ARTICLE IN PRESS

Journal of Air Transport Management 13 (2007) 23–30

www.elsevier.com/locate/jairtraman

Innovation: The winning formula to regain profitability in aviation?

Markus Franke
Booz Allen Hamilton, 40221 Düsseldorf, Germany

Abstract

Most airlines have overcome the immediate effects of the recent global aviation crisis partly because of economic upturn and partly
because of massive restructuring. Legacy network carriers had to take on the challenge of low-cost carriers, and regain competitiveness in
short- and mid-haul business through considerable cost cutting and more flexible pricing models and are now profitable. On the other
hand, many airlines do not make a reasonable profit, and the majority of carriers do not earn their capital cost. Airlines claim that they
are still squeezed between their neighbors in the aviation value chain that leverage local monopolies (such as airports) or oligopolies (such
as aircraft equipment manufacturers). Many legacy carriers, however, have not properly prepared for an era of deregulated and changing
markets. They have not yet taken appropriate steps to escape from there positions between the few successful premium carriers and low-
cost carriers. This middle position has little differentiation potential, an unsatisfactory growth perspective, and poor profitability
prospects. Further, despite ongoing liberalization, the regulatory framework still does not enforce far-reaching consolidation, leaving the
industry in a fragmented status with massive overcapacities. Consequently, the industry needs to further leverage external deregulation as
well as internal restructuring to establish more efficient and competitive business models. Aside from basic cost cutting, innovation may
become the decisive driver of progress, comprising advanced business models, customer segmentation, and technologies (Franke, M.,
2006. Innovation: the winning formula to regain profitability in aviation? Speech at the Hamburg Aviation Conference, Hamburg).
r 2006 Elsevier Ltd. All rights reserved.

Keywords: Airline strategy; Innovation; Legacy carriers; Low cost carriers

1. No future for ‘stuck-in-the-middle’ carriers
The airline industry is sensitive to economic cycles.
History has shown that airlines tend to make up for all
losses of past downturns in good times and lose more
money than they have ever gained in each subsequent
crisis. Over- and under-performers have always existed, but
as long as carriers pursued similar business models (flag/
legacy carriers with hub-and-spoke networks), no funda-
mental deviations from this trend have occurred. This rule
changed for the first time in the past aviation crisis and the
subsequent upturn phase. The success of the low-cost
carriers established a second paradigm—at least in
continental travel—when these airlines offered a very lean
and simple product at aggressively low prices. On inter-
continental routes, new carriers from emerging regions
(such as Emirates or Etihad) are trying to change the rules
E-mail address: franke_markus@bah.com.
of the game, investing heavily in new mega-hubs and
convenient products.
Both challenges have forced established legacy carriers
from Asia, Europe, and the US to rethink their traditional
business models. Because their passengers are no longer
willing to pay for carriers’ complex, monolithic hub-and-
spoke systems, airlines had to reinvent their business.
Although intercontinental connections can still be profit-
able, making money on short- and mid-haul routes has
become extremely difficult. In the worst case, an unprofi-
table continental feeder network eats up earnings from
intercontinental services. Thus, legacy carriers have taken
three measures to regain a competitive position:
 Massive cost cuts.
 Merger and acquisition activities to consolidate capa-
cities and increase market power (e.g., Air France/KLM
and Lufthansa/Swiss).
 Repositioning of existing operational platforms or
introduction of new platforms, leading to a more

0969-6997/$ - see front matter r 2006 Elsevier Ltd. All rights reserved.
doi:10.1016/j.jairtraman.2006.11.003
 ARTICLE IN PRESS
24 M. Franke / Journal of Air Transport Management 13 (2007) 23–30

