Saturday, September 28, 2013

University of Connecticut - School of Business: interview on aviation opportunities in the GCC and Africa

I was recently honoured to be chosen by Sebastien Perraud - School of Business University of Connecticut - to provide the intel for his paper on trends and opportunities in the GCC and African airline markets.

I was impressed by the level of knowledge of an 'academic' in matters of practical business, and especially in start-up strategies. The whole conversation grew into a very pleasant interview and I do hope that my ramblings assisted in providing an interesting framework for his paper.

It should be noted that the expressed thoughts and concepts are entirely Sebastien's view so please give him the credit that is due. Sebastien, thank you again for your patience!

Interview Report on Trends

Recent trends & opportunities in the airline industry: Start-up companies in the emerging markets of GCC and Africa

I. Overview of the industry

With 239 IATA member airlines worldwide and hundreds of non-IATA affiliated, the airline business has been a constantly changing industry since its existence. In the United States, the Airline Deregulation Act of 1978 allowed entrepreneurs like Southwest Airlines’ founder Herb Kelleher to compete with major carriers such as the now defunct Eastern, TWA and Pan Am by trying new avantgarde business models (e.g. no-frills low cost carriers). To this day, most business models for flight operations have been experimented and many such as business class-only carriers proved unsuccessful. Majors airlines have to constantly produce new ideas to stay ahead of the competition and most investors in the industry are now looking at emerging markets.

This healthy discussion confirmed the general idea that engaging in the establishment of a new venture in the airline industry in the developed world was not only risky but presented very poor prospects of profitability in the long term. Even though some airlines established in the US during the last decade such as JetBlue or Virgin America have fairly succeeded, most failed. We have to keep in mind that many of these capital intensive structures manage to keep afloat thanks to parent companies (Virgin America). Some European start-up airlines such as Norwegian Air Shuttle, EasyJet or Ryanair have also managed to become market leaders in 20 to 25 years of existence. It will be however interesting to note that these three case examples benefit from factors such as lower oil prices (agreement between Norway’s Statoil and Norwegian), EasyJet employees are paid in average 30% lower than the industry average and Ryanair treats both its customers and employees badly (high fees, trade unions forbidden and arguable EU regulations compliance when it comes to safety rules and labor laws).

II. Introduction of the interviewee

After completing an MSc in Electrical Engineering in his home country, the Netherlands, Alex de Vos attended a flight school and began his career as a pilot and joined Continental after a few years of flying experience. Continental Airlines has been the only major airline/company he worked for. He later continued his career flying private jets in smaller companies, where he also held management positions such as head of the marketing department and operations department. This ground experience gave him the tools to pursue entrepreneurial opportunities in the Middle East, including Saudi Arabia and Bahrain, where he founded a consultancy company serving charter airlines. Mr. de Vos also completed an MBA at the University of Wales. He later founded Eastern Express, a regional airline operating scheduled flights from the United Arab Emirates and sold its shares a few months ago to finance the establishment of another consultancy company, Al Hajjar Aviation.

III. Discussion of the trends and changes

"I would like to express my gratitude to Mr. de Vos for his patience and kind assistance. This interview would not have been made possible without his sharp insight and spontaneity. Thank you."

1. Could you briefly explain the direct effects of the GFC to the attractiveness of the market and the industry?

The airline industry as a whole hasn’t had generated tremendous profits for the last 50 years. Start-up airlines must always produce new ideas to compete with established major airlines, which involves great risks. Emerging markets are less affected by the side-effects of the Great Financial Crisis, while we can qualify present times for established airlines in the developed world as ‘fairly catastrophic’.

2. In recent years, major airlines (Qatar, Emirates, Etihad) of the region have been growing significantly. Do start-up airlines operating regional and business jets also benefit from lower oil prices and operating costs?

The GCC is a small region and these airlines’ growth comes at a price for some of them. Gulf Air has been in deep financial trouble for the past decade, Oman Air is not performing better than a loss-making US-based carrier, Kuwait Airways has been in a time of great turmoil and Saudi Airlines is very conservatively managed, which has as a direct consequence a business model with poor growth prospects. The GCC region as a whole is not performing better than the US or Western Europe. Even though Emirates and Qatar are good examples of wealthy companies, their main objective is actually to support the sister companies in the country, which might generate financial losses but creates profit for the whole GDP (airport taxes, tourism, etc.). Their strategy is to expand beyond any geographical limit by all means, translated into a tremendous growth rate on paper but also an unhealthy cash flow.

