SOME CLOUDY THINKING

In January 2012

It has been a bit of a gloomy start to the New Year, both for most world economies – especially Europe – and for many airlines. The Davos gathering was salutary in the confirmation that the established countries are desperate for investment and trade from the so called ‘emergent nations’, such as Brazil and China, quite a reversal of the established world order.

Not everyone agreed with Gerard Lyons, Chief Economist for the Standard Chartered Bank that the Euro as a currency is fundamentally flawed and cannot survive, and Mario Draghi, President of the ECB, is certainly trying to prove him wrong with his innovative form of quantitative easing; but the future of the Eurozone could remain unsettled for some months. Meanwhile the general prescription is for further austerity measure and raised taxes, reducing incomes and therefore possible expenditure on air travel.

IATA has also revised its forecast down from last September and produced two alternative scenarios for 2012. A ‘central forecast’ reduces predicted airline profitability to $3.5 billion in 2012, down from the previous forecast of $4.9 billion: a level of profitability that in previous years has seen airline failures and a lack of investment. The second more pessimistic IATA called the ‘banking crisis’ forecasts that airlines could face a loss of $8.3 billion in 2012, with over half of these losses ($4.4 billion) being attributed to European airlines.

Eric Beinhocker in a recent booki speaks of some of the problems of change, even under potentially calamitous circumstances. He comments that humans are fairly stubborn creatures and don’t just immediately change their mental models and behaviours in response to speeches from their bosses, or because of PowerPoint presentations. To Beinhocker change programmes need to address the more story loving, pattern-recognizing, more emotional and inductive side. This is easy to say, but rather harder to do as a manager. One approach is to use some cloudy thinking as an alternative to the more traditional blue sky and analytical thinking. Sometimes the numbers do not hold the answers to the future and uncertainty is encouraging, not dispiriting.

In a recent issue of Fortune magazine Bob Rodriguez the very successful CEO of First Pacific Advisers shared the best advice he ever received. It was read history. So Bob read a lot of economic and financial history as a well as general history. He comments that when the financial crisis came in 2008 he felt able to react to like an old friend because it had so many similarities to the banking crisis of 1907. He concluded that reading history allowed me to put those things in context.

A recent example of using the patterns of history to provide context comes from Charles Mannii who reflects that the collapse of the Scottish investments in the New Edinburgh a colony in Panama in 1698, mainly due to disease, destroyed between a quarter and a half of Scotland’s available capital. This was possibly a major factor in the agreement to the Act of Union with England within the next ten years and should remind leaders of both companies and countries that loss of capital weakens both.

Similarly Ian Morrisiii notes that in the 16th and 17th centuries whilst Spain believed that the bulk of the silver from Bolivia came to its Treasury in fact at least half, and possibly more, was being routed across the Pacific and through the Philippines to satisfy the needs of China. The Silk Routes were not just the land corridors through the Steppes or the Central Asian deserts, the sea was also very significant; a factor of which Europe was largely oblivious, and which eventually cost the Hapsburg Empire dear. A pattern from history that could possibly repeat itself as Asia and South America become very significant economic powers, and may not see the value of routing future trade through Europe.

Does such history have any relevance to airline managers? Perhaps not directly but it does remind managers that the major threats to airlines may lie outside of the immediate competition.

Currently a lot of management attention is focused on managing the actions necessary for operations to be safe, efficient and with full payloads – whilst cutting cost. This is not new. British Airways coined the phrase the unforgiving minute in the 1980’s to symbolize the loss of value caused by poor punctuality, and focused on this as an essential foundation for the later customer driven initiatives. In Continental Airlines over fifteen years later the foundation of the Go Forward plan was on time performance and fewer lost bags. Currently American Airlines and United face a similar need to redress poor operational performance as a recent Wall Street Journal survey places them well below Delta and Southwest Airlines in the league tables.

So for airline managers one implication from history seems to be to remember to manage the complicated business of delivering reliable and efficient operations, generating and retaining demand – and also to constantly reduce cost.

A second implication is the importance of taking a broader strategic view. in 1960 Theodore Levitt urged organisations to define their industries broadly in order to take advantage of growth opportunities. The danger, he argued was to follow the fate of the US railroads that defined themselves as being in the rail industry, rather than the transportation business, and with such marketing myopia- only competing with other railways they missed opportunities to adapt and grow. Instead they went into near terminal decline. Airline managers may therefore consider whether their priorities are only about competition between airlines, or about wider goals such as transportation, and the role of aviation within the environment? Ryanair has always been very clear that it is competing for leisure spend, not travel spend, but now with the rest of the industry it faces questions about sustainability. Environmental issues were quite muted at Davos, but the implementation of the European Emissions Trading Scheme has certainly started an international debate of some heat, and many EU governments favour environmental taxes.

