Airlines 2020 substitution and commoditization

IBM Global Business Services Travel & Transportation
Executive Report

IBM Institute for Business Value

Airlines 2020:
Substitution and commoditization
Two developments the global airline industry can no longer afford to ignore

IBM Institute for Business Value
IBM Global Business Services, through the IBM Institute for Business Value, develops
fact-based strategic insights for senior executives around critical public and private
sector issues. This executive report is based on an in-depth study by the Institute’s
research team. It is part of an ongoing commitment by IBM Global Business Services
to provide analysis and viewpoints that help companies realize business value.
You may contact the authors or send an e-mail to iibv@us.ibm.com for more information.
Additional studies from the IBM Institute for Business Value can be found at
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Introduction

By Steve Peterson

The 2000s were a rough decade for airlines. Battered by unprecedented
global turmoil, airlines that survived learned powerful lessons about cost
containment, efficiency and the importance of financial strength. Airlines that thrive
in the next decade, however, will have to do more to stay ahead of the competition.
In particular, they will need to think strategically about two issues that have received
little attention of late: substitution and commoditization. The IBM Institute for
Business Value Airline 2020 Study focuses on these two key challenges and provides
a roadmap for how they will likely play out in the next ten years, as well as
recommendations for action.

Many airlines, buffeted by uncertain economic conditions and As the industry looks forward to the next ten years, many of
a turbulent market, struggled to remain viable through the first these same challenges – increasing competition, economic
decade of the millennium. Volatile demand, larger and an volatility, heightened customer expectations – will remain. But
ever-increasing number of competitors, unstable fuel cost, two other issues, which currently fly beneath the radar of many
more diverse traveler needs and a constantly changing distribu- carriers, threaten to have an adverse and potentially long-
tion model taught airlines to expect the unexpected. lasting impact on the future state of the industry: substitution
and commoditization.
And as if the challenges of demand variance, competition and
economic fluctuations were not enough, airlines were With the prevalence of alternative modes of transportation,
confronted with a series of calamities that made the first ten particularly high-speed rail, customers often have the choice of
years of the twenty-first century among the industry’s most substituting air travel with less costly modes of travel that
challenging. The September 11, 2001, terrorist attacks on the require less of a personal time sacrifice. And with commoditi-
United States severely impacted global air travel demand and zation, consumers often find few differences among the
further degraded the customer travel experience by compli- product offerings of different airlines – or are unwilling to pay
cating airport security procedures. The outbreak of SARS and for the differences they do perceive.
avian flu decreased travel and increased restrictions at a time
when carriers were struggling to regain traveler confidence. As Substitution has been around since the advent of mechanized
the decade progressed, oil prices began to increase dramati- transportation. From covered wagons to steam-driven locomo-
cally, and jet fuel, typically among the industry’s top three tives, from horse and buggies to automobiles, from steamships
outlays, increased in price more than 200 percent from 2000 to to airliners, passenger transportation has been shaped by the
2008.1 The global economic meltdown during the latter part of immutable desire to travel farther and faster. Travelers have
the decade hit many carriers especially hard – at a time with accepted new modes of transportation when reliability, cost
they were least able to withstand another contraction. and convenience combine to make the competing alternatives
viable.

2 Airlines 2020: Substitution and commoditization

For most of the past 75 years, air travel has enjoyed a substan- through economic turmoil must be a dedicated commitment to
tial advantage over alternative modes in speed and conve- maintaining cost discipline. This is an essential step to be
nience. But in today’s world of heightened security and undertaken before embarking on any program of change.
congested skies, the hassles and complications of booking,
boarding and departure have stolen much of the time To break the cycle of commoditization and to compete more
advantage conferred by higher point-to-point speeds. effectively against substitute travel providers, most airlines
Customer dissatisfaction with the increasing difficulties of need to increase the degree of segment specificity that defines
flying has made many travelers eager to try new or different their marketing program. Product development must be
alternatives. undertaken with only specific target customers in mind. All
subsequent efforts to reach and serve these customers must
The increasing complexity and time involved in air travel also be unique to the specific needs of the chosen travel
comes at a time when government-subsidized high-speed rail segment. By targeting narrower customer segments, airlines
in many nations has negated some of air travel’s speed will find that, over time, their products and services will stand
advantage, at least over short-to-moderate distances. out from their competitors, and the customers they attract will
Combined with ease of booking and boarding, the usually be more willing to pay a premium for the differentiated
lower cost of high-speed rail, where available, has made it an experience delivered.
attractive option for travelers. Further, many companies now
substitute telepresence in place of meetings that would Another viable response to the threats of substitution and
previously have required in-person attendance. Travel manage- commoditization is to increase the level of journey integration
ment companies often work to integrate telepresence into their between airlines and other travel service providers. An airline
corporate travel solutions. that elects to pursue this strategy will coordinate more closely
with other modes, such as hotels, airports, and public transpor-
Substitution would be a problem in and of itself. But the tation providers, to provide consumers with a more integrated
financial picture for airlines is further darkened by commoditi- travel experience. This is a service no travel provider currently
zation. Airlines, more focused on immediate operational delivers. It should provide an enhanced customer experience
challenges, have failed to sufficiently differentiate their that will enable airlines to compete more effectively against
products and services to appeal to the specific needs of their substitutes.
diverse customer base, making it a struggle to increase revenue
per passenger kilometer. While this was poor strategy in the Finally, for the truly transformational play, an airline can elect
past, it will become completely untenable if either the threat of to move forward aggressively with both higher degrees of
substitution continues to grow or a competitor begins to offer segment specificity and increased levels of journey integration.
truly differentiated, compelling and well-targeted service-based These carriers will find themselves delivering specific-
products. segments products that satisfy the unmet desires of travelers
for a seamless travel experience.
How can airlines combat these multiple challenges and
position themselves for prosperity in the coming years? A Properly implemented, we believe each of these strategic
cornerstone of any preservation strategy to guide the industry options can provide transformational results over the long
term.