3. Incentives for entrepreneurs: is the Gulf Region a good place to start a business?

Definitely, though it has its shortcomings. For example, the legal system is not as developed towards entrepreneurship as it is in the US or Europe since industrial life here has started around the 1940s. However, you are in general fairly certain to find funds for an airline even though it is a capital intensive industry. Petrodollars make the money available in the region and some routes are underserved or simply non-existent. For example, GCC carriers have always focused on long-haul flights and there was no dedicated airline flying domestically in the region. Our second opportunity was that there was no airline established airline based in Fujairah airport, where the infrastructure was state-of-the-art.

The nature of competition in it, and the attitudes and preferences of the customers it serves

4. Who are your main competitors for your consultancy and ad-hoc charter flights activities? What are the general trends in preferences and tastes of customers you serve and how does Al Hajjar Aviation attract and keep them?

Our main competitors are established operational consultancy companies from Europe and the US. People in the region do prefer to see regional or local companies taking part of the economic development process. Basically, regional start-up companies like us compete with large established companies of the Western World, though some happen to fail because of the completely different legal and corporate systems. We have a fairly good advantage over industry leaders such as Lufthansa Consulting because we are trading under local owners, sponsors and names: Al Hajjar refers to the highest mountain range in the UAE.

5. Benchmarking: could you give an example of a major process, product or any other idea you borrowed from a competitor?

When we set up the predecessor of Al Hajjar Aviation, we did not look at potential competitors so we tried to establish the best approach. We have our own and different expertise, which concentrates on the operational aspects of an airline and aerospace design. As a small company you need to focus on a niche.

What new opportunities have these changes created:

6. What new opportunities have these changes created for your activities?

Offering flights from the UAE to Somalia under the name of Eastern Express. It was a war-torn country and our objective was to pioneer in Somalia to get aviation off the ground in a safe manner. Our establishment opened doors for catering and airport management. Our vision of entrepreneurship is to open doors both for you and the others.

7. Which significant regional macro-level market changes have benefited the industry including Al Hajjar Aviation?

Even though the country was facing a reasonable amount of fighting, we saw the end of the civil war in Somalia as an opportunity. Moreover, the country was trying seriously to get out of a war-transition state towards a ‘normal country’. We considered the country safe enough to do business even though we came to the conclusion that we had to implement special safety procedures for our crew, passengers and local partners. Concerning the macro-level market attractiveness, average salaries are extremely low in Somalia and 95% of the population cannot afford an airline ticket so there was a dramatic need to consider a lengthy period of time without positive net income on ticket sales, hence we had to find ways to make profits. The group thus expanded to airline-related operations such as ground handling, which was nearly non-existent in Somalia.

8. With a yearly average growth of 5%, Africa has begun to become the primary focus for new market-seekers in the airline industry while African countries hold close business and diplomatic relations with the UAE: are you going to follow GCC-based companies’ moves to look for new opportunities?

Africa is a fairly large landmass and the Horn of Africa should be the most difficult region to do business. Aviation safety standards are poor and we had to invent the whole process of running an airline from scratch. With traditional cultural links between the two regions, it is no surprise that many GCC-based companies from various industries such as real estate or engineering expand there.

9. In conclusion, would you think the industry presents strong opportunities for those aspiring to establish a start-up airline?

Worldwide-seen opportunities for flight operations is getting more and more difficult, since most models have already been tried. There is no strong opportunities for the industry worldwide unless no major improvement in technology, e.g. revolutionary fuel-efficient jet engines. There are however plenty of opportunities even on established markets on the supplier front, i.e. airport handling or consulting. In consultancy, there is a need of having a certain level of wealth to make yourself successful. If you jump into a market at its very early stage, then the wealth is not sufficient to attract third party consultancy services.

IV. Opportunities emerging in the airline business

There are new opportunities in both established and emerging markets. For instance, Japan has always been one of the hardest markets to penetrate for newcomers. Two main major airlines (namely JAL–Japan Airlines and ANA–All Nippon Airways) have been duopolizing the market for both domestic and international routes. Japan is in fact a challenging market: it has one of the
strictest aviation safety regulations and customers expect a very high quality of service. However a dramatic change occurred in early 2012 with the launch of three low-cost carriers: Peach Aviation, AirAsia Japan and Jetstar Japan; the first one is partly owned by ANA, while the second one is a joint-venture between JAL and Malaysia’s AirAsia (which is also Southeast Asia’s leading low-cost carrier) and the third one is a joint-venture between JAL and Australia’s Qantas Group. They have been so far successful on legs such as Tokyo - Okinawa or Osaka - Sapporo especially among low-budget students. Services both in air and on ground are minimal, even though punctuality and a decent customer service are culturally critical factors, things that most European low-cost carrier passengers are less regarding about.