As a market it appears that the world may develop at two speeds. As US and European airlines consolidate there is a rapid growth of new airlines in Asia – some sixteen new low cost airlines at the last count. The US and European argument is that aviation has finally become global and competition will only be maintained by fewer truly international airlines. There is also the possible implication that immunity for metal neutral joint ventures may signal the end for the large global alliances as some members of an alliance may be required by law to compete with other members. The transportation concern for regions and cities within the USA and Europe is that such consolidation will squeeze out many connecting services, and leave some cities with no air services. Both the USA government and the European Parliament see high speed rail connections rather than air travel as a solution. This alleviates the need for more airports and might also reduce high level atmospheric emissions.

The environment remains a major opportunity and threat for airline strategic thinking. Currently there is adverse reaction to the European ETS, largely because it has been imposed unilaterally and applies to total flight length, not just flights in European airspace. There is also strong industry criticism of increasing aviation taxation, most notably in Germany and the UK. However, there is a steadily growing body of science that argues that there is evidence that humans are influencing long term climate change. Like all science this is disputed. A recent Princeton study found that corn ethanol may have an insignificant effect on reducing emissions compared to cleaner gasoline. Its production has helped the USA reduce its dependence upon imported oil – but perhaps only whilst also raising global food prices, and taking an increasing share of scarce water resources. Next generation ethanol, maybe cellulosic might avoid this in future but still the question of land use for fuel or food production remains.

The more airlines protest that taxation is reducing demand, the more they strengthen the argument of those who wish to limit flying. So the industry may have to look hard at how to reduce flying, and the inefficiency of air traffic control and airports rather than merely mediate its excesses.

Current economic developments also raise a longer term question as to how many international airlines and airports will Europe need? As investment continues in Arabia and the new generation long range airliners come into service an increasing proportion of intercontinental traffic from Africa, Asia and the USA may transit the Gulf airports, or connect through the Pacific routes to South America and the USA. These will avoid the congested airports of Europe, and perhaps may also offer a more welcoming culture for international passengers. If so then significant traffic could start to bypass Europe and utilise these new entrepots: i.e. the competition will not be ‘airports’ but integrated business and leisure centres. AT the moment European airports simply cannot match conference facilities, in-terminal spas, in-transit city tours, or butterfly gardens.

Nor is it certain that the latest EC proposals on airport and slot regulations will increase the international attractiveness of Europe. Some slots may be freed up, but given the dominance of the three major alliance partner airlines in Amsterdam, Frankfurt, London, and Paris, probably not a lot. If European countries are serious about realigning their air services with the thirst for new connections from Brazil, China, Chile, India, Indonesia, Russia, Vietnam and others then they will need to free up many more slots than the current provisions are likely to make available; and at peak times. Without them the continuing rapid growth of non-European airlines may result in them developing new international route networks, with Europe offering more feeder connections than main hub transits. The favoured political development is for the railways to reduce short haul flying, widening the scope for transportation partnerships rather than just airline alliances.

When faced with even more cost cutting at the same time as international competition from Asia, and soon South America increases, there is a risk that airlines and their governments resort to protectionism. This may take the form of resorting to restrictive bilaterals, and maintaining slot dominance at airports. Such reactions are not dissimilar to the earlier management of the US railways that Leavitt wrote about. They competed fiercely with each other whilst their industry weakened.

In this context history may provide some useful metaphors, rather than being a source of directly transferable action. Perceived environmental pollution and resulting popular taxation may be a modern equivalent of tropical disease in its erosion of scarce capital. Similarly the rejuvenation of the historical ‘silk routes’, across the Asian land mass and the Indian and Pacific Oceans is a reminder of an old, and for several hundred years, very successful economic model. The physical nature of the modern air transportation model, including intermodal travel and a view of airports as destinations rather than transit points, may need to be reviewed. The cultural reorientation of these to a new global economy may also need to be recognised. The required changes in mental mindsets may be more easily accessed through historical stories and patterns that are accessible; enabling discussion to include the more emotional and inductive side of airline managers and lighten the rather depressing emphasis on only cutting costs.

© Roger Niven: The Management Coach-house Ltd. February 2012.