2087-4 e-ISBN: 978-3-7908-2088-1
DOI: 10.1007/978-3-7908-2088-1
Contributions to Economics ISSN 1431-1933
Library of Congress Control Number: 2008932181
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Preface
The debate on the future of the aviation sector and the viability of its traditional
business practices is the core of this book. The liberalization of the EU market in
the 1990s has radically modified the competitive environment and the nature of
airlinecompetition.Furthermore,thenewmillenniumbeganwithterroristattacks,
epidemics,tradeglobalization,andtheriseofoilprices,allofwhichcombinedto
pushtheindustryintoa“perfectstorm”.
Airlineindustryprofitabilityhasbeenanelusivegoalforseveraldecadesandthe
recenteventshasonlyaccentuatedexistingweaknesses.Themainconcernofindus-
tryobserversiswhethertheairlinebusinessmodel,successfulduringthe1980sand
1990s,isnowsustainableinamarketcrowdedbylow-costcarriers.Theairlinesthat
will respond rapidly and determinedly to increase pressure to restructure, consoli-
dateandsegmenttheindustrywillachievecompetitiveadvantages.Inthiscontext,
the present study aims to model the new conduct of the ‘legacy’ carriers in a new
liberalizedEuropeanmarketintermsofnetworkandpricingcompetitionwithlow-
costcarriersandcompetitivereactiontotheglobaleconomiccrises.
ThecurrentevolutionoftheaviationsectorinEuropecanbedescribedinterms
ofthecombinationoftwomainfactors:(1)theliberalizationprocesswhichbeganin
theEUduringthe1990sandthesucceedingboomofthelow-costcarriers.Thishas
changedthenatureofcompetition,asnewentrantsorpotentialentrantshavediffer-
entbusinessmodels,especiallyconcerningthenetworkorganization;and(2)theset
ofspecificexogenousfactorssuchasterrorism,epidemics,tradeglobalization,and
theriseofoilprice.
Thetraditionalmodelthatwassuccessfulduringthe1980sand1990sisevolving
in a market where there is fierce competition from the low-cost carriers. The low-
cost carriers have had a serious impact on the airline industry, but the extent and
nature of this effect have been largely regionalized. The concept of ‘low-cost car-
rier’originatedintheUnitedStateswithSouthwestAirlinesatthebeginningofthe
1970s.InEurope,theSouthwestmodelwascopiedin1991,whentheIrishcompany
Ryanair, previously a traditional carrier, transformed itself into a low-cost carrier
anditwasfollowedbyotherlow-costcarriersintheUK(e.g.easyJetin1995).In
theliterature,thereareseveralsimilardefinitionsofalow-costcarrier,alsoknown
vii
viii Preface
as a ‘low fare’ or ‘no-frills’airline, which is described by core characteristics that
seemtobecommontothemajorityofthelow-costmodels.Thesearehighaircraft
utilization;Internetbooking;useofsecondaryairports;minimumcabincrew;lower
wage scales; lower rates of unionization among employees; one class of seating;
short ground turn-around times; no cargo carried; very simple fare structures and
pricestrategies;adoptionofstrictyieldmanagementtechniques;e-ticketing;often
noseatallocation(forfasterboarding);nofrills,i.e.thepassengershavingtopayfor
foodandbeverages;noconnections;point-to-pointservices.Itshouldbenotedthat
thisincreasedcompetitionintheaviationsectorledthetraditionalairlinestoadopt
someofthecharacteristicsofthelow-costairlinesinanattempttobettersurvivein
thisnewderegulatedenvironment.
This book represents arevised version of myPhD thesis.The originaldecision
to start researching the observed phenomena in airline economics was based on
two motivations: my passion for aviation and the great positive influence of a few
outstanding persons whom I have met during the course of my life. My passion
for aircraft and flying began as a childhood dream, and today in writing this book
I am still living the dream. First, I would like to thank Prof. Aura Reggiani. She
introduced me to the international academic arena by offering me the opportunity
to work at the University of Italian Switzerland in Lugano. With her intellectual
stimulationandpragmaticandtenaciousattitude,sheconvincedmetopublishmy
thesisasabook.
Aura also introduced me to Prof. Peter Nijkamp and Prof. Piet Rietveld. They
agreedtopromotemythesisdespitemybusyagendawithKLMRoyalDutchAir-
lines, and I could not have had better supervisors. I would like to thank Peter and
Pietforthestyle,qualityandefficacyoftheirsupervision.Ateverymeetingorwork
sessionandinemails,theyneverforgottoaddinspiringandencouragingwordsto
theirindescribableprofessionalismandscientificknowledge.Eventheirtacitcriti-
cism was motivating and aimed at getting the best out of me. I was impressed by
Peterbecause,injusttwolinesofcomments,heidentifiesandsolvesissues,andby
Pietbecauseheisalwaysrightwhencommentingonmathematicaloreconometric
models.
Dr.MarcoAlderighiofMilanBocconiUniversityandValleD’AostaUniversity
was a great help. He closely followed all my work and contributed actively. His
intuitions,innovativeideasandcollaborationhavemademythesisabetterwork.I
considerMarcooneofthemostintelligentyoungresearchersIhaveevermetinmy
life.Aboveall,IhavefoundafriendwhomIwillneverforget.