fragmented portfolio and allowing the airlines to better
serve the needs of specific customer segments (e.g.,
regional and low-cost platforms of SAS or Lufthansa).
Further, as a fourth lever, some of the major carriers
have succeeded in establishing or sustaining a premium
brand perception in the marketplace. It is not easy to define
what a premium airline is, but it is clear that some flag
carriers, such as Singapore Airlines, Lufthansa, and British
Airways, are able to realize premium prices, at least in
some segments.
None of the four levers may be sufficient to alone bring a
carrier back to profitability, and each entails major
investments and risks. On the other hand, if a carrier does
not move any of the levers, it will certainly stay in an
unfavorable ‘sandwich’ position between premium and
low-cost carriers. Remaining stuck in the middle in a more
and more commoditized industry translates to poor
differentiation potential and, thus, mediocre yields, making
profitable operations a real challenge.
This critical area is often referred to as ‘airline no-man’s
land’ (Manning et al., 2006) because survival in it is very
tough. The historic profit curves of the three airline clusters
over time underscore this term, as illustrated in Fig. 1. The
dip in 2001 affected premium carriers mildly, and they
returned to their previous levels of profitability within 3–4
years. Surprisingly, low-cost carriers have experienced a
deeper dip than premium carriers, but they also came from
a higher operating profit margin level (14% compared to
5% for premium carriers). The losers of the carriers are all
other network carriers, showing a stuck-in-the-middle
circumstance. This group made decent money in the
1990s (9–10% margin on average) and then slumped down
to 10% during the crisis, recovering very slowly after-
ward (breaking even in 2005–2006).
The rationale behind these curves is that traditional
network carriers invested heavily in new capacities in the
‘Golden ‘90s’, leading to reasonable profits and decent
yields in times of high demand. In the course of the crisis,
slumping demand created a revenue crisis that was
followed by a cost and profit crisis, fueled by massive
overcapacities. Carriers that were not quick enough to
reduce capacities and take consolidating actions experi-
enced huge losses, which increased as their continental
feeder networks unraveled under the attack of the low-cost
carriers.
2. Innovation as a driver for success
Most network carriers have undertaken cost-cutting
exercises, creating competitive operational platforms.
These exercises have led the group back to the break-
even point, but not beyond it. For sustainable value
creation, carriers must further leverage the current
upturn, unleashing potentials on the revenue side as well.
Fig. 2 illustrates how innovation cycles of the airline
industry have mirrored economic cycles over the past two
decades.
 After years of operational improvement, the unique
upturn phase of the 1990s drew the attention of airlines
more to the revenue side. With the invention of network
management as a central instrument to optimize profits,
hubs achieved maximum connectivity, expanding service
offerings to as many destinations and customer seg-
ments as possible.
 With the big aviation crisis, dusk came quickly for the
upturn phase. Customers have widely changed their
buying criteria, preferring price and convenience over
extensive connectivity and seamless travel. Low-cost

Global - Weighted Average Operating Profit Margin

(1) LCCs = Southwest,
by Airline Category 1995-2005
15 Jetblue, EasyJet,
RyanAir, Air Asia,
Virgin Blue
Operating Profit Margin (%)

10 Lo

Premi um = Cathay,
5 P Malaysia, Singapore,
British Airways
N
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Network = Air
-5 France-KLM,
Lufthansa, Alitalia,
SAS, Iberia, Air
China, Asiana, EVA,
-10 Korean, Thai, Qantas,
JAL, American,
United, Northwest,
Delta

Fig. 1. Profitability of different airline models.

 ARTICLE IN PRESS
M. Franke / Journal of Air Transport Management 13 (2007) 23–30 25

Focus on
Services Adaptation
and Optimization of
Revenues of Low Cost
connectivity business Innovative
elements Business
Models,
processes,
etc.?

Focus on
Operations
and Cost Advanced
Operational Depeaking; segmentation
Optimization Optimization
of
productivity

1985 1990 1995 2000 2005 2010

Fig. 2. Innovation cycles as a response to economic cycles.

