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AVIATION INFRASTRUCTURE 2011



Editorial 1

1. The Changing Profile of Airport Investors 3

2. Pricing Airport Assets Adequately 11

3. Rebundling for Airline Revenue and Margin Growth 21

4. Success Factors for Airport Express Trains 27

5. Impact of the Single European Sky on Air Navigation Service Providers 37

6. Airline Bankruptcy: Impacts and Remedies 45

7. Pursuing Sustainable Aviation 53

8. A New Airport Security Model 61

Contents

For more information on this topic, or to find out more about Booz & Company, visit www.booz.com

http://www.booz.com

1



Dear Reader,

The global aviation industry is currently recovering from what must be seen as the worst global recession since the Great Depression in the Thirties of the last century. But it is not only the economic cycles which keep executives in the aviation infrastructure industry busy. They also need to cope with fundamental changes, like deregulation, reduced public spending, privatisation, enforced environmental regulations and global competition. While key players previously enjoyed the status of state-owned natural monopolies, today they need to cope with a dynamic market and competitive environment.

Aviation infrastructure, comprising airports, air traffic service providers, their suppliers and regulators, by its nature is a truly global industry. Likewise, the Aviation Infrastructure team of Booz & Company is a global player—following the clock around the world, our main centres supporting clients in this industry are in Brisbane, Beijing, Kuala Lumpur, Mumbai, Dubai, Stockholm, Munich, Rome, Frankfurt, London, Madrid, São Paulo, New York, and San Francisco. We work together as one team, supporting clients in many countries and cultures to achieve essential advantage through winning strategies, professional transaction support, leading-edge business models, superior operational performance and value-creating marketing strategies.

In 2007 we published our last Aviation Infrastructure Reader, however, as this industry fundamentally changed, our thinking advanced as well. Therefore, we are pleased to present to you our new edition which discusses the latest trends, selected examples of ground-breaking project work and our intellectual capital. We think of ourselves as trusted advisors to our clients and as pacesetters in the aviation infrastructure industry. In this Reader we share our perspective on key industry issues and discuss strategic and operational responses which were taken by our clients based on our advice. To the extent possible we are not presenting individual examples, but approaches and solutions which we find relevant for the industry as a whole.

Our authors discuss the changing profile of airport investors, pricing airport access, changing airline marketing strategies, key success factors for airport express trains, the strategic and financial impact of Single European Skies (SES), the impact of airline bankruptcies and potential remedies, pursuing sustainable aviation and a new airport security model. We are confident that not only will you find this interesting reading, but that you will gain new insights into this fast-changing industry and key elements of winning and sustainable strategies.

Editorial

Aviation Infrastructure 2011

Booz & Company 2



We believe that this rapidly evolving industry is making great progress in becoming a highly professional and efficient foundation for the global aviation sector. While this is partly triggered by external forces, namely deregulation and privatisation, we see more experienced and demanding stakeholders, better management, application of global best-practices, advanced technologies and tools as key drivers behind this profound change.

It is exciting to be part of this journey and to engage with leading players in this sector to truly make a difference.

If you aim to set the pace rather than follow, talk to us or one of our experts.

Michael Burns Edward Clayton Dieter Schneiderbauer

3

The Changing Profile of Airport InvestorsToby Cuthbertson, Christopher Brown and Philip Lee



Booz & Company 4



IntroductionAirports, once seen as a public sector asset providing a core government service, are rapidly evolving into a private or mixed ownership model.

The first private sector airports, such as BAA, were established via corporatisation and privatisation. These were followed by organisations whose parent companies

were involved in the construction of airport infrastructure and then entered into investment and operations, such as Hochtief. Following the emergence of these airport operating companies, financial organisations have become increasingly involved, seeking stable income streams and turnround possibilities. Transactions now occur on a global basis, with the USA a notable exception.

Exhibit 1: Examples of Airport Privatisations and Transactions

1987 1992 1993 1994 1995 1996 1997 1998 19992000

20012002

20032004

20052006

20072008

2009

2010

ArgentinaAucklandSkavstaAustralia IIHannoverNaplesSouth AfricaLondon LutonWellingtonMexico IShanghai

BAALondon City

Copenhagen IEast Midlands

CardiffPrestwickVienna IILondon City II

Australia IDüsseldorfRome IIstanbulBirminghamKent Int’l

Mexico IIMalaysia

PrestwickFraportNewcastleLondon Luton IIBristolBirminghamBournemouthEast Midlands II

Sydney IIBelfast CityTeessideSenai

London Luton IIICardiffExeterBangaloreMumbaiBudapest

FraportExeterFriedrichshafenBudapestAdRBirminghamLeeds BradfordXian XianyangTAVTreviso

CairnsLondon GatwickBristol

HamburgMexico IIIRome IITurinNewcastleBeijing

Sydney IHainan

BrusselsTBITiranaBlackpoolThailandArgentina II

London CityHamburgBAAAdPGAP, MexicoMumbaiNew DelhiAberdeenBristol

BrisbaneMackayLondon CityBelfast CityBlackpool

London GatwickPeel Airports

AthensCopenhagenBelfast Int’lXiamen

SheffieldBelfast Int’l

Vienna I

Exhibit 2: Private Sector Investment Drivers

1 2 3

Public Sector Budgets Monopolistic AssetsProfit Potential

Government funding • constrained across developed and developing countriesGaps between • infrastructure requirement and the public sector’s capacity to fund them via traditional means

Globalisation and • increasing incomes gives strong growth marketEfficiencies can reduce • operating costsInnovation can raise • revenues from retail, car parking, property, etc

The lack of nearby • competition leads to captive marketsGovernments can step in • to stop exploitationPrice certainty for regulated • revenue streams

A Catalyst for Change

Attractive Returns

Stability

Aviation Infrastructure 2011 5



Public sector budget constraints have been a key catalyst for change, with the private sector attracted by the chance to profit from high revenue growth as well as efficiency and innovation opportunities. Even the involvement of government regulators can be attractive, providing the reassurance of stability for the longer term investor.

A number of models exist for private participation ranging from management contract to outright divestiture, with the private sector increasingly favouring Build-Operate-Transfer (BOT), lease and divestiture, because of the greater control afforded.

Airport valuations and investors Experience shows that the more control the vendor can give to a single strategic investor, the higher the sale price is likely to be as a multiple of EBITDA.1

In particular, flotation on the stock market does not deliver high value to the vendor in comparison to a sale to a single buyer (trade sale), and trade buyers value a controlling stake more highly than a minority stake. These facts have led to the recent increase in trade transactions.

We have categorised airports by size—small (less than 5 million passengers), medium (5 to 15 million) and large (15 million or more). Based on EBITDA multiple valuation, smaller airports on average have achieved the highest multiple valuation of 20.1, followed by medium sized airports (18.1) and large airports (15).

The reasons behind small airports’ high valuations relate to:

high historic and potential traffic growth often • driven by low-cost carriers and capacity problems at larger neighbouring airports;

simple operations (single runway and • terminal) with excess capacity available;

opportunities to increase non-aeronautical • revenue (car parking, retail and property) by introducing more sophisticated approaches to retail management and car park policy.

Exhibit 3: Private Sector Involvement in Airports

The more control the vendor can give to a single strategic investor, the higher the sale price is likely to be.

Range of Private Sector Involvement in Airports

Maximum Government Control

Maximum Private Control

State Ownership Management Contract

BOT Lease Divestiture

Full Government • ownership of assets and management

Can hire on ad-hoc • basis experts to help operations

Public sector • contracting out management and operations of part of the airport to a private sector entity

Limited • autonomy and decision-making

Creation of a • special purpose vehicle either wholly owned by the private sector or with the state retaining a degree of ownership/control

Long-term • concession

Agreement where • private sector obtains the use of Government property for a given period

Periodic • instalments paid to Government for usage

Long-term • agreements

Private ownership • of air transport infrastructure

Transferred either • through IPO or Trade Sale

Government • may keep a ‘golden share’

Example: Dubai

Example: Jeddah

Example: Athens

Example: Luton Airport

Example: BAA

Less leverage of private sector involvement in airport operations and development

Recently the private sector has become more involved in BOT and private ownership

1. Earnings Before Interest, Taxes, Depreciation and Amortisation.

Booz & Company 6



For medium airports, traffic growth has tended to be slightly lower and the traffic base tends to be more diverse as more airlines with transfer traffic add to the complexity of the operation. The result is a need for additional facilities and associated capital

expenditure for terminals and baggage systems. The valuation multiple reflects the experience that although opportunities still exist to maximise income, it tends to come with additional capital and operational cost compared to smaller airports.

Exhibit 4: Airport Transactions by Sale Type

0

5

10

15

20

25

30

80

60

40

20

140

120

100

0

Bris

bane

(08)

12.

4%

Syd

ney

(02)

100

%

Bei

jing

Cap

ital (

00) 1

0%

BA

A (

06) 1

00%

TBI (

04) 1

00%

Bru

ssel

s (0

4) 7

0%

Cop

enha

gen

(05)

41.

1%

Sou

th A

frica

(05)

20%

Frap

ort (

01) 2

9%

Bud

apes

t (05

) 75%

Luto

n (0

1) 4

6.4%

Bud

apes

t (07

) 75%

Birm

ingh

am (0

7) 4

8.25

%

Bris

tol (

09) 3

5.5%

Luto

n (0

4) 2

8.6%

Auc

klan

d (0

1) 7

.1%

Hai

nan

Mel

lan

(02)

20%

Mex

ico

Nor

th C

entra

l (00

) 15%

Ham

burg

(00)

49%

Leed

s B

radf

ord

(07)

100

%

Pre

stw

ick

(01)

100

%

Lond

on C

ity (0

8) 7

5%

Exe

ter (

07) 1

00%

Luto

n (0

8) 5

0%

Bel

fast

City

(08)

100

%

Pre

stw

ick

(01)

67%

Mck

ay (0

8) 1

00%

Bris

tol (

02) 1

00%

Bris

tol (

00) 1

00%

Bel

fast

City

(03)

100

%

Fire

nze

(03)

29%

Cai

rns

(09)

100

%

Eas

t Mid

land

s (0

1) 1

00%

New

cast

le (0

1) 4

9%

Birm

ingh

am (0

1) 2

4.1%

TAV

Hav

alim

anla

ri (0

7) 1

0%

Aer

opor

ti di

Rom

a (0

0) 5

1.2%

Aer

opor

ti di

Rom

a (0

2) 4

4.7%

Av 20.1x Av 18.1x Av 15.0x

Less than 5 million pax 5-15 million pax Greater than 15 million pax

EV/

EB

ITD

A

Pax

(mil)

Industry Investor (i.e. Airport Operator, Construction/Engineering Company)

Consortium (Mix of Industry and Financial Investors)

Financial Investor (i.e. Investment Fund, Private Equity, Pension Fund)

Equity Offering

0

5

10

15

20

25

30

80

60

40

20

140

120

100

0

TBI (

04) 1

00%

Hai

nan

Mel

lan

(02)

20%

Frap

ort (

01) 2

9%

Leed

s B

radf

ord

(07)

100

%

Bud

apes

t (05

) 75%

Lond

on C

ity (0

8) 7

5%

Exe

ter (

07) 1

00%

Luto

n (0

8) 5

0%

Bel

fast

City

(08)

100

%

Bud

apes

t (07

) 75%

Pre

stw

ick

(01)

67%

Mck

ay (0

8) 1

00%

Bris

tol (

02) 1

00%

Syd

ney

(02)

100

%

Aer

opor

ti di

Rom

a (0

0) 5

1.2%

Bris

tol (

00) 1

00%

BA

A (

06) 1

00%

Bel

fast

City

(03)

100

%

Cai

rns

(09)

100

%

Eas

t Mid

land

s (0

1) 1

00%

Bru

ssel

s (0

4) 7

0%

TAV

Hav

alim

anla

ri (0

7) 1

0%

Luto

n (0

1) 4

6.4%

Birm

ingh

am (0

7) 4

8.25

%

Bris

tol (

09) 3

5.5%

Bris

bane

(08)

12.

4%

Luto

n (0

4) 2

8.6%

Fire

nze

(03)

29%

Aer

opor

ti di

Rom

a (0

2) 4

4.7%

New

cast

le (0

1) 4

9%

Auc

klan

d (0

1) 7

.1%

Birm

ingh

am (0

1) 2

4.1%

Mex

ico

Nor

th C

entra

l (00

) 15%

Ham

burg

(00)

49%

Sou

th A

frica

(05)

20%

Bei

jing

Cap

ital (

00) 1

0%

Cop

enha

gen

(05)

41.

1%

Pre

stw

ick

(01)

100

%

Av 15.9x Av 21.1x Av 12.1x

Minority Stake Trade Sales/Majority Stake Equity Offering

EV/

EB

ITD

A

Pax

(mil)

Equity Offering: Multiple based on equity share transaction on listed marketNote: Minority stake classified as <50% and majority stake >50%

Exhibit 5: Airport Transactions by Airport Size and Investor




Large airports are typically major or secondary hubs with a diverse carrier mix, including large aircraft and national flag carriers along with significant transfer traffic. Growth has generally been at the lower end of the growth spectrum while infrastructure requirements often include multiple terminals and runways. The complexity of the operation adds to capital and operational costs and although revenue opportunities can be increased through premium and long-haul traffic, the overall lower multiple reflects operational complexity and lower growth prospects.

In recent years, financial investors have become increasingly prominent, with infrastructure funds successfully winning bids for a range of airports and pension funds now emerging as direct investors. For example, a leading Canadian pension fund has invested directly in Birmingham and Bristol Airports, while the recent sale of Gatwick has involved the original investors selling minority stakes to pension funds and a sovereign wealth fund.

Financial investors have been active in the smaller airports market, perhaps driven by the opportunities to capture long-term growth through use of excess capacity. For medium-sized airports the story is mixed. With the exception of minority stake transactions for Bristol and Birmingham, all other buyers tended to be airport industry operators or consortiums driven by the need to develop operational expertise.

Financial investors are prominent for larger airports, whether buying stakes in airports on their own or part of a consortium with industry operators. Large airports are complex operations and can serve the national interest as gateways to individual countries. Purchasers of these airports will be under increased investment and regulatory scrutiny from governments to ensure that they have the ongoing financial and operational capacity for prominent transport infrastructure.

This trend of more financial investors owning airports is in line with the growing allocation

of funds directed towards investment in infrastructure. Alongside this trend is an increase in direct ownership by large pension funds. Infrastructure is now very much on the investment radar for many pension schemes given its ability to act as a hedge against inflation, provide long-term stable cash flows and match long-term liabilities.

Watson Wyatt research indicates that pension fund scheme allocations to alternative assets including infrastructure have tripled over the last 10 years and this is set to continue. This increased exposure is driven by the fact that investors have become more comfortable with infrastructure as asset class.

In addition, large pension funds are now looking to ‘cut out’ the fund manager when it comes to infrastructure investments. For example, the California Public Employees Retirement System made its first direct investment in mid-2010 when it purchased a 12.7 percent stake in London Gatwick Airport. It now joins the direct investment path in infrastructure pioneered by a number of Canadian pension funds.

