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Disruption: Flying the Not-So-Friendly Skies

As traditional air carriers check in and out of bankruptcy court, discount carriers like JetBlue and Southwest are flying high. Here's a look at the airline industry's newest innovators.

No American industry has been as consistently plagued with crises and cutbacks as the air travel sector. Terrorism jitters, escalating oil prices, war in the Middle East, and now SARS have complicated what was already an incredibly challenging business environment.

While the traditional air carriers have been lumbering in and out of bankruptcy court, discount carriers like Southwest Airlines and JetBlue Airways have been maneuvering to gain more of the buzz—and the profits—in the sector. Less encumbered by demanding union contracts and freer to create new route systems than traditional airlines, these carriers have created offerings that appeal to an ever-growing percentage of the flying public.

Another tale of incumbents disrupted from below? Yes, partly, but the air travel story is much more complex.

Incumbent players—the traditional air carriers—have been buffeted by two types of disruptions concurrently. They have been attacked both by low-end and new-market disruptors. In turn, the incumbents are taking on the disruptors, positioning themselves with the use of regional jets (RJs) or launching new subsidiaries like Delta's Song.

This is unusual in the story of disruption. In other industries, incumbents facing disruptive entrants typically thrive for a time by moving to more profitable upmarket tiers. But mainstream airlines can't make that move, says Clayton M. Christensen, Harvard Business School professor and author of The Innovator's Dilemma (Harvard Business School Press, 1997).

The traditional air carriers have been buffeted by two types of disruptions concurrently.

"Companies in other industries have more options when attacked. Computer companies, for instance, can migrate to high-end products with lower volumes," he says. "The high fixed-cost structure of hub-and-spoke airlines means they can't run away from the volume in the lower tiers of the market."

Two companies' efforts to grow within this incredibly complex competitive milieu provide a case study in understanding the crosscurrents of disruption at work.

High-flying independent JetBlue enjoys the speed and flexibility of a start-up. Its infrastructure and processes were finely tuned to seize opportunities in today's challenging air travel market, says founder and CEO David Neeleman. Because JetBlue focuses on secondary airports in major metro areas, it competes head-to-head with some of the nation's largest carriers, Christensen says.

"The big carriers won't cede the lower-priced tiers of key markets," says Christensen. "Incumbents won't be making life easier for JetBlue."

Delta's Song is in the vanguard of a new competitive response against discounters like JetBlue. It targets some of JetBlue's most important routes and has adopted many key elements of its service, including the much-ballyhooed seatback televisions. Delta believes that Song can implement a new strategy even as it relies heavily on the resources, employees, and processes of its parent. Its critics say that operating under such a parent may limit its strategic flexibility.

Deregulation and disruption
The forces leading to the disruptions within the sector have been at work for more than twenty years. The United States Airline Deregulation Act of 1978 allowed large airlines to remold their route networks into so-called hub-and-spoke systems, which enabled the major carriers to gain operational efficiencies and fill more seats. It also opened up the market for a new breed of competitors such as Southwest Airlines.

Southwest was the primary instigator during the mid-1980s of a low-end disruption in the air travel market. Low-end disruptions target the least-demanding customers in an existing marketplace with lower-priced products that are good enough to get the job done, but no better.

Rather than trying to beat the majors at their own game, Southwest rejected the hub-and-spoke system. Instead, it created an economical network of point-to-point short-haul flights while using less-expensive gate slots at secondary airports whenever possible. Southwest offered no assigned seating and minimal food service, allowing rapid airplane turnaround and increased capacity utilization.

At the same time Southwest created this low-end disruption, it simultaneously instigated a new-market disruption by targeting segments of the potential marketplace where people were not flying or not flying often, according to Christensen. Southwest and other discounters have grown sales by getting travelers out of cars and trains and enticing underserved customers in many smaller cities to make that extra bargain trip.

Christensen views Southwest's new-market disruption strategy as the key to its longevity and profitability—and the reason that JetBlue and Song will have difficulty taking on this highly successful discounter. "Ultimately, it is Southwest's power in these new markets that will make it so potent a competitor for anyone attempting to supplant it from its position," says Christensen. "It's very similar to the situation we see with Wal-Mart, where its new-market disruption strategy gave it ownership of certain markets. Now, it's very deeply entrenched."

JetBlue: Starting from scratch
Christensen's scenario does not paint a rosy picture for JetBlue, an innovative but vulnerable newcomer potentially trapped between a well-entrenched Southwest and a horde of large carriers motivated to come back and fight for the lower tiers of the air travel marketplace. However, over the last three years, JetBlue has gained renown as a smart, nimble upstart that has created what appears—right now, at least—to be a winning formula.

