Authored by Isaac Teoh
Edited by Jing Wen Soh
TURBULENCE: ENTERING THE AFTERMATH OF A GLOBAL PANDEMIC
Faced with an unprecedented global pandemic and economic recession, the aviation industry has been battered by a sharp decline in travel demand and prolonged travel disruptions[1]. In 2020, this translated to a reduction of approximately 2.88 billion passengers and an industry loss of USD 390 billion of gross passenger operating revenue[2].
Airlines have turned into crisis-prevention mode with the immediate strategic objective of cost-cutting to reduce cash burn and improve their liquidity. Conflict between airlines, governments and labour unions are centred between the struggle to secure financial assistance, placate shareholders, and protect livelihoods. While domestic air travel has been gradually recovering in areas such as China, international travel which is dependent on the absence of sporadic outbreaks to maintain travel corridors will recover at a slower pace[3]. Moreover, the decline in household spending due to recessionary conditions are likely to drive a re-segmentation of air travel markets. Expect an intensification of price competition for a shrinking tourist dollar, with low-cost carriers and other airlines with strong cost advantages likely to emerge strong.
As Schumpeter mused, “every day, firms are born that cannot live”. The aviation industry has entered a period of market consolidation, as the different financial positions of airlines entering the crisis and differing levels of government support will influence the overall market structure of the industry. The latter depend on the strategic value of airlines, especially national carriers, to the countries’ long-term economic objectives and the consequent process of governments selecting champions.
...decline in household spending due to recessionary conditions are likely to drive a re-segmentation of air travel markets...
A notable example involves Malaysia’s state fund, Khazanah, threatening to withdraw funding to Malaysia Airlines in the event of unsuccessful restructuring talks with aircraft lessors. However, Malaysia Airlines has been struggling after the two disasters involving the downing of MH17 and MH377 prior to the pandemic. This suggests that airlines enjoying a strong financial position entering the crisis are likely to emerge stronger, and vice versa. Movements by Korea Air to acquire debt-laden Asiana Airlines is part of eliminating unnecessary competition and driving room for future growth. Despite continued uncertainty, there is some optimism of clearer skies ahead and sound growth opportunities.
Some of these opportunities include the alleviation of excess market capacity, which may prevent the oversaturation of markets. However, as the prices of airplane leases are depressed and the recent trends towards the liberalisation of air travel has lowered the barriers to entry, the air travel industry is likely to remain competitive and contestable.
TECHNOLOGICAL DISRUPTION AND CHANGE IN THE AVIATION INDUSTRY
Before the onset of a global pandemic, there are underlying forces that have been influencing travel patterns for both tourists and businesses. Some of these trends involve the growth of increasingly close substitutes to compete with air travel, including tele-conferencing and the expansion of high-speed rail networks across Europe and Asia. The pandemic has accelerated the growth of tele-conferencing as businesses shift their operations online due to lockdown restrictions and border closures hindering international travel. Approximately 43% of businesses intend to travel less after the pandemic, due to a combination of a successful transition in business operations, a stronger exercise of fiscal prudence and health concerns. Nevertheless, essential travel cannot be replaced due to the need for firms to travel to maintain client relations and demand is likely to grow in emerging markets.
Other sub-trends include a decrease in spontaneous trips due to the administrative requirements for health screenings which the travel industry has lobbied intensively to streamline, and a consequent increase in the popularity of travel advisors to provide convenience for travellers. However, this provides an opportunity for airlines to continue their build-up of digital capabilities to improve flight demand management. This can be achieved through data sharing agreements with travel advisors and airports.
Approximately 43% of businesses intend to travel less after the pandemic, due to a combination of a successful transition in business operations, a stronger exercise of fiscal prudence and health concerns.
ENTERING UNCLEAR SKIES: BEYOND PARIS?
In the context of the Paris Agreement in 2015, governments have committed towards realising ambitious environmental targets through meeting nationally determined contributions. Introducing environmental regulations is a logical part of the process: aviation accounted for 2.5% of global CO2 emissions in 2019 and is expected to grow to 3.5% in 2030[4].[5]
Beyond pressure from regulators, airlines are faced with demands from consumers who are increasingly vocal about their desire for more sustainable travel. These include protests against activities, ranging from the construction of a third runway in Heathrow airport, to Greta Thunberg’s flight shaming movement in Sweden which has resulted a contraction of the number of international flights in Swedish airports by 4% in 2019[6]. Across Europe and Asia, respondents claim to fly less due to climate concerns[7].
Environmental claims by businesses attract intense scrutiny and are sometimes responded with accusations of greenwashing if the claims are perceived to not be credible in the absence of third-party accreditation. EasyJet’s internal market research suggested that 72% of customers are more likely to purchase based on the knowledge of carbon offsetting action taken by the carrier, which means that sustainable travel is deemed desirable.