IBM Global Business Services 3

Forces shaping the industry increase, particularly in emerging markets, more people from a
To understand the issues and consumer dynamics likely to wider range of social, geographic and economic origins will be
shape the airline industry over the next ten years, the IBM travelling. As the travel population expands and becomes more
Institute for Business Value surveyed more than 2,000 business heterogeneous, the preferences of travelers will come to mirror
and leisure travelers, conducted in-depth interviews with travel those of the population at large. As a result, the traditional
subject-matter experts and leveraged other external market “one-size fits all” business model common to many airlines will
research and data (for study methodology, see page 18). What make it increasingly difficult to meet customer expectations.
we found is that a number of transformative forces – and how
airlines respond – will determine how prosperous the industry This increase in traveler diversity will spur competition for
in general, and individual carriers in particular, are likely to be every passenger kilometer from more and larger players.
over the next decade (see Figure 1). Recent mergers and radical changes to airline cost structures
have blurred the lines between low-cost and traditional
Travel population and competition soar network carriers, with low-cost carriers accounting for an
Once confined to an elite few, air travel is now a medium for increasing percentage of global passenger traffic. Also, some
the masses. As both population and discretionary income governments have begun allowing cross-border mergers,

Population – worldwide growth results in more Competition – survivors are healthier and will
travelers and greater air travel demand continue to fight to increase market share

Liberalization – under pressure, some Expectation – customers bring high
governments allow cross-border mergers expectations from other travel sectors

Disruption – unexpected events that made past Preservation – airlines are hoarding capital to
survival challenging will persist Airline prepare for future volatility

Globalization – trade between countries drives
industry Substitution – travelers are eager to adopt
up air travel demand context alternative modes of travel

Democratization – greater wealth distribution Commoditization – customers fail to see
brings travel to the masses differentiated value in air products

Intervention – protectionist policies in some Innovation – airlines are applying new
countries prevent airline failures technologies to common industry challenges

Expansion – spotting opportunities, providers Variation – airlines adjust capacity in times of
and intermediaries get involved in air travel weak demand to maintain profitability

Source: IBM Institute for Business Value analysis.

Figure 1: Forces shaping the future of the airline industry.


paving the way for larger, multinational carriers. Further Through a host of intermediaries and tools, travelers now
fueling the competitive fires is the fact that certain marginal- control the complex travel purchase process themselves and are
to-poor performers, which might have folded under unre- less likely to use traditional travel agents than they once were.
stricted market conditions, will continue to survive and In the United States, the number of traditional travel agents
compete via the protectionist policies of some governments. fell from 37,000 in 1995 to fewer than 18,000 in 2009, and the
share of airline revenue sold through this channel dipped
Intermediaries multiply below 25 percent.2
With the projected increase in air travelers, we can expect
more third parties to become involved in air travel. The Customer satisfaction continues to plummet
explosion of intermediaries is likely to dilute the control of Airlines have seen customer satisfaction decline for many years,
exclusive proprietary booking systems and web sites, resulting but despite investment to improve customer experiences,
in the ratio of propriety to intermediary web sites decreasing. consumer dissatisfaction continues to grow. In fact, the airline
The traditional provider-controlled “push” model of travel industry consistently generates some of the lowest scores in
distribution, in which airlines control bookings through U.S. customer satisfaction surveys (see Figure 2).
proprietary distribution networks and brick-and-mortar travel
agencies, is giving way to a customer-driven “pull” model.

1%
Cigarettes Major appliances
Newspapers Soft drinks
10-year satisfaction score CAGR

Postal service
Hotels
0%
Airlines Hospitals

-1%
Airlines consistently rank
among the least satisfying Internet travel
industries to consumers
-2%

-3%
64 69 74 79 84
Relative consumer satisfaction score (2010)

Source: IBM Institute for Business Valueanalysis, “The American Customer Satisfaction Index,” University of Michigan. 2010.

Figure 2: Airlines consistently rank low in customer satisfaction.


Airlines were among the pioneers of industry loyalty programs, Airlines have responded to many of these challenges . . .
but the difficulty in redeeming frequent flyer points among With varying degrees of success, airlines have directed
many airlines has actually become a source of increased attention and investment to account for many of these forces
customer dissatisfaction. The difficulty in redeeming loyalty of change. The common response to economic fluctuation and
points was the second most common customer complaint demand variability, for example, has been to reduce costs and
about airlines in 2010, and the value of the rewards was increase scale. Carriers have continued to satisfy their urge to
another frequent complaint.3 Obviously, there is a significant merge despite the obvious inverse relationship between size
disconnect with frequent customers when programs designed and profitability (see Figure 3). Many airlines have added
to build brand loyalty instead serve as an additional source of capacity and routes in markets where they see the most
alienation. opportunity, and many more have reduced or eliminated
service to less profitable destinations. Competitive forces have
Disruptions will continue compelled airlines to adjust to a new normal whereby the
In addition to the other forces exerting pressure on airlines, the marginal profit or loss on any one flight is determined by only
disruptive events that plagued the industry throughout the past a few seats. Indeed, many airlines have gotten very good at
ten years, some of which are virtually impossible to anticipate, filling the planes they have in service. Load factors in the 60-70
will undoubtedly persist. Fuel price volatility and economic percent range were common in the first part of this decade, but
uncertainty will likely be issues for some time to come. For the today 75-85 percent is more the norm.6 Smaller carriers tend
immediate future, the International Air Transport Association to limit complexity and maintain higher profitability in less
(IATA) predicts a short-term return to profitability for the contested regional markets. Large airlines are less able to
industry beginning in 2010.4 But these forecasts are based on quickly adapt and respond to changes in the markets they serve
assumptions for increased travel demand spurred by an than the smaller and more nimble airlines.
improving economy. These forecasts will also be impacted by
the overall capacity in the market and the prevailing prices.
Historically, airlines have enjoyed less pricing power than
companies from other industries, so changes in seat capacity or
prices could derail an industry-wide recovery.5 Any economic
slowdown will negatively impact air travel demand and airline
Airlines typically respond to demand shocks by
profitability. The key question is whether airlines, bolstered by increasing scale to lower costs and reducing
government stimulus plans and an industry-wide reduction in capacity to stabilize prices.
capacity, can maintain the discipline and prices needed to
sustain positive results going forward.