Changed customer/traffic
segments
Success of Low Cost Model
Changed customer New Intercontinental carriers
behaviour/demand from emerging countries
Poor differentiation New Business Consolidation and new
potential in „Airline‘s No- Models partnership models
Man‘s Land“
Advanced segmentation New vehicles for customer
approach for customers interaction/information
and services („Smart and terminal handling
Customization“) Regulatory New distribution
Framework channels/platforms
New Aircraft types impact
Advanced New network patterns
Segmentation Technologies

Fig. 3. Three areas of potential innovation.

carriers have established a service offering that does not
impose the cost penalties of complexity on clients.
Consequently, network carriers have not only cut costs
but also re-evaluated the tradeoff between connectivity
and productivity in their hubs, resulting eventually in
the ‘de-peaking’ of heavily waved hub structures for the
sake of more efficient use of airside and landside
resources.
 After massive efforts on the cost side, the current
economic upturn once more opens up opportunities on
the revenue side of the business. If it holds true that
passengers are showing more diverse buying patterns,
and the variety of market segments cannot be served any
longer by the monolithic network model of the past,
legacy carriers need to deploy a more flexible portfolio
of partly innovative business models, preserving net-
work synergies where possible.
Fig. 3 illustrates that innovation can be achieved in three
areas:
 Through new business models—as a response to the
challenges imposed by low-cost carriers and interconti-
nental carriers from emerging regions, or as an indis-
pensable realignment of resources after consolidation.
 Through advanced segmentation—as a reaction to more
diverse customer requirements, and as an attempt to leave
airline no-man’s land by examining carefully which
customer segments should receive which types of services.
The entrenched one-size-fits-all approach of legacy carriers
is dead because clients no longer pay for the complexity of
a system that offers uniform services that are needed—and
valued—by only a minority of passengers.
 Through new technologies—as a vehicle for more
efficient customer interaction (e.g., Common Use
 ARTICLE IN PRESS
26 M. Franke / Journal of Air Transport Management 13 (2007) 23–30
‘Self-Service [CUSS] self-check-in kiosks or wireless
network applications) or more efficient operations (e.g.,
next-generation aircraft types).
3. Levers and impact of innovation
This section provides examples of innovative options
and discusses required actions as well as potential risks.
Innovation has no value in itself—it must solve a major
problem or create a competitive advantage, and it needs to
be developed and implemented in a professional manner.
3.1. New business models
As stated earlier, legacy carriers are no longer able to
cover all customer and market segments with a single
network model. They need to preserve their core business
with intercontinental connections (if profitable) and the
required continental feeder platform. Around that core, a
variety of other business segments will emerge (Fig. 4).
 Premium continental point-to-point (P2P) traffic—
smaller in size than a decade ago, but still alive.
 Standard or budget continental P2P traffic—because
this will be—by far—the largest segment in continental
traffic, all major airline types will compete in this space
(network carriers, low-cost carriers, charter carriers).
 Intercontinental low-yield/budget traffic; mainly P2P,
but also connected—this segment will from the current
long-haul charter business and converge with the low-
yield outbound business of network carriers.
Carriers that want to be successful in one of these
segments must be fully competitive on a stand-alone basis
in terms of cost and quality. Cross-subsidizing among
High 1 RRO
Intercontinental premium
3 Continental
premium (P2P)
5
Intercontinental
Service and Low Yield P2P
Continental
Contribution feed
Level Of A
Segment
Continental
standard
(low yield, P2P)
4 segmented portfolio
Low
Low
Complexity and Unit Cost
To Serve Segment
Fig. 4. Future customer and business segments.
segments—as in the old network paradigm—no longer
works.
The second driver of business model innovation lies in
the evolvement of new multi-hub systems, especially in
Europe. Unlike the structures US network carriers have
established to cover the huge North American land mass,
European multi-hub formations are a byproduct of
consolidation. The more carriers affiliate themselves with
the ‘Big 3’ (Air France/KLM, Lufthansa/Swiss, British
Airways), the more hubs have to be coordinated under one
roof. This requires new models for allocation of demand to
competing hubs.
The third driver of business model innovation is the
pressure that carriers from emerging regions put on
established airlines in Asia, Europe, and the United States.
Ambitious new entrants, such as Emirates or Air China,
invest heavily in new P2P connections to major spoke cities
of their legacy counterparts in an attempt to alienate
passengers from the hub systems of the latter.
3.2. Advanced customer segmentation
The segmentation lever is closely linked to the business
model discussion, taking it to the next level of detail. If an
airline wants to escape from airline no-man’s land, it can
adopt one of three strategies:
 become a premium carrier (like Emirates),
 transform into a low-cost carrier (like Aer Lingus),
 become a ‘better’ network carrier (like Qantas).
Transforming an airline into either a premium carrier or
a low-cost carrier is a big bet that requires considerable
investments at high risk. A premium strategy requires a lot
of new expertise; a low-cost strategy requires a new
CO
((EES CO
SPP. NNCCEEP
ORR PTTUUAAL
. FFO
EEUU L
OPPE
E))
Existing business models
Premium carrier
2
Traditional Hub & Spoke flag
carrier
Network carrier with focus on
intercontinental connecting
traffic
Niche Players (esp. smaller
flag carriers and second
tiers)
Network specialists with
Low cost carrier
High
Charter carrier
 ARTICLE IN PRESS
M. Franke / Journal of Air Transport Management 13 (2007) 23–30 27