Although consumers desire the growth of sustainable travel, it is not matched by the willingness to pay and actual changes in their consumption patterns. It is harder for airlines to command a price premium from customers for sustainable travel, which is only exacerbated by decreased incomes in a recession.
Beyond pressure from regulators, airlines are faced with demands from consumers who are increasingly vocal about their desire for more sustainable travel.
On the other hand, it is difficult for airlines to shift the responsibility to consumers through introducing voluntary carbon offset schemes, in accordance with terms under ICAO’s Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) agreement. To continue the path of embracing sustainable travel, airlines must strengthen their cost advantages to further incorporate sustainability as part of its value proposition to consumers.
FINDING THE IDEAL FLIGHT PATH: STRATEGIES TO RISE ABOVE
Corporate Diversification and Brand Focus: Recognising growth and value
The ongoing movement towards corporate diversification is a strategic move to leverage on the airline’s core competencies applicable to the travel, lifestyle, and service industry. During times of uncertainty, the ability to secure alternative sources of revenue is vital in risk management and responding to the inherent volatility in the aviation industry, which includes avoiding the thorny issue of short-term cash flow problems.
If airlines can develop existing or new core competencies through diversification, it places them in a strategically advantageous position to respond to future developments, forming the bedrock of a long-term sustainable growth strategy. A minor possibility is that if future growth in the aviation industry remains lacklustre, then diversification opens a pathway towards an asset-light business model through divestment.
We recommend that airlines expand their presence in sectors that are resilient to adverse macroeconomic shocks are likely to enjoy an immediate rebound, especially in the areas of online retail and healthcare services. However, individual airlines must identify the core competencies that they possess or desire to acquire, looking out for critical opportunities for generating internal networks effects and technological leapfrogging. Note that this needs to be aligned with the airlines’ long-term strategic outlook.
However, diversification into red oceans and shifting the core focus on the airline can bring about known challenges, which AirAsia Group is currently facing after its digital lifestyle segment is struggling to become profitable amidst stiff competition from existing players. Surviving or prospering in these waters require utilising their existing firm-specific resources, such as harnessing passenger data[8] to better understand consumer behaviour. These are long-term strategic moves which require time and commitment. Moreover, the ability of airlines to diversify is dependent on shareholder interests, such as national carriers with restricted autonomy.
Moreover, the relentless pursuit of alternative revenue streams amidst lacklustre demand conditions should be cautioned against. Short-term revenue streams, while attractive, may have longer term costs on harming brand image and the brand’s positioning over the longer term.
...airlines expand their presence in sectors that are resilient to adverse macroeconomic shocks...
Case Study: Flights to nowhere
The marketing departments in airlines have introduced innovative solutions to secure alternative revenue streams, to maintain a strong brand presence and tap into latent travel demand caused by the continued imposition of travel restrictions restricting international travel. These include flights having identical destinations as the origin. More creative versions include Taiwanese airline Eva Air to include speed dating on flights as a means of continuing to engage the public and garnering additional interest as a novelty[9].
Korea estimates that the adoption of “flights to nowhere” will generate an additional USD 4.3 million in annual revenue which is crucial to limiting unemployment in the aviation and retail sector[10]. For airlines with little financial support and limited ability to raise external capital, the revenue may be insignificant but will be crucial in protecting the interests of protecting jobs and to remain solvent.
However, under scrutiny from environmental activists and the public, some airlines have been hesitant or dissuaded from pursuing similar activities. It is likely that in countries with stronger environmental groups and a more environmentally conscious public, the negative effects on brand image are harder to reverse. Not all publicity is good publicity.
Consequently, Singapore Airlines (SIA) has decided against such flights amidst the polarisation of its consumer base. The limited revenue that it will generate is far outweighed by the irreversible damage that it will cause to SIA’s goal to continue to position itself as a global airline. Avoiding these “flights to nowhere” is part of a strategic move to avoid association with excess and preserve its image as a sustainable, global-oriented airline. The company has sourced alternative revenue streams, including providing luxurious home catering and creating an academy offering service training to companies[11].
Therefore, airlines need to understand their own core competencies in crafting their own approaches to diversification. In the absence of strong firm-specific advantages, smaller airlines may struggle in diversification.
Expanding Freight Capabilities and Fleet Management
Compared to the significant decline in passenger revenue, the 8% growth of cargo revenue in airlines cements its status as a crucial source of revenue and as an irreplaceable service during a pandemic. Airlines have been expanding their expertise in transporting specialised goods, such as perishables and medical goods, which will further integrate the aviation industry into sustaining the growth of emerging global value chains. Beyond the immediate opportunity of transporting COVID vaccines[12], expanding air freight capabilities can help airlines promote business growth through connecting cargo hubs.