KLM Royal Dutch Airlines has been my employer for the last eight years and
hasprovidedmewiththefacilitiestofinalizethebooksuccessfully.Inparticular,I
wouldliketothankAntonvanDasler,DomingoDeCola,HesterBruijninckx,Peter
Bootsma, Paul Gregorowitsch, Just Kerckhoff, Toon Balm, Harm Kreulen, all the
staff at the Revenue Management Department in Amstelveen, and my colleagues
intheKLMItalianoffice,fromwhomIhavelearnedthebestbusinesspracticesof
the airline industry and some of the “secrets of KLM success”. A ‘thank you’ to
PatriciaEllman,whotookcareoftheEnglishcorrectionwithincrediblespeedand
quality.ThanksalsotoDr.EricPelsandDr.OlivieroBaccelliwhoofferedmethe
Preface ix
opportunitiestoorganizeafewworkshopswiththestudentsoftheFreeUniversity
ofAmsterdamandMilanBocconiUniversity.
Finally,Cristina,mylove,andourchildrenMarco,EsterandLuca.Wordsarenot
enoughtodescribethestrengthyouwereabletogiveme.Therewereuncountable
nightsandweek-endswhenIcouldhearCristinasingingalullabytoourlittleones
whileIwasbusywritinganewsection.Aspecialthankyouforyourpatienceand
yourfaithinme,thathelpedthisflightarriveatitsfinaldestination.
Milan,Italy AlessandroCento
12May2008
Contents
PartI TheAirlineIndustryinPerspective
1 Introduction................................................... 3
1.1 The‘OldIndustry’.......................................... 3
1.2 The‘NewIndustry’......................................... 5
1.3 TheObjectiveofthisStudy .................................. 8
2 CharacteristicsoftheAirlineIndustry............................ 13
2.1 Introduction ............................................... 13
2.2 MarketDeregulation........................................ 14
2.3 TheOpen-SkiesAgreementbetweentheEUandtheUS.......... 16
2.4 AirlineBusinessModels..................................... 17
2.4.1 Full-ServiceCarriers ................................. 18
2.4.2 Low-CostCarriers ................................... 19
2.4.3 CharterCarriers ..................................... 21
2.5 CompetitionbetweenBusinessModels ........................ 22
2.5.1 FSCAimingforHigherCost-Efficiency ................. 25
2.5.2 TheRiseinFuelPrices ............................... 27
2.6 AirlineNetwork............................................ 29
2.6.1 NetworkEconomics.................................. 29
2.6.2 NetworkManagement ................................ 30
2.6.3 NetworkDefinitions.................................. 31
2.7 Pricingand‘Yield’Management.............................. 33
2.7.1 TheFSCYieldManagement........................... 33
2.7.2 TheLCCYieldManagement .......................... 36
2.8 AirlineAlliances ........................................... 38
2.9 MergersandAcquisitions;ThreeMega-CarriersinEurope? ....... 41
2.10 Conclusions ............................................... 42
xi
xii Contents
PartII CopingwithCrisesintheAirlineIndustry
3 Short-andLong-TermReactiontoExogenousDemand
Shifts ......................................................... 47
3.1 Introduction ............................................... 47
3.2 ExogenousDemandShifts:TheAmericanandAsianCrises....... 49
3.2.1 TheSeptember11TerroristAttack...................... 50
3.2.2 TheSARSEpidemic ................................. 52
3.3 TheoreticalModel.......................................... 54
3.4 Results ................................................... 60
3.5 Conclusions ............................................... 61
4 TheAirlinesConductduringtheCrisesof2001/2003............... 63
4.1 Introduction ............................................... 63
4.2 EconometricAnalysis....................................... 63
4.2.1 TheDatabase ....................................... 64
4.2.2 EmpiricalModel..................................... 65
4.3 Results ................................................... 69
4.4 Conclusions ............................................... 73
PartIII TheRiseofLow-CostCarriers
5 EffectsofLCCEntryonPricinginAviation....................... 77
5.1 Introduction ............................................... 77
5.2 PricingModelsforDifferentMarketStructure .................. 78
5.2.1 YieldManagement................................... 78
5.2.2 TheoreticalFramework ............................... 79
5.2.3 Monopoly .......................................... 82
5.2.4 SymmetricDuopoly.................................. 82
5.2.5 AsymmetricDuopoly................................. 83
5.2.6 ExtensionandGeneralOutcomes....................... 85
5.3 EvidenceonPriceSettinginEurope........................... 87
5.3.1 TheDatabase ....................................... 87
5.3.2 Results............................................. 90
5.4 Conclusions ............................................... 94
6 NetworkCompetition:TheCoexistenceofHub-and-Spoke
andPoint-to-PointSystems...................................... 95
6.1 Introduction ............................................... 95
6.2 TheTheoreticalModel ...................................... 96
6.2.1 ThePricingRule..................................... 98
6.2.2 TheEquilibriumoftheGame ..........................100
6.2.3 AlternativePricingRules..............................102
6.3 Conclusions ...............................................104