20%
COPA Airlines
Republic Airlines
Allegiant Air Air Arabia Smaller carriers tend to limit
15%
Air Asia complexity and maintain
Air Wisconsin higher prices in less
10% contested regional markets Large carrier performance
is limited to relatively
Profitability in 2008-2009

Emirates Airline
Qantas modest profitability
5%
Lufthansa
Singapore Airlines Southwest Airlines

0% Air Canada
ANA
All Nippon Airways
Finnair British Airways
Cathay Pacific
-5%
Japan Airlines International American Airlines
US Airways
-10%
Austrian
United Airlines
-15%
China Eastern Airlines Delta Air Lines
-20%
0 5 10 15 20

Relative size (where size is a function of seat capacity and revenue)

Sources: Institute for Business Value analysis, Revenue data collected from airline annual reports 2010, Industry fleet data from IATA. Seat capacity calculated by multiplying the number of seats on
each aircraft by the specific fleets of each carrier.

Figure 3: Relative size and profit performance of selected airlines.

. . . but two significant threats have gone largely Yet airlines have largely ignored the threat, both because they
unaddressed were more focused on more pressing business needs and
As travelers enjoy a wider range of positive experiences with because they enjoyed an inherent advantage in convenience
alternative modes of travel, their expectations of the services and point-to-point speed. But with the growing acceptance of
airlines provide and how they are delivered will only grow. high-speed rail and the nearly universal availability of cost-
Failing to deliver on these expectations will serve to push effective telepresence, substitution is an issue that airlines will
disenfranchised customers further away and increase their need to address with a great sense of urgency.
willingness to explore alternative modes of travel. Travel
substitution, as previously referenced, is not a new phenom- Moreover, the inability of airlines to differentiate their
enon but has been around since the dawn of the industrial age. offerings and attract a highly targeted and loyal following will
further encourage customers to seek modes of travel where
they feel their needs and desires are more likely to be met.


No doubt, the ability to maintain financial discipline, rapidly
adjust scale and preserve capital for distressed times will allow While the fastest planes Without faster aircraft or
can now reach over 900 fleet upgrades, airlines will
some carriers to maintain some semblance of profitability. But

( Expressed in kilometers per hour for select years)
(To maintain constant travel time budget while
KPH (at altitude), the have to deliver more
for the industry at large, a radical change in business models is large number of slower seamless journeys to meet

Passenger speed requirements

increasing distance traveled per year)
aircraft bring the average consumer speed-distance

Average IATA airline speed
in order, and the issues of substitution and commoditization speed down to below expectations
must be addressed. For most airlines, the status quo is no longer 700 KPH

sustainable.
?
700
680
Substitution
600
Airlines have historically enjoyed a market with few substitutes,
but as travelers and technologies evolve, the magnitude of the
substitution threat continues to grow.
300

For hundreds of years, substitution between travel modes has
followed the same general and predictable patterns. As new
technologies emerged, they quickly displaced other modes 1950 1970 1990 2010 2020
once customers became convinced that these alternatives were Average IATA airline speed (KPH)
Passenger speed requirements
accessible, fast and affordable. The lesson from history is that
once a new mode or technology is able to satisfy all of these Source: IBM Institute for Business Value analysis, IATA Annual Reports 1950 to 2005, 2010
estimate based on fleet changes 2005 to 2010 – IBM, Passenger speed requirements
basic travel criteria, it usually displaces the older technology documented by Schäfer in “Long-Term Trends in Global Passenger Mobility,” 2005.

within a few decades. Although the automobile was faster than Figure 4: Airlines have historically delivered on the customer desire
the horse and buggy in 1885, cars did not become the for faster travel, but are losing their advantage.
dominant technology until 1910, when they were also available
and affordable. This historical pattern is repeated with other
transportation technologies and should guide our thinking Evidence suggests that many customers have indeed come to
about substitutes for modern jet travel. see substitutes as a more viable alternative to air travel and are
willing to change if given a choice. Many travelers have high
Speed has enabled passengers to satisfy their desire to travel expectations about both substitute technologies and express a
further without increasing the amount of time they must clear willingness to explore these alternatives when and if they
allocate to travel. Across incomes, time periods and geogra- are available.
phies, individuals dedicate between 45-100 minutes per day to
travel.7 Historically, airlines have satisfied the demand for a
speedier travel experience with faster aircraft, but they are on
the cusp of losing this advantage, as more laborious search
processes, constant security delays and more frequent baggage
hassles combine to increase point-to-point journey times (see
Figure 4).