Key advantages of direct investments by large pension funds include increased return possibilities, more control via governance, no need to pay investment management fees and not being constrained by infrastructure fund managers’ internal investment horizons.

Investment requirements and opportunitiesA key driver of future private sector involvement will be the increasing need for investment in expansion, coupled with constraints on government budgets. For example:

Large pension funds are now looking to ‘cut out’ the fund manager when it comes to infrastructure investments.

Booz & Company 8



Europe—Demand for air traffic is expected • to double by 2030, far exceeding existing capacity. Airports have already committed a total of ¤120 billion in new facilities between 2000 and 2015. An additional 41 percent increase in airport capacity is planned by 2030.

East Asia—The developing economies in • East Asia need to invest $165 billion per year over the next five years for electricity, telecommunications, transport, water and

sanitation. The World Bank estimated that $9 billion was required to be spent on Indian airports alone between 2006 and 2010 to keep up with demand.

United States—The infrastructure deficit • totals $40 billion a year in the roads sector alone. Overall, the American Society of Civil Engineers (ASCE) estimates total US infrastructure investment needs over the next five years to be $1.6 trillion.

Norway

Sweden

United Kingdom Ireland

France

Germany

Denmark

Netherlands

Airport Size (Pax)Ownership Structure

Belgium

Hungary

Romania

SpainPortugal

Italy

Switzerland

Austria

Bulgaria

Macedonia

Albania

Greece

Croatia

Bosnia & Herzegovina

Serbia

MontenegroKosovo

Latvia

Estonia

Lithuania

Czech Republic

Poland

Slovakia Ukraine

Notes: Excludes airports with less than 2 million annual passengers Source: Airports Council International, Air Transport Intelligence

Public

Corporatized

PP, Majority Public

PP, 50/50

PP, Majority Private

Private>30m15m–30m5m–15m2m–5m

Exhibit 6: Airport Transactions by Sale Type




Looking forward, there are still plenty of opportunities for private sector involvement. Airport Councils International (ACI) studies show the majority of European airports (78 percent) are still fully publicly owned, but this proportion is set to reduce with privatisations planned for around 20 European airports over the next five years.

Although the quality of the assets vary, it is clear that new opportunities will continue to come to market. Indications of this can be seen throughout Europe, for example:

the Polish Airports State Enterprise continues • to transfer the management of its airports into local airport companies;

the Spanish government announcing • in December 2009 a change in Aena’s management model and the creation of ‘Aena Aeropuertos S.A’. This entity is expected to funded partially by private capital-up to 30%.

France, where a number of French airports • are now managed at least part-privately with this process of increased private sector involvement set to continue.

Although few airports remain available for privatisation in the UK, some small airports have expressed interest, including Derry City and Newquay. Even so, existing private sector owners will continue to divest assets, for example:

Peel Airports recently divesting to YVRAS;•

Global Infrastructure Partners selling minority • stakes in Gatwick direct to pension funds; and

the expectation that BAA will continue to • sell off assets—(1) to increase its focus on Heathrow and (2) as a result of the UK Competition Commission decision that it must sell Stansted and one of its Scottish Airports.

Outside Europe, airport investment opportunities will continue to come to market:

India/Asia—In India the first privatisation • projects occurred in 2007 with airports such as Delhi, Mumbai, Bangalore and Hyderabad. The government is looking for private sector investment in a number of regional airports to support ongoing development. In South Korea, Seoul Incheon Airport is examining options for privatisation.

North America—Investor interest continues • to grow in the US market, but much seems to depend on the re-opening of the Chicago Midway Airport privatisation process. If this sale process re-starts and is successful, four additional airports could follow under the FAA’s privatisation pilot programme. A number of airports have indicated interest in privatisation including San Juan/Puerto Rico, Louisiana and Minneapolis/St. Paul, Minnesota.

Middle East—Earlier this year, expressions • of interest were sought for the Design, Build, Finance, Operate (DBFO) for Medina airport in Saudi Arabia and the private sector already has management contracts at some of the larger airports which may result in further private sector opportunities.

This is just a sample of potential opportunities. There are certainly others—for example China—where traffic growth will continue to require additional infrastructure.

Even with the recent economic slowdown, buyers and sellers in the market are keen to engage in the continued process of private sector investment in airports. However, some uncertainty remains, due to government and private sector owners’ hesitation to sell assets. Recent examples of privatisation delays in Europe include Prague and Lisbon Airports, which have been put on hold, and Schiphol, where the decision was withdrawn last year.

Booz & Company 10



The future of airport investmentGovernment, industry operators and financial investors will need to work closely to ensure that investment is available for the airport sector.

Governments will always be an important stakeholder. Their critical role is to ensure an appropriate environment for investment, including sound regulatory and institutional investment frameworks.

Operating companies provide the expertise for global airport operations and development. We see their role focusing more heavily on airport development and management, particularly in developed economies. In emerging markets they will also have the opportunity to utilise their skills and resources in capacity expansion projects including BOT transactions where strong demand will drive developments.

Financial investors will be the key investment source, particularly in developed economies with mature airport assets. Experienced infrastructure fund managers will continue to play an important role in raising, distributing and managing funds focused on infrastructure assets such as airports. Larger pension funds who invest directly will need to ensure they have appropriate resources to manage airport assets as numerous additional risks come with direct ownership.

Irrespective of the challenges that lie ahead, the ongoing development of the airport sector looks promising. With the evolving ownership nature of airports globally, all parties need to proactively fulfil the roles where they can contribute the most value to deliver and operate airport assets while balancing financial and economic investment objectives. Finding that right balance will be one of the biggest challenges faced by airport investors and government.

11

Pricing Airport Assets AdequatelyDieter Schneiderbauer, Edward Clayton and Martin Haller



Booz & Company 12



IntroductionWith the world economy in a strong rebound, global passenger demand is growing and most airlines are posting profits again. With the worst of the global recession behind us, tension between airlines and airports over regulated airport charges is likely to increase again. Right before the downturn, sharp increases of airport charges at London-Heathrow and London-Stansted were viewed as excessive and unjustified. Following comprehensive research into airport charges around the globe, we have come to the conclusion that the current debates are missing the mark when arguing about cost justification and/or inflationary increases in charges. These charges should rather be seen as the price to access a certain airport and its catchment area together with the associated average yield levels, plus compensation for the airport infrastructure and services which make significant contributions to overall punctuality, efficient aircraft rotation as well as quick and reliable transfers. Our research suggests that neither airlines nor airports recognise the full picture when developing their strategies and preparing for negotiations.

The airline perspectiveThere is a long tradition of airlines complaining about excessive airport charges. In their ideal world, airport access would be free of charge. Some carriers are even demanding that airports should remunerate them in recognition of the economic benefits they deliver to the local community by providing air services and bringing passengers to the region. Certainly airlines have a legitimate point when referring to airport revenues and profits which are often barely affected by events such as a downturn in global aviation markets or even severe crises like the aftermath of 9/11 and the latest global recession. As a consequence, the relationship between airlines and their main airports becomes strained when consultations or negotiations about airport charges are taking place.

Reviewing the decision-making hierarchy of airlines regarding airport choice, it is necessary to take a broader view of more issues than just the price paid for airport services (see Exhibit 1). Firstly, the long-term decisions about fleet strategy are typically taken without any consideration of specific airports except for new extra-large aircraft which need specific airport infrastructure,

Exhibit 1: Decision-making hierarchy of Airlines Regarding Airport Choice

Source: IATA Ancillary Revenue Discussion, June 2, 2009

• Long-term strategic (investment) decision of airline• Relocation or allocation of new fleet (segment) or single

aircraft as part of airline growth strategy of restructuring• High influence of market attractiveness (e.g. catchment,

yield level), but less influence of charging level. Capacity of infrastructure (e.g. slot availability, terminal, maintenance) an important criterion

FleetStrategy

Allocationof Fleet

Segments orSingle Aircraft

NetworkDesign and Route

Planning (City Pairs)

Offering Design(Frequencies, Schedule,

Aircraft)

Maxmizing of Route Profitability(Yield Management)

Sho

rt-te

rmLo

ng-te

rmD

ecis

ion-

mak

ing

Hor

izon

• Highest impact of charging level and airport marketing • Attractiveness of destination (demand, catchment, actual

yields) and airport performance/charges/available services are key criteria

• Tactical decision to optimise offering at certain airport – as far as possible given available aircraft capacity and current rotations

• Less driven by airport charges, but rather depending on actual and expected demand (e.g. O&D and transfer passengers, passenger mix of business/leisure, weekly and seasonal demand fluctuations)




like the Airbus A380. Airlines study long-term demand forecasts for their core markets, try to understand the future moves by competitors and define fleet expansion strategy in the context of their strategic positioning and future ambitions. At this stage, only in rare exceptions is the choice of a specific airport a driving force behind the decisions on sizing the fleet and/or selecting a specific aircraft model. Usually the airline already has a home base—for network carriers this is the major hub airports. For point-to-point carriers, the ultimate decision on where to base short-haul aircraft is a tactical decision which adapts to changing demand patterns.

At the other end of the spectrum, there are issues such as designing the product to cater best to the needs of different passenger segments, maximising route profitability through deployment of certain aircraft model and diligent yield management. Once an airline has defined its network (including the airports to serve) it has to decide on the number of frequencies per day or per week, the schedule (arrival and departure time) and the aircraft size and seating configuration (number of seats offered per class). While this is generally defined for a scheduling season, more and more network airlines have moved to a flexible model changing aircraft models depending on the time of the day and the day of the week to adapt to forecasted demand and/or the actual booking curves, in order to optimise route profitability. In this short-term horizon, the choice of airport does not play any significant role.

Airport choice is most relevant for airlines when they decide about network design and route planning. When evaluating a new route, the airline assesses the market attractiveness (e.g. population in catchment area, overall demand for air travel, expected average yield given the forecasted mix of business and leisure travellers) as well as the airport value proposition (e.g. slot availability, terminal facilities, transfer time,

available airport services, like ground handling, fuelling, maintenance) and the level of airport charges. All these factors are considered when making trade-off decisions for new routes and selecting the preferred airport. In the final stages of the decision-making process, the airline will enter into negotiations with the airport about available slots, access to certain facilities, provision of services and, of course, the available marketing support for introduction of new services and frequencies.

So, what are the key decision-making criteria for an airline to select an airport? This question has different answers for long-haul and short-haul services. A global survey by Booz & Company (see Exhibit 2) revealed that the most important criteria reported by airlines for long-haul services are level of total airport charges and slot availability at the right time, as there are only relatively short windows to allow for optimal aircraft rotation. Airport performance criteria are also key: minimum delays inbound and outbound as well as minimum connecting time (MCT). Finally, average yield level and connectivity at the specific airport are important. Looking at the top six criteria for airport choice we recognise that airlines have to make complex trade-off decisions which take into account capacity and performance aspects (e.g. slot availability, average delays, minimum connecting time) and economic aspects (e.g. total amount of airport charges, expected average yield, additional revenue due to connectivity). Generally, the attractiveness of the Origin and Destination (O&D) market and the current and future competition are the primary aspects when deciding to add a new destination or to increase frequencies for an established intercontinental service.

The impact of airport charges on route profitability varies significantly for different types of carriers. While low-fare carriers are impacted most with a share of total cost of up to 25%, the short-haul services of network carriers are less impacted and for long-haul services the level of airport charges are of

Booz & Company 14



relatively low importance as their share of total costs is only about five percent.

In comparison, the key criteria for airport selection when offering short-haul services are quite different (see Exhibit 3). In order to support optimal aircraft rotation, slot availability at the required time and minimal delays are of utmost importance. As airlines strive to achieve maximum fleet utilisation they cannot afford unnecessary dwell time or delays at airports. Total amount of airport charges and prices for ground handling services are also quite important as is operational excellence (e.g. quality of ground services, minimum ground time). It is known that low-cost carriers are quite aggressive in negotiating very low rates for airport access and service provision, but usually only regional airports have bowed to their

pressure and introduced charging regimes which are geared toward their specific needs. Major airports are not ready, nor able, to provide split charging regimes and differentiated services which evenly cater for the needs of network carriers and low-cost carriers in the best possible way as this usually would result in significantly lower revenue and earnings as a ‘spill-over’ of such concessions to traditional carriers cannot be avoided.

Our research reveals that major hub airports are typically offering a balanced profile of market attractiveness and overall charging level (see Exhibit 4). Airports with the highest attractiveness from the perspective of airlines also post the highest charging levels while those with lower attractiveness also charge less. This empirical evidence is even more surprising when the

Exhibit 2: Key Criteria for Airport Choice (Long-haul)

Exhibit 3: Key Criteria for Airport Choice (Short-haul)

Total Amount ofAirport Charges

Slot Availability atthe Desired Time

Minimal Delays(Outbound)

Short MinimumConnecting Time

Higher Yieldper Passenger

Connectivity

84

100

99

48

59

36

Source: Booz & Company Analysis

Short-haul

Total Amount ofAirport Charges

Slot Availability atthe Desired Time

Minimal Delays(Outbound)

Short MinimumConnecting Time

Higher Yieldper Passenger

Connectivity

100

99

94

89

87

87

Source: Booz & Company Analysis

Long-haul




different charging regulations of EU Member States are considered. Our take is that the market forces prevail and that over time the level of airport charges reflects the ‘true value’ of a specific airport to all airlines serving this O&D or leveraging the connectivity at a certain hub. This natural balance only seems to be distorted for emerging hubs with an aggressively expanding home carrier and massive infrastructure expansion or in contrast for declining hubs where the home carrier went bankrupt or had to reduce its fleet significantly.

For typical O&D airports the spread of value propositions seems to be wider (see Exhibit 5). While traditional airports at major cities (e.g. airports B, C and D) seem to have a balanced positioning, several hub airports (i.e. airport A) and regional airports (i.e. airport E) are perceived as expensive. While for hub airports this appears to be natural as their charging levels are geared towards the value they bring to long-haul carriers and derive from their complex transfer infrastructure, it does cause problems for destination and regional airports. Generally, their relatively unfavourable price to value ratio is a result of their low utilisation and only a

few of them managed to win leading low-cost carriers as core customers to leverage their capacity despite their remote location and limited catchment. Even when airports are succeeding in boosting passenger numbers it is uncertain that they will be able to post sustainable profits as their charging levels are low and they have to provide a lot of additional hard and soft discounts to retain their low-cost carrier customers.

Our analysis further revealed that some airports do not fully leverage their value if their operational performance is taken into account (see Exhibit 6). In this example airports I and J provide airlines with the best operational performance, but their charging levels are significantly below that of their peers—airports A, G and H. In contrast, airport F shows a poor operational performance and the highest charges overall. In other words this airport charges far too much to airlines as the value coming from its geographic location is heavily devalued by its below par operating performance. This evidence seems to support the hypothesis that airlines focus primarily on market attractiveness when making airport choice decisions. They calculate route profitability and seem to hope

Exhibit 4: Long-haul and Exhibit 5: Short-haul

Mar

ket A

ttrac

tiven

ess

Total Charges per Turnaround

Most attractiveLeast attractive

Leastattr.

