Differentiation in Airlines

August 18, 2008

I think a lot of airlines are in the old world thinking that their service is flying people from one place to another. They believe that what people are paying for now is an airplane taxi. And for some that is true. They will  go for the lowest price as a differentiator to show that they can get you from point to point the cheapest. The flight may not always be on time; and they might not have the most amenities, but they are cheap, and they’ll get you there, as long as you’re flexible.

Then there are those that realize that flight is now thought of as pure transportation. So what you do then? Do you get into a price war since everyone goes from one place to another? If we learned anything in our strategy class, it was that price wars are never good. We covered the Coca-Cola case and realized that Pepsi and Coke could have gotten a price war and choked each other to death; where the winner is barely alive. That’s a bad way to run a business because you’re reducing your margins. You want to increase your margins always. If you’re making $100M revenue at $99.9M cost, you only have $.1M (or 0.1%) profit. But if you can sell something for $2M at $1M cost, then you’re profit is $1M (of 100%) profit. That means that for putting in $1M, you will get out $2M. That’s a good formula. If you get the formula right, all you have to do is scale, and then you’ll be sitting pretty. But fight over the last penny, and you’ll run to exhaustion. It’s the old adage, “work smarter, not harder.” I could go into the counter-point, but I’m skewing away from the point.

The differentiator for airlines is service and amenities. That’s what’s make me, as a customer, choose one airline over the other. We’re all going to be in the air for 3 hrs. The only reason to pick another flight is like picking friends: because you enjoy the time spent with them. So who’s doing this and how? And who’s doing the price war?

Price War: US Airways

They have the cheapest flights on farecast consistently. But to fly from San Diego (hence, Rady school of Management) to Indianapolis, IN, I had to travel to Charlotte, NC first, before getting there. If you look at a map, you quickly realize that we’re overshooting to hit one of their hubs, and then bouncing back to Indianapolis. To save on money, you give up convenienct and time. You also give up amenities. They offer no snacks or drinks, but they’ll sell you anything a la carte. Snacks, meals, sodas, water (no tap water for free), booze, headphones. All for a price. Plus, you get to watch commercials before your in flight movie. Yah! And the in flight screen? You share it with 9 other people on a mono sound channel. Don’t forget the fabric seats that absorb sweat; everyone’s sweat.

Product Differentiation: Virgin America

I must say, I’m new to VA. February, I flew the airline for the first time (because it was lowest on farecast) and was pleasantly surprise. I went up with nick, Jason, and David. We were up there for the Game Developer’s Conference (a great place to go to break into the industry). We all flew it and enjoyed the experience.

Alright, the purple panels aren’t the coolest thing, but they do have nice amenities. Complimentary headphones when you get in. Each seat has a it’s own media center running Linux. Their free content includes Video games. Chat rooms. Google Maps to track your location along the path. Free YouTube like content. Music Videos. Brand new artist albums. Their a la cart menu is new DVD releases and TV shows.

Their prices will go up soon because their low price promotion will end. But they’ve shown me that there’s a better way to fly then on what people traditionally call, “cattle cars.” I would be willing to pay that extra $20 for a better 3 hours. The time is the same, so we might as well have fun doing it.

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7 Responses to “Differentiation in Airlines”

  1. SvanG Says:

    Don’t forget that Virgin America isn’t profitable just yet…how much more did you say you were willing to pay for those 3hrs?

    VA is certainly trying to differentiate themselves with their aircraft decor, in-flight entertainment, and british-pop-cool branding. However, segmentation – ala creating different levels of service for those willing to pay – can be a good way to extract value from different consumers and to create more personal interactions between a businesses and their customers. As industries face greater local and global competitive challenges, many will look to expand their offerings to gain both the customers willing to pay $20/3hrs and those that want the air taxi for the lowest price.

    Speaking of air taxis, the light and very light jet market may be the game-changer that the industry needs in order to overhaul the current hub-and-spoke and pension-drowning legacy carriers.

  2. joecool79 Says:

    @SvanG,

    I think to determine how much more I’d pay for the 3hrs can be calculated by conjoint analysis. You bring up some good points. I especially like the comment about very light jets. I haven’t rode one yet, but they’re getting a lot of attention and I think they definitely have the potential to be a game changer.

  3. harconllc Says:

    There are few business models worse than the airline industry. It’s mature, capital intensive, labor intensive and entirely dependent on wildly fluctuating fuel prices for profit. Southwest airlines offers no product or service differentiation yet it is the only profitable name brand airline in the U.S. Why? Because it has the least complexity, by far, in the types of aircraft it flies (1), the number of seat configurations it offers (1), the types of meals it serves (1), reservations bookings, gate turnarounds and other key cost components. It operates primarily on point-to-point routes, not hub and spoke, and uses the #2 airport in larger cities to save on gate costs. In addition, Southwest began hedging, in 1999, against future rises in fuel costs by purchasing oil on long term fixed price contracts. This has saved the airline an estimated $3.5 billion since 1999.

    Because the airline industry is so mature, success is no longer about marketing strategy. It’s about operations and purchasing strategy. Product and service differentiation can quickly reach a point of diminishing returns, especially in mature industries.

  4. Joseph Says:

    Hi Mike, thank you for the comment. Though I think all your points are valid, I still stand by my original post that value added for the customer creates differentiation. If you look at the PC market, Dell had an operational advantage for a long time but HP eventually caught up to them. With margins being so slim for them right now, the only way to attract customers is by providing a better experience for the users. Airlines do that by providing a more comfortable flight and amenities. It’s true that PC makers don’t suffer from fuel price fluctuation, but at a certain point, the operational advantages become moot and you have to look somewhere else for more business.

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