Air Wars

April 1 1990 by Chief Executive

Privatization has been a boon not only in financial terms, but it has given BA a wing up on its state-owned competitors by injecting niche marketing into a competitive but cost-driven business. Created by the 1971 merger of BEA and BOAC, state-owned BA had losses exceeding $1 billion in 1981. Today it is a premier European air carrier with annual revenue exceeding $7.5 billion and profits of $477 million. Flying 24.6 million passengers to 166 cities in 80 countries, BA is overshadowed internationally only by Aeroflot. (And who’s to say it won’t catch privatization fever someday.)

Given a free hand by Prime Minister Margaret Thatcher, ex-Babcock International Chairman Lord King brought Marshall into BA as CEO in 1983.  Marshall had no experience running an airline, but he immediately set about revamping marketing strategies by introducing brand management techniques to increase business travel market share, upgrading the image of British Concord, and entering a marketing pact in 1987 with UAL. Treating air transport like soap or Jello owes something to his transatlantic career. Having gone to sea on the P&O line in his youth, and worked as a management trainee at Hertz, Marshall rose to the presidency of Avis in 1976. (Later he was kicked upstairs to Avis co-chairman and executive VP of Norton Simon following its takeover of Avis.) He later returned to the U.K. for a brief stint at Sears Holdings (not related to the U.S. retailing giant).

In 1988, a healthy BA gobbled up British Caledonian Airways (price: $418 million), trumpeting its patriotism against an earlier SAS bid for the airline. (Remember Freddie Laker claimed that it was BA among others that forced Laker Airways out of business.) This was King and Marshall‘s masterstroke, for it gave BA the size and scope it needed to think of itself as a global competitor, as well as providing further opportunity for internal restructuring. In 1989 came the purchase of 20 percent of Sabena, in a three-way agreement which also gave KLM an equal stake in the Belgian state-owned carrier. BA gained a crucial hub in Brussels and further positioned itself for future EC deregulation and increased competition.

Meanwhile, having sparred legally with American Airlines over computerized reservations systems, BA bought into UAL’s Apollo/Covia system and in a partnership with KLM, Alitalia, and Swissair created the Galileo system. In turn, both TWA and Northwest filed a legal complaint against BA’s system. Finally came the bid for UAL itself, in which BA was to put up 78 percent of the equity ($750 million) for 15 percent of the shares, satisfying the congressional 25 percent limitation on foreign ownership of U.S. flag carriers (while effecting de facto financial control), and paralleling the KLM role in the Northwest acquisition.

But with the collapse of US. financing on the UAL side, King and Marshall pulled out of the deal, citing among other reasons, the US. Department of Transportation’s subsequent limitation of KLM to 25 percent ownership and 25 percent of equity interest. Future emphasis will be on location specific deals similar to the one BA struck with Delta at Dallas/Fort Worth. BA clearly intends to move quickly to increase market share when EC airline deregulation becomes a reality, but as he indicates in the following interview, Marshall sees this achieved through alliances and partnerships, not through mega mergers.

Fierce as competition will be in this decade, air carriers face a more formidable threat from “airweed”: overcongested airports with inadequate road and rail links that are beginning to choke off business, and overcongested air traffic corridors and control methods which can no longer cope with rising demand. Add to this the not-in-my-backyard environmental opposition to building new or expanding existing airports. “Like other airline chiefs, I grow weary of spending considerable effort and money on service improvements only to have it dissipated because of the way travel arrangements of our customers are mangled by factors outside our control,” says Marshall. He proposes an IATA-backed “action group” of all international carriers to push for industrywide solutions. He also hopes that within Europe, where 80 percent of the air space (which is largely unused) is reserved for the military, some portion can be assigned for civilian use.

As the size and complexity of international air travel increases, so does a carrier’s reliance on decision support technology. American Airlines’ Robert Crandall is said to be unique among CEOs, regardless of industry, for his grasp of expert systems as a tool to create market niches or carve up competitors          witness People Express. Part of BA’s brand management strategy involves increasingly sophisticated yield management systems, which allow controllers to price seats on individual routes for maximum revenue. (This is why the guy sitting next to you on your flight didn’t pay the same fare as you did.) BA, for example, is a leader in using such systems to take advantage of currency fluctuations. So if, say, yen- or dollar-paying customers for certain routes need to be maximized, flight availability in a given route may be reduced from parts of the world where people pay in dinars or pesos. Over the next three years BA will spend $33 million to $50 million on more sophisticated Al modeling systems to increase the airline’s response time to market and operational changes. (The logistical deployment of crews in real time is one area of particular emphasis.) As competition among carriers heats up, old-fashioned fare wars will be fought with new IT weapons featuring advanced mathematics. By the end of the millenium, it may be only a slight exaggeration to say that BA stands for British Algorithm.

