Airline Strategy and Business Model

At a Glance

• The lines continue to blur between FSCs and LCCs. Business models are less clear and so is aircraft deployment.

• A worldwide shortage of pilots is threatening to stall projected growth. Some airlines are limiting their operation due to insufficient pilot supply.

• Passengers are becoming more discerning when it comes to their on-board experience, largely due to the wide range of choice available to them, meaning that airlines must begin to put passenger experience at the heart of their operation.

Business Models and Competitive Strategies

Converging FSCS and LCCS

In today’s highly competitive marketplace, the dynamic is continuously changing. The landscape of the airline industry can no longer be defined by the dichotomy between Full Service Carriers/Regionals and Low Cost Carriers. While some FSCs are trying to find less costly approaches that meet broad customer needs with minimal complexity in products and processes, others are evolving away from the traditional LCC model in search of different sources of revenue, like premium passengers.

The formerly separate business models or unique selling points (USPs) of FSCs and LCCs have converged in recent years – even swapped in some cases – partly in response to the competitive pressure between the two.

A Fiercely Competitive Landscape

The cost gap between traditional and budget airlines has fallen by an average of 40% in 10 years both in the US and Europe, partly because FSCs have abandoned old differentiators like free baggage and in-flight catering on short-haul flights. The growing intersection led airlines to a broader scope and variety of their products and services to fight for the same passengers. Persistent underperformance in airline margin terms owes much to the fragmented nature of the industry and the market share battles resulting from the fierce competition.

Business models are less clear and so is aircraft deployment. The ‘one size fits all’ approach is clearly ageing. Airlines are gradually evolving away from this traditional mindset in favor of business sustainability. Within the structurally changing environment multi-class services and multiple types of aircraft to serve different missions are key facilitators to go beyond the minimum operational and financial performance required.

Business Models and Competitive Strategies cont.

A Need for Versatility

While cost efficiency is critical for an airline’s ability to remain competitive over the long term, airline assets (fleet, network) and revenue management strategies need to be optimized. One of the biggest assets of a right-sized aircraft is its versatility: versatility to open new low and mid-density markets, ride the peaks and troughs by matching aircraft capacity to market demand, offer high frequencies in high-yield business markets, and keep service level with additional seats in markets currently operated by 50-seat regional jets.

Pilot Shortage

Growing Traffic, Shrinking Resources

Embraer projects a 4.5% annual growth in airline traffic over the next 20 years as measured by RPK, which will drive the need for thousands of new aircraft and pilots to fly them. Today’s worldwide fleet of 25,000 airliners will increase to approximately 45,000 aircraft between now and 2036, requiring more than 600,000 additional pilots. Retirements and attrition will demand even more hiring of airline pilots.

Although emerging markets worldwide will lead growth in demand for pilots, the shortage threatens to slow the airline industry growth on a global scale.

Cracks are Starting to Show

Airlines throughout the world are struggling to crew their airplanes as they expand schedules. Some air carriers are limiting their operations due to insufficient pilot supply.

In North America, Embraer’s largest market, the problem is particularly acute since most Embraer aircraft are 50-76 seats and fly with the regional airlines that are the number one source for mainline recruiting of pilots. In addition, the 2013 regulation that requires that co-pilots have the same minimum ATP qualifications as captains, 1,500 hours, has reduced the pipeline of new pilots.

Pay raises, hiring bonuses, retention pay and other incentives are helping attract more students to a career in the cockpit. However, the impact on the issue is limited and there is no solution in sight without a change in business as usual.

Pilot Shortage cont.

A Need for Larger Aircraft?

There has been some loss of service to smaller communities, and reduced frequencies on many city pairs. The trend towards larger aircraft is partly attributed to the pilot shortage, since airlines need to maximize productivity with a limited pilot supply. In North America, there is a trend towards the mainline flying small narrow body aircraft, serving the traditional regional markets.

The general solution has to be driven by market forces and natural laws of supply and demand. The problem is too big for one simple fix.

Preventative Measures

All stakeholders need to do their part to make the profession attractive. Initiatives underway:

• Significantly higher pay both at the Regional level and at the Majors is already making the profession more attractive.

• Pathway and flow-through programs are removing much of the uncertainty in a pilot’s career, by defining a career path from the date pilots are first hired.

• In North America, the FAA should allow additional pathways to qualify as a first officer while building hours towards the ATP 1,500 hours. Students that graduate from qualified training institutions qualify with 1,000 hours today.

• Additional pathways are under discussion.

Airline Passenger Experience

Active Passengers

Since deregulation of the industry, along with the proliferation of airline choices, the explosive growth of tools and information have provided consumers an unprecedented control over their travel experience. Airline passengers are quickly evolving from a passive player in the seller-buyer interaction to a more active involvement in order to ensure that each touch point of their journey is as seamless, as comfortable and as efficient as possible.

Air transport demand, measured in RPK, will increase 2.5 times over the next 20 years, resulting in an ever-increasing challenge to meet the growth and rising expectations across all passenger groups and journey purposes.

Improving Experiences

A revamped airport experience that integrates fragmented steps into a single process from surface-access journey time to a modern, effective, and efficient boarding operation is critical for a hassle-free experience with minimal inconvenience for passengers until they reach their aircraft seat.

The airborne experience is critically important as well. The industry needs to move beyond commodity pricing and competition based solely on fares. Instead passengers are now having access to fact-based metrics about their products, including the aircraft type, which would justify a higher fare.

Airline Passenger Experience cont.

Right-sizing to Address the Problem

Right-sized aircraft like the E-Jets E2 can regularly generate higher revenue per seat since they have fewer available seats allocated for low-fare passengers, resulting in higher unit profit and return on aircraft assets.

Additionally, it provides the opportunity to further enhance the passenger experience. The innovative design of the E2 program has delivered an aircraft family capable of enhancing each individual passenger’s journey with increased space, new levels of connectivity and ingenious seat configuration options.

If the airline industry is to be profitable, airline passengers need to experience the upside, too. Airlines are gradually replacing the race to the bottom in search for low-fare passengers to more personalized options. The E-Jets deliver higher ROCE on both per-seat and per-trip bases compared to its larger competitors. Comfort and profit can be complimentary rather than exclusive terms, and the E-Jets E2 is widely seen by its passengers as setting the benchmark in airliner comfort.

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