Travelers choose air for a variety of reasons; chief among them markets because longer distances magnify the effects of slower
are costs and time. As high-speed rail improves, however, more travel speeds. But for travel distances of less than 1,200
travelers will re-evaluate this alternative, and many will defect kilometers, high-speed rail is often a viable choice.
because the reasons they dislike air travel, such as booking/
check-in/security hassles, lost productive time, lower-than- Nowhere has the growth of high-speed rail, or the commit-
expected reliability and negative environmental impact (see ment of government to infrastructure development, been more
Figure 5). Not surprisingly, in regions where rail travel is dramatic than in China. High-speed routes in that nation are
common and high-speed rail is an option, substitution has expected to grow from approximately 12,000 kilometers in
already taken a significant toll on the demand for air travel. 2009 to about 16,000 kilometers by 2020.9
And airlines are subject to additional vulnerability in future:
research reveals that price reductions for high-speed rail would In those nations where high-speed rail has yet to take hold,
result in dramatic increases in passenger volumes across several such as the United States, other substitute technologies are
European markets. For example, if rail prices were to fall by taking a toll on airlines:
5.5 percent on the Barcelona-Seville route, passenger volume
would be expected to increase more than 28 percent.8 • In 2009, 60 percent of surveyed travelers worldwide had cut
travel through remote conferencing use.10
Air travel providers in those regions where high-speed rail is • In 2009, 79 percent of global travelers reported greater use of
common, such as Asia and parts of Europe, consistently conference calls, WebEx, and telepresence.11
perceive such substitutes as a material threat to their core • In 2010, Asia-Pacific video conferencing market will grow 9.5
business. Rail is not a complete substitute for air travel in all percent year-to-year.12

Traditional air High-speed rail
Assumptions Assumptions
Cost Economy class domestic or near-region journey Total Business class domestic or near region journey on Total
on full-service carrier $450 RT high-speed rail $360 RT
Time 1 hour shopping/booking, 1 hour transit, 2 hour Total 1/2 hour shopping/booking, 1/2 hour transit, 3 1/2 Total
flight, 1 hour transit 5 hours hour high-speed rail, 1/2 hour transit 5 hours
Hassle Complex shopping, cross-mode coordination, Very high Fewer choices, less complexity, shorter transit, Fairly mild
security, delays, etc. limited security, few delays
Reliability 85% on-time airline arrival plus cross-mode <70% Fewer weather/network delays and higher on-time >80%
connection points on-time performance on-time
Productivity <50% chance of work in flight plus possible time Maximum Higher class of service results in higher chance of Minimum
in transit etc. 1 hour productive time 3 hours
Environment Enormous carbon footprint relative to other High Relatively moderate environmental impact Low
modes of travel impact impact

Source: IBM Institute for Business Value analysis, IBM-Oxford Economics Global Travel provider Interviews September 2010.

Figure 5: When high-speed rail delivers the full complement of expected improvements, some portion of current air travelers will migrate to rail.


• Telepresence is expected to replace 2.1 million airline seats And while customers do detect a difference among airlines,
worldwide per year by 2012.13 they are less willing to pay a premium for a favorite carrier
• Travel agencies are integrating telepresence into corporate than a less differentiated but favorite hotel (see Figure 6.)
travel solutions to make it easier for companies to leverage a Among traveler segments, business travelers are more willing
growing network of public and private telepresence centers than leisure travelers to pay for their preferred air carrier. And
• The economic downturn in 2009 dampened global in those nations where high-speed rail is relatively well
telepresence spending, but corporate spending on developed, such as France and Germany, customers are even
telepresence hardware, software and services grew much faster less inclined to pay premiums for their favorite airlines.
than air travel.14

Level of perceived differentiation
Taken as a whole, the developments occurring in the area of
substitution are certain to negatively impact many carriers and Airlines
have the potential to affect even more. 11% 33% 57%

Hotel chains
Commoditization 10% 53% 37%
Despite efforts to innovate, many airlines deliver undifferenti-
ated products to price-sensitive consumers overrun by an
No noticeable Differences Significant
abundance of too-similar choices. It is no surprise that air
differences are minor differences
travelers are often focused on price and do not see many
meaningful differences in air travel products. But our research Willingness to pay 10% more for favorite provider
shows that even when they do perceive differences, travelers Airlines
are rarely willing to pay a premium for the differences they 34% 25% 41%
notice most. We believe this is in large part because airlines
have focused product development efforts on quickly and Hotel chains
efficiently introducing the next new airline seat or the latest 28% 22% 51%
in-flight entertainment capability, while overlooking that
customers care more about the intangible, service-oriented Not willing Neutral Willing to pay
aspects of their journeys. to pay

Source: IBM Institute for Business Value analysis, IBM-Oxford Economics Global Traveler
Airlines and industry analysts have asked travelers to rank Survey September 2010.

airline selection criteria for decades, and while their secondary Figure 6: Customers are not as willing to pay a premium for their
and tertiary concerns vary from survey to survey, price consis- favorite carrier as they are for a less unique, but favorite hotel.
tently ranks as the most important decision factor. In 2010, for
example, 36 percent of travelers in our survey ranked price as
their top consideration, with schedules and routes, at 32
percent, the second most valued factor. Airline brand was the
only other consideration in double digits. On-time perfor-
mance, customer loyalty programs and star rating all garnered
7 percent or less.


To overcome commoditization, airlines must understand the
On their most recent trip…
actions and inactions that have exacerbated this problem in Business travelers are more efficient, but more than 40 percent of them spent
the past: more than 2 hours shopping/booking.

61
• Brand fatigue – Travelers spend many frustrated hours
choosing between products they see as similar because brands 46
are not useful to distinguish and select among available
choices. 29
27
• Products are similar – By leveraging the same suppliers and
adopting the fast-follower approach in product development,
12
airlines have created undifferentiated customer experiences. 9 9
4 2
• Messages are similar – Marketing messages match products, 1

and are not distinct enough to resonate with target customers. 1-2 3-4 5-6 7-9 >8
• Search is not simple - Search takes too long, leading to hours hours hours hours hours

dissatisfaction. Leisure traveler
• Lack of personalization – The complexity of population Business traveler

served does not match segmentation complexity. Source: IBM Institute for Business Value analysis, IBM-Oxford Economics Global Traveller
Survey September 2010.