Mostattr.

Mar

ket A

ttrac

tiven

ess



Leastattr.

Mostattr.

Long-haul Short-haul

F A

H

G

I

J

A

B

C

E

D

= Yield = Connectivity = Population in Catchment Area

Comments: “Most Attractive” represents an index score of 100Source: Booz & Company Analysis

Booz & Company 16



that the operational performance can be fixed later. We believe that this is an invalid assumption as the operational performance of airports is quite stable over time. The reasons behind are both the impact of infrastructure limitations (including air navigation capacity) and the operational capabilities of an airport itself. As these are structural factors, they should be considered in an integrated approach to assess airport attractiveness. The key lesson for airports is to carefully assess their total attractiveness and performance with peers in long-haul and short-haul markets in order to present their full value to airlines when talking about their airport charges.

The airport perspectiveAirports are not free to set their aeronautical charges independently. EU Member States historically have implemented different

regulatory regimes for airport charges; these sometimes even differ from airport to airport within one country. Key elements in reviewing, setting and approving charging levels today are mainly considering the true costs of airport infrastructure investment and operations. Only in rare situations, the competitive situation with other airports in a certain catchment area and the level of demand for air services in the region served by the airport are factored in. Recent EU proposals allow airports to levy their future capex for renewal and expansion of capacity and to improve services to airlines and passengers when calculating the required level of airport charges. Furthermore, their income from the so-called non-aviation business does not have to be considered to lower airport charges (‘dual-till’ concept). This stands in sharp contrast to the airlines’ position of a so-called ‘single-till’ concept. Airlines argue that non-aviation profits should be at least partially used to lower airport charges based on the argument that the airlines bring the passengers and therefore should be credited for profits resulting from passenger spending at airports. From an airport perspective both the current and likely future EU regulatory framework is quite favourable and will allow the development of pricing strategies supporting sustained growth in the core aviation business.

Despite a generally favourable airport charges regulatory regime, more and more airports recognise that their charging income does not cover the full costs of airport infrastructure investments and operations even when they are not striving for a high return on equity. Together with small profits—and in some cases significant losses—from deregulated ground handling services major airports face a situation where they have to cross-subsidise the aviation business with the strong profits from the non-aviation businesses despite the ruling ‘dual-till’ regime. One can state that airlines have de-facto introduced the desired ‘single-till’ regime through simply leveraging their purchasing power in negotiation with

Exhibit 6: Operational Performance vs. Charging Level

Ope

ratio

ns



Leastattr.

Mostattr.

Long-haul

= MCT = Delays

Comments: “Most Attractive” represents an index score of 100Source: Booz & Company Analysis

I

A

H

G

F

J

More and more airports recognise that their charging income does not cover the full costs of airport infrastructure investments and operations.




airports and their lobbying power dealing with regulators and/or authorities approving any changes in airport charges. There are numerous examples in Europe of airport charges stagnating or exhibiting only modest growth over the last few years.In addition, there were even retarding effects when calculating airport charges on a per passenger basis due to introduction of fee caps, higher proportion of variable charges and higher load factors. From an airport management and a shareholder perspective this must be seen as an unfavourable trend, but so far, with the exception of the ruling on a very significant increase of airport charges at London-Heathrow and London-Stansted in April 2008, this trend seems to prevail across Europe. Despite being ‘natural monopolies’ in most cases airports do not seem to have achieved monopoly rents or even a full, risk-weighted return on investment for access to their infrastructure.

Currently, most airports appear to follow a rigid cost-based approach when calculating the required level of airport charges. The asset portfolio for the aviation business is fully considered and differentiated depreciation periods are calculated for different assets depending on their technical and/or economic useful life, the maintenance and capital improvement costs are assessed and the operating costs of terminals are separated between the aviation and the non-aviation usage of these facilities. Many further calculations are carried out to come up with the best possible view of the ‘true cost’ of the airport infrastructure. Finally, the right factor for the cost of capital needs to be found. This is more like a negotiation or consultation process with the regulator or major airline customers than an independent calculation of the weighted average cost of capital (WACC). When all this has been done with great precision the airports are still not in a position to know whether the result reflects a fair market value of their assets and services or not. In most cases they will either ask for a charging level which fails to reflect their true value to airlines or will aim to charge far too much,

which might be justifiable under regulatory principles, but will likely have a negative impact on future demand. This would, when taken to the extreme, result in a vicious cycle where the airport loses traffic and even key airline customers, resulting in an inability to cover the full cost of infrastructure investments and operations. This could encourage a further increase in charges, while the only right answer in such a situation would be to lower charges again to bring back lost customers.

It is critical for airports to gain a complete picture of their competitive positioning and to assess the true market value of access to their infrastructure. Based on our experience, a scoring model can assess airport capacity and performance along several different dimensions. The airport performance index includes criteria like:

process efficiency• (e.g. minimum connecting time, minimum ground time, short shipped baggage index)

punctuality• (e.g. inbound and outbound delays)

aviation offering• (e.g. number of destinations and daily flights)

Booz & Company 18



catchment area, ground access• and intermodal connections (e.g. high-speed train)

connectivity•

customer satisfaction along several • dimensions

The capacity index calculates runway capacity (based on coordinated slot capacity and available slots) and terminal capacity (aircraft stands, passenger throughput).

Using such a tool, we assessed several major European airports (see Exhibit 7) and marked their position in a matrix separating lower and higher than average scores in both the capacity and the performance dimension. Currently, two airports are suffering from significant capacity constraints with the marked difference that airport A, despite this constraint, provides superior service levels, while airport F provides only inferior service levels.

When taking into account the average charging levels this analysis reveals that three primary European hubs are able to charge more than €17 per passenger while the others average at €14–15 per passenger (see Exhibit 8). It can be noted that three hub airports seem to be able to charge a premium over their rivals which still have some free capacity and in some cases a less attractive catchment area as well. This analysis confirms that superior airport performance along several key operational criteria is not adequately reflected in the current level of airport charges. In other words, some airports do not get compensated adequately for the value they bring to their airline clients while others seem to be overpaid. Even when the potential impact of a more attractive catchment area and higher average yield levels are considered, there remains a performance-related gap of about €1 per passenger and hence, a lost opportunity to cash in on a substantial double-digit millions per annum.

While in the short-term this may be welcomed by airlines as they pay less than they should, this situation potentially poses a threat to them in the longer term. When airports do not sustainably cover the full costs of their core aviation infrastructure they may be less willing to invest or even lose the ability to do so in the long run. With public sector spending increasingly constrained and an increasing number of airports being privatised this is not good news for the industry. It should be in the interest of all players that the value of airport infrastructure is adequately reflected in its pricing and that airport charges are set at a market equilibrium which provides proper incentives to the market participants. It appears that such a balance is not reached in many cases due to regulatory restrictions, lack of critical information, an inadequate assessment of operational performance when assessing airport attractiveness, and, in some instances, undue bargaining power of the airlines as well.

If there is no platform for a trusting partnership between an airport and its

Exhibit 7: Capacity vs. Performance Index

H

KG

I

JF

A

Low excess capacity and operational performance

High excess capacity and operational performance

Low excess capacity and low operational performance

High excess capacity and high operational performance

Per

fom

rnac

e In

dex

Valu

e

Capacity Index Value

Source: Booz & Company Benchmarking

87654323

4

5

6

7

Superior airport performance is not adequately reflected in the current level of airport charges.




key airline customers to jointly orchestrate sustainable long-term growth, their relationship only becomes transactional and negative ‘tit for tat’ behaviour may become predominant. In such a scenario airlines may succeed in paying lower airport charges in the short run, but in due course the airport’s operational performance may deteriorate and/or the required capex for improving and expanding the infrastructure will be delayed or even cancelled completely. We are concerned that this would jeopardise the healthy development of the European aviation industry and could even have a negative impact on the European economic development in the longer run.

How airport access can be adequately pricedThis is not a call for sharp increases of airport charges at European hubs and major O&D airports, but our evidence supports the conclusion that setting airport charges correctly is much more than calculating the full costs of airport infrastructure investment and operations and dividing them by the number of passengers and flights. Airports rather should take an integrative view and make this a vital part of their strategic planning process. They should thoroughly analyse their competitive position in both the short-haul and long-haul markets, the strategies of their major airline clients and finally use sophisticated tools to calculate the true market value of their infrastructure taking into account the ‘willingness to pay’ of their core airline clients.

Booz & Company has developed a comprehensive tool box to assist airports in doing such assessments and to advise on future charging regimes that are market-based and still compatible with the respective airport regulation. For example, we use sophisticated choice modelling techniques to assess the customer value of certain airports and their key performance attributes as well as the main drivers of their charging regime. This tool allows the simulation of ‘real market’ behaviour (see Exhibit 9) as network

managers and route planners from airlines are polled in an internet-based survey with a set of so-called choice tableaux where real airports alternatives and concrete levels of airport service attributes and charging levels are presented. Respondents evaluate these alternatives and make a choice of which one they would choose. This experiment is repeated several times and based on a large

number of responses an integrated airport market model can be calculated. This model provides the cross-elasticity of demand depending on several different criteria for airport choice and allows the assessment of different scenarios for future charging systems and varying levels of total charges at one airport. As this model will predict the demand impact of all changes our clients can do strategic simulations that take the behaviour of their key airline clients into account.

Making decisions about future charging systems and the overall level of charges with a more complete understanding of

12

13

14

15

16

17

18

19

2 3 4 5 6 71

K

H

G

I

J

F

A

Primary hubs with capacity constraints

Primary/secondary hubs without capacity constraints

Cha

rges

per

Pax

Capacity Index Score1

1: highest = 10, lowest = 1

Source: Booz & Company Benchmarking

Airport charges should be set at a market equilibrium which provides proper incentives to the market participants.

Exhibit 8: Capacity Index vs. Average Charges per Pax (Intercontinental)

Booz & Company 20



market behaviour enables airports to better align their strategic priorities and to get fair compensation for the value of their infrastructure and operational performance. Furthermore, these insights allow them to better prepare and facilitate consultations

or negotiations with their airline clients and to identify ‘win-win’ arrangements which support growth strategies of airlines without undermining the profitability of the aviation business of an airport.

Exhibit 9: Choice Modelling Techniques

Cross-elasticity of • demand driven by several independent criteria (e.g. slot availability, charging level, minimum connecting time)

Demand curves based • on different scenarios for total level of airport charges, degree of variable charges and special conditions (e.g. transfer rebates)

Simulation of ‘real market’ • behaviour based on discrete choice theory

ResultsChoice Model

Please assume that you have additional capacity with a typical 240–260 seat long-haul aircraft for 7/7 frequencies in addition to your current schedule. Please indicate the airport you prefer at the bottom of the page.

Airport name Airport A Airport B Airport C NONE

Slot availability at preferred time of day

No, but > 2 hrs earlier/later that day

Yes Yes

Total airport charges ¤9,000 per turnaround

¤7,500 per turnaround

¤4,500 per turnaround

Variable airport charges 33% of total airport charges

0% of total airport charges

66% of total airport charges

Passenger services/amenities Premium Standard Budget

Outbound delays (more than 15 min)

25% of all flights

15% of all flights

20% of all flights

Lost Baggage Rate (missing bags per 1,000 PAX)

30 60 15

Minimum Connecting Time (MCT)

75 min 30 min 45 min

Discount per transfer passenger (related to passenger charge for international origin passenger) [¤]

0.00 10.00 6.60

I would assign additional capacity at…

Airport A Airport B Airport C NONE

21

Rebundling for Airline Revenue and Margin GrowthStefan Stroh, Martin Haller, Daniel Roeska and Volkmar Koch



Booz & Company 22



Getting stuck down a dead end road?The aviation industry has reached a crossroad. Just coming out of the toughest crisis, competition is as high as it has ever been. Consequently, margins of network carriers—which never were excessive—are further under pressure. In this critical situation, many of the airlines have been reacting by further reducing unit costs in their operations—an effort the airline industry has been focusing on already for years. Airline executives have pulled every lever possible to reduce costs and stay competitive. They have scrutinised their operations from top to bottom to cut expenses and improve efficiency, and have passed those savings on to their customers.

As a result, many more passengers now have access to air travel options—but the airline business has become more and more a commodity—and the industry’s margins have not significantly improved. And although customers have welcomed the decline in prices, they have also responded negatively to the resulting lower service levels and have

become increasingly dissatisfied with the flying experience.

In their effort to keep basic ticket prices in check while maintaining margins, many airlines have recently started to unbundle their products—charging incremental fees for anything beyond the basic cost of air travel. Although unbundling has been somewhat effective in improving airlines’ financial performance, it has also sparked an ugly backlash from customers who are angry at having to absorb what they view as hidden price increases, and having to decide at every step along their journeys whether to pay extra for even the most basic services, from seat reservations to blankets. Any additional attempts to cut costs and prices by unbundling will only push customers further away.

It is time for airline executives to take a different approach to product design—one that has the potential to differentiate their offerings from those of competitors, restore goodwill with customers, and improve margins. The time has come for smart rebundling.

Source:IATA Ancillary Revenue Discussion, June 2, 2009

Share of AR 2008 [%]

Growth of AR Share 2004–08 [%]

18161412108642

0

30

60

90

120

150

180

480

Qantas

SingaporeAmerican

Continental

United

US Airways

Ryanair

easyJet

jetBlue

Aer Lingus

Air Asia

Virgin BlueAir Berlin

LegacyLow cost

Exhibit 1: Airline Ancillary Revenues




Smart rebundling—six steps for margin improvement Rebundling begins with parsing the product into its individual elements, analysing the cost and the willingness of different customer segments to pay for each element, and then creating new tailored offerings that closely align with each customer segment’s needs and perceptions of value. By including in each offering only those components that customer segments want and are willing to pay for, the airline can sift out low-margin components and improve average margins across the board—and it may be an important step toward improving customer satisfaction and loyalty. The small-business manager flying on a domestic day trip may have no need for access to the airport lounge, but would value the convenience of a voucher that could be redeemed at any airport coffee shop.

Reshaping product design and the product design process ultimately needs to happen on various levels, down to the operational workflow. This article takes a strategic perspective and will focus on:

High-level product design •

Pricing approach/strategy•

Channel/sales approach•

Starting with a high-level perspective on what needs to be achieved gives us an impression of what the endgame should look like: airline customers should have the choice of which product and service really fits their needs—in any given situation. In order to identify these needs it is important to think about customer behaviour first. We know that buying behaviour has become more complex and less stable as an individual customer can behave quite differently depending on the specific situation.

For fashion retailers, for example, there is no typical ‘H&M customer’, but people will mix H&M with D&G—the same is true for airline customers: there is no typical BA or Lufthansa or Ryanair customer, because customers will mix Air France with easyJet with Air Berlin, etc. as it fits their needs or schedules. We generally observe a trend to individualise choices (i.e. not buying standardised products) and to mix styles, brands, qualities. This development increases product design complexity.

Taking that into account, we propose a six-step thinking logic to conceive a next generation airline product design.