The interview gave us an overview of the market in the Horn of Africa. I personally think that there is also a great deal of opportunities in West and Central Africa, especially in Senegal, Ivory Coast, Ghana, Nigeria, Cameroon, the Republic of Congo and Gabon among others. These countries in particular present cultural advantages compared to other countries on the continent: they are either English-speaking or French-speaking. They are natural resource-rich since they produce and export crude oil, precious woods, cocoa beans, phosphates, and ore in large quantities. The average growth in the region is of 5% and the literacy rate is slightly over 60% of the population. The rising middle class and a somewhat wealthy proportion of the diaspora in Europe compose a growing market. These politically instable and corruption high countries have more or less taken efforts towards a democratic transition but the main beneficiary is the corporate world: foreign direct investment is highly encouraged and free economic zones are created to attract investors and start-ups.

South African Airways, Egyptair, Royal Air Maroc, Ethiopian Airlines and Kenya Airways are among the top 500 African companies and link the continent to the world. They are competing directly with western airlines such as AirFrance-KLM, British Airways and Lufthansa Group on North-South routes thus are more profitable on transcontinental routes. Since the collapse of Air Afrique in 2002, a number of countries have lacked of a flag carrier, which gives many opportunities for entrepreneurs: in recent years, many domestic and international start-up airlines such as CamairCo (Cameroon), Arik Air (Nigeria), Equatorial Congo Airlines (Congo-Brazzaville), Air Côte d'Ivoire, Korongo Airlines (D.R. Congo) and Senegal Airlines have emerged, mainly because of their predecessors’ poor management and bankruptcy or ‘democratic transitions’. In many cases, these airlines are partly-owned by established parent companies such as Brussels Airlines and AirFrance or regional investment funds. Despite high airport tariffs and a highly regulated market–liberalization of intra African tradehas not been governments’ main objective so far – niches are likely to exist both for airlines and industry-related companies (i.e. airport management and consultancy). Culturally speaking, local companies are favored since lowly conscious western conglomerates face anti-imperialist resentment (e.g. Royal Dutch Shell), though European brands in the region are known for being reliable (e.g. Orange, AirFrance). I do not necessarily see new opportunities by adding another airline on the playing field but rather on reshaping it. Freshly founded start-ups in the region can develop and catch up with already established airlines by providing a locally-tailored high quality product at a reasonable price, provided that they encourage intraprenarial behaviors and get full support from government agencies. I have also noted that these companies have a fairly poor and outdated online/marketing exposure. On the supplier side, African airlines will be in need of more expertise and globally-minded human capital in order to grow internationally: hence there might be a future for consultancy companies in this market. All we can hope for the industry and the region as a whole is better governance (less corruption), more regional cooperation for liberalizing markets (lowering or abolishment of tariffs) and more public-private partnerships: macro-level evolutions and social and economic progress will do the rest.

Thank you for your attention.

Thursday, September 19, 2013

Network Planning - Mis(t)ery 101

Not so long ago, I was asked by a well known regional carrier in Europe to head their network planning department. Intrigued by the request - I am probably better known to fill positions that require long hours with my feet on my desk and a coffee in my hand rather than doing actual work - I accepted the preliminary discussions with management and found the network planning department in dire straits. This made me wonder, after all the airline was one of the more successful ones in Europe and network planning is an important intermediary in creating the big bucks. What went wrong with this particular airline and with many airlines all over the world in general?

Without doubt, the airline industry is a relatively new one compared to other industries in the modern world. Not that long ago - in fact, my grandfather actually remembers the prevailing headlines of his youth - two brothers hopped a few steps a few meters in the air on an engined crate that we now recognize as the initial predecessor of the B787, F35, and other mighty winged machines of today that are capable of performing incredible endeavours.

It is therefore of little surprise that the airline industry is far from a sophisticated one (but don't tell your passengers that, they might get scared!). Quite rightly, the focus of airlines have lied and still do today on safety, environment, and shareholders equity. Efficiency, on the other hand, is a topic that airlines all over the world, be it in Europe or Africa, still only are trying to get to grips with.

As an example, only in the 1970s was the ever so important topic of yield management developed (or should I say invented?). A lot had to do with regulatory bodies, of course. When IATA tells you that you absolutely cannot fly from A to B for less than 1,000 bucks and you can under no circumstances offer more than a cold, mushy sandwich and a bottle of water on that same route, who are you as airline CEO to worry about yield? Relax, have some coffee. After all, your competitor is bound to the same restrictions.