Figure 7: The increased number of choices available to travelers
The increased number of choices available to travelers, and the requires significant time investment in pre-booking searches.
profusion of options for shopping, planning and booking their
trip, requires them to spend significant time in pre-booking “satisficers.” While the “maximizers” prefer a larger number of
searches (see Figure 7). According to our survey, almost 20 choices than do the “satisficers,” both groups of consumers
percent of travelers spent five or more hours shopping and/or experience lower levels of satisfaction when the assortment size
booking flights on their most recent trip. Twenty-five percent of they have to choose from becomes too large. In the academic
leisure travelers spent more than four hours shopping and/or context, an assortment size of 24 was considered large for most
booking. Business travelers were generally more efficient, yet consumers, but travelers typically face far more choices than
almost 40 percent of them spent at least two hours shopping and that when they book even the simplest trip.15 Extreme
booking. complexity is a reality that confronts travelers for each journey
they plan, which may well diminish airline satisfaction.
The common perception is that the more choices presented to
the consumer, the happier he or she will be with the provider. Technology as a differentiator
Surprisingly, academic research suggests that the converse is Technology can differentiate the travel experience for a short
often more accurate. Consumers who face too much choice are time, but when all travel providers implement the same
more likely to be dissatisfied. Psychologist often group solutions, differences become hard to discern. Lessons in this
consumers into two broad categories: “maximizers” and area can be learned from the hotel industry. Advances that were


considered cutting edge in 2000, such as in-room high-speed will make possible substantial passenger and revenue gains.
internet, were approaching ubiquity by the end of the decade. And they are prone to believe that profitability is “just right
The benefits of such advances are fleeting – innovations are around the corner.”
quickly replicated by competitors. Novelties become
mandatory; as penetration increases, customers come to expect With their continuing efforts to forestall changes in their
these innovations. Accordingly, active engagement and sector, some airline executives may strive to strengthen balance
continuous improvement is required; after customers have sheets to protect against downturns and to opportunistically
come to see an innovation as essential, they will eventually expand, consolidate and partner, hoping to maintain the status
expect additional enhancements to that feature. quo. For the industry at large, however, this is not an option.
They must accept the threats that substitution and commoditi-
Unfortunately for airlines, not only are their core products zation pose and develop strategies to combat emerging
similar, but the messages carriers take to the marketplace are competition, including both high-speed travel alternatives and
often indistinguishable to travelers. It is not unusual for two or telepresence, and to provide real degrees of customer-focused
more airlines to simultaneously introduce identical solutions. differentiation.

Keeping up with market segmentation The roadmap to accomplishing this is divided into two steps.
Travel is no longer the exclusive privilege of an elite few, but a The first is to maintain cost discipline. Airlines must continue
product for the masses. Airline segmentation, however, has not aggressive cost-reduction campaigns; create or extend fuel-
kept pace with this development. Over time, the travel popula- hedging programs; redouble efforts to achieve operational
tion has grown from a very small number of the wealthiest elite efficiency; resist the temptation to initiate spending in times of
to travelers with a wider range of ages, incomes and travel growth; and introduce cost-justified optimization solutions.
objectives. But current airline delivery platforms limit special-
ization because diverse customer needs must be fulfilled with a New challenges do not change old realities – airlines must
single collection of assets, such as planes, processes and remain committed to controlling both fixed and variable costs
employees. in the next decade. Airlines must prepare for future volatility
and crises by continuing to strengthen balance sheets. Efforts
What are airlines doing to combat to improve profitability have become a part of the corporate
substitution and commoditization? DNA for most carriers, and any airline that forgets this lesson
Unfortunately, many providers are not doing enough to of industry history is destined to repeat it. Tools and solutions
prepare for the threats that substitution and commoditization that help airlines optimize resource utilization and lower direct
pose. From the carrier perspective, customer preferences will costs should be pursued.
continue to evolve slowly and in mostly predictable ways.
Airline executives often think their particular company has the
right model for the future and that radical change is not
needed. They believe their planned improvement in execution To address substitution and commoditization,
airlines must maintain cost discipline and
introduce some element of segment specificity
or travel integration.


After these essential measures are undertaken, airlines must of aircraft, and that innovation equates to new seats, planes,
make a strategic choice in how to proceed. Their options and systems. These notions need to change, but change of this
include: magnitude will not be easy to digest or execute. That said, it is
just the type of change that is essential if airlines are to meet
• Target narrower traveler segments – Airlines adopting this the challenges of the next decade.
strategy will tailor programs targeted to only specific
segments of the flying population. They will delist segments Carriers will need to start with a fresh look at the market
that do not fit their strength profile and will deploy sub- through the lens of a more complex segmentation model that
brands to avoid brand dilution. Airlines that focus on this reflects the full complexity of the travel population. Next,
strategy will increase differentiation by satisfying unmet carriers will need to make sure they have selected target
needs. They will abandon the “fast-follower” strategy of segments that are aligned to their current and future capabili-
product development and, instead, will set aggressive new ties. These capabilities will evolve over time to more closely
product targets to capitalize on service-based innovations. align to the needs of the target segment, but at a minimum,
• Coordinate across other travel modes – These carriers will targets should be chosen that mostly closely hue to the carrier’s
harmonize operations with rail operators, hotels, public natural advantages and strengths.
transportation organizations and other travel services
providers. Travel planning, product pricing, trip booking, Another byproduct of narrower segmentation is a more
ticket processing and, of course, journey fulfillment will be effective product development program. Without losing sight
coordinated across travel modes. They will look to increase of the basic needs that customers have come to expect, carriers
margins on cross-mode, value-added services and will delight should focus on identifying and satisfying unmet customer
their customers by taking responsibility for their entire travel needs in their target segment (see Figure 8). Unmet needs are
journey – not just the relatively limited time the traveler difficult to identify and even more difficult to satisfy.
spends in an aircraft seat.
The desire to mitigate current customer frustrations provides
Target narrower customer segments ample fuel to feed product reinvention, including the unmet
Increasing segment specificity will result in the development of needs for smoother transitions to, through and from airports.
products, services, and supporting messages that meet more In some cases, carriers should rethink the basic value equations
unique (and valuable) customer needs. Carriers will change that have governed the industry and commit to adding new
from making one product work for the entire market to value for their target customers as a regular part of the product
developing multiple products for the right segments. For many development process.
carriers, this shift in focus will require a reinvention of the
business. Executives, managers and employees have designed
the enterprise around the notions that all customers are
targets, all customer needs can be satisfied with a uniform fleet