It is time for airline executives to take a different approach to product design.

Integrateloyalty program

Differentiatesales process

Createbundles

Offer a menu

Strip downproduct

Price thebundles

1 23

4

5

6 Exhibit 2: Approach to Airline Product Design

Booz & Company 24



Step 1: Strip down the productThe first step is to take everything out of the product that the customer does not necessarily need in order to get from A to B. Stripping down the product essentially means follow the low-cost carrier approach and let the airline start from a clean sheet, building the product from its base, rather than amending a legacy product. This is also a good way to think about some radical cost-cutting moves, even though that is not the primary objective of this approach. The result of the stripped down product is the ‘core product’, which is simply a flight from A to B with unavoidable add-ons (right to take a seat on the flight, making use of a toilet on board, etc). Customers can fly just using the core product, but they likely will ask for more. For the core product alone, airlines would earn a lower yield. Therefore a hard discussion with Sales is necessary already here in the process of thinking through the proposed six steps. So, following this idea of stripping down the product means that any airline can have a core product that is (almost) competitive with LCCs—apart from inherent cost drivers—for example, labour cost.

Step 2: Offer a menuBecause most customers will ask for more than the core product, additional add-ons matching the customers’ needs should be offered. Customers should be able to choose from a potentially vast menu of additional services, from seat reservations to different pre-ordered meals, from a variety of airport services to insurance, etc. It depends on the airline how far they want to go—and how far away from the core flight product additional offered services can be. By offering this menu, airlines give their customers the choice to assemble an individualised product based on the core product (‘the flight’) including whatever amenities they believe fit their needs (see Exhibit 3). From the airline perspective, margin for both the core product and the add-ons can be earned. To do so means to fundamentally change the approach how airlines have been selling their seats, and to some extent how customers purchase air travel!

Step 3: Create bundlesOffering dozens of individual service components will undoubtedly bring frustration even to the most internet-savvy

Con

vent

iona

l Ser

vice

Cla

sses Which class

do I travel in?

Decision to fly from A to B

Firstticket Fixed First Package

Economy ticket Fixed Economy Package

Business ticket Fixed Business Package

After-Sales Pre-Flight In-Flight Post-Flight

Ser

vice

s fo

r Reb

undl

ing

Which additional services do I purchase?

Decision to fly from A to B

Basic Flight ticket

After-Sales Pre-Flight In-Flight Post-Flight

Premium Call Center Services

30kg baggage allowance

Seat pitch: 55" Fast baggage services

Flexible fare conditions

40kg baggage allowance

Three pieces of hand-luggage

Arrival services

Advance seat reservation

0.5hr check-in limit

(Soft-)Drink(s) Basic mileage

Lounge access Meal(s) Double mileagePassenger decides which service to choose

Optional

Exhibit 3: Services of Traditional Travel Classes vs. Services for Rebundling




and price-conscious customers, because they will lack the time and patience needed to browse through a vast array of service components, deciding individually what they would like to use on any given flight. Therefore, and to allow sophisticated pricing strategies, services should be ‘rebundled’. In this context ‘rebundling’ does not imply re-creating the traditional economy, business and first class products—although admittedly the current three-classes-hierarchy will not entirely disappear. But product managers in this situation are free to create whatever packages they feel may fit their customer segments (e.g. the holiday-city-trip-package, the overseas-business-package, the domestic-business-package, etc). And furthermore, bundles are not meant to be fixed. They are merely a pre-selection to bring customers along the road they want to take. But customers should still be able to add further service components, and potentially take out unwanted ones. Having this in mind, it is clear that this fundamentally changes the logic of an airline’s product design and sales approach.

Step 4: Price the bundlesFundamentally, pricing of the core product, the individual service components and the bundles needs to be chosen along price-volume-curves that are derived from the customers’ willingness-to-pay. By selling customers their components of choice, airlines should be able to derive higher margins for those components than for their classic products. To ensure maximum margins, new components can only be offered if the expected revenues (price-volume-curve) for that component exceed the incremental production costs. In the context of pricing strategies for bundles it is possible to utilise the compensation effect, caused by different individual willingness-to-pay of different customers, to maximise revenues. Therefore it is necessary to cluster customer groups and design bundles to extract maximum revenue and value from customer preference clusters. These customer preference clusters should be aligned with airline customer segmentation.

Step 5: Differentiate sales processAs put forward above, airlines nowadays are not focused on customer needs and mostly expect their customers to approach them if they intend to purchase an upgrade or additional services. In other words, airlines of course try to obtain a flight booking, but after that customers are left alone. That is not best practice, because customers’ demands, buying behaviour and willingness-to-pay will vary over time. For example, at the point of booking, when customers typically seek as cheap a flight as possible, they might settle for a London-San Francisco ticket in economy class—however, a few days before the flight, their desire for a business class seat might be high enough to justify some additional spending. At this point of time they should be approached by the airline to stimulate buying and generate additional margin. Another upselling opportunity is offering meals and drinks packages in advance to lock in revenues that would otherwise go to the airport. Currently, these aspects are not addressed adequately by many airlines, although we do see airlines such as Germanwings or British Airways successfully offering some close-to-flight add-ons.

Implementing the concept of upselling throughout the travel cycle not only requires much more sophisticated thinking in terms of sales process, but it also requires direct contact channels to the customer. These direct contacts have been established by the airlines, although in cases where the booking is made through a travel agent—still a significant proportion of high value travel—it is less easy to tempt the passenger to upgrade—although email and cell phone contact directly to the customer is increasingly possible.

Rebundling fundamentally changes the logic of an airline’s product design and sales approach.

Booz & Company 26



Step 6: Integrate with loyalty programmeFrequent flyer programmes need to be integrated into the described approach; where possible, the proven foundation of current status and mileage systems should be supported. Finding the right balance between a new product design approach and maintaining the proven incentive logic is a challenge. Upholding loyalty, especially of well-paying business travellers, is crucial and should by all means be sustained in a new system. To achieve that, add-on components might be purchased for money (or mileage), but could be available for free to higher-status customers. Making individual service features available exclusively to high-frequency customers, the general idea of today’s frequent flyer programmes would be upheld.

The implementation challengeThe outlined concept of Smart Rebundling requires airlines to abandon their legacy definition of their ‘product’ and take a fresh view from the customers’ perspective. By tailoring products and services in this way, airlines can capture selling and up-selling opportunities throughout the entire travel cycle, from booking to landing, and beyond. In the process, they can provide the best possible experience to each customer, while increasing loyalty and margins. As such, the concepts laid out in this article can serve as a guideline to conceptualise a new approach to product design and product management for airlines.

Implementing such a new approach requires significant changes in the organisation and so there are some challenges to be addressed, for example:

Product Management• – Restructure the legacy product

management setup according to product definition (in-flight/ground, short-/long-haul, eco/premium)

– Build competence to perform required complex analyses around customer intelligence and pricing

– Avoid diluting the brand when introducing rebundling (overcoming the fear and move ahead anyway)

– Align with partner airlines, especially alliances

Sales & Distribution• – Make the product fit with sales channels,

especially with the compartment-based Global Distribution System (GDS) logic (economy, business, first)

– Gear sales processes/capabilities towards selling not only ‘a flight’, but additional services as well

Service Offering (e.g. in-flight)• – Put processes in place to individualise

in-flight service offering (today only based on chosen compartment)

– Work out ways to increase service offering even though crew time/resources are of limited availability

IT/Systems• – Build capabilities of IT systems to offer

differentiated services (bundles) on an individualised level

– Re-focus revenue accounting processes, e.g. Billing and Settlement Plan (BSP), to not only look at ticketed revenues

Having these challenges but also the vast potential in mind, we believe airline managers should:

stop focusing excessively on operations • and cost cutting, and start again to focus on customers and their needs;

stop charging additional fees for services and • amenities, and start offering products that customers value and are willing to pay for;

stop unbundling and start rebundling to • differentiate their offerings from competitors, restore goodwill with customers, and improve margins.

27

Success Factors for Airport Express TrainsDieter Schneiderbauer, Toby Cuthbertson, Daniel Bonsemeyer and Hanno Schulz



Booz & Company 28



1. IntroductionAir travel never really starts at an airport—travellers in fact begin their journeys to the skies quite some time before take-off, typically at their homes, offices, hotels or other locations. For this initial part of the journey, they can use a car, a taxi or public transport. In recent years, Airport Express trains have become the transport mode of choice for key passenger segments at selected airports. However, systems at different airports show very different success rates. What is it that makes some Airport Express systems successful, while others continue to struggle? What can stakeholders, such as airports, airlines, rail operators and local authorities do to make them a success?

This article aims to identify key success factors for Airport Express trains and suggest how to achieve commercial success while meeting travellers’ expectations and preferences. We will also propose a reshaped involvement of key stakeholders, possible commercial setups and tailored offerings to relevant customer segments.

Key success factors for Airport Express trainsMost studies on Airport Express trains reveal that there is no simple and obvious correlation between factors such as journey time, distance, airport size or airport function (i.e. business, leisure, origin or destination, range of flights, destinations, carriers). No single attribute such as average train speed, directness of on-airport connections and connectivity to the rest of public transport system can by itself explain propensity for high market shares1 or commercial success.

In general, there is strong evidence to suggest that individual circumstances and local factors determine commercial success and modal

share of Airport Express trains. Key for success are the right fundamental design elements as well as an attractive combination of service attributes to meet specific needs of different customer segments.

Getting the basics right—not every airport can sustain an Airport Express trainThe relevance of public transport in general and, more specifically, of Airport Express trains is significantly impacted by the size and geographic location of the airport. Successful Airport Express trains require a critical mass of O&D passengers, driven by a sizeable and attractive catchment area. However, airport size alone does not explain passenger volumes and utilisation levels2/3 of Airport Express trains. For instance, Dallas/Fort Worth (DFW), one of the world’s busiest airports located in a large and vibrant catchment area, only sees six percent of its originating enplanements arrive by public transport (rail and bus). On the other hand, the traffic volume of smaller airports will often just be too small to sustain public transport systems other than buses.

Distance traveled to the airport seems to be an important factor: the longer a round trip from airport to downtown, the less competitive are cars or taxis due to costly fares and/or congested roads. On the other hand, airports located very close to key economic areas and city centres will often have their passengers considering Airport Express trains as inconvenient and not worth a price that would be economically reasonable. Ultimately travel time between airport and downtown area is a very important attribute supported by the location and connectivity of downtown stations.

Appropriate connection to the hinterlandDepending on geographic market characteristics, a differentiation is typically used between densely populated markets, peripheral markets and intermediate markets (based on number of trip ends per square kilometre i.e. market concentration). To increase catchment Airport Express trains should also provide appropriate connections to the hinterland.

1. ACRP Report 4— Ground Access to Major Airports by Public Transport.

2. An empirical ranking of public transport use cannot be explained exclusively by size and location of the airport.

3. It is not always straightforward to use number of overall Airport Express passengers as proxy for customer success, as total number of passengers using airport station can vary significantly from number of air passengers using express. For example: 20 percent of Gatwick Express passengers have no interest in the airport as such. Their concern is having a reliable train service for their daily commute between that part of England and London, while being willing to accept the premium fare (see ACRP Report 4).

The directness of services provided may be more important than the pricing, promotion or line-haul speed.




Especially for longer distance, multi-modal and multi-segment trips, the choice of mode to or from airports is part of a larger set of decisions made in planning the trip—those decisions are different from those made by commuters4. Door-to-door travel times should be minimised as much as possible (including both transit time and waiting time). Key levers are frequency of trains and network coverage. In addition to direct connections to the central station, this can be achieved by providing good transfers with regional train services, thereby serving passengers to/from downtown and densely populated areas and business districts. Intermodal integration can be further supported by provision of bus and taxi services and park and ride facilities at Airport Express stations (though this can raise issues of revenue abstraction from airport car parks).

Easily accessible and quick direct connection to the airport terminalsLocation and architectural design of Airport Express stations should allow for convenient and fast transfer of passengers to/from terminals. While this depends on the airport configuration and terminal layout, one centralised station for Airport Express trains should be sufficient in most cases. More than one station at the airport inevitably will increase construction costs considerably and is only advised when airport terminals are distributed over quite some distance and no people mover or airport transit system is available.

However, the on-airport transfer is considered as part of total travel time and as a consequence additional transfers and dwell time at the airport are likely to make the Airport Express product less attractive in the eye of the target customers. Therefore, when planning Airport Express trains, an optimal location for the train station should minimise distance to and dwell time within terminals, and provide a seamless and hassle-free connection from the train to the check-in areas and from arrivals to the rail platform. This should be supported by clear signposting and professional promotion that is easily recognised by non-frequent travellers and incoming passengers.

Finally, attractive transit time, high frequency of trains correlated with airport peak hours and long operating hours (including late evening, night and early morning trains) complete the structural design elements of successful Airport Express trains.

Pleasant journey at airline-like service levelCustomers enjoy having their complete journey as ‘seamless’ as possible, with separate services appealing to separate market segments. In this context, high attention should be put towards integrated baggage (handling) and airline (inter-) ticketing strategies. Several Airport Express providers offer airport-like check-in services at off-airport and downtown locations to optimise travel experience for customers5. Cooperation between Express train operators and airlines on providing integrated ticketing (reservation) between ground and airline services further add to a seamless trip experience (e.g. combined tickets, online offerings, web platforms).

In addition to ticketing and baggage check-in options, the provision of sophisticated ground access information and itinerary trip planning systems is another value proposition appreciated by travellers.

A unique Schiphol Airport website for • ground access services offers a trip planner that is a fully integrated tool in terms of all modal options available, also supporting reservations and sales (e.g. airport-specific and regional travel information).

A system at Heathrow reviews all • combinations of modal segments (‘Transport Direct’).

Cooperation between Airport Express trains and airport operators on this matter could be highly valuable in improving travellers’ perception of a quality service.

Employing highly service-oriented on-board staff (e.g. ex-flight attendants or hotel staff), offering newspapers and providing passenger


5. But: Off-airport terminal services often have been discontinued, for example: at London Victoria Rail Station for Gatwick Express and Paddington Rail Station for HEX both due to economic cost, at Madrid in 2006, at Munich Main Railway Station due to lack of customer use, at Tokyo Central Airlines Terminal after pull-out by US flights in 2002. Examples for baggage check-ins in operation are Vienna Central Airlines Terminal and Moscow Downtown Rail Station. Discontinuing operations of check-in service at Heathrow-Paddington had no visible negative impact on rail ridership in the Heathrow Express. Overall, resident business travellers are least likely among market segments to release bags at downtown station.

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information on request as well as free internet access, sufficient storage space for baggage with proximity to travellers, and real-time on-board flight information does improve the quality perception of the traveller. Finally, cleanliness, safety and security are basic characteristics that should be guaranteed by every Airport Express train.

Customer segment oriented product, promotion and pricing, and clearly differentiated service offeringIn general, four customer segments exist, separated by their trip purposes: business passengers, leisure passengers, employees working at the airport and airport visitors. In addition to trip purpose, residential status has a significant impact on marketing and pricing of services, thereby reflecting on respective price elasticity. Offers should be targeted to key customer segments, with class and price differentiation reflecting their specific needs and ability to pay.