"Starting with a blank slate, we had an opportunity to simply 'build a better mousetrap,' which gave us a tremendous advantage in our markets," says CEO Neeleman. "Larger airlines might have fine operations people and fine planning people, but if your product—from a service, delivery, and cost level—does not work, you're in trouble."

Actually, Neeleman acknowledges, JetBlue's slate was not completely blank—Southwest's operational practices were an early source of inspiration.

Neeleman first earned his wings at a start-up airline, then joined Southwest after the discount airline bought out Neeleman and his partners. Neeleman soon parted ways with Southwest, but when his noncompete expired, he formed JetBlue Airways, which launched in early 2000. By spring of 2003, JetBlue served twenty U.S. cities with more than forty aircraft.

Delta's Song: Building on a legacy
Song is not Delta's first foray into the discount air travel game. The new subsidiary is replacing Delta Express, which will be phased out gradually. Delta's experience to date with the "airline within an airline" concept has been similar to that of other major U.S. carriers; US Airways, Continental, and United have all started and then shuttered in-house low-frills operations.

To its credit, Delta seems to be establishing a stronger underpinning for Song than it did for its previous effort.

"This is an evolution of the Delta Express product, but founded on a much more solid basis. Delta Express was created with a temporarily lowered pilot pay scale and a temporarily deferred maintenance cost program," says Stacy Geagan, Song's general manager for corporate communications. "Those were transitory cost benefits, and not the best basis to start a business for the long term."

Early on, Delta faced two questions that many large firms must address when they attempt to launch a business around a disruptive innovation: How should we position the new unit within the corporate structure? What capabilities should we transfer over from the parent and which should we develop from scratch?

Delta chose a model that, though granting a great deal of autonomy in the areas of marketing, branding, and in-cabin operations, keeps Song very dependent on the parent's resources and processes. "Delta considers itself the 'operation'—we consider ourselves the 'marketing engine,'" says Geagan.

Different organizations, different choices
In many ways, Song's and JetBlue's service offering are similar. Both use nontraditional brand and marketing approaches to attract customers. Both build much of their in-flight customer experiences around advanced seat-back entertainment systems. Both boast novel cleaning and turnaround processes that get their planes back in the air much faster than most competitors are able to. (Song's jets will be in the air on average 1.2 hours more per day than Delta's, generating significant cost savings.)

But Song's heavy reliance on the resources of its parent could prevent it from reshaping key elements of its operations, a limitation not facing JetBlue.

Labor issues
To date, nearly all of Song's employees have come from Delta, including the 300 flight attendants hired as of early March 2003. "Could we have gone further in making this a more independent operation? We could have hired all of the employees from the street instead of from within Delta. But that would have delayed the launch and it might have spurred further unionization within Delta itself," says Geagan.

Though the flight attendants brought over from Delta will operate under adjusted work rules, many other functions will not be overhauled to the same degree; Song will take flight with overall wage rates close to those of its parent. Some industry analysts view this as a real weakness for Song. In particular, the unit's profitability could be negatively impacted by the salary levels of the Delta pilots who will operate Song's planes—salary levels that are reportedly the highest in the industry.

JetBlue, on the other hand, has been able to craft a work force and compensation system from scratch. According to Forbes magazine, JetBlue's labor costs equal around 25 percent of its revenues. This is quite a bit lower than the 33 percent of revenues low-cost paragon Southwest spends on employees—and a world away from Delta's 44 percent figure. These advantages may be transitory; after all, JetBlue was founded during a rough time for the industry when unemployment lines were filled with experienced airline workers. Some veteran pilots, for example, have gone to work at JetBlue for tens of thousands of dollars a year less than they made with their previous employers.

Reservation processes
Tying into other Delta systems aided Song's quick ramp-up. However, one wonders if in doing so, Song's planners missed an opportunity to reengineer core processes in the way that a "blank slate" innovator like JetBlue did. Song will be linked into Delta's information technology systems for all major functions, including customer-facing activities. Reservations will be handled through existing Delta call centers.

Rather than develop a traditional call center, JetBlue chose to create a system that relies heavily on home-based telecommuting reservationists. Some industry observers feel this decision has allowed JetBlue to tap into a much more educated work force. Employees save commuting and often child-care costs while JetBlue minimizes real estate outlays and other overhead expenses.

Because of the parent's large presence at a variety of airports, Song's maintenance will be handled through Delta's facilities. "I really see us using Delta over the long term at this point. Delta's quality levels are at the top of the industry and very cost competitive, we feel," says Geagan.