Carriers will need to make sure they have
targeted travel segments that align with their
capabilities.


Of course, airlines should resist the temptation to adopt new But hard-to-deliver service-based innovations linked to
product improvements that are easily replicable. The fast- segmentation and loyalty programs, such as automatic
follower model of product development has contributed to rebooking across multiple travel modes for select segments, are
airline product commoditization in the past, and will put more likely to create sustainable advantage as other carriers
carriers who continue this strategy in a vulnerable position as struggle to deliver this more complex service.
substitutes become more viable and extend their geographic
reach in the years ahead. Narrower customer segmentation will help travelers manage
complexity by simplifying the search process and bringing
Product innovations that are derived from commonly available meaning to airline brands. Via their own web sites and other
inputs, such as new aircraft, lie-flat seats and special meals, will controlled channels, airlines could offer itinerary recommenda-
be quickly copied by competitors and are not likely to be a tions based on a vast array of customer and segment specific
source of lasting advantage. Likewise, automatic upgrades data to reduce choice complexity for their target customers.
given to top-tier customers may become necessary for most These recommendations would have to meet rigorous criteria
carriers, but the relative ease with which such innovations are for relevance to the traveler’s specific situation and preferences,
copied make them an unlikely source of competitive advantage. but properly executed, such a service could help differentiate
airline brands and deliver unique value to travelers. Given the
profusion of airlines in the most competitive markets, carriers
who do not deliver to the needs of more narrowly defined
Product-based elements segments fail to stand out and will not represent brands that
• Plane / room configuration hold meaning or value for travelers.
Level of investment/interest

• High-tech connections and devices
Journey- • Bundles of add-on services
based elements • Seat comfort and pitch Finally, to deliver the full benefit of targeting narrower traveler
• Minimizing • Bed quality
connection times
segments, carriers must support this new marketing model by
• Loyalty points
• Coordinating schedules leveraging segment-specific messages at each and every
with other travel providers customer touch point. From a shopping experience that is
• Adjusting for changes based on
traveler preference geared to the unique needs of the defined segment, to on- and-
• Coordinating with partners to prevent off airport customer management tools that guide customers
multiple check-in / out and multiple payments through the travel process, every aspect of airline marketing
• Facilitating traveler-driven changes in transit
must be aligned to the target segment. Marketing communica-
tion and promotions should speak directly to the needs of the
Travelers ...what matters most to... Travel providers
chosen target segments.

Source: IBM Institute for Business Value analysis, IBM-Oxford Economics Global Travel
Provider Interviews September 2010.

Figure 8: Providers invest time and money into physical product
improvements while most customers place a higher value on
the experience-based elements of their journey. Future product
development efforts should reverse this disconnect.


Naturally, not all of these suggestions will fit neatly into the the impacts of substitution and commoditization over the next
existing strategic development programs and investment plans decade (see Figure 9.)
in place at most carriers. Large carriers may need to deploy
sub-brands to address segment-specific needs, and many will Coordinate across other travel modes
struggle to remove segments from their current list of targets. Consumers view the travel experience holistically. Many
The choices about which customers to target and which to customers place a higher value on the experience-based
delist will be difficult, but the alternative is a model in which elements of their journey than they do on the physical attri-
commoditization continues unabated in the industry and butes of their seat or meal. They are often frustrated by the
emerging substitutes steal share from the most highly processes that precede air travel and are equally vexed by their
commoditized carriers. post-flight travel experiences. This impacts their views on
travel in general and on air travel in particular. As substitutes
In short, the airline marketing model should be defined by continue to evolve, travelers will be more apt to consider the
focused segmentation, insight-driven product development and alternatives to air travel if, in choosing those alternatives, they
differentiated branding. This model will help carriers combat can avoid the most frustrating aspects of a journey. For better

Current marketing model Marketing model for 2020
Broad-based orientation Focused segmentation
• Bring in all customers, but focus on top tier • Develop positions and capabilities that appeal to specific
• Disproportionate allocation resources, but limited (even narrow) segments
Target specialization of message • Granular individual measurement, contextual targeting
• Strive to meet all needs - no customer segments or • Concentrated marketing resource allocation
needs excluded

Mass-customization approach Insight-driven development
• Products are developed without consideration of specific • Determine product features and attributes based on
Product market needs observed needs
• Tier-based specialization and add-ons are possible, but • Develop product bundles to attract and retain only target
require customer involvement customers

Single-mode coordination Whole journey integration
• Focus on improving coordination within a single mode of • Single provider to be responsible for end-to-end
Experience travel customer experience
• Ignore cross-mode disconnects and points of • Coordinate not just within modes, but between them to
dissatisfaction optimize schedules, etc.