Typically, visiting inbound passengers exhibit a greater propensity to purchase ground access service such as Airport Express train connections, with a modal share of public transport twice as high as local passengers frequently using the airport. The provision of dedicated services6 itself does not guarantee higher market shares to rail; the market segment most impacted by premium service is the resident business segment, whereas the resident non-business segment is more concerned about cost minimisation and luggage issues (e.g. car drop-off by friends or family).

Customer segmentation, service design and pricing should go hand-in-hand with professional promotion strategies landside and airside (e.g. through co-operation with airlines). In this context, also catchy and consistent corporate identity encompassing design of trains, platforms, signposts and staff uniforms is important for recognition value.

The directness of services provided (without need to transfer) is critical and generally more

important than the pricing, promotion or line-haul speed to the terminal point. Transfers are particularly problematic for passengers with luggage.

In addition, the reliability and punctuality of the train service is a key part of the decision criteria for passengers. Perceived reliability and timeliness is a prerequisite to gain a competitive advantage in comparison to car/taxi. This is valid not only for frequent travellers who always aim to minimise travel times, but for all customers with limited price sensitivity. For example, Arlanda Express in Stockholm guarantees punctuality and offers a free new ticket to passengers when service is more than two minutes late. Similarly, 96-97 percent of Oslo Flytoget trains arrive within three-minutes of their scheduled time and 95.8 percent of Heathrow Express trains arrive at their destination within five minutes of scheduled time.

But there are also factors that matter more to the operator than to the customer:The choice of the airport access mode has more to do with policy decisions made for the rest of the regional transport system than with capacity limitations inherent to any given mode. Existing regulations or concessions and local public policies have to be considered carefully (e.g. concerning the management of taxis at the airport), as these regulations impact the success in gaining modal share as well as limiting courses of action.

Furthermore, it is important to avoid capacity constraints at peak hours as experienced on busy commuter services, such as Stansted Express.

In terms of profitable and efficient operations, two further aspects receive specific attention:

Manageable investments, e.g. usage/• upgrading of existing rail infrastructure as much as possible, construction of new track in combination with other (joint) investments for attractive financing (e.g. terminal extension, building of new multi-functional

6. Opposite of dedicated service is a shared service, e.g. as provided in Munich where low-speed shared service options are well integrated into the local ticket distribution system.




rail and ground transport stations), integrated rail property development, usage of standard rolling stock, risk sharing (e.g. through joint venture with airlines/airports), solid investment case and trying to avoid counter-productive political deflections (e.g. arbitrary price-setting by local political stakeholders).

Optimised operating model, e.g. outsourced • maintenance, usage of synergies with other rail operators, simple stand alone fare and ticketing structure, commercial setup (configuration of stakeholders).

Selected best practices— brief overviewStockholm Arlanda Airport Express as a privately funded and managed venture is often referred to as an example for successful operations. Having started operations between central Stockholm and Arlanda Airport on 25 November 1999, the modal share was quickly hitting the bus service hard and also leading to a decrease in car traffic. To cope with the very successful train service, the express bus service (Flybus) in 2004 was forced to halve its fares and to double the offered frequencies. Key reasons behind the success of Arlanda Express include the long distance of 40km between the airport and the city alongside the high speed (up to 200km/h) and short transit time of 20 minutes. These factors, paired with the high punctuality of the train service, generated an acceptance of comparatively high fares equivalent to $29.

An impressive modal share shift has also been achieved by the Flytoget Airport Express in Oslo, a high-speed service to downtown and with direct services to destinations beyond. Overall, airport related rail mode share reached 39 percent (compared to 18 percent in Stockholm and 24 percent at London Heathrow)7. Transit time advantages to taxi and other modes of transport can be successfully leveraged because of the 48km airport distance from downtown. Flytoget only takes 19 minutes versus an average of 45 minutes journey time for other modes. With six trains per hour, three of which continue beyond

Oslo’s Central Station, passengers do not need to worry about train schedules as waiting time is always short. Besides that, Flytoget provides a convenient travel experience and provides baggage storage close to the passenger due to a unique seating layout. As a result overall customer satisfaction rate has reached 83 percent.

In contrast, the City Airport Train (CAT) in Vienna only seems to have achieved limited success. Opened in December 2003 as premium Airport Express, CAT faces strong competition from the S-Bahn sub-urban rail system also connecting the airport with downtown Vienna. At the same time as CAT started its service, the S-Bahn journey time fell because of upgraded infrastructure and frequencies were standardised at two trains an hour. Today the S-Bahn still has a higher mode share than CAT, and also achieved growth in mode share over time even after CAT was established. In addition, sub-optimal connections to the central rail station and lack of seamless transition to other transport modes creates a less compelling value proposition of CAT8.

Value creation opportunity—the Heathrow ExpressThe Heathrow Express train serves as an excellent example for successful value creation. Introduced in June 1998 as a dedicated high-speed non-stop Airport Express running every 15 minutes, the Heathrow Express (operated by airport operator BAA) uses a two-track tunnel to serve the central terminal area, and a single-track tunnel to Terminal 4—thereby serving the complex layout of Heathrow’s scattered terminals. Besides direct and frequent connections to central London without interim stops, several additional services such as WiFi and news-channel video are provided. Distinction between two different classes ensures a very high comfort and service level for premium passengers and a cheaper alternative for leisure travellers or price-sensitive customers. Catchy and easy to remember promotions (‘Everybody will be famous for 15 minutes’) and corporate identity

7. Meyer, Schmid, Steimann, Windisch: Vergleich internationaler Flughäfen, Projekt 42, Zurich Airport Authority (2005).

8. To increase CAT catchment, plans exist e.g. to also extent the railway towards Bratislava.

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(colouring scheme and design fully aligned across ticketing, interiors, trains and staff) leave an attractive impression.

Nonetheless, the overall success of heavy investments into Airport Express trains is difficult to evaluate: an investment of £500 million into Heathrow Express resulted in relatively little mode shift. The car and taxi share appears fairly constant (at around 63–66 percent) with a slight drop in 2007, whereas the bus share has been in steady decline9: the number of express bus services between the city and airport dropped when Heathrow Express started its operations. In parallel, this decrease has been partly offset by increased use of local buses which have received marketing and seed-funding support from the Heathrow Airport Transport Fund under the ‘Freeflow Heathrow’ programme10.

Overall, a shift of 4 percentage points away from private car to the train can be observed between 1999 and 2007 (although Heathrow Express is the most expensive train connection in the UK at about $30 and therefore focuses on business travellers and non-price sensitive leisure passengers), while the overall traffic volumes have also grown. Nonetheless it has to be mentioned that Heathrow is a major

international hub with a catchment area embracing nearly the whole of the UK, whereas the Heathrow Express only serves Central London—so an overall modal shift is very hard to achieve.

As a rail transport alternative, Heathrow Connect was introduced in spring 2005 as a stopping service using the same rail link but running only every 30 minutes (at significantly lower fares than Express). Besides that, the Heathrow Express also competes with London Underground’s Piccadilly Line which is still an attractive alternative for a wide number of destinations across London.

Overall, the opening of the Heathrow Express has led to an increase in the rail mode share as well as a change within it (mode split in 2007: Heathrow Express: 10 percent, London Underground: 15 percent).

Strengthening the core business—intermodal integration to enlarge airport catchmentWhile we have so far looked at how Airport Express systems are doing within the airport’s given catchment area, an Airport Express itself may enlarge that catchment, opening up new market segments. This is most relevant in densely populated areas such as Europe, parts of Asia or the East and West Coast of the US, where travellers have a choice between several airports.

Decision-making preferences towards Airport Express connections vary between long-distance travellers and metropolitan travellers. Nonetheless, a sufficient intermodal integration and high quality of distribution services to enlarge the airport catchment are key success criteria.

Three models of intermodal integration exist, especially with regard to rail networks:

Direct connections to central stations cover • significant portions of the airport catchment and enlarge it further; in addition, central stations tend to be, by definition, centrally

9. IARO report 14.10.

10. Funded by levy on car parking at Heathrow Airport.




located within cities and a hub of local transport systems (examples: Narita Express Train and Tokyo Station; Arlanda Express and Stockholm Central).

Links with regional/second-tier hubs of train • networks (e.g. Heathrow Express)—may not be as beneficial as central stations, but this might not be possible in all cities and also not necessarily a show-stopper for Airport Express train schemes.

Airport Express systems may also connect • to second-tier stations in the local transport network (e.g. Shanghai), which increases disadvantages compared to car travel.

Besides rail modes, other transport networks matter as well, e.g. road networks, and business/shopping districts in walking distance to attract further customers.

Each service offering should be examined in terms of the catchment area in which the Airport Express service is the logical choice for the traveller. The overall mode share can be too simplistic to reveal the extent to which a given Airport Express strategy is actually working11.

Therefore, it is important to consider that a well-integrated Airport Express train enlarges the airport catchment area: depending on the degree of intermodal integration, catchment area is enlarged by allowing shorter travel chains, covering an overall larger catchment. An example is the high-speed train link between Frankfurt and Cologne stopping at the AirRail station at Frankfurt airport. There is no Airport Express train, but the ICE high-speed train service significantly reduced travel time from the densely populated Rhein/Ruhr region to Frankfurt and resulted in a significant modal shift. The utilisation of existing catchments may also be improved, especially in competitive situations with other airports or at the catchment’s fringes by offering less stressful/more convenient travel to the airport.

Managing stakeholders well and choosing the right operating modelA diverse set of stakeholders determines and influences the choice among possible operational and commercial models:

Airport operators• have their core focus on transport infrastructure and should have a vital interest in enlargement and full utilisation of their catchment. An Airport Express train also opens a new revenue stream. Traditionally airports have no opportunity to benefit from public transport revenues and only limited possibilities to participate in taxi fares.

Airlines• depend on a full utilisation of the available O&D customer base. Even though they are experienced in aircraft operation and maintenance, they might also focus on marketing of Airport Express trains and risk-sharing with other stakeholders.

Local transport providers• may seek to integrate Airport Express systems into their existing networks and open up new customer groups for their core business. Typically, they may also try to impose their tariff structure on the Airport Express train, but this should be avoided if commercial success is sought.

National/regional train operators• may seek to integrate airports into their networks to trigger significant share of inter-regional onward travel. In addition, they can operate and maintain the Airport Express trains.

Municipalities and local authorities• may play multiple roles as stakeholders and also shareholders of the above-mentioned players and may seek to foster regional development through better integration of the local transport infrastructure and to gain further political influence.

Taking into account various stakeholder interests, the right operating model must consider environmental impact and a lengthy political and administrative approval process. It is also important to consider (future) airport expansions and expected passenger growth

11. IARO report 14.10: Not the number of terminating air passengers, but people whose journey start or end within catchment area of railway has to be considered as relevant passenger potential of Airport Express trains.

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when developing the business case. There are several examples:

The new Oslo Airport at Gardermon was • built to serve as an exemplary intermodal transfer facility. It was designed from the outset to serve as part of an integrated access system, being centralised with all gates served by a single landside terminal12. The Norwegian authorities set a policy goal of achieving 50 percent market share capture for combined rail services, providing attractive basic parameters for setting-up the Flytoget. As the Airport Express was opened in the same year as the airport, close proximity is also ensured to ticketing, check-in and baggage claim areas.

For Arlanda Express, the government • motivation was important for building the rail link: the aim was to facilitate future traffic growth at Arlanda and limit total emissions of traffic to and from the airport.

The ‘Free Flow Heathrow’ project related to • airport expansion was linked to design and subsidisation of new local bus routes for airport employees.

In Zurich, modal share of rail was raised to • 42 percent supported by significant capital investments linking airport terminals directly to a new underground rail station where both local, regional and long-distance trains stop.

Taking a clear position early in the planning process will provide the most attractive opportunities for future Airport Express operators to establish and/or improve the competitive market position. The operating model of Airport Express trains has to anticipate and reflect trends and dynamic changes related to the outbound and inbound passengers as well as the local customer segments (e.g. employees, visitors). The growing relevance of low-cost carriers has prompted network carriers to respond with low fare offers and generally led to an increase of air travel. Those new or now more frequent air travellers are typically more price-sensitive as

legacy customers. Therefore both capacity and pricing schemes of Airport Express trains have to be reviewed and eventually be adapted. Further changes may need to be incorporated into operating models going forward.

Commercial success depends on the right structural decisions Establishing a link between the chosen operating model and resulting profitability of an Airport Express train is difficult due to a lack of published data. Doubts exist over whether a significant number of Airport Express trains really operate profitably.

According to media reports the prestigious high-speed Maglev Train at Shanghai airport is loss-making13. The operator had to face a poor capacity utilisation of below 20 percent and a loss of at least €100 million until the end of 2007 which was three years after the start of operations. A single ticket in second class costs 40-50 RMB, which is double the price of the airport shuttle bus connecting downtown with the Pudong International Airport. The Maglev train captures only six percent of the ground access market, whereas airport buses achieve a modal share of 45 percent offering direct services to variety of city destinations. Despite a maximum speed of 430km/h, leading to an express journey time of about eight minutes (versus a taxi or shuttle bus journey time of at least 50 minutes), the Maglev train's success is limited by its terminus at a peripheral metro station rather than a city centre location.

There are a significant number of Airport Express trains around the globe which likewise are loss-making and some of them despite significant public subsidies to keep the service running. So, what are the key drivers for commercial success? Our research confirms that this depends on getting the fundamentals right.

It starts with a robust forecast of passenger numbers which heavily depends on the distance between city centre and the airport (where 25–50km is a good distance), frequency of service (every 15–20 minutes


13. Welt Online (20 January 2009), quoting China Business Journal.




should be targeted), the attractiveness of competing modes (e.g. taxi fares, express bus fares, road congestion) and the total number of O&D passengers of the airport (minimum of 10 million passengers per annum). Further, it is important that the location of the train station at the airport allows for easy and rapid transfer with check-in and baggage claim areas and that there are good connections to other ground transport at the city station.

Finally, it is important that the Airport Express operator can determine its product design, ticket prices and distribution strategy independently from the local transit authority and the national or regional railway company to allow for differentiated pricing which addresses customer segments adequately and maximises commercial success. As with any infrastructure investment, the business case is unlikely to be profitable in the first couple of years given the significant capex and launch investments (e.g. distribution system and introductory fares), but when the fundamentals are right and customer expectations (especially punctuality and service on board) can be consistently met, Airport Express trains can become a commercial success posting sustainable and growing profits in the long run. Some systems are designed, built and operated as concessions and their run time typically ranges from 30 to 50 years.

Customer segmentation and targeted offeringsFour core segments form the customer base of an Airport Express train:

Business Passengers:• prefer fast, reliable connections, high frequency of service, comfortable travel, internet access and mobile network.

Leisure Passengers• : prefer cheap tickets, space for luggage and combined tickets with airlines (ideally at reduced rate).

Employees• : ask for connections early in the morning and late in the evening matching their shift schedule, monthly or annual passes with rebate (e.g. as at Heathrow Express).