company culture. Thus, these extreme scenarios cannot be
recommended right away, which leaves the ‘better’ network
carrier option as the most likely remedy. Fig. 5 shows that
restructuring is a must for this option, but a more
differentiated approach to key customer segments will
then make the real difference.
Although this new approach to markets and customers
certainly depends on the individual framework of each
airline, each should follow a common governing theme: as
stated earlier, carriers must examine very carefully which
services they provide to which customers, and what these
passengers are ready to pay for. The example of Qantas
shows how the outcome of a such-like evaluation might
look. After being attacked by low-cost carriers and
experiencing dropping yields like many other legacy
carriers, Qantas discovered that its clients could be
segmented into not only domestic versus intercontinental
travelers and leisure versus business travelers but also into
two additional dimensions: loyal versus opportunistic
clients and outbound versus inbound clients.
In fact, premium prices were mainly paid by loyal
business and high-yield leisure travelers, and that the vast
majority of these loyal clients were Australians traveling
abroad (i.e., outbound clients). Most inbound travelers
(and some of the low-yield outbound travelers) chose
Qantas opportunistically as their carrier, driven mainly by
seat availability and price.
Consequently, Qantas realigned its customer segmenta-
tion and reshuffled both its brand and platform portfolio
(Fig. 6). Qantas remained the premium brand, operating
preferably on intercontinental city pairs with a high share
of loyal outbound customers. Australian Airlines was
introduced as the convenient value-for-money option for
routes dominated by opportunistic inbound travelers. For

Example Comment Main Driver

Repositioning Emirates Expensive, high

Transition to risk
a premium Upgrading and Requires
carrier uptrading development of
foreign markets Differentiation

Differentiation + Qantas
Customisation New
Multiple brands, Business
shared costs segmentation
Options to Become a
leave betterÓ
AirlineÕs no- network
manÕs land carrier Restructuring Northwest Painful and
potentially
Massive cost insufficient
reduction

Severe
Repositioning + Streamlining
Air Lingus Cultural and
Become a Restructuring other constraints
low cost Lean business model may make this
carrier impractical

Fig. 5. Advanced segmentation as a means to become a ‘better network carrier’.

Short-Haul/Domestic Long-Haul/Inbound Long-Haul/Outbound

Business

Price-sensitive
Leisure

Loyal clients,
clients,
high yield
low yield

Fig. 6. Multi-brand approach introduced by Qantas.