Market to the masses Differentiated branding
• Little perceived differences between competing brands • Focus on difference-driven positioning
• Rely on loyalty programs to differentiate • Develop trust with customers that unique position is
Brand
• Requires regional/hub control of customers reliable and consistent


Figure 9: The travel marketing model should be defined by focused segmentation, insight-driven product development, whole journey
integration, and differentiated branding.


Case study
An example of narrow targeting – Allegiant Air16
By most standards, Allegiant Air is a small carrier. With fewer Not surprisingly, Allegiant Air spends less in marketing and
than 50 aircraft and less than US$560 million in revenue in distribution than other competitors because its brand reso-
2009, Allegiant Air is the antithesis of the largest global air- nates with consumers. Plus, its promotion efforts do not cast
lines. But Allegiant Air also stands out in terms of profitabil- a wide net over potential customers with un-targeted mes-
ity. While other carriers have struggled to eke out a profit in sages.
the past decade, Allegiant Air has posted a profit every year On many of the traditional performance metrics that guide
since its re-birth from bankruptcy in 2000. What lessons can the industry, Allegiant Air is not a top performer. Flight
Allegiant Air teach other carriers about focusing on narrow schedules are limited, on-time performance is average and
customer segments? revenue per available seat mile (RASM) are all lower than
While the concept of focusing on some customers to the ex- many of its competitors. Instead of working to improve on
clusion of others is an anathema to most airlines, Allegiant these variables, Allegiant Air focuses on continually improv-
Air has executed on this approach consistently for the past ing on the factors that matter most to their target customers.
ten years. By targeting sun-hungry residents of mostly north- At 8 cents, Allegiant Air’s cost per available seat mile (CASM)
ern states in the central United States, Allegiant Air set up a is among the lowest in its region, and revenue generated
network of point to point routes that shuttles vacationers to from non-ticket sales are substantially higher than most car-
popular warm weather destinations such as Miami, Las Ve- riers, accounting for over 20 percent of passenger revenue in
gas and Phoenix. 2009. While Allegiant Air’s target customers are not willing to
pay for luxuries as part of their base fare, their spending pat-
Allegiant Air is a low-cost carrier not only because of its abil-
terns suggest that they are willing to do so after completing
ity to manage common industry cost swings in jet fuel, labor
their purchase.
and landing fees, but also because it has a simple operation-
al structure and a segment appropriate marketing model. For Allegiant Air has demonstrated that by targeting a narrower
most of its history, Allegiant Air has maintained a single-type segment of the air travel market it has changed the basis of
aircraft fleet, MD-80s. Cabin configurations are simple and competition. Its products are unique in a market that is highly
relatively luxury free. Customers respond well to the product commoditized. As a result, the threat of substitution is lower
on offer, however, because this simplicity enables Allegiant for Allegiant Air than many of its competitors. Allegiant Air of-
Air to keep fares low and because the company has targeted fers a strong example of what a carrier can do to successfully
customers not willing to pay for the common luxuries found counteract the forces of substitution and commoditization.
on other carriers.


or for worse, airlines must recognize that by failing to address to the forces of substitution and commoditization and resolves
the most pressing customer concerns – even when these some of the key pain points that travelers face today. If
concerns are directed at non-air aspects of the travel journey executed well, an airline that delivers seamless travel will simul-
– they are making it easier for customers to select alternate taneously differentiate its product offering to reduce the
providers. impacts of commoditization, while saving travelers time in
their travel journeys. The end result is a travel population less
Seamless travel is not a new concept in the travel industry. For eager to try substitutes.
years, providers have discussed the possibility of improving the
travel experience for customers by more closely aligning The challenges of substitution and commoditization, together
interconnecting pieces of the traveler’s journey. Unfortunately, with our recommendations for change, will require change in
most of these discussions resulted in few tangible improve- the business models prevalent in the airline industry. Airlines
ments because, in addition to the challenges of coordinating that execute these recommendations will create the potential
across travel modes on behalf of the consumer, the technolo- for more stable profitability and the increased loyalty of
gies needed to fulfill this vision were not available. customers who value consistently delivered and unique travel
experiences.
Today, however, these technologies are in place across almost
every dimension of the travel value chain. In the next ten years, Conclusion
as advancements continue, we expect at least a few providers to Despite the storm of change sweeping through the airline
deliver seamless travel. Further, we expect that the company industry, carriers must maintain their commitment to control-
that succeeds in this endeavor will lock-in loyal customers and ling both fixed and variable costs. Any lessening of resolve in
further commoditize providers who are not participating in a this matter is an invitation to disaster.
seamless travel solution.
But beyond that, to create the opportunity to flourish in the
Many travelers have a clear desire for seamless travel, and realities of an increasingly competitive travel environment,
would be willing to pay a premium to a provider that delivers airlines must accept the threat that both substitution and
on this promise. Travelers are equally willing to accept such a commoditization pose. Those that continue to embrace the
service from an airline, as they are from a hotel, airport status quo are likely to struggle. But airlines that offer a truly
authority or travel intermediary. In essence, any other member differentiated customer experience, utilizing both segmenta-
of the travel value chain could offer this service and would tion and/or integration, are those we believe will be industry
likely be rewarded with loyalty and lasting price premiums. outperformers in the coming decade.