Visitors• : require excellent signage, prefer cheap fares and appreciate combined tickets with vouchers for airport shopping or admission to exhibitions.

In addition to the trip purpose categories, the demographic characteristics need to be understood in order to create an appropriate service offering. Categories of residential status are also of major relevance, e.g. for a non-home end of a trip decision, a potential customer takes additional parameters such as car availability and familiarity with local and regional transit systems into consideration.

These four segments plus residential status categories can form the basis for clearly targeted offerings, for example:

Product bundles according to segment • preferences, e.g. first-class offering for business passengers and corporate travellers with opportunities to be reimbursed.

Differentiated pricing scheme to fully • leverage individual willingness to pay—e.g. monthly passes for employees/visitors, interchangeable multi-journey tickets.

Furthermore, marketing and sales activities should be geared to tailor the offering and pricing to specific customer groups, e.g. based on the following measures:

Seek integration with airline tickets, • especially for inbound leisure travellers.

Offer discounted monthly and annual passes • for employees and ticket schemes as part

Key success factors are competitive transit time, high frequency of trains, and good connections both at the city centre and at the airport.

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of compensation packages to airline/airport employees.

Combine Airport Express and entertainment • tickets (e.g. airport tour) for visitors.

Launch targeted marketing campaigns for • leisure travellers.

Targeted investments at the airport, e.g. in shopping malls, entertainment or cinemas, to tap into new customer reservoirs and increase the passenger base at off-peak times can create additional potential. For example, MTR in Hong Kong already uses rights to market stations and hotels along the railway line which they received in return for jointly financing the railway line together with the British and Chinese governments.

ConclusionsProviding a dedicated Airport Express train alone does not automatically lead to establishing a successful alternative transport mode for airports. Instead, it is clear that no one market exists for airport ground transport services: in fact, clearly definable segments/sub-markets exist, each of which requires

specific services based on an analysis of needs. To meet key requirements of target customer segments, service design should ideally be defined before the Airport Express train is developed. It is key to ensure a robust business case prior to the launch of a project. Once infrastructure has been built and trains have been ordered, the fundamentals have been fixed. Thus, investors should ensure that the business case is structurally profitable; otherwise, it is unlikely that an Airport Express train will yield sustainable profits even when public subsidies can be obtained for the launch period.

Key success factors are competitive times, high frequency and reliability of trains, good connections both at the city centre and at the airport. Getting these factors right results in superior value proposition versus other modes. Product/price targeting of key customer segments, effective ticket distribution and attractive customer service help complete the picture. Addressing these issues in the right way can make Airport Express trains a lucrative investment opportunity for airports, rail operators and infrastructure investors.

37

Impact of the Single European Sky on Air Navigation Service ProvidersDieter Schneiderbauer, Daniel Roeska and Rainer Schramm



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Improving the efficient use of airspace over Europe has long been a central pillar of the European Union’s (EU) transport activities. Starting with the Single European Sky Initiative (SES) in 2004 (SES I) the EU laid out a roadmap to improve performance and increase capacity for the increasingly congested airspace over Europe. SES-I did not result in the targeted improvements, and the EU complemented it with a second legislation package, SES-II, which is currently unfolding. SES-II brings major changes for the business model of European Air Navigation Service Providers (ANSPs), especially with regards to a new regulatory approach to Air Traffic Management (ATM) performance and EU-wide target setting. Even if the SES-II legislation does not achieve all objectives, the rapid succession of legislative action is an indication that the EU is determined not to let the overall initiative fail. If ANSPs in Europe fail to adapt sufficiently, the EU is expected to impose further regulation to achieve improved performance of Europe’s ATM network.

European ANSPs therefore cannot continue with the same ‘business as usual’ approach they have followed in the past. Significant improvements in terms of cost, performance, capacity and safety are necessary to create the ATM infrastructure needed for Europe’s economic growth. The ‘old days’ are over and the European Commission has changed the rules of the game—although many of the ANSPs acknowledge this fact, the question remains whether the ANSPs will be able to act effectively to deliver the required changes.

Development of the Single European Sky InitiativeEuropean air traffic has seen an average annual growth of 4–5 percent over the past decades. A major initiative to improve airspace congestion in the 1980s led to

the establishment of the Central Flow Management Unit (CFMU) in Brussels, which provided alleviation for a decade. However, by the end of the 1990s demand had once again outgrown airspace capacity, leading to severe flight delays, cost inefficiencies and constraints to growth for the whole air transport sector. The EU responded to this crisis by creating the SES Initiative with the aim of reforming European Air Traffic Management.

In 2004 the first package of legislation (SES-I) came into force, which established ATM competencies at the EU level and set a new regulatory framework in Europe. Furthermore, SES-I aimed at improved interoperability and capacity improvements through the creation of Functional Airspace Blocks (FABs). The concept of FABs was limited to the upper airspace and the actual creation of FABs was left to the Member States. SES-I was supported by several implementing rules, including a 2006 charging regulation which aimed at providing greater transparency by defining determination, imposition and enforcement of ANS charges to airspace users.

However, SES-I fell short of its goals. In the first years after its adoption, SES-I delivered slower progress than planned and the European Commissioner for Transport appointed a High-Level Group to review the status and to propose recommendations for a new aviation regulatory framework. In 2007 the report of the High-Level Group revealed challenges to the progress of SES, in particular, in the areas of performance and governance and recommended measures to accelerate the SES initiative.

New heading enforced by SES-IIAs a result of the recommendations of the High-Level Group, the European Commission (EC) prepared a second legislative package, SES-II, which was adopted by the Council in 2009. SES-II is substantially broader in scope and builds on the objectives of SES-I such as safety and capacity. In particular,

By the end of the 1990s demand had once again outgrown airspace capacity.




SES-II introduces a new performance and charging scheme, extended responsibilities for functional airspace blocks, and extended mandates for Single European Sky ATM Research (SESAR) and EASA.

At a 2010 High-Level Conference the European Commission, Member States and other European aviation stakeholders agreed in the Madrid Declaration on the importance of the SES and its ambitious goals to be achieved by the year 2020 (versus the 2004 baseline):

50 percent cost reduction for the ANS cost • of flying.

10 percent decrease in environmental impact • of flight.

3 x capacity increase.•

Further improving safety of European airspace.•

To achieve these ambitious goals a regulatory roadmap of the SES-II was structured along five key pillars: performance, safety, technical innovation, airports and human factor. Along this roadmap, the EC is pursuing concrete

legislative actions which has led in 2010 to the adoption of two new regulations:

The Performance Regulation, introducing a • binding performance scheme.

A revised version of the Charging Regulation, • introducing economic regulation of ANSPs.

Both new regulations have a significant impact on European ANSPs and their business models. 2012 is the first key milestone for ANSPs when those new regulations take effect with the first reference period (2012–2014) and full compliance must be established on the national level.

Further legislative actions are ongoing, including the completion of the SES-I package (implementation of FABs by end 2012) and the establishment of EU ATM network management functions as of January 2012.

To drive forward the area of technical innovation, the SES is advancing the SES ATM Research (SESAR) programme. The deployment of SESAR will be governed by further EU Implementing Rules. Overall

Source: PRC, Analysis of data submitted by States for calculation of route charges; SESAR output D2 (performance targets)

2004 2005 2006 2007 2008 2009 2010P 2011P 2012P 2013P 2014P 2015P 2016P 2017P 2018P 2019P 2020P

0

10

20

30

40

50

60

70

80

67.465.0

62.9 61.0 60.665.5 63.8 62.5 60.7 59.0 57.3 55.9

26.1

En-

rout

e co

st p

er S

U (¤

)

Average en-route ANS cost per Service Unit

PC adopted target

2020 target en-route ANS cost per Service Unit

SESAR target

Exhibit 1: Trend in En Route Unit Costs Compared to SESAR Targets

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consistency and ANSPs’ progress in SESAR implementation will be also followed through mechanisms of the performance and charging scheme which make performance and investment planning more transparent.

In the key performance area of cost efficiency, a recent analysis by the PRC, based on actual figures up to 2009 and cost projections submitted by States, shows significant lack of progress towards the political target for 2020.

The challenges for ANSPsThe new direction which European ATM regulation has taken with SES-II will have substantial impact on ANSPs and the way they deliver their services.

For ANSPs we see three main challenges:

1. Future cost and performance targets.

2. Accelerated implementation of functional airspace blocks.

3. SESAR ATM concept and new technology.

1. Future cost and performance targetsThe introduction of the new performance and charging regulations means that the full cost recovery model is now undergoing certain changes. This affects not only the determination of the user charges, but it also acts to introduce more transparency in performance and financial planning. ANSPs will in the future have to share their planning data with the Performance Review Body (PRB) under a common EU-wide performance framework.

The most relevant change for the ANSP business model is the shift from full cost recovery to the determined-cost model. In that model, parts of the financial risk induced by traffic volume fluctuations are shared between airspace users and ANSPs. However, in the currently proposed legislation this risk sharing is limited. Major changes in unit rates due to external factors or due to large traffic fluctuations continue to be borne by the users.

A new Performance Scheme, based on pan-European targets and ANSP benchmarks, will set targets for improved performance in several domains including: cost, capacity, safety and environmental impact. The detailed definition of those targets will be carried out by the National Supervisory Authorities (NSAs), which significantly expand their role by becoming the ANSPs’ economic regulator. Starting in 2012 with an initial three-year reference period, the performance targets will be set from 2015 for a cycle of five-year reference periods. For the first reference period (RP1) the EC must adopt an EU-wide performance target by the end of 2010. The EUROCONTROL Performance Review Commission has been designated by the EC as SES Performance Review Body to develop EU-wide target proposals.

The process for performance planning has a tight time line and Member States have been given a deadline of June 2011 to deliver their national performance plans to the EC. This will have the following key consequences for ANSPs:

Expansion and adaptation of planning • processes: The new regulations require more detailed and robust planning. Future plans must be aligned with the performance reference period and require a much more binding authority throughout the entire organisation.

Close co-operation with the NSA• : ANSPs must work closely with their national regulators to coordinate the own business plans and performance targets with EU targets. A pro-active approach towards the

The introduction of the SES performance scheme in 2012 will result in significant performance and cost pressures for ANSPs.




NSA is also important because airspace users will gain increasing influence in the review and discussion of national targets.

Preparation for capacity enhancement • measures: ANSPs must prepare to provide significant additional capacity beyond the current EUROCONTROL target of one minute summer en-route delay. In its initial consultation the PRC has suggested that in RP1 an EU-wide capacity target of 0.7–0.35 minute delay per flight (all delay causes included) is achievable by 2014. An additional target for airport ANS capacity will be introduced in the second reference period (RP2) from 2015 onwards.

Preparation of cost-reduction measures• : The SES objective to reduce ANS cost per flight by 50 percent will drive an EU-wide trend towards lower unit rates and ANSPs can expect national targets aiming at further cost reductions. A first PRC proposal for EU-wide target is aiming for an annual reduction of the determined costs per service unit between 4.5 percent and 5 percent per annum in real terms over the period 2009–2014. In RP2 the KPIs will be expanded by a determined unit rate for terminal air navigation services.

Preparation for environmental target setting• : For RP1 the performance scheme defines already EU-wide targets for average horizontal en-route flight efficiency. States and their ANSPs must implement complex changes in airspace and route design which requires substantial international coordination. RP2 will see the introduction of an additional KPI addressing environmental performance related to specific airport ANS.

Preparation for additional safety targets• : RP1 does not yet include EU-wide safety targets. However, safety will be monitored in this period more closely through specific safety performance indicators (SPIs) which will demand additional reporting from ANSPs. Eventually safety targets will be set in RP2 and new safety KPIs must be developed by the end of 2012. ANSPs must anticipate these developments to align their operations and safety management systems for the implementation of new Implementing Rules.

2. Accelerated implementation of functional airspace blocksWhile the initial FAB concept of SES-I is mainly aimed at improved network capacity, SES-II included FABs as a means to achieve

Source: PRC

2009 (actual)

2010(States forecast)

2011(States forecast)

2012(RP1)

2013(RP1)

2014(RP1)

45

47

49

51

55

53

57

59

61

63

65 ¤63.78

¤51

¤ pe

r Ser

vice

Uni

t

¤49-4.5%

-5.0%

Reference Period 1

Exhibit 2: Example for EU-wide Performance Target Setting: profile and level of targeted en route determined unit rate until 2014

Booz & Company 42



de-fragmentation and to realise economies of scale, cost reduction and performance improvements. A coordinator was designated to facilitate at high political level the negotiations between the States engaged in the creation of FABs. The FAB coordinator will further increase the transparency in Member States’ progress of FAB implementation.

SES-II established a deadline for the establishment of FABs for December 4th 2012. The deadline increases pressure on Member States with the following implications for ANSPs:

Concrete targets for improved performance• : Significant synergies and economies of scale can only be realised by a pro-active establishment of FABs as a ‘performance partnership’.

Determined focus in FAB initiatives• : An effective FAB initiative requires the identification of selective strengths and core competences amongst partners, including the exploitation of opportunities for consolidation.

3. SESAR ATM concept and new technologySESAR is an ATM infrastructure modernisation programme for Europe and as such the technological component of SES. SESAR is aiming to improve system capacity and performance at an overall reduced cost for the airspace users. The implementation phase of SESAR, however, requires a substantial upfront investment. The initial estimated total cost of the first two SESAR Implementation Packages (up to 2020) for European stakeholders is €30 billion. The large majority

UK-IR

Blue MED

Danube

Baltic

FAB CE

NEFAB

NUAC

FAB EC

SW Portugal-Spain

Source: European Commission, PRC

Exhibit 3: Proposed FABs in SES Airspace




of this investment will have to be borne by the airspace users, who must equip their aircraft fleets with new technology. ANSPs will not only face investments in technology upgrades but must also introduce significant operational changes to offer new SESAR services. The EU will govern the SESAR deployment phase with a set of comprehensive Implementing Rules for both stakeholders. This has the following implications for ANSPs:

Compliance Management• : The implementation of SESAR will be governed by binding regulatory measures as part of the broader SES legislation. On the national level the introduction of SESAR and the related service levels services must be regarded within the overall technical evolution of individual ANSPs’ infrastructure. For this reason, it appears sensible for ANSPs to appoint a dedicated SESAR compliance manager.

Change Management• : SESAR will introduce a paradigm shift in ANS operations (4-D trajectory management) which implies significant changes to operating and working procedures of air traffic controllers. It is essential that ANSPs prepare for this change and develop appropriate simulation and training concepts early on to assure a smooth transition.

SESAR Implementation within an FAB• : The establishment of an FAB offers ANSPs opportunities for new cooperations in the implementation of systems (e.g. joint specifications and procurement) as well as joint efforts in transition concepts and compliance management.

