A Grid in the Sky, part II - Bonus points
Why Ryanair and Qatar Haven't Killed The Good Old Airlines?
Programming note: Money in Transit will be off next week, back on the 21st.
This post is part of an ongoing series called A Grid in the Sky, which explores how the airline industry is moving beyond the centralization of Sabre and Amadeus now that APIs aren’t strategical. You may go back to part I, although this post stands on its own. If this topic is of interest, you can read part III.
Companies that rise to the top of their industries usually fail to stay there when things change: technology companies such as IBM, Nokia or Windows are good examples of this trend. However, the reason that these companies capitulate is not because they are doing something wrong, but because they adhere to the popular dogma of making something customers actually want.
Disruption was the term originally coined by Clayton Christensen on The Innovator’s Dilemma to describe how incumbent companies, in their efforts to satisfy their customers, ignore technologies that are not a good fit to their current needs. But sometimes, as the new technology matures, it expands its addressable markets, until it ends up dominating. By the time the incumbent notices the change in trend, they are years behind, and most perish.
In the case of the airline industry, budget airlines like Ryanair, which we covered last week, have disrupted the industry:
[Ryanair] dominates similar, but competition-free routes, and expect their customers to “make ends meet” with train or public transport. Try flying to Malaga, Spain on anything but Ryanair, and you’ll learn that what this strategy is all about.
That’s, in a nutshell, Ryanair’s secret source: they focus on the effectiveness of their flights, and only then think about milking it.
Rather than choosing already popular routes, Ryanair looks precisely those that have been abandoned by incumbents based on historical data. Where incumbents conclude that “not enough people would fly this route”, Ryanair asks “at what price would people start flying this route?”.
The technology that Ryanair used to disrupt incumbent airlines was looking at routes differently, not as cows to milk in heavily competitive pastures, but as tranquil gardens to tender to and control.
Yet, budget airlines didn’t destroy the incumbents.
From the Middle East, too, competition comes from a handful states, who have sponsored their own airlines, and are willing to endure big losses if that’s what it takes to promote and bootstrap the reputation of their countries. They are not businesses, but political branches of wealthy monarchies.
The old incumbents are between the rock of Ryanair and the hard place of Riyadh. How on Earth are they not bankrupt already?
Oh, but they have. What’s surprising about incumbent airlines is that they are no longer airlines. They’re something else.
In the context of COVID-19 and no flights in the horizon, big airlines such as United and American Airlines were struggling to stay airborne. They were granted massive loans, in the order of billions of dollars, to tie things over. As collateral, and given the uncertainty of the pandemic, there was only one thing that they could offer: their loyalty programs.
In order to offer these subsidiaries as collateral, they had to be valued. And the bank syndicates that agreed on giving airlines these massive loans also agreed to value these loyalty programs more than the collective market capitalization of the airlines as a whole.
Bankers, and the industry’s executives, publicly agreed that incumbent airlines are worth less than zero.
Years before COVID-19, airline executives understood that budget airlines’ blow was final. The old generation of airlines that came after the de-regularization of the industry in the 1970s had been completely disrupted, and it was a matter of time that they were going under.
They could cling to the way things were. But they could also lean into it.
Since 2002, when Joel Spolsky coined the term, a new strategy for fighting disruption has become more relevant, especially in the context of technology. This strategy is called commoditizing the complement. This happens when companies that enjoy a quasi-monopoly in products that are understood as part of a series of layers, dominate one of those layers and foster innovation on the rest, sometimes by offering free, or at least below-cost prices. Total price goes down for the end customer, but the spur in demand is more than offset by the quasi-monopoly.
Loyalty points are exactly that: airlines are nowadays financial companies whose business is to nudge you to signing into their loyalty programs, using cheap flights as bait.
This works thanks to three mechanisms: partnerships, interchange and dynamic chart awards.
Loyalty programs are compelling for customers because they allow you to fly for “free”. Like your friendly supermarket punch card, the more you buy on their website, or via one of their partners, the more tax-free points you earn. These partners, such as Hertz, are willing to spend part of their marketing budget on acquiring these loyalty points in order to give them to you with your purchase—customer acquisition is truly a very counter intuitive business nowadays.
Even better if you are issued one of those credit cards that are co-branded by these airlines. Business travelers, who rarely need to use commercial loans, become the product that the airlines sell to merchants around the world that want them as customers. In exchange for the priviledge of accepting these co-branded cards, the airlines get a percentage of each transaction, called interchange.
And when the moment comes when the traveler is willing to spend their hard-earned loyalty points, airlines optimize the “pricing” of their tickets with dynamic chart awards so that the opportunity cost of giving you the ticket for free is below what they got from you to earn those points.
Long-haul carriers are nowadays a gigantic financial spreadsheet, with its real assets a mere footnote. A significant portion of big companies’ efforts is dedicated, not to what “their mission” says, but to influence you every time you enter their sphere into joining their frequent flyer program. They have become central banks for their loyalty points, and regulate their supply with iron fist. While Ryanair’s CEO is committed to charge for the use of toilets, incumbents are very happy that he does exactly that, driving the demand for their loyalty points higher.
Incumbents have been disrupted. They’re just playing a different game.