Airlines that can coordinate across travel modes have the
potential to offer value to customers and generate lasting
loyalty in the process. All aspects of passenger travel should be Seamless travel is a powerful response to the
managed seamlessly, including travel planning, product pricing,
trip booking, ticket processing and journey fulfillment. This is
threats of substitution and commoditization.
the promise of seamless travel. It serves as a powerful antidote

Perspectives on seamless travel
Although elements of the seamless travel concept have been alternatives when such disruptions occur would win the
discussed in the travel community for years, IBM wanted to loyalty of many travelers.
gain more insight about how travelers and travel providers Travel providers, including airlines, airports, hotels, ground
perceive seamless travel. To support this objective, a transit companies and public transportation providers, also
concept test was conducted whereby IBM shared a video supported the concept. Several expected that such a solu-
depiction of a more seamless travel concept to of travel tion for seamless travel support was likely to emerge in the
professionals and frequent travelers and collected their feed- next 3-5 years. Providers had differing views on which travel
back in a focus group setting.17 provider was in the best position to the seamless travel
In this simple test, participants were asked to react to a service that was depicted, but almost all of them believed
travel enhancement scenario in which the traveler used a that by 2020 seamless travel would be enabled for many
not-yet-developed, hand-held travel support application to portions of the travel population.
make real-time adjustments to a trip that took them across a Travelers and travel providers both agreed that such a solu-
city, through an airport and across an ocean to their destina- tion would be most likely to have value for frequent travelers,
tion. The solution that was depicted was based on data and but many also expected that occasional travelers would
decision support technologies that are in use today, but the value such a solution if it were offered up as a travel supple-
innovative enhancement that was depicted in this scenario ment, like trip insurance.
brought all these disparate solutions together via a simple,
easy-to-use travel management solution. Providers indicated that systems should be designed around
customer needs and that the broader marketplace would
In general, travel providers and frequent travelers had a very eventually find ways to deliver such a solution. They believed
positive reaction to the concept, with over 75 percent of that standards would be essential to develop a truly global
them indicating that they thought the concept was both solution, and many expected that governments and industry
“viable and desirable.” Travelers expressed interest in such a bodies would have a significant and positive role to play in
solution and said that under the right circumstances they establishing consistent standards of data sharing and
would be willing to pay a premium to any service provider update frequencies. At the same time, several industry
that could deliver this solution in a consistent and reliable participants cautioned that the industry was not likely to wait
manner. for such standards to be defined if they believed the market
Travelers were intrigued by the idea of simplifying their travel opportunity for seamless travel was large enough.
purchases through more coordinated schedules, products Of course, no matter how valuable and desirable the concept
and offers, but they were even more enthused by the idea of of seamless travel is to consumers, the challenge to develop
getting better service in times of crisis. Travelers said that it will fall to the travel provider community. Will airlines step
travel is least “seamless’ today when unexpected events up to this challenge or will they let other travel providers and
disrupt large numbers of travel providers at the same time. intermediaries capitalize on this compelling opportunity?
Any travel provider who can offer integrated service recovery


Key strategic questions for airlines Study methodology
• What is your airline doing to create sustainable competitive
advantage in its chosen target markets?
Distribution of survey respondents
• Will the programs you have in place lead to improved
financial performance in the face of substitution and China
France
commoditization? 13% 13%
• What is being done to ensure that your products stand out in
the marketplace and are truly differentiated? Russia
• Do you manage a distinct brand that means something unique Germany 10%
13%
to travelers?
• Do your products stand out in the market and lead to more Brazil
customer loyalty from those who value a unique travel 11%
experience? United
Kingdom
• What is your airline doing to evolve with the changes in the India
14%
populations it serves? United States 9%
14%
To learn more about this IBM Institute for Business Value
Travel experiences in the past 12 months
study, please contact us at iibv@us.ibm.com. For a full catalog
609
of our research, visit: 539
ibm.com/iibv

Be among the first to receive the latest insights from the IBM
Institute for Business Value. Subscribe to IdeaWatch, our 228
190 200
monthly e-newsletter featuring executive reports that offer
122
strategic insights and recommendations based on IBV research: 93
28
ibm.com/gbs/ideawatch/subscribe
1 trip 2-4 5-8 10 or
trips trips more trips

Developed countries
Emerging countries


Figure 10: Study methodology.


Author Contributors
Steve Peterson is the global Travel & Transportation leader for Eric Conrad is a Vice President and Partner leading IBM’s
IBMs Institute for Business Value. He has worked as a strategy Travel and Transportation practice globally. He can be reached
consultant to airlines and travel companies since 1998 where at eric.conrad@sg.ibm.com.
he focused on operations, marketing, distribution, and cost Brian O’ Rourke is a Partner and Airline Segment lead for
reduction initiatives across the travel and transport sector. IBM. He can be reached at beorourk@us.ibm.com.
Steve can be reached at steve.peterson@us.ibm.com.
Tom Liebtag is IBM’s Industry Marketing Manager for Travel
and Transportation. Tom can be reached at twliebt@us.ibm.com.
Charles Vincent is a Vice President and Partner in IBM’s
Travel and Transportation practice. He can be reached at
charlesv@cn.ibm.com.

The right partner for a changing world
At IBM, we collaborate with our clients, bringing together
business insight, advanced research and technology to give
them a distinct advantage in today’s rapidly changing environ-
ment. Through our integrated approach to business design and
execution, we help turn strategies into action. And with
expertise in 17 industries and global capabilities that span 170
countries, we can help clients anticipate change and profit from
new opportunities.


References 6 IBM Institute for Business Value analysis based on data
1 IBM Institute for Business Value analysis. Jet fuel was from US DOT Form 41 schedule T2, 2010.
US$.087 per gallon in 2000 and $2.80 per gallon in 7 Schäfer, Andreas. “Long-Term Trends in Global Passenger
mid-2010, based on information from Platts. http://www. Mobility.” University of Cambridge. http://www.members.
platts.com nae.edu/nae/naefoe.nsf/0754c87f163f599e85256cca00588f
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travel/travel.agent.comeback_1_travel-agents-travel- 8 Sanchez-Borras, M., Nash, C., Abrantes, P. and Lopez-Pita,
booking-online-booking/2?_s=PM:TRAVEL and “ASTA A. (2010), `Rail access charges and the competitiveness of
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encing/


13 “Gartner Predicts Video Telepresence Will Replace 2.1
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