The road aheadThe introduction of the SES performance scheme in 2012 will result in significant performance and cost pressures for ANSPs. Despite the fact that national governments with their NSAs are ‘sitting between’ the EU and the ANSPs, it can be expected that non-performers will experience political pressure, in the event that the EC rejects their

targets or if performance targets are not met. This situation may lead to the development of two likely scenarios:

Scenario 1: The envisioned ‘bottom up’ SES implementation on the national levels succeeds according to plan. Cost reductions and performance improvements can be achieved through the restructuring of ANSPs, the successful establishment and operation of FABs and the implementation of SESAR concepts and technologies.

Scenario 2: No substantial cost and performance improvements are achieved, under the sovereignty of Member States. The situation is escalated to the multi-national political levels within the EU. Future ATM reforms are increasingly decided at the EU level and imposed upon ANSPs top-down and the national influence is reduced in favour of a pan-European approach for ANS provision.

Both scenarios require that ANSPs establish competitive cost structures and prepare short and long-term cost reduction measures—in Scenario 1, to fulfill the SES and national performance targets, and in Scenario 2, to be prepared as a strong and prevailing player for a possible consolidation of control centres.

Booz & Company 44



ANSP decision makers must now take the necessary actions and address the challenges with structural reforms. Such reforms have long lead times of three to five years before they deliver the envisaged impact on performance and cost structure. Furthermore, opportunities for cooperation with partners should be explored as long as

ANSPs have room to manoeuvre. FABs are an essential element of the European political agenda. If the FABs are exploited by partners with a truly innovative operating concept and opportunities from SESAR, the synergies may prove invaluable to achieve the SES performance targets.

45

Airline Bankruptcy: Impacts and RemediesGwyneth MacLeod and Elizabeth Hodson



Booz & Company 46



IntroductionAirline bankruptcy, with images of irate passengers queuing for days in the airport and red-faced holiday-makers stranded in foreign climes, will always make for a good news story. Several high-profile cases over the last couple of years have caught the headlines, but the question for policy-makers and for the industry is whether this is indeed a substantial problem, and, if it is, what steps, if any, should be taken to reduce the risk or mitigate against the consequences of airline bankruptcy.

Running airlines, with a few notable exceptions, is rarely a profitable business. Multiple studies have attested to the idea that airlines are the least profitable player in the aviation chain1, with airports, leasing companies and manufacturing firms all enjoying considerably higher returns on sales. It is therefore unsurprising that, as liberalisation has increased the level of competition in the market, airline bankruptcies have become more frequent. This paper will survey the situation, focusing on the EU, and examine changes affecting the industry that have exacerbated the situation for airlines and consumers alike before going on to consider possible regulatory solutions and their potential impact on the industry.

Is airline bankruptcy a real problem?There are two facets to this question which deserve consideration. The first is the question of whether airline bankruptcy itself is a problem, and the second is whether the scale of problems resulting from bankruptcies is sufficiently large to warrant further investigation and, potentially, intervention by policy makers and regulators.

It is uncontentious to state that demand for air travel is both highly cyclical and subject to shocks. This inevitably puts pressure on

the aviation industry. Deregulation of the market, encompassing the opening of the air transport market to new entrants, and the subsequent increased competition for all firms, is a clear driver for the increased rate of airline bankruptcies observed over the last decade. This normalisation of air transport markets has brought multiple benefits: in many markets, airlines are now free to fly the routes and the frequencies they choose, set and adjust ticket prices without reference to an external body, utilise the aircraft they deem commercially appropriate, and are able to enter new markets which were previously closed to them. This has enabled a massive increase in capacity in the market. However, these freedoms come at a cost, and airlines, especially the former flag carriers, are now left less protected from market forces—buffeted in turn by exogenous shocks to the demand as much as by the threat of new carriers with new operating models aggressively competing in what were previously closed markets. The flow diagram (Exhibit 2) illustrates how liberalisation of the air transport market leads to economic benefits. One mechanism by which this occurs is the replacing of less efficient firms by more efficient firms, as carriers with a cost advantage are enabled to grow their market share and potentially cause other airlines to exit the market. In reality, it is more common for new entrants—small start-up carriers—to exit the market than for established carriers to do so, but even in this case, such airlines can still serve to increase the competitiveness of the market. Thus, bankruptcies can be seen as a natural, if wholly not agreeable, result of increased competition, a necessary evil to be tolerated, and mitigated, in order that the positive effects of competition may be reaped.

From the point of view of the consumer, that is, passengers and potential passengers, deregulation of the air transport market has empowered them, giving them greater choice, in terms of carriers and routes, as well as delivering substantial cost savings—for example, it was estimated that the consumer surplus due to the EU-US Open Aviation Agreement alone would amount to approximately €15 billion2. In the extreme

1. See, for example, Spinetta 2000 or the AEA-TEATS study.

Over the last decade there have been at least 85 airline bankruptcies in the EU alone.




case of airline bankruptcy and subsequent cessation of flights, thousands of people can find themselves stranded, far from home, and sometimes without the means at their disposal to return home themselves. Furthermore, such a situation also affects the passengers who have not yet departed on their air trip but find that they have suddenly lost both their flight abroad and potentially, in addition, other money they have spent on the holiday, such as pre-booked hotel rooms and car hire. Both these contingents may expect protection and redress under such circumstances, but whether such redress is given depends on laws and regulations which are not, in general, clear to the passengers and may depend, to a large extent, on goodwill of industry and governments.

It is worth saying at the outset that not every airline bankruptcy leads to a suspension of services; in many instances, the airline may be taken over, and minimal disruption is caused, or there may be sufficient warning allowing the airline to fulfil its obligations. From a consumer perspective, problems only arise when a flight is not operated as planned.

So, what is the scale of the issue? Over the last decade there have been at least 85 airline bankruptcies in the EU alone—this frequency is substantially higher than in the previous decade. The actual effect on the market is more difficult to quantify, and it is true to say that the majority of the bankruptcies were small, regional carriers and thus the number of passengers affected were proportionately low. However, there have been notable cases where literally thousands of passengers are left stranded abroad and thousands more lost their pre-booked flights without compensation due to an unanticipated bankruptcy of an airline, and this cannot be easily dismissed as insignificant.

How has the industry changed?The deregulation of air transport across the European Union has led to profound changes in the travel market. One major change, which was unanticipated by most major players and industry observers during the 1990s when deregulation occurred, was the rise of low-

cost carriers (LCCs). In the mid-1990s they had a market share of less than 5 percent; today, LCCs account for around a quarter of the capacity in the EU market as measured in available seat kilometres, and their market share is greater still in terms of number of flights.

The penetration of the holiday market by LCCs has resulted in declining demand for traditional package travel. While some areas in Europe have been more affected by this than others (the UK has been particularly hard hit compared with Northern and Central Europe), EU-wide, many charter airlines have either failed, demised or changed their business model, for example, by becoming low-cost carriers themselves (e.g. Air Berlin). Focus for the remaining charter carriers has shifted from short- to long-haul markets, in which the LCCs are not currently represented.

The purchasing methods of consumers have also shifted significantly. Changes in distribution channels enabled by an increase in internet penetration have made direct online booking available to new consumers, bypassing the middle man and travel agents. Air tickets, like music and books, are highly amenable to being sold over the internet since they do not require actual physical inspection. LCCs have pioneered online sales which offer customers the ability to ‘self-package’ holidays, creating tailor-made trips, including accommodation and car hire, over the internet. This sales method has since become common practice for all airline business models and has the added advantage of allowing airlines to price dynamically in order to optimise sales and revenue.

When it goes wrong: some passengers are more equal than othersThese industry changes have unintended consequences on the amount of protection consumers are afforded in the case of airline

2. The Economic Impact of an Open Aviation Area between the EU and the US, European Commission, prepared by Booz Allen Hamilton in association with the Campbell Hill Aviation Group, Mr Erwin von den Steinen, Dr Ingomar Jœrss and Dr Pablo Mendes de Leon.

LCCs account for around a quarter of the capacity in the EU market.

Booz & Company 48



bankruptcy. A passenger booking an all-inclusive package holiday through a travel agent, as was formerly the norm for most holiday makers, is covered by the Package Travel Directive (Council Directive 90/314/EEC). This is the most far-reaching passenger protection currently offered in the EU. In case of insolvency of tour operators and travel agents, liability is placed on operators to perform the package booked by the customer. EU Member States have all implemented this on the national level: the level of protection is of a similar standard, although different compensation schemes are currently in existence. However, airline tickets when sold independently of an agreed package are not within the scope of this Directive. Thus, in the case of failure of a scheduled carrier, passengers are not generally protected; they are unlikely to be able to purchase alternative products at similar cost and may find themselves stranded.

Across the entire air transport sector, there is a trend toward consumers choosing to book their travel independently of an agent or pre-packaged tour. In some instances, self-packaging options may lead customers to believe they have the same protection they would enjoy under the Package Travel Directive (PTD). In others, customers may believe, from past awareness of ‘package’ protection schemes, that they are protected, when in fact they are not. For example, in the case of the bankruptcy of XL Airways in September 2008, over 80,000 passengers were left stranded but the majority were booked on package holidays

and were therefore entitled to free repatriation; however, around 8,000 to 10,000 passengers were holders of flight-only tickets and thus not covered when the carrier ceased operations.

From the perspective of the travel industry, some players complain about a lack of level playing field, since tour operators and travel agents operating package tours must provide a higher level of consumer protection which is not always valued by the customers and which places a greater financial burden on these companies compared with the firms they are competing against—flights and hotels bought directly over the internet outside of a package deal.

The protection mechanisms available to non-package passengers are credit card refunds, a Scheduled Airline Failure Insurance (SAFI) which may be purchased by individuals either as a stand alone insurance or as part of a travel insurance policy, or by voluntary arrangements of other airlines offering help to travellers in need. In most instances, these provide only partial protection for any passengers who have ‘self packaged’ a holiday.

Thus, more people are travelling without protection against airline failure. There are now a larger number of holiday-makers who more frequently book in such a way that they are not protected, and who, in general, are the most financially exposed. It is this section of the market which has been the most protected in the past which now is left increasingly vulnerable.

Exhibit 1: European Airline Bankruptcies

Source: AIRREG (2000–2005), ATI, Booz & Company Analysis (2005–2010)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Total

3

1 January 2000 – 31 December 2009 85

11

7

10

14

13

8

3 124




More people are travelling without protection against airline failure.

What are the solutions?What are the solutions available to governments and, in particular, to the European Commission, in order to alleviate the problems caused by airline bankruptcies?

Firstly, raising standards of financial fitness could be considered in order to reduce the likelihood of the bankruptcy occurring in the first place. An alternative approach would accept that bankruptcies are a ‘natural’ result of the rigours of the competitive marketplace, and to put the onus on the consumer to protect themselves, both by better informing the consumer and by offering insurance. Another approach would be to put safeguards in place to protect consumers when bankruptcy occurs; this could be done, for example, by making airline bankruptcy insurance compulsory, or by setting up a general relief fund to be used when the situation demands it. Finally, when an airline gets into financial difficulties, it should be recognised that, for most parties affected, a restructuring programme is far more attractive than liquidation, and putting policies in laws which encourage this course of action, as well as protecting the rights of the ticket holders in such cases, is also an option worth consideration. These approaches will each be reviewed in turn.

Raising standards of financial fitnessCan the problem of bankruptcies be tackled directly, by raising standards and pro-active monitoring of financial fitness, and intensifying technical oversight of airlines on the edge? This method, if applied in an appropriate manner, could decrease the frequency of bankruptcies. Present European Community regulations (Regulation 1008/2008) establish the principle that financial fitness is a condition of receiving an Air Operator Certificate (AOC) to operate and hold out flying services to the travelling public. The regulation also sets forth minimum standards of enterprise liquidity. One course of action might be to make such standards or at least their enforcement more rigorous.

While the goal of the measure is clear, oversight always demands judgement as well as expertise, and financial regulation is far from

simple. Comparing treatments of individual cases might also produce variances across the Member States and indicate the need for monitoring at Community level as well. For example, in the case of failing low-cost carrier, Sky Europe, authorities did not take action at a time where a bankruptcy might have been prevented. Application and enforcement of this measure will add conditions to market entry and work to constrain it. It must be noted that such stricter regulations would also need to apply to flag carriers. In order for this to work, a strictly independent authority would need to be established to avoid governments treating new entrants and flag carriers differently.

Greater stability of performance will benefit consumers; however, costs of doing business will rise at the margin and for individual operators this could be significant, and it is likely that some fares, particularly those currently at a low level, would rise.

Caveat emptor—let the buyer bewareIn a competitive marketplace, a certain level of churn with firms entering and exiting the market may be expected. Given this, perhaps responsibility for protection in case of bankruptcy should be down to the consumer. One complicating factor is that some passengers are fully protected in the event of bankruptcy, while other passengers, who may even be travelling on the same flights, may not enjoy such protection. So, the first step would seem to be to ensure the consumers are better informed, and the second step would be to make sure that protection against bankruptcy is available to consumers if they wish to pay for it.

Firstly, then, one option is to strengthen information requirements, to help ensure passengers are better informed about the risks, the insurance options available, the terms of credit card protection, and alerting

Booz & Company 50



vacation planners to the protections they could have under the PTD if they book through an accountable organiser. This would not prevent bankruptcies occurring, but could possibly reduce the number of people left unprotected in such an event. It would also mitigate, to some extent, against the lack of level playing field complained of by charter carriers and tour operators—if awareness of the superior protection given to package deals were more widespread and appreciated by consumers, then the financial obligations upon package tour operators would be more justified.

While this would seem to be a good solution as a first step, the dynamic nature of the market presents a significant challenge in ensuring that standards, once set, are fully implemented across the EU. Current problems relate directly to marketing trends and the increase of sales via the internet. As a rapidly evolving medium, the internet is very difficult to regulate in an efficient, fair and timely manner. Moreover, while regulation can ensure that the information is displayed, it may be more difficult to persuade time-conscious consumers to read it, particularly if it is not presented in an enticing fashion. Ongoing monitoring is required and also presents a major challenge. Thus, a strengthening of information standards could provide some benefits, but is difficult to regulate and only addresses one side of the problem in a limited fashion.

In order to ensure consumers are able to protect themselves, the creation of a requirement for some form of consumer self-insurance to be available in case of scheduled airline failure should be considered. This would allow the consumer to make their own decision about whether they wish to purchase insurance and, allied with a regulatory focus on information requirements, could help ensure that they make an informed decision based on their own consideration of the risks involved.

This measure creates a procedure that could go far to reduce consumer risks while at the same time placing the costs of coverage

on the consumer who would benefit from it. Acceptance by stakeholders, however, appears to be mixed. Airlines are resistant to new regulation that applies mandates not only to their marketing and sales procedures but which also sets forth new conditions for their financial relationships. Tour operators, for their part would prefer a stronger regulation to govern insurance of non-packaged travel services. Consumer groups may also criticise this proposal for not going far enough in the right direction.

Protect the passengersSince ceding responsibility entirely to the consumers could be seen as too harsh, it is worth considering measures which protect all passengers. This could be achieved by insurance of the airlines, or through the creation of a general reserve fund to be used in the case of airline bankruptcy.