And network planning is in a similar stage of evolution. Even with large flag carriers of today, network planning is often done by senior managers that have a gut feeling that a certain route might be a good one for the company. Middle management then sets to work on the new route planning, and lower management implements the plan while finding out that the current fleet of aircraft actually is a rubbish one for the new routes! Airlines are high tech? Think again! This article's intent is to give a very brief overview of where the industry stands today with respect to network planning and where I believe it should focus on (and in all fairness, quite a few airlines adhere to the discussed concept, so I am certainly not entitled to that Nobel Price just yet!). I fully realize that I probably kick a few industry seniors against their shins by stating my views but hey, I just return the favour!

When we have a look at the current state of the industry's utilized networks, we quickly can see that airlines all over the world base their routes on two distinct network models:
  1. Hub and Spoke network; and
  2. Point-to-point network.

Of course, as with any model structure, any combination of the individual models is possible, too. We would refer to this combination model as a hybrid model. Since logically a hybrid model comes with all the advantages and disadvantages of the individual models, for the sake of this brief overview, we will not further discuss it in this text.

A Hub and Spoke model is the one that has been in existence since the early days of aviation. A Hub is an airport that is used by an airline to connect revenue traffic from at least two different flights. A Spoke then is an a flight that connects a Hub with a non-Hub airport.

A Point-to-point network is just that. There is no connecting airport, all routes are operated directly.

Both models come with individual advantages and disadvantages. The biggest advantage of the Point-to-point network is that very little network planning is required. This obviously comes with a considerable cost saving making it therefore the ideal network type for low cost (and this time I actually mean low cost as opposed to no-frills) airlines. Hubs come with other disadvantages too. So called banks (a cluster of arriving or departing aircraft to/from the hub) must obviously be scheduled in as short a time window as possible. After all, you do not want your fleet arriving spread-out throughout the day, keeping your resources bound and under-utilized. On the other hand, optimal banks create serious consequences for the hub. Just imagine having twelve A380s arriving within the same hour at the same airport. Apart from stand availability, baggage, catering, and cleaning bottle-necks, the airline would probably lose a considerable number of customers because of long immigration waiting times.

A direct revenue consequence of the Hub and Spoke model is a lower aircraft utilization. It is hardly possible to create equal distance hubs an thus individual banks are difficult to optimize. The latter directly resulting in lower load factors since passengers do not like to wait a longer period of time during a stop-over.

I would argue that this is also the key concept to successful network modelling. Traditionally, network modelling has been done based on individual financial aspects only. Obviously, this has been regarded as the optimum yield generating method. 1+1=2, right? Yet, by optimizing financial numbers on paper, one certainly might be able to please upper management but the most important yield generating parameter of the airline has been completely left out: the customer! An airline is, per definition, a company that renders services. Yet, good services please the customer and therefore generate better revenue overall. As a direct consequence, a low load factor on an individual flight should not necessarily be a reason for immediate termination of this service. If this flight contributes positively to the network as a whole, pro-rated yield could very well exceed individual yields thus creating added value to the network as a whole.

In practice, network planning should therefore consist of three individual major stages:
  1. Network strategy;
  2. Network design;
  3. Network optimization.
The network strategy comes directly from the top. It is derived from the airline's vision substantiated by its mission. For example, FlyHappy might have the vision to become the dominant carrier on Timbuktu to Brasil routes. Or it might want to be the number one feeder to the MilkyWay Alliance in Europe.

The design of the network then comes-up with a number of banks that fulfill the airline's strategy, simulates their respective profitability to the network individually and collectively, and, as a direct consequence, also determines the ideal fleet mix.

The last step fine-tunes, optimizes and monitors in real operations. This stage can also very well be used to evaluate additions to the network before handing over the network to yield management.

Concluding, I would like to reiterate again that network planning should be just that: planning of a complete network. Profitability of individual routes should be valued against the network as a whole. As my financial professor told me a long time ago, the art of financial success is not to turn individual minuses into pluses, it is to combine many minuses to one big plus. I wonder if the guy should have been working for the airline industry?

Thursday, September 5, 2013

The WRONG investor

You might say that there is no such thing as a wrong investor. After all, any business needs money in order to survive. So who really cares where the money comes from? Well, you are right, obviously, and at the same time you are dead wrong! Confused? Then keep reading, it gets even better!

Let's take, for example, an intelligent, smart and generally nice - and don't forget good looking - serial entrepreneur. He has established a number of companies already, mainly in the aviation industry. Just to give him a name, let's call him Alex.