To respond to the surge in demand for air freight and improve fleet utilisation, airlines have tried to utilise both the belly-hold cargo area and passenger cabin to store cargo in passenger aircraft. In the short-term, airlines are likely to prioritise aircraft models that provide flexibility or contain larger belly-hold capacity in their purchases and lease agreements.
Hence, over the medium-term, airlines are likely to place a stronger premium on flexibility over strategic value of direct aircraft ownership. We further expect airlines to employ leaner fleets and lease a large proportion of their aircraft, which will result in improvements in fleet utilisation and a smaller carbon footprint. This will likely occur as expectations on the path to economic recovery and on the profitability or strategic value of flight routes change. In the short-term, fleet upgrading may be delayed until airlines are more certain of a recovery in the sector.
Improving the data analytical capabilities of airlines in the[13] short-term are therefore crucial in making airlines more responsive to market conditions through efficient fleet management[14]. Other innovations include investment in lightweight air cargo unit load device to decrease fuel consumption[15]. From a sustainability perspective, encouraging airlines to undergo a rigorous process of fleet renewal and reduce the average fleet age to curb maintenance costs has an additional benefit of reducing emission levels.
We further expect airlines to employ leaner fleets and lease a large proportion of their aircraft, which will result in improvements in fleet utilisation and a smaller carbon footprint.
Developing Competitive Advantage in E-Commerce
Moreover, e-commerce, especially in the Asia-Pacific region, offer strong growth potential for the industry[16]. The growth opportunities from e-commerce create new expectations for air cargo operators to strive towards. The increasingly sophisticated demands by businesses to incorporate higher-value added services such as tracking services, responding to last-minute requests, last-mile optimisation present new technological and digital capabilities that airlines need to develop to remain competitive[17]. Using Porter’s Diamond for National Advantage, mature markets are likely to have stronger demand for sophisticated digital services compared to emerging markets.
However, expanding a foothold in e-commerce requires competing with established players[18], which include Amazon Air’s fleet exclusively intended to transport Amazon packages. Despite flights lasting less than a day, the average delivery time for traditional air cargo is 6.5 days due to delays in ground handling processes and lengthy administrative procedures. Hence, improving the efficiency and transparency of air freight and giving e-commerce operators and consumers more convenience allows airlines to enter the lucrative e-commerce market. These include Lufthansa Cargo’s founding of heyworld to provide transport solutions for the e-commerce sector. AirAsia’s introduction of Freightchain provides a unique value proposition of allowing shippers to leverage on all available cargo network operations and book them through blockchain, providing a model for using smart contracts through blockchain for other airlines to emulate. Moreover, blockchain solutions should be aligned with existing capabilities of the firm and offer opportunities for scaling.
Going Green: Transition to Sustainable Aviation Fuels (SAF)
Sustainable aviation fuels (SAF) are an integral part of many airlines’ strategies to become carbon neutral. As a relatively new technology, there is a clear price-spread between fossil fuels and SAF, such that SAF only accounts for less than 1% of airline fuel consumption. According to Neste, the leading producer in SAF, an increase of 10% of SAF in the jet fuel mix results in a rise of average costs of USD 40 – 50 per passenger[19].
Although countries are prohibited from imposing fuel excise duties on international flights under existing ICAO arrangements, the price differential differs from country to country depending on the level of governmental support for the adoption of SAF[20]. These include emissions trading schemes in the EU and US federal carbon credit programmes.
In recent years, airlines have been considering a strategy towards further integrating SAF into their flight operations. Their decisions are influenced by expectations on the increase of government quota requirements on minimum SAF use and the increasingly sophisticated demands of consumers and businesses. Although airlines are hesitant to significantly increase investment due to the uncertain payoffs for first movers, securing access to SAF can be a future source of competitive advantage in improving brand positioning and adhering to regulatory requirements. Currently, the sheer lack of supply[21] of SAF will make it a valuable commodity as the aviation industry recovers.
Leveraging on existing airline alliances such as OneWorld and Star Alliance or negotiating new strategic alliance and joint venture arrangements may be ideal for airlines to explore collaborative opportunities, with the goal of improving economic and environmental efficiency with economies of scale.
...securing access to SAF can be a future source of competitive advantage in improving brand positioning and adhering to regulatory requirements.
