A New Operating Paradigm
Booz Allen Hamilton
Leading strategy and technology consulting firm
– 11,000 employees, $2.2B
– Founded in 1914
Our clients in air transportation:
– Governments, airports, air navigation providers
– Airlines, logistics, GDSs, travel agencies, equipment and service providers
A global team: USA, Europe, Asia, Latin America, Africa
Breadth:
– Strategy, operational restructuring, organizational design
– Systems design and implementation support
– Policy and regulatory advice
RPUS1747-0126-011303v1.ppt
1
Airline crisis is unprecedented – current price levels appear
consistent with long term trends
Unprecedented
cost-revenue gap,
started before 9-11
0.16
Unit Revenue (RASM)
0.15
Unit Cost (CASM)
0.14
0.13
0.12
0.11
Q1 2002
Q1 2001
Q1 2000
Q1 1999
Q1 1998
Q1 1997
Q1 1996
Q1 1992
Q1 1991
Q1 1990
Q1 1989
Q1 1988
Q1 1987
Q1 1986
Q1 1985
Q1 1984
Q1 1983
Q1 1982
Q1 1981
Q1 1980
Q1 1979
0.08
1993–1998: -1.0%pa
1993–1998: +0.6%pa
Q1 1995
0.09
CASM
increase:
RASM
increase:
Q1 1994
CASM decline: 1979–1992: 1.5%pa
RASM decline: 1979–1992: 1.8%pa
Q1 1993
0.10
Q1 1978
Cents Per Available Seat Mile(c/ASM)
(Adjusted To 2001 Dollars)
Unit Revenue and Cost Trend
(U.S. Industry)
Risk that
revenues will
revert to “old”
trend line
Note:
CASM reduction Q3 2002 somewhat overstated due to accounting effects
Source: Company Financial Statements, Back Associates, BAH Analysis
RPUS1747-0126-011303v1.ppt
2
The paradigm shift between point-to-point and network business
models is far from over
U.S. Domestic Market Structure
(O&D Passenger Trips Y2000)
Non-Stop
Service
Available
Non-Stop
Service
Not Available
Low Cost Carrier Potential
Total
Major Hub Cities
44%
6%
50%
Minor Hub Cities
7%
2%
9%
Large Non-Hub
10%
3%
13%
SWA Connection
6%
2%
8%
Other
9%
7%
16%
Total
78%
22%
100%
~ 10% Over 2,000 Miles
RPUS1747-0126-011303v1.ppt
 Low Cost Carriers (LCCs) can
conservatively participate in 70% of the US
market
 LCCs now participate in 43% of O&D market
 Significant growth potential remains
– Eastern U.S.
– Increased breadth in existing strongholds
– Increased depth in O&Ds currently served
~ 16-18% Small City
Markets
3
The fundamental threat to hub and spoke carriers lies in price
realization
Average Yield(1) in Hub Markets
60
OA Yield No SWA
preserve
50
 SWA non-stop competition
reduces OA yields 25%-35%
OA Yield
SWA conn
40
C/ASM
30
OA Yield
SWA direct
competition
 SWA one-stop competition
reduces OA yields 15-20%
SWA Yield
connect
20
SWA Yield
non-stop
10
0
0
500
1000
1500
RANGE
2000
2500
Note: (1) Revenue per revenue passenger mile, including PFC and taxes
(2) OA: Other Airline
Source: DOT Y.2000 data, BAH Analysis
RPUS1747-0126-011303v1.ppt
4
The situation is complicated by an excess of hub capacity
Current Travel Structure
(Passenger Trips, Y2000)
~110 M
O&D PAX
Connect In USA 30%
~70% Do Not
Connect in US
International
~60% of
Domestic Trips Are
Non-Stop
~410 M
O&D PAX
Domestic
Other Connections 9%
Inadequate Non-Stop
Service 10%
No Non-Stop Service
Available 22%
Total U.S. and U.S. International O&D Market
Connecting Passenger
Trips
Current Domestic
Connections
~40%
Non-Stop Passenger
Trips
Source: U.S. DOT, BAH analysis
RPUS1747-0126-011303v1.ppt
5
…resulting in an unsustainable revenue positions at hub-andspoke carriers
Competitive Composition: Typical Mainline Carrier, Pre-Crash