Now Alex has really done many things right in is illustruous career as a serial entrepreneur. He has managed to personally and professionally challenge himself on a daily basis, he has made a name for himself within - limited - industry circles, and - probably most importantly of them all - he has managed to keep his family not only well fed but also happy with his professional lifestyle! What he has never successfully achieved, though, is to find the ideal investor for his various businesses. Now, I am not talking about his one-man shows in the service industry that requires only minimal capital and where the funding was usually supplied by Alex himself. I am talking proper airlines, requiring big bucks.

Alex has found an tried them all: institutional investors, private investors, larger numbers of investors, just a few of them... it always turned out to be a less than perfect marriage. "Now stop complaining", you will say. "At least this Alex chap found himself money for his businesses. We, on the other hand, have tried to do unsuccessfully, unfortunately, so he really should consider himself lucky"!

And of course, you are right. Without money, no business. Without business, no income, Without income, one unhappy family!

But look at the aspect from a different perspective: As an entrepreneur, you have put limitless efforts in your business idea. You live, breathe, and dream the venture. You know that the company will succeed because, well, it is just a splendid idea that the world is impatiently waiting for! And as a consequence, you do expect that any potential investor buys into your fab idea mainly because he feels the same way about it. The potential investor thinks of you nothing less than a hero who is here to serve the community. He will put in his money, sit back and waits patiently for you to get him his promised return. Simple. And any entrepreneur's dream.

Reality is different though. As you might have found out during your fund raising sessions, the first question is always: "how much"? Good for you if you actually started your presentation about the required capital and not about the business concept. This way, you saved yourself probably many, many rounds of painful discussions.

Any investor, be it a VC, a private equity investor, or any other money investing organization with usually a fancy address in New York, London or Paris as its head office, is interested in one, and one thing only: RoI. True, the fund or private individual might have a scope that dictates certain 'greener' or other society beneficial investments but in the end these funds need to deliver the results to their clients the same way as a conventional investor needs to do. No investor will accept a capital leak under any circumstances. Period.

So what does that mean for Alex and you as an entrepreneur? Well, to put it simply: interference. Interference by the board in operational matters that goes above the mandated supervisory board duties. At best it means a drilling of the company's management team during the regular board meetings with some advice that is expected to be adhered to, at worst it means a CXO - often in the form of a board member - supplied by the investors. After all, especially in the case of an airline, the investors trust the entrepreneur with a considerable amount of money and they would like to be updated of the company's cash-flow regularly and preferably 24/7 in real-time. And what is the next logical step after receiving the intel? Correct. Act on it! And I do not even blame them. If it were my money, I would probably feel the same!

Yet, what investors do not realize is that such behaviour is counterproductive to the company's efficiency and thus its income and bottom-line. Any outsider has per definition only a limited knowledge of the company. He might be a trusted professional in the company's industry but he certainly is not an expert in company internal matters. After all, you, as the entrepreneur, established your business idea on a niche market concept, right? And I doubt that the CXO cum board member has been studying this niche just as you have done over the last few years. And with limited knowledge arises disaster, as any Captain is more than willing to tell you about his First Officer.

Now, in all fairness to the investor, there are two sides to the medal. The entrepreneur - often quite rightly - considers himself the expert and expects anybody else to respect his expertise while the investor has constant second thoughts about his investment strategy - and quite honestly, who wouldn't? - and would like to take an active role in the running of the company since it is a human trait to consider oneself the best in its field and the field of an investor comprises of the world, or so he likes to think. These two sides are obviously not compatible. Even a good ole Swiss compromise would only be beneficial to the company, and thus its generated profits, if the interference comes in the form of a perfect match to the company's culture and knowledge basis. And, by the way, and Rudolf really has a red nose!

So, what is he solution to this dilemma? Well, one obvious possibility would be to start companies that require a cash amount that you are able to provide yourself only. It might not be very practical but this solution comes with an added advantage: if something goes wrong, you only can blame yourself!

However, it would be a sad day if an entrepreneur can only succeed with concepts that require a capped amount of cash instead of ideas that he believes in. So here is my advice: if you find that your potential investors like the financial gains you promise them but are not interested at all in your product, say politely 'thank you for your time' and look somewhere else. Also, if your potential investor has a little knowledge of your specific industry, prepare an executable document that specifies the exact roles of the investors and their representatives. If your investors do not want to sign this, walk away! Remember, a little knowledge is a dangerous thing. And obviously, if your potential investors try to divert your idea to a path you do not believe in or you even have moral objections to, thank them for their time and call somebody else, right now. I mean it, right now!

The idea of turning down hard cash might be a frightening one but believe me - I mean believe Alex, of course - he has been there when interference of a shareholder resulted in the collapse of an otherwise very valid business model. And the legal consequences of such a mess usually take all the entrepreneur's time that he rather should spend on a new business concept! Believe me, I, err Alex, has been there!