JetBlue's Neeleman wanted to ensure that his airline had the highest degree of flexibility in deciding where to conduct maintenance and sees outsourcing as a part of his long-term strategy. While it usually conducts time-sensitive repairs out of its JFK facility—staffed by relatively expensive New York workers—JetBlue has much more flexibility than larger airlines when it comes to scheduled maintenance programs, for which the company utilizes facilities and technicians in Louisiana, where wage rates are much lower.

Route assessment and selection
Song and Delta will have what Geagan calls a "matrixed relationship" when it comes to choosing routes and schedules. The parent airlines will assemble the necessary data, conduct analyses, and make recommendations to Song about possible new flights. But will these choices about new routes reflect the mentality of a hungry, innovative start-up or that of an industry giant trying to defend core markets? Despite the protestations of Song executives, many industry observers feel that Song's route selection to date looks to be a defensive response to JetBlue's encroachment.

Neeleman believes that JetBlue's fresh approach to new-route analysis, decision making, and ramp-up processes is a key part of his company's "better mousetrap."

"It's really amazing how fast we're able to make a commitment to new routes and get them fully operational. We have a real advantage over larger competitors using traditional approaches," he says.

The shape of innovations to come
Playing out the end game of the multiple-disruption scenario put forth by Christensen, high-profile disruptor JetBlue may find itself subject to intense competitive pressure from players that in most industries would be only too glad to exit the lower tiers of the market.

Christensen's scenario does not paint a rosy picture for JetBlue.

JetBlue may yet avoid being trapped between an entrenched Southwest and struggling but motivated incumbents. In early June, JetBlue announced its intention to purchase 100 regional jets from Brazil's Embraer. "If they decide to use the regional jets mainly to feed into their long-haul routes, they would just be replicating the same model of today's giants," says Christensen. "But if they target new markets with a different service, they could create a very defensible long-term position."

JetBlue has the potential to establish the kind of disruptive business that regional airlines—so deeply enmeshed with major carriers—have thus far not rolled out.

Ultimately, a business unit like Song may not represent the type of incumbent repositioning that will cause the likes of JetBlue to falter. While it has created and borrowed many operational elements that may make it an interesting player in the discount travel market, Song may very well face limitations due to its tight operational linkages to Delta. One wonders if an entity like Song will have the strategic and operational freedom to pursue truly disruptive strategies.

Whether they turn to regional jets, fully autonomous business units, or some other as-yet-untried innovations, America's large carriers will need entirely new competitive tools to survive in this complex and hypercompetitive sector.

Reprinted with permission from "Multiple Disruptions on the Radar Screen," Strategy & Innovation, July/August 2003.

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Jeremy Dann (HBS MBA '98) is an innovation consultant.

More Disruption on the Horizon: Regional Airlines

by Jeremy Dann

The regional air transport market started taking off in the mid-1990s with the development of new classes of regional jets (RJs) from manufacturers such as Canadair and Embraer. Employing new turbofan technology, these planes could be operated very inexpensively on a cost-per-seat-mile basis.

The new jets' efficiency made it easier for operators to expand service to markets with low to moderate demand. Regional carriers were able to offer much more frequent service between small municipalities and large hub airports and could also establish routes between city-pairs that were not connected before.

Much of the RJ capacity in the U.S. has thus far been deployed in support of the hub-and-spoke system of the major carriers. Most regional operators either are wholly owned subsidiaries of large airlines (as with Comair and its parent Delta) or have deep code-sharing alliances with them (as with publicly traded Mesa Airlines and Skywest). These regional operators have seen traffic expand dramatically, achieving nearly a 30 percent growth rate from 1998 to 2001, according to an industry association.

RJs may soon play an even greater role in the highly competitive aviation space. In May, US Airways announced that it planned to expand its regional air fleet by as much as fivefold. In the first week of June, JetBlue announced that it was ordering 100 RJs from Embraer.

While the large airlines have thus far used RJs as a sustaining innovation for feeding their hub-and-spoke networks, the true potential of regional aviation is only beginning to be tapped, says Clayton Christensen. RJs will be used more and more to provide economical and reliable service between small airports. "If the major airlines want to exploit this new market, they need to create business units which have the complete freedom to develop their own strategies," he says. "If they don't, we'll see the rise or expansion of regional airlines built by independent entrepreneurs who recognize the unique opportunities which regional jets give."

Reprinted with permission from "Multiple Disruptions on the Radar Screen," Strategy & Innovation, July/August 2003.