Degree Of Price
Sensitivity
Connecting Passenger
Flight
Low:
Individual chooses
airline, travels on
business or rich personal
travel
20% - 30% revenue
20% - 25% of revenue
Medium:
Corporation is principal
decision maker, drives
bargain
10% - 15% revenue
10% - 15% revenue
High:
Mostly leisure travel and
price sensitive business
15% revenue
10% - 15% revenue
Moderately Vulnerable
Vulnerable
RPUS1747-0126-011303v1.ppt
Non-Stop Passenger
Flight
Generally Product Advantage
Significantly Higher Yields
(Without LCC Price Impact)
Product Parity Or
Disadvantage
6
Network carriers have a huge cost gap vs LCCs
CASM Versus Stage Length
2000
25
SK
Cents / ASM
20
AZ
15
AF
LH
US
BA
EasyJet
IB
10
AirT
Ryanair
AA
UA
AS
TW
DL
KL
NW
CO
AWA
ATA
SWA
5
Britannia
0
0
200
400
600
800
1,000
1,200
1,400
1,600
Average Stage Length (miles)
Source: BAH Analysis
RPUS1747-0126-011303v1.ppt
7
Much of this cost differential is a result of production model
choices, not frills
Drivers Of Unit Cost Differences
U.S. Network Carriers and SWA
(737-300: Stage Length, Seat Density and Factor Cost Adjusted, Y2000)
7.2
c/ASM
12%
Other
G&A
15%
Sales and Res
70%
Schedule
Pax, Bag, Cargo Handling
-50%
Process & Pace
Ownership Costs
Onboard Costs
Distribution
Maintenance Costs
Fuel Costs
Frills
Other
Pilot Costs
Financial Structure
Work Rules, Labor
Relations
Production Model
3%
Other
Baseline
(SWA)
Note: Average Airline based on Delta, United, and US Airways
RPUS1747-0126-011303v1.ppt
8
A new business model may emerge that closes 70-80% of the cost
gap and re-establishes product differentiation
Restructure Network / Hub
Operations to Remove
Scheduling Constraints
(“Below the Wing Processes”)
Random hubbing
Improved asset productivity
Reduce TAT and handling complexity
Alter trade-off between efficient operation
and optimum connectivity
Provide
specialized
services and
appropriate
schedule
qualities
Simplify Customer Interface at
the Airport and in Distribution
(“Above the Wing Processes”)
Reduce
complexity,
increase
pace
Separate simple from complicated tasks;
apply tailored process streams
Reduce low-value interactions with staff
Simplify reservation, ticketing, check-in
Lower Cost
Differentiated Services
Viability
Create Separate Business
Systems for Distinct
Customer Segments
(“Product Differentiation”)
Achieve pure
business
streams
High service levels where needed or
expected (local vs. connectivity)
Low-cost service levels where possible
(high-value vs. low-value customers)
RPUS1747-0126-011303v1.ppt
9
A new industry structure may emerge – or the next crisis will be a
repeat on steroids
New Business Model
 2-3 new network based carriers emerge
by continent
– 1 or 2 random hubs each
– Many centers of mass a la SWA
– Greater focus on non-stop services
Incremental Evolution
 Network carriers stick to current business
model
– Continued share loss to LCCs
– Low cost subs fail again
– Regional operators take over larger
proportions of network
 1-2 low costs carriers by continent
 Regional carriers that perform two
missions
– Feed for limited number of random
hubs
– Point to point flying in business and
smaller markets
RPUS1747-0126-011303v1.ppt
 1-2 low cost carriers succeed by
continent
 Regional carriers pick up failing routes,
remain more focused on feed
 Next crisis is an amplification of current
one
10