 ARTICLE IN PRESS
28 M. Franke / Journal of Air Transport Management 13 (2007) 23–30
domestic business travelers, Qantas launched the CityFlyer
service; for domestic budget clients, it installed a dedicated
low-cost operation called JetStar.
The main success factor for this new model was the right
balance between front-end differentiation and back-end
synergies. Although the client perceives a more customized
service offering than before, a dedicated governance model
ensures as many network and operations synergies as
possible.
As of now, Qantas’s approach seems to be successful
because it was able to stop passenger attrition and push up
its profit; however, the necessity of fine tuning a suchlike
model became evident when Qantas cut back its portfolio
from four to three brands with the closure of Australian
Airlines in June. The viability of a suchlike model needs to
be tested for each airline against its specific environment,
and realistic options might look quite different across
various carriers. The tradeoff between added market
traction and wasted synergies needs to be calculated to
determine an advantageous solution.
3.3. New technologies
Many people associate innovation with new technolo-
gies. Even though this association is too simplistic (as
demonstrated by the two previous topics), technology is a
crucial driver of innovation. In the given context, three
types of technological innovation appear relevant, next-
generation aircraft type, advanced information technology
(IT) solutions and devices for terminal handling, and new
distribution systems.
On one hand, next-generation aircraft types, such as A
380, A 350, or B 787, will reduce fuel costs for flights,
assuming that they drive fuel efficiency to the next level. On
the other hand, they will intensify the struggle between
intercontinental P2P and connected services. The scales
achievable by employing an A 380 force the respective
carriers to strengthen their hubs, whereas Boeing’s
‘Dreamliner’ B 787 or Airbus A 350 will foster inter-
continental P2P connections.
1st CUSS kiosks to serve multiple
CUSS
airlines introduced last April in Toronto
Test of 2D barcode on mobile
Cell Phone phone with a Brazilian airline (SITA
and Siemens)
EyePass-System introduced at
Biometrics Charlotte Douglas 2003/tested in
FraPort in BioPII
Test of biometric Smart -card check -in of
SmartCards Singapore Airlines at Changi Airport and
of Swiss in Zurich
Fig. 7. Advanced technologies in terminal handling.
Fig. 7 shows a selection of state-of-the-art technologies
that could help to raise efficiency, process stability, and
service quality. Some of these applications, such as CUSS
self-check-in kiosks or mobile phone barcode solutions,
aim to streamline the check-in and boarding process. New
security solutions, such as biometric eye pass systems, aim
to increase the confidence level of security checks while, at
the same time, removing bottlenecks. Wireless networks
can be used for surveillance and also to provide the client
with a wide range of online services. Finally, the complex-
ity of front- and back-end systems requires a joint
platform; thus, integrated databases and host systems,
such as Altéa by Amadeus, coordinate all airline and
airport applications along the value chain—from reserva-
tion and check-in to departure control.
Large integrated computer reservation systems (CRS),
such as Amadeus, Sabre, and Worldspan, have dominated
airline distribution systems in the past decade. These
systems offer a wide range of inventory-related function-
alities and extensive coverage at relatively high costs. The
good cost position of low-cost carriers is partly a result of
their strategy to bypass the established global distribution
systems (GDS) (see also CRS) and deploy simple stand-
alone solutions, based on their own websites. In the United
States, GDS new entrants (GNE), such as U1 or Switch-
works, have added a new option to the market for GDS,
offering relatively cheap services, especially for smaller and
mid-sized carriers. The next generation of low-cost GDS/
CRS applications will probably be built on so-called
federated networks, using peer-to-peer node technology.
In addition, many carriers establish direct links to online
travel agents/portals (OLTA), such as Opodo or Expedia.
The end game will probably bring a portfolio of coexisting
systems, legacy CRSs, low-cost GDSs, and stand-alone
solutions.
4. How to turn innovation into sustainable profitability
It has been argued that innovation needs to solve a
major problem or create a competitive advantage to be
Almost industry standard in most
(Interlined)
developed countries (only 20% of tickets
eTickets
issued in America are on paper)
Lufthansa tests 2D Barcode technology
2D Barcode integrating biometric data (fingerprints) for
check-in
Las Vegas McCarran first airport worldwide
RFID to use RFID for Baggage tracking with 99%
correct read
AmadeusÕAlteadeployed at British
Integrated
Airways/Qantas (for Reservation/Inventory),
CTMS
Star Alliance first to move to new Altea DCS
 ARTICLE IN PRESS
M. Franke / Journal of Air Transport Management 13 (2007) 23–30 29

Effect On Effect On Effect On

Main Drivers/Effects
Revenues Cost Quality
1

New balance within portfolio of

New Business platforms, hubs, and brands
Models Additional scale effects
More decentral control