In the U.S., American and United have become mega carriers. The same thing is happening in Europe. American Airlines is now British Airways’ most formidable competitor. Where will the rash of mergers and takeovers take the industry within the next five years?

In the context of looking at sheer size and scope of operation, that’s not an unreasonable assessment. But there are restrictions on where airlines are able to fly. We have a myriad of competitors according to what route it is that we’re operating. We’re competing head-to-head with American on Dallas/Fort Worth. And we’ll obviously compete head-to-head with them on any other U.S. points linking into the U.K. that they are able to obtain.

There is a tendency in the U.S. to look upon open skies as meaning that all international agreements are more or less cast to the winds. But that is only one part of the open skies issue. The other part is the fact that the U.S. market is deregulated only as far as U.S. carriers are concerned. We need a true open skies policy within the U.S. because U.S. carriers already have many authorizations to carry passengers between cities within Europe. When we have a single market, those carriers are effectively going to try and unify those routes in Europe. And yet no foreign airline, no European airline, is permitted to fly unrestricted within the U.S., which is by far the biggest market in the world.

On the other hand, American Airlines is constantly complaining that you are using your clout with the British government to hold up their proposed New York-Manchester route.

While you have bilateral agreements in effect, nobody is going to concede anything without getting something equivalent back in return. American Airlines keeps pressing the U.S. government to get greater access to Manchester. The British government says, in turn, there are these things we want for British airlines, not necessarily for British Airways. And the problem is that the U.S. says, “Oh no! Manchester isn’t really worth giving you anything,” and so they get to a complete standoff.

What’s a fair trade for Manchester?

The British government’s last proposal was that three routes would be permitted into regional points in the U.K. (and that was clearly anticipating Manchester), in return for Virgin [Atlantic] airlines being given a license to operate from Gatwick to Boston, and BA being given some rights between Canadian points and U.S. points.

Those were the principal features. The matter is now in the hands of the officials, and from what we hear, the U.S. airlines have unanimously rejected the deal.

Do you think most U.S. carriers fear open skies competition from European carriers? U.S. airlines are seeking whatever routes they feel they can attempt to get and cope with, because there is a feeling in the U.S. that the fortress Europe mentality will prevail after 1992. I don’t happen to support that view.

What about using mergers to expand?

Cross-border mergers in Europe are not feasible at the present time. In the airline business, the best you can have is a minority investment such as the 20 percent stake we have in Sabena or a marketing agreement such as exists between Air France and Lufthansa.

The critical issue with all of this is going to be the role governments will play. At this point in time the possibility of the airline of one country acquiring the airline of another country is virtually nonexistent. I personally believe that within the Common Market, by the second half of the ’90s, governments will be prepared to accept cross-border acquisitions. The extent to which it would be permitted outside of that is even harder to conjecture.

Part of the open skies idea involves a much greater willingness on the part of U.S. authorities to permit foreign participation in U.S. carriers, and not have this absolute limit of 25 percent foreign ownership. Sometimes the U.S. imposes a lower level than 25 percent. This is ironic considering almost 30 percent of our own shares, for example, are held in the U.S. today.

Have you rejected equity participation entirely?

In principle, I’m not against it. But I feel very strongly that globalization is only going to be accomplished through alliances or partnerships as opposed to actually going out there and acquiring, or going out there and trying to expand. Maybe subsequently the opportunities will arise to convert those partnerships-maybe make minority investments-but that’s going to be very much in the hands of government.

You say that the opening up of Eastern Europe will change the international aviation map. What’s it going to look like?

The most optimistic view is that the Eastern European countries would be accepted into-in effect-the common market for air transport. In air transport more than any other business, it’s going to be quite ludicrous to have countries within Europe where deregulation doesn’t apply. That clearly will take some time, and it’s going to be a long time before the people of those countries can afford to travel out of their own pockets.

How efficiently can a privately held firm like British Airways compete with a lot of other firms that are basically national carriers without going back to being a national carrier?

We do not want to go back. That’s one of the reasons we are quite vociferous in advocating that all airlines be privatized. They should be sold by their respective governments-so that one is effectively starting up from a reasonably level playing field. Our view is that governments do not have a place in commercial business. Government’s responsibilities are towards ensuring the right infrastructure for commercial business to be able to operate. And that is where their money should be spent.

