Leap of Faith

2 September 2009 (Last Updated September 2nd, 2009 18:30)

While they must focus on short-term costs, airlines cannot neglect long-term network development strategies. KLM's Jurriaan Stelder warns against being at the back of the queue when the market picks up.

Leap of Faith

The world's economic woes have put an industry that functions on low margins under enormous pressure to reduce bottom lines. Airlines have been forced to rethink their strategy of network expansion, which was once a booming global market. For many airlines, the pressing priority is short-term profitability, whereas for others, their main concern is survival.

Not so long ago, there was less risk involved in running what at first seems like an unprofitable route to open a market that would bear fruit in the future, but times have changed. Airlines were once able to afford long-term strategies in order to expand their global network. However, the economics of long-haul flights in particular are now being scrutinised carefully.

"The industry is definitely affected by the economic climate," says Jurriaan Stelder, senior network planner for KLM Royal Dutch Airlines. "Our horizon is much shorter. Previously, when there was good economic growth, we could extrapolate that growth – especially on long-haul routes – but that has all come to a stop in the past nine months. Extrapolation is in the waste bin. I'm confident that growth in long-haul routes will come back when the economy improves, but the questions remain: when that will be, and how many long-haul players will be left?"

KLM is part of the Air France-KLM group, the world's largest airline in terms of total operating volume and passenger miles. Like many airlines, KLM has been forced to reduce capacity. Declining demand has prompted it to cut its summer schedule for long-haul and medium-haul networks, but the result is a leaner and fitter schedule.

"We are fortunate to have the right IT tools to help with planning and network building."

"We can't afford too many loss-making routes," remarks Stelder. "The industry as a whole is less tolerant of such routes so, for example, we have closed the service to Hyderabad in India. Long term, there is certainly a growth opportunity there, but for now we can't afford to make a loss on it.'

The focus is on making adjustments to the short-haul network, and the planning horizon has come much closer, but Stelder warns of the dangers of putting long-term, strategic planning on the back burner. "We are making adjustments in the two to six-month period, during which we usually leave the network stable," he says. "Now we have to look at reducing capacity and, in a few cases, increasing capacity. At the same time, we have to know what the plan will be when the economy improves and long-haul starts to show moderate growth again."

Founded on flexibility

The network planning process is made more challenging by uncertainty about macro-economic factors, but strategy must hold its place alongside tactical thinking. For KLM, this means considering many possible futures.

"There is much uncertainty over when the economy will recover, so we have to do scenario planning," explains Stelder. "We are looking at what will happen if economic conditions improve in 2010, but we also have to look at what will happen if the global economy becomes even worse next year. We have to simulate many different scenarios using our historical data on traffic and costs. We must then extrapolate many different outcomes, from the most optimistic to the most pessimistic. We then
choose the one with the least downward risk."

"We are very responsive in terms of cost and activity, but the key challenge will be when the economy picks up."

The key factor in shaping the network is to maximise the trade-off between service delivery and cost.

"The transfer network is the priority now," adds Stelder. "We need to respond to economic conditions, so we have to find ways to reduce capacity without affecting the connectivity we offer. We have to maintain a solid position in connecting traffic in Europe. If, for example, we cut a flight to Birmingham, we have to ask how we will maintain connectivity to long-haul connections within two or three hours. There is a trade-off to be made with the hub system – do we phase out aircraft or do we become stricter on the times that flights are planned? The problem is choosing between saving real cost in the short term, or possibly gaining future revenues that remain uncertain."

Such decisions are now part of a constant review process. KLM adjusts and reviews network planning and flexibility issues on a weekly basis but maintains a long perspective. The flexibility in its fleet enables it to achieve this balance.

"You need the fleet to be flexible," explains Stelder. "We either have downward flexibility by phasing out older aircraft and not replacing them, when we would usually expand the fleet every year, or an upward flexibility, where we keep aircraft that were due to be phased out and fly them for an extra two or three years. The only problem with this is making sure that cockpit crews are available."

Difficult decisions

Keeping tactics and strategy in balance is no easy task, but the first step is to have realistic expectations. Stelder believes the best course of action is to be clear about where an airline's strengths and weaknesses lie and adapt its network accordingly.

A realistic perspective on where the opportunities lie will enable quick thinking and prompt action. This has proven to be the case at KLM, where decisive action was taken in the early stages of the current economic crisis.

"For many airlines, the pressing priority is short-term profitability."

"KLM is very well placed in these challenging times," says Stelder. "This is the most difficult environment the industry has experienced in more than 40 years. One of our priorities is to have worldwide long-haul coverage. We are not reliant on niches as, for example, Iberia is on South America, so we are less vulnerable. We are fortunate in that we have the right IT tools to help with planning and network building, but it comes down to logic and experience. One of our key strengths is that we have learned to adapt our cost levels. We have reduced costs – including fixed costs – without the difficult programmes of job layoffs."

Nevertheless, there have been cutbacks in staff. Air France-KLM recently announced a further reduction in its workforce for the year ahead. But once again, it is not alone in having to take such steps, and the quick reaction of senior managers to the onset of the global downturn has enabled it to be more selective and strategic in where those cuts are made.

"We have very good communication within the organisation and we felt a sense of urgency early on in the economic crisis," says Stelder. "Our top management saw the severity of it in its earliest stages and acted very quickly. We are very responsive in terms of cost and activity, but the key challenge will be when the economy picks up. We must ensure that activity increases again."

Every airline is feeling the pinch in these economically uncertain times, and there is a necessary focus on cost control and short-term capacity requirements. Planning, modelling and decisive action will not rule out every tough decision an airline has to make, but they will be vital in helping airlines not only to survive but also to look beyond the recession and prepare for better times to come.