2
Better fit between service offering and
customer needs
Advanced
Better skimming of customersÓ
Segmentation
propensity to pay
of Customers
Smart customization Š comple-xity
and Services
only where it is paid for

3
Integrated data and information flows
saves cost
Deployment of More efficient sales channels and
new Technologies customer interfaces
More efficient process planning and
control

Fig. 8. Contributions of innovation to sustainable profits.

truly useful. In addition, the inherent potentials of
innovation need to be unleashed, managed, and materi-
alized in a target-oriented manner to achieve tangible
results. Fig. 8 illustrates the potential impact of innova-
tions on revenues, cost, and quality.
New business models mainly aim to establish a new
balance of platforms, brands, and services within an
airline’s portfolio, responding to more volatile demand
and more intense competition within fairly new business
segments. Redefining what services are offered to which
customer segments at which prices should help carriers
prevent unpaid complexity and services, resulting in cost
reductions. On the other hand, offering more customized
services at reduced prices will help stimulate additional
demand. Quality of services is not the primary lever in this
category; however, customer satisfaction could improve.
Advanced customer segmentation will help to deepen the
positive effect on demand and revenues described above. It
is important to understand the criteria for which clients
select an airline’s services and how they tend to pay for
them. Offering solutions that are more tailored to the loyal
core is a prerequisite for realizing premium yields (‘skim-
ming’) without too much extra effort. A better under-
standing of clients’ needs will also provide a stable basis for
advanced branding and direct marketing, hopefully result-
ing in further revenue potentials.
However, a new segmentation can also be instrumental
to driving down cost. If services are not provided across the
board to every passenger, regardless of whether the
passenger values them, cost-to-serve can be brought down.
This ‘smart customization’ into basic and extended services
enables airlines to develop ‘tailored business streams’ for
different categories of clients and needs. Provided that the
additional complexity can be mastered, these streams can
improve the return on effort for an airline.
One of the purest examples of a tailored business stream
is the fully differentiated procedure that Lufthansa has
developed for its most valuable frequent flyers (HonCir-
cle)—a service concept covering the entire value chain and
granting utmost convenience to those who pay for it in the
course of their lifetime. Even if the investments in the
HonCircle are considered customer loyalty or marketing
costs, this concept could be a role model for other tailored
business streams, helping to focus offerings and avoid costs
of unvalued services.
New technologies are primarily deployed to increase the
speed and reliability of processes, effecting a positive
impact on customer satisfaction and operational efficiency.
New scanning devices or more upstream passenger identity
checks will smoothen demand peaks and reduce waiting
times. Self-check-in devices and mobile passenger informa-
tion reduce touch points, which cost time and money.
On the other hand, mobile applications (e.g., via cell
phones or smartcards) can open up new revenue streams,
providing passengers with real-time information, custo-
mized entertainment, and individual support. Passengers
can pay for these applications on a case-by-case or
subscription basis, eventually leaving some features free
of charge for status clients.
In a nutshell, this article states three basic hypotheses:
 Further cost cutting is a necessary, but insufficient,
precondition for the future success of an airline; it is
especially insufficient for carriers stuck in the area of
little differentiation and poor margins.
 Most carriers need to unlock new revenue potentials.
 Innovation of business models, segmentation, and
technology can help not only to tap these potentials
but also further boost efficiency, speed up processes, and
improve customer satisfaction.
Unfortunately, innovation is not a simple remedy. If new
procedures and technologies are commonly applicable,
they will quickly lose their differentiating effect and turn
 ARTICLE IN PRESS
30 M. Franke / Journal of Air Transport Management 13 (2007) 23–30

into ‘must haves’. If they are not commonly applicable, Reference

they must be tailored, which entails cost and risks.
Professional innovation management in its classic sense Manning, C., et al., 2006. ‘Airline no-man’s land’—the crisis faced by
traditional hub carriers and how to escape it. Viewpoint by Booz Allen
can mitigate risks by ensuring that new ideas are
Hamilton, Sidney/Düsseldorf.
professionally tested and selected improvement levers are
implemented. In any case, taking the innovation chal-
lenge—at manageable risk—should be better than fading
away in the ‘airline no-man’s land’.