The fallacy of outsourcing and code share

Posted on 21. Jan, 2010 by in Blog, Featured

Japan Airlines As recent events have proven, code share and alliances are a two-edged sword.  In fact, I will go as far as to say ultimately it will doom an airline or business if taken too far.  The reality is you lose control of the product, operational reliability and most importantly for aviation, safety.  It is a house of cards that depends on other companies that are also looking for a better deal.   JAL shifting from One World to Sky Team shows the inherent danger; they wanted a better deal.  Loyalty is for suckers, it is all about the bottom line this quarter.

It is a fundamentally flawed model: the equivalent of having a thriving business and not owning the building.  Or worse yet, not even having a long term lease; let alone a non-compete clause.  If you could ask Sam Walton he’d tell you that is exactly how he lost his first business.  The owner of the building he was located in refused to renew a short term lease and simply took over his existing business.

The ultimate dream of current airline management “group think” is to rid themselves of their biggest problem, employees.  This from a service based industry.  Putting the service (or lack thereof) question aside, the operational structure is un-sustainable.

Shrinking the production level, in the case of the airlines mainline flying, raises the overhead costs per flight hour.  Ultimately the stand alone revenue stream becomes incapable of supporting the overall structure.

Legacy airlines have been outsourcing at both ends of their systems with disastrous results.  High cost Regional Jets and their subsidiary companies have been handed the tertiary and some secondary city pairs.  High CASM (cost per available seat mile) due to high fuel cost and low seat count has exceeded RASM (revenue per seat mile); in short the small jets are upside down.  At the inception of this model high yield and low fuel costs spread across an entire network allowed profitability.  However in their zeal to outsource both ends of their networks the major airlines have reached a tipping point.  The production level (mainline) can no longer support the costs.

The small jets are dragging down the bottom end of the network and code share is now doing the same to International.  Synergy, virtual mergers, etc. etc.: where is the synergy?  Did either company of an alliance reduce overhead?  Was either management team or their inherent over head eliminated? Marketing?  Public Relations?  HR? Training? Operations? Anything?

Yes; flights and the production level employees that flew them, a lower percent of the company producing revenue.  Taken to its ultimate conclusion, many managers dream, no employees at the production level at all.  A holding company, selling tickets by brand name only, no production level costs.  Sounds good on paper until you realize that translates to a company that is pure overhead.  Pure cost at its core.

Many would argue it is pure profit at its core and thus the perfect company; a self sustaining management team that produces nothing but revenue.  What it really is; is a business that doesn’t own the building.  What is to prevent any discount website from cutting a better deal with the suppliers of an airlines network?  In the brave new “IT” world that could be done in nanoseconds.

On the bottom end the Network Airlines have been outsourcing via small jet providers and pressuring them to slash costs by pitting them against each other.  On the top end they have been aggressively seeking partners to outsource International flying.

Every action causes an equal and opposite reaction.  (Newton’s Third Law of Motion/Physics)

On the top end a shifting alliance can leave a large hole in a network over night, with a subsequent catastrophic loss in revenue.  The JAL loss to One World illustrates the double edged nature of code share; here today gone tomorrow and no real control of an airlines own network.  On the bottom end the first reaction was Independent Air striking out on their own after UAL slashed their contract.  Ultimately; poorly structured, executed and underfunded it failed.  However; it cratered revenue on many UAL routes while it flew.  Republic has learned from Independent Air’s mistakes and is quietly building a National Airline that will compete directly with UAL in Denver via their latest acquisition, Frontier.

Network Airlines no longer own their buildings; their very networks are dependent on other companies at both ends of the scale.  They have outsourced their ability to cover costs, let alone make a consistent profit.  In true irony they have even outsourced their own management team’s ability to control revenue by dumping tickets on the Internet.

Within 12 years the vast majority of all airline pilots will be forced to retire.  The military has slashed pilot production and civilian flight schools are shuttering their doors.  The pending shortage will give the power to the suppliers as they move to the highest bidder.  Future networks could very easily collapse overnight.

The primary tenants of business are to control cost, revenue and especially the product.  Outsourcing surrenders that control to the lowest bidder.  In today’s world of globalization, some code share will be required on thin routes, but it is perilous to sacrifice your network for another’s for short term gain and the resultant instability.  Ultimately the proof is in the pudding; US Network Carriers, as a group, have not been profitable in a decade.  In that decade outsourcing has been the Holy Grail.

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