Expert Contribution: "Why chameleons will lead airlines towards segmentation"

By Pascal Burg, Edgar, Dunn & Company

What do chameleons and the airline industry have in common? Chameleons, like airlines, must adapt to a harsh environment in order to survive. For airlines, this environment includes negative global industry profitability since 2001, strong competition from low cost carriers (representing over 20% of all weekly seats in the US and EU) and high fuel prices.

Against this background, airlines have undergone three “skin color changes.” First, they have reduced internal costs to match low cost carriers. Continental, for example, has achieved a reduced cost per available seat mile (CASM) of 7.29 cents, comparable to Southwest’s CASM of 6.40. Second, airlines have reduced external expenses (e.g., travel agency commissions, GDS fees). Third, they are optimizing the revenues generated by airline tickets. Air Canada allows customers buying a “Tango” fare to elect additional benefits for a fee (e.g., $15 CAD for advance seat selection).

However, skin color changes alone will not be sufficient for airlines due to two major structural changes in the airline industry: buyer empowerment and migration to direct sales.

Buyer empowerment is driven mainly by increased access to information. Meta-search engines (e.g., Kayak, SideStep), enable buyers to search across multiple travel supplier and travel agent websites for the lowest fare. Kayak also offers a service called Buzz, which shows the lowest fare that was actually paid by a customer. Farecast offers a forecast of future fares to help buyers decide when to fly and when to buy in order to get the lowest fare.

Additionally, the migration to direct sales from agent sales has reached a turning point. According to a Forrester survey, 2006 will be the last year for the predominance of the agent channel in the US. In 2006, just over half of all airline tickets (51%) were sold via agents. This is a significant decline since 2001, when 70% of airline tickets were sold via agents.

Due to these two structural changes, airlines are increasingly competing in a “retailing” environment. It is therefore critical that airlines migrate towards a retailer model: this requires developing “customer intimacy”, i.e., offering a differentiated product tailored to specific customer segments.

Segmentation starts with the basic principle that not all customers are created equal: “Some customers are very profitable and loyal. Some customers are unprofitable and fickle (…) we can increase our profits by studying these variations, and by using this newly acquired knowledge of our customer base to market differently to each discernable profit group .” (1)

Transposing this into the airline industry, we would suggest that airlines start with an analysis of customer profitability among their Frequent Flyer Program (FFP) membership. This analysis involves a two-step process. At first, it requires collecting, validating and allocating two types of data at the individual member level: (1) revenue data such as flight revenue, sale of upgrades, lounge fees, change fees, and (2) cost data such as fuel, aircraft, personnel, distribution (travel agency commissions, GDS fees, credit card fees), cost of miles earned, overhead. Once this data is allocated at the FFP member level, we can then start the analysis by splitting the FFP members into ten deciles (from most to least profitable) and by identifying differences in profiles and behavior across deciles.

Typical outcomes from a three-month project include:

The identification of which customers are and are not profitable (accounting for all relevant  revenues and costs to serve)

An understanding of behavioral patterns of frequent flyers and the impact that this has on profitability

A segmentation based on the profitability analysis that can be used to drive changes
To the structure of the frequent flyer program

And/or at the individual customer level (e.g., what benefits are offered, which level of service, how often a communication is sent out)

In other words, a customer profitability analysis helps to address the three key marketing questions: who to target, what to offer and how to communicate that offer.

As an example, we found a significant difference in profitability among the elite status flyers (flyers that had achieved the highest annual threshold of flown miles) at a large international airline. A large percentage of these flyers generated a negative profitability. The analysis showed that this variation in profitability was driven by a significant difference in profile and behavior: some elite status flyers always bought weeks ahead the lowest fares in economy class.

In summary, to respond to significant structural changes in the industry, airlines will need to act like a retailer and take a segmented marketing approach. This demands a more complex evolution than the simple surface skin color adaptations of the recent past. It will involve upgrading processes and systems to achieve customer intimacy based on customer-centric systems and through data mining / customer profitability analysis.

Changing skin color will not be enough for airlines to survive and thrive. Successful airlines will be those that become a new species. A new species that is market driven and that makes decisions based on a meaningful and relevant customer segmentation.

Pascal Burg works for a management consultancy (Edgar, Dunn & Company). Pascal can be contacted at pascal.burg@edgardunn.com

(1) Database Marketing Institute, “Managing Customer Segments”, Arthur Middleton Hughes and Paul Wang, September 2006

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