We recommend that airlines develop a comprehensive plan to increase capital investment in expanding the supply of SAF and developing the relevant infrastructure to support an increased uptake. With fuel demand low and fuel hedging contracts cancelled or restructured, there is manoeuvrable space to begin increasing the intake of SAF. The long-term strategic focus of airlines will be to understand the dynamics of a mature SAF market and be in a strategic position guaranteeing control and access to SAF.
A large determinant in ensuring the success of the green transition is to ensure continued support from regulators, and to ensure the harmonisation of voluntary carbon offsetting schemes with global regulations, namely CORSIA. The decision by ICAO to use 2019 emission levels as the baseline will be crucial in giving airlines breathing space to build demand and benefit from low fuel costs[22].
LANDING: CONCLUDING REMARKS
Despite the challenges for the aviation industry, there are immense transformation opportunities. Sustainability does not necessarily need to be a financial burden to airlines but can be a source of strength in developing new core competencies to cope with future trends in the sector. Under the dynamic circumstances of change and disruption, staying ahead will be a long-lasting strategic advantage.
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[2] International Civil Aviation Organization. (2020, November 18). Effects of Novel Coronavirus (COVID‐19) on Civil Aviation: Economic Impact Analysis. ICAO. https://www.icao.int/sustainability/Documents/COVID-19/ICAO_Coronavirus_Econ_Impact.pdf
[3] Lee, Y.N. (2020, December 1). Singapore and Hong Kong push back their travel bubble again, this time beyond 2020. CNBC. https://www.cnbc.com/2020/12/01/singapore-and-hong-kong-push-back-their-travel-bubble-again-this-time-beyond-2020.html
[4] Source: International Energy Agency (IEA)
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[7] Fox, L. (2020, January 21). EIB fly less research. PhocusWire. https://www.phocuswire.com/EIB-fly-less-research?ctxp= [8] Schaal, D. (2020, August 28). Just Like That, AirAsia Group Says It’s a Digital Lifestyle Company — Or Not. Skift. https://skift.com/2020/08/27/just-like-that-airasia-group-becomes-a-digital-lifestyle-company-or-not [9] Jennings, R. (2020, October 14). What it’s like to take a flight to nowhere: a desperate Taiwanese airline, ecstatic passengers, but still a... South China Morning Post. https://www.scmp.com/lifestyle/travel-leisure/article/3105284/flights-nowhere-desperate-taiwanese-airlines-ecstatic
[10] Jung, M. Y. (2020, November 19). Duty free sales allowed on Korea’s ‘flights to nowhere.’ The Moodie Davitt Report. https://www.moodiedavittreport.com/duty-free-sales-allowed-on-koreas-flights-to-nowhere/ [11] Yong, C. (2020, November 3). SIA to offer training in customer service, other areas to firms. The Straits Times. https://www.straitstimes.com/singapore/sia-to-offer-training-in-customer-service-other-areas-to-firms-0
[12] Goldstein, M. (2020, November 18). COVID-19 Vaccines Are Here; Are Airlines Ready To Transport Them? Forbes. https://www.forbes.com/sites/michaelgoldstein/2020/11/17/covid-19-vaccines-for-8-billion-people-would-fill-8000-747-freighters-can-the-airlines-help/?sh=18563f1430ed [13] Devanesan, J., Devanesan, J., & Devanesan, J. (2020, September 15). How AirAsia renewed its purpose with the first blockchain-based air cargo network, Freightchain. Tech Wire Asia. https://techwireasia.com/2020/09/how-airasia-renewed-its-purpose-with-the-first-blockchain-based-air-cargo-network-freightchain/
[14] Molenaar, D., Bosch, F., Guggenheim, J., Jhunjhunwala, P., Loh, H., & Wade, B. (2020, November 9). The Post-COVID-19 Flight Plan for Airlines. BCG Global. https://www.bcg.com/publications/2020/post-covid-airline-industry-strategy
[15] BusinessWire. (2019, October 9). The World Market for Air Cargo Unit Load Devices (ULDs) to 2024 - A $427.5 Million Industry Opportunity - ResearchAndMarkets.com. https://www.businesswire.com/news/home/20191009005490/en/The-World-Market-for-Air-Cargo-Unit-Load-Devices-ULDs-to-2024---A-427.5-Million-Industry-Opportunity---ResearchAndMarkets.com [16] Mwanalushi, K. (2019, December 18). Why invest in e-commerce for air cargo. Aviation Business News. https://www.aviationbusinessnews.com/cargo/air-cargo-ecommerce-logistics/
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[22] Otley, T. (2020, November 22). Asia Pacific airlines call for support for sustainable aviation fuels. Business Traveller. https://www.businesstraveller.com/business-travel/2020/11/22/asia-pacific-airlines-call-for-support-for-sustainable-aviation-fuels/