Considering first airline self-insurance, that is, mandating insurance of all airlines for all classes of travellers against bankruptcy risk. This could be achieved by obliging airlines to extend the same scope of coverage currently required under the Package Travel Directive to all purchasers of scheduled airline transport. At first glance, making the highest level of protection available to all would appear to be a good option. However, there are a number of difficulties with pursuing this course.

Firstly, there is strong stakeholder opposition, particularly from airlines, for adding such a general requirement, with the exception of tour operators and travel agents who already face this obligation and feel discriminated against as a result. All airlines would have to pay a new set of costs. While the insurance premiums could be negligible or low, they will also vary in accordance with risk perception. Since airlines are already running on tight margins this could hit them hard.

While this requirement would be relatively simple to formulate, legal and policy issues would be significant. Airline insurance requirements in relation to airline liability for




damage caused to passengers and shippers of cargo during air carriage have been extensively addressed at the international and multilateral level (e.g. the Montreal Convention of 1999). A unilateral decision to impose new forms of insurance requirements on all carriers operating to the EU could result in international protests. A decision to impose the requirement only on Community carriers could lead to distortion of competition.

Given these issues, there appears to be a strong likelihood that the economic costs and the political complications would outweigh the potential benefits.

An alternative to insurance would be the creation of general reserve funds on the basis, for example, of a flat fee per ticket (as opposed to risk-based premiums on insurance), which could then be called upon when bankruptcy occurs. Such funds could be established at the national level with oversight by aeronautical authorities who issue AOCs. On the other hand, community airlines increasingly operate in multiple markets and this would raise issues as to whether fees should not go to funds maintained in the country of travel origin? In any event, given the level of air travel in the EU, even a fee of ¤1 (or £1) per ticket would build up considerable funds rapidly—assuming such a tax does not significantly dampen demand, it could raise in the region of ¤50 million every month3.

While simple and clear in basic outline and seemingly equitable in structure, a general contingency fund will raise complex questions such as:

Whether a single flat fee is really fair and • whether claims for compensation are then limited to set amounts, or whether there should not be some variability in premiums (e.g. percentage relationship to the prices paid) or based on the amount of coverage needed or desired in the individual case?

Whether the scope of coverage of such a • general fund should be limited to cases

of service stoppage for financial reasons or whether it would also deal with flight cancellation due to emergency situations?

What to do with funds if few or no • bankruptcies occur and fund balances swell? Should ongoing contributions then be suspended or past contributions paid back, and if so to whom, the airlines or the travellers?

Should the funds simply be administered • by financial institutions or should they acquire an own institutional form and perhaps competences to go with that?

Would the goal be to displace the role of • private insurers entirely?

The core idea may be simple, but this measure will create new administrative machinery whose remit over time is not clear. The test of such a fund is not just how it collects money but how it manages and disburses it. Will it need to establish a permanent staff for claims administration that can act rapidly in emergencies that are only very occasional events for most Member States? Indeed, the risk of producing unintended consequences, such as either piling up money, creating high and redundant administrative overheads or otherwise not being cost-effective in their operational use, are significant.

Most fundamentally, policy makers need to ask how general the problem has become and whether the creation of large general funds to relieve problem cases are essential and whether they will support and compensate or interfere with the natural disciplines of the market.

Amend bankruptcy lawsA final policy option would be to consider standards under the bankruptcy laws such as steps to encourage the use of reorganisation procedures under which companies with prospects for restructuring can maintain services, as well as to ensure fair and efficient treatment of ticket holders as a creditor class in cases of liquidation.

3. Estimate based on EUROSTAT figures for air passenger departures (2009).

Booz & Company 52



Considering the fair and efficient treatment of ticket holders: concretely, ticket holders are creditors if they have not received the transport they paid for or refund of the monies paid. Should they recover their money by a reversal of credit card charges when the airline fails to deliver service, then they effectively subrogate their creditor claim to the credit card company. As a general matter, credit card companies and insurance companies are in a far better position than individual claimants of smaller sums to bundle claims and to seek partial recovery in the bankruptcy proceeding from the available asset mass based on the legal standing of such claims under the applicable national law.

In terms of encouraging restructuring, it is worth noting that bankruptcy proceedings can essentially follow two courses of action: liquidation in which remaining assets are simply divided up among the creditors; and reorganisation in which efforts are made to save at least parts of the company.

From an operational standpoint, and in the interests of travellers as well as employees and investors, restructuring of the airline is far more attractive than liquidation. it may be useful to explore the scope of policy to encourage greater

pursuit of such strategies. These are obviously most important in the case of larger airline failures where meaningful service demand has existed and perhaps can be revitalised (e.g. Swissair bankruptcy and launch of Swiss as an successor) than with very recent and small start-ups which have less market to work with.

Conclusion: there is no silver bulletAs the discussion has shown, of the options considered here, there appears to be no single solution which can fully address the problem in an equitable manner without giving rise to significant adverse consequences. Thus, it is fair to say that there is no silver bullet, no ‘one-size-fits-all’ solution to the problem of airline bankruptcies. Instead, a combination of measures should be applied within the framework of general responsibility of governments, industry and the courts to create and provide rapid ad hoc responses if and when emergency conditions arise, as well as ensuring fairness in the treatment of all damaged parties. In particular, seeking to restructure the airline where possible, rather than allowing it to enter liquidation, has clear positive impacts not only for the airlines, investors and the passengers, but also for the industry as a whole.

Exhibit 2: Implications of Regulatory Change

Removal ofbilateral

restrictions

Amendment ofOwnershipand Control

rules

Outputincreased

Increasedcompetition

Price (fares)decreased

Demandstimulated

Closercooperation:

deeper alliances;code shares

Mergers andAcquisitions

occur

Pricingsynergies,

economies ofscale

Efficient firmsreplace

inefficient firms

Consumersurplus

Employmentstimulated

Economy(GDP)

stimulated

Costsreduced

53

Pursuing Sustainable AviationJürgen Ringbeck, Volkmar Koch, Daniel Roeska and Rainer Schramm



Booz & Company 54



Why the aviation industry should care about climate changeThroughout the industrial age, economic growth has been generating ever greater atmospheric concentrations of CO2 and other greenhouse gases (GHG). There is a large scientific consensus that anthropogenic GHG emissions are a primary cause of the global warming observed over the last century. Unless we stabilise or reduce the emission of GHG, the earth is likely to experience dramatic climate change and global warming which will have broad impacts on the global ecosystem.

The aviation sector currently produces approximately 2 percent of global anthropogenic CO2 emissions. Including non-CO2 GHG emissions, aviation contributes about 3.5 percent (2005 data) to the anthropogenic radiative forcings responsible for overall climate change1. The impact of contrails and aviation induced cirrus cloudiness is not included in those figures. This is still under scientific investigation, and it may even further increase the footprint of aviation in global climate change.

Compared to other transport sectors, aviation has already compiled an impressive history of technological advances and improvements in fuel efficiency. New engine technologies, aircraft designs and light-weight materials significantly contribute to the high efficiency of modern aircraft. Over the past 40 years, average fuel consumption of new aircraft has been decreased by 70 percent2.

Jet and turbo-prop aircraft depend on kerosene as primary energy source which makes fuel the main driver of aviation emissions. But given the strategic importance of fuel to the aviation sector, and the continued rise in fuel cost, the sector needs

little external incentive to continue to improve fuel efficiency. Fuel is one of the main costs for airlines, accounting for up to 30 percent of total operating cost. Although fuel prices have declined since the recent peak in the summer of 2008, it seems likely that they will eventually resume their rise. The medium-term International Energy Agency (IEA) forecast for 2016 estimates fuel prices surpassing $150/barrel under its high price scenario3. At this price, fuel would account for more than 45 percent of airlines’ total operating costs, further increasing the need for more efficient fuel consumption. In fact, meaningful efficiency initiatives are already underway, such as the ongoing development of new airframes and engines, infrastructure improvements, and modernisation of air traffic management (e.g. NextGen in the USA and SESAR in Europe). In short, it has always been and will continue to be in the airlines’ interest to operate as fuel efficiently, and consequently, as emissions efficiently, as possible.

Yet, the aviation sector cannot rely on its past achievements. Despite the great gains made in sustainable aircraft and engine development, the positive effects of these achievements are likely to be outweighed by the increasing growth of global air traffic. This rise in air traffic will be driven by macro-economic factors such as the increase of global population and the economic growth, particularly in emerging markets. Furthermore, traffic growth looks set to outstrip the pace at which capacity is being developed, especially in highly density markets and at existing and emerging global mega hubs. This will give rise to growing airport and airspace congestion, and translate into less efficient air travel.

In a recent report the World Economic Forum (WEF) and Booz & Company estimated that demand for air travel will grow by 5 percent per annum, which translates into a three-to-fourfold increase by 2035. As a result, without extraordinary additional measures, the global airline sector will significantly increase its carbon footprint from

The positive effects of past achievements will likely be far outweighed by the increasing growth of global air traffic.

1. Lee, D.S., et al., Aviation and global climate change in the 21st century, Atmospheric Environment (2009).

2. IPCC, Aviation and the Global Atmosphere: A Special Report of the Intergovernmental Panel on Climate Change (1999), Cambridge University Press.

3. US Energy Information Administration, Annual Energy Outlook 2010 (Update May 2010).




0.6 GT CO2 in 2005 to approximately 1.5 GT CO2 in 20354. This represents an emissions growth rate of 2.8 percent per annum after already accounting for foreseeable emission reduction measures (see Exhibit 1). Even if the aviation sector would only commit to ‘carbon neutral growth’, i.e. growing production without increasing emissions, the sector would have to radically rethink its strategies and policies to accommodate its growth within the next years.

Aviation stakeholders are acting to address the growth of emissions and to respond to the ongoing public discussion and increased public focus on the impact of aviation on climate change. The International Air Transport Association (IATA) defined ambitious targets for the sector in advance of the 15th United Nations Climate Change Conference (COP15) in Copenhagen in late 2009. IATA proposed:

+1.5 percent per annum average efficiency • improvement until 2020.

Carbon neutral growth from 2020 onwards.•

An absolute reduction of 50 percent of • emissions compared to 2005 levels by 2050.

How to deal with the COP15 failureUnfortunately, COP15 fell short of its goals. States managed to achieve a consensus on the existence of global warming, but the conference did not produce a binding agreement or set deadlines for legally-binding commitments. Nor did it produce a proposal for a global approach to emissions, emissions targets, or any other actions for the aviation sector.

The lack of agreement on COP15 alleviated the immediate regulatory pressure on the aviation industry to address climate change. Nevertheless, the aviation sector’s dependence on kerosene, the inevitable increase of emissions with traffic growth, and the growing public concern requires the industry to take action. The aviation sector must learn to think ‘outside the box’.

The lack of a binding global political and legal framework for emissions reduction constitutes a significant opportunity for

Exhibit 1: Aviation Emissions Forecast

The aviation sector must learn to think ‘outside the box’.

Emissions volume2005

Growth despite currentlyplanned emissionsreduction measures

Net growth in emissions‘business as usual’ 2035

~1.5

~0.6

~0.8

2.8% p.a.Volume Growth

WEF and Booz & Company Emissions Forecast (Gigatonnes CO2 2005-2035)

4. Chiesa T, Ringbeck J: Towards a Low Carbon Travel & Tourism Sector, World Economic Forum Report prepared with the support of Booz & Company, May 2009.

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the aviation community to fill the gap left by COP15. Aviation stakeholders can now proactively shape their own future by continuing to develop a more environmentally sustainable air transport system. Conversely, the ‘regulatory vacuum’ also increases the risk of insufficient and uncoordinated regional actions with unintended consequences. Individual nations could easily pursue misaligned environmental agendas, and implement measures that will be hard to reconcile once a mandate for a global framework is finally agreed upon. A recent example is the proposed ‘green departure tax’ for air travel in Germany which originates from efforts to generate new tax revenues for alleviating the country’s national budget deficit. The measure was not coordinated with other countries or EU-wide initiatives (such as the emission trading scheme) and will only create an outflow of funds from the industry without any direct returns or benefits for the environment.

Therefore, it is an absolute necessity that the aviation industry takes the lead by building a consensus among IATA members and the International Civil Aviation Organization

(ICAO) member states regarding aviation-related climate change mitigation. The COP15 accord gives these stakeholders the breathing space needed to harmonise their efforts and reach a common solution which addresses the sector’s impact on global climate change.

For the creation of a sustainable aviation sector it will be central to coordinate investments in new technology. The following four major investment areas form the core of a sector-wide strategy which can create the right conditions for a more sustainable, low-carbon economy:

1. Improved infrastructure and air traffic management.

2. Next generation aircraft and engines.

3. Accelerated fleet renewal.

4. Alternative fuel sources, such as aviation biofuels.

A comprehensive framework that addresses each of these areas would ensure that the right conditions and incentives exist for investment. Today, the aviation sector is marginally profitable at best, and therefore, the framework will have to manage the inherent conflict between accelerating the environmental agenda through financial investment and the limited availability of financial resources. In the short term, it is likely that the aviation sector will be penalised for its emissions (as is the case with the EU emission trading scheme and the German air travel emission tax). At the same time, the sector will be required to make costly long-term investments in technology to reduce its emissions footprint.

This inconsistency in governance risks to impede an effective mitigation of the climate impact of aviation. A more effective global framework is required that better balances short-term and long-term demands and impacts.




Given regional differences, there is also a need to balance scope and responsibilities between national and regional regulations and the global framework. This raises key questions regarding the geographic dimension of the most effective approach: will a comprehensive framework require equal treatment of all parties or can it take a ‘common but differentiated’ approach to accommodate geographic differences? How should specific responsibilities be divided and ultimately tied to the global framework?

Further, a global framework must carefully consider possible funding and financing mechanisms. How will the framework affect the outflow of funds from the sector (in the form of emissions penalties, for instance) versus the in-flow of funds from sources such as government-funded research in the sector? Once again, there must be a balanced approach, such as allowing the sector to offset emissions penalties with green technology investments.

Finally, the framework will need to specify transparent measurement, control and

tracking mechanisms to verify and ensure that the targets which are set by the sector are being achieved. Without these governance tools it will be difficult to incorporate already existing or future national/regional frameworks (see Exhibit 2). The framework also requires the establishment of agreed metrics which allow the stakeholders to recognise and prevent unintended consequences.

How to crack the fundamental issuesManaging the emission footprint of the aviation industry will not be an easy task. The costly development of aviation infrastructure, including higher-capacity airports and the more efficient use of airspace, is already underway. So is the

Exhibit 2: Examples for Sustainability Initiatives

FinancialMechanism

A/C and EngineDevelopment

Ticket/AirportTaxes

BiofuelR&D, Production

Development

GlobalEmissions

Trading

Inflowof Funds

Outflowof Funds

USACAAFI

NextGenSESAR

EU ETS

National Global

ScopeExistingIn progressTo be discussed

For the creation of a sustainable aviation sector it will be central to coordinate investments in new technology.

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development of next generation air traffic management systems. However, multiple barriers remain. In the European Union, for example, the fragmentation of airspace and Air Traffic Management remains a major

bottleneck to improvement. For political reasons many States are reluctant to give up sovereignