The (Once) High Flyer Creates Lessons For All
As frequent United Airlines passengers, we felt compelled to deconstruct the airline’s demise and pull out a few lessons for all businesses. Much has been reported of United’s cost structure, one of the highest in the industry (with labor the primary culprit.) One can also assume management did not run as efficiently as possible―perhaps from bloated headcount or inefficient processes. But in fact three areas, not often written about, have also had a huge impact on United’s demise, and we believe can offer management lessons for all organizations. These three areas are SKU rationalization, asset utilization, and pricing strategies.
SKU rationalization for an airline one might ask? Absolutely. Manufacturers are familiar with the notion of the 80/20 rule―80% of a firm’s profits typically come from 20% of their products. How does that relate to an airline? In our estimate, United probably ran far too many unprofitable routes, thinking it had to in order to keep its most profitable customers. Our research suggests this is almost never the case. Consider this example. During the 1960’s-1980’s a U.S. ceramic tile company led the U.S. industry with market share of over 40%. By the late 80’s the share began to decline dramatically, undoubtedly due to new retail formats and changing buyer behaviors. It took the U.S. tile manufacturer many years to figure out that they had been inefficiently producing hundreds of SKU’s to support very small orders for just a few distributors. But when the distributors were asked what the impact would be to their business if these lines were discontinued, they stated the impact would be less than 10% of their revenues. Our point? Kill the dogs early and often.
This brings us to the second piece of our decomposition, asset utilization. Many airlines increased capacity (e.g. bought more planes) without matching demand (and by demand we refer to profitable demand only). A $150 fare for most two-hour domestic flights represents the break-even point. After September 11, only airlines like Southwest that ran profitable routes before, avoided disastrous declines. Manufacturers face the same concerns. At what time is it appropriate to add capacity? Some firms rush to expand capacity during long running upward demand cycles but fail to assess whether the industry as a whole has too much capacity or not enough. But manufacturers have one advantage over the airlines―they can lower cost structures via outsourcing low-value production processes.
Our third area, pricing strategies, also offers valuable lessons. Most major airlines support over 30 pricing structures for all flights. Imagine the overhead required to support these structures. In addition, leisure travelers are often able to fly for less than many airlines’ break-even point. Why do airlines do this? The logic goes something like this: we’re better off getting something for this seat as opposed to flying it empty. This is the whole notion of yield management. Though this provide cash in the short term, it creates unprofitable flights. In contrast, the Southwest pricing model has proven most successful, mainly because of its simplicity―the airline has less than a handful of pricing strategies at all times. How can manufacturers learn from Southwest? Instead of wasting time and energy developing and administering complex pricing and discontinuing schemes (increasing SG&A costs), focus on creating simpler pricing designed to cover fixed and marginal costs, creating sustainable, consistent margins.
Taken together, these three lessons are invaluable for running businesses of all sizes. To avoid being grounded, U.S. manufacturers must choose simplicity over complexity while acknowledging that less may actually be more.