Is that why you’ve called for an industry-based action group?

There is an underlying cooperation among the airlines, despite the intense competition that exists among them. Many governments have been talking out of two corners of their mouth at the same time. On one side, they say yes, we believe in deregulation; we believe in more competition; we believe in getting millions more people to fly. On the other side, they haven’t been making the decisions to improve the infrastructure that will enable the airlines to carry all those people. The customer today at many airports is put through an absolute harassing. It’s so crowded and congested at the busiest airports. The part that gets overlooked most of all is the need to have the sound infrastructure to get the people in and out of the airports. It’s very much the airlines that have got to take the lead in bringing the pressure to bear.

Let’s take Heathrow and Gatwick, two of the world’s most congested hubs. Air traffic in Europe is predicted to reach some 400 million passengers annually, rising to about 1 billion by the year 2010. What’s in store for them?

We’re talking about many millions more people who are coming each year because the actual volume increase is increasing in a greater proportion. And in terms of the airports here, the two that you named, the BAA, which is the authority that owns the airports, are now committed to an expansion of the domestic terminal at Heathrow and of the north terminal at Gatwick. They are building the first big new terminal at Stansted, London‘s third largest airport. And it is our hope, and we certainly are pressing very hard, that they will make a decision later this year to go forward with the construction of a fifth terminal at Heathrow, which we hope will be a giant-sized terminal-one of the largest in the world. It will accommodate all of British Airways so that we would be operating from a single terminal in our principal base airport for the first time in our history.

American Airlines is widely viewed to be on the cutting edge in its use of expert systems and artificial intelligence to create niches that could only have been dreamed of five years ago. Is BA keeping up?

We see ourselves not far behind American. We think we are the most advanced in the whole IT field outside of the U.S. We think that a number of our systems are at least as good as those American has. Our management and yield system works by controlling the overbooking levels on each single flight. That means we deny boarding to the fewest possible people while maximizing our average load and yield that we get from that load, by enabling us to offer low fares-but not selling the whole aircraft with those fares. This is another example of what I refer to as a proactive airline. It means that we anticipate the needs of the customer.

What sort of needs do you proactively identify?

We saw a need three or four years ago for a substantial improvement in our business class service. That led to our introducing what we called our Club Europe and Club World operations, which really were a quantum leap from anything any airline had done in business class before. It’s all part of what we see as the need to brand our classes of service-to take a page out of the book of consumer products and recognize that branding is very important in persuading customers to use a service. The effect of the club branding on business class has been enormously successful. Last year, after our second year of operating it, our revenues grew 27 percent in our club operations. That was on top of a much higher increase the year before.

You’ve turned the Concord from a disaster into a great success. When that aircraft has to be retired, how are you going to replace it, or are you just going to do without that cash cow?

We don’t look forward to the day when we won’t have it. We have just done the first major overhaul, and that’s after 12 years of flying. They should now be capable of going on for at least the same time as they’ve already been in service. The Concord doesn’t spend that many hours in the air. It actually flies about one quarter of the hours that a 747 flies in a year.

We believe that a new supersonic aircraft will be developed. It would have to be a consortium effort, but we hope it’s going to happen by the time the Concord is pensioned off.

Does air transport face lean years ahead?

U.S. carriers are pessimistic about 1990. Our view of 1990 is that traffic is going to continue relatively strong by our standards. We are anticipating traffic in the high single digits, which is a lot more than U.S. carriers are anticipating. Our revenues are going to be relatively strong, so our concern is directed at the cost side rather than the revenue side. The fuel cost increase has been very substantial and very rapid indeed. Our labor costs are of some concern, obviously, so we are concerned that there is going to be pressure on the margin.

You’ve worked at Avis and Hertz, and you spent some time in the U.S. midwest. Would you say your management style is American?

It’s a hybrid style of transatlantic management. I have great respect for America and American business, and I certainly look upon New York as a second home.

Is that where you got your whole brand management impulse?

Yes, to the extent that I’ve spent most of my life working for U.S. companies, whether in the U.S. or this side of the pond. I constantly look around for new ideas, new programs, and new schemes.

Knowing both British and American management firsthand, which is superior and why?

There isn’t a straight answer. But there are very good executives in both countries, as there are in many other countries, and there are plenty of poor ones and bad ones around in both places. But in America you have had a higher level of education for much longer on a relative basis than has this country. That helps too.

From my own experience, the key element of American management style that could be used much more in the U.K. relates to strategic planning and a more open style of management, with senior management being much more available to the employees of the company. Looking at it the other way around, British management is better at the interface with different nationalities.