From Open Skies to Big Data: The Next Force for Creative Destruction in the Airline Industry

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The past fifteen years have seen mid-tier players face increasingly stiff competition from budget travel firms. Nowhere is this more evident than in the airline industry where deregulation and declines in operational costs have provided a platform for budget airlines to thrive amidst market giants such as United Airlines, British Airways and Virgin Atlantic. Within the UK, ‘no frills’ travel has been the cornerstone for companies such as Ryanair and EasyJet, whose emergence and growth over the past three decades has led to increased scrutiny of their business model. Among the many reasons that can be attributed to the success of budget airlines so far, structural reforms and lower fuel costs are perhaps the most important. EU legislation facilitated operations between countries in Europe and paved the way to the “Open Skies” agreement with the US, which led to greater operational ease on a transatlantic level. Moreover, an emphasis on Internet sales to reduce labor costs alongside a transition from free amenities and services to promoting ancillary revenues has padded out the profit margins of companies like Southwest Airlines and Jetblue.

The economic basis for such a business model has long been part of the mainstream theory of the firm. In short, the model is heavily reliant on second-degree price discrimination, or more specifically product lining, in which several related services are sold separately in order to differentiate consumers based on preferences and willingness to pay. In theory, this results in a reallocation and expansion of surplus that heavily favors the producer. And it is the nature of the services provided by this industry that has meant firms that exploit second-degree price discrimination naturally tend towards success. Consumers travel for a variety of different reasons resulting in a wide range of elasticities of demand. For example, students and business executives are two of the many distinct demographics that have a demand for travel with the former being much more responsive to changes in price. In addition, many of the ancillaries such as a three-course meal onboard or in-flight entertainment are designed for immediate consumption, making the opportunity for resale impossible. Add to that the lower administrative costs from online sales and increased operational opportunities from multilateral agreements, and it is clear why such a business model thrives.

But there is strong reason to believe that budget airlines may experience turbulence in the future, particularly in the case of small budget airlines that have yet to experience the growth of their competitors. Following the model of relying on second-degree price discrimination, the airlines that can price discriminate most effectively have the best chance of augmenting market share. This is where recent advances in data analytics and artificial intelligence come into play. Leveraging big data is the next key goal for airlines as greater understanding of clients’ needs and requests from dietary requirements to entertainment preferences allows for greater customization and better practice of second-degree price discrimination. And it is this that well-established mid-tier players should in theory be better equipped to do.

First and foremost, mid-tier players have the capability to cater to all demographics and price discriminate. While budget airlines target those who prioritize the cheapness of a flight as opposed to the quality of the service such as students and families on budget holidays, mid-tier airlines have the potential to target those consumers as well as those who value the experience of flying. It is for that reason that mid-tier airlines should be able to exploit a wider consumer base and should therefore be able to collect more data on customer preferences. Here, the airlines are in a strong position to benefit from the Netflix Effect. The more data they can acquire, the more valuable their offerings are to the consumer, and the greater its market share will be. This in turn can lead to the acquisition of more data, further personalization in terms of depth and breadth, and even greater growth. This virtuous cycle, if all the necessary structures are in place, can be a powerful catalyst for sustained customer satisfaction and growth.

Alongside that is the notion that as artificial intelligence and big data afford more significant improvements in the travel industry, budget travelers will be able to better justify a modest trade-up to the middle in order to exploit a more significant quality differential. Moreover, the logistical benefits that artificial intelligence brings will result in personalized services becoming available to a much wider section of the population. Mid-tier operators can provide for passengers more cost effectively concierge-style amenities that upper-tier and luxury providers currently offer, but with more expensive labor models. In short, the general forecast is that mid-tier players may be able to benefit at the expense of budget and luxury services.

Already, we are seeing some signs of this trend unfolding. As an attempt to replicate the budget airline model, mid-tier airlines such as British Airways and Delta have already made check-in baggage an additional expense leaving the basic fare a near facsimile of the stripped-down tickets EasyJet and Southwest offer. More recently, airlines have also proceeded with an expansion of membership accounts and a focus on brand loyalty. Air miles can be exchanged for seat upgrades and car hire while tiered services form the foundations for greater personalized travel. Some developments on the horizon may include the integration of student memberships to flight accounts as well as increased partnerships with hotel chains and transport services to streamline the travel itinerary. However, this is only skimming the surface. The most adventurous of firms should seek to utilize their data to predict consumer purchases in order to price and market accordingly. This should not only be limited to flight tickets but also in-flight ancillaries. If executed correctly,we should observe a resurgence of mid-tier flight operators over the decades to come.

More posts by Justin Chan.
From Open Skies to Big Data: The Next Force for Creative Destruction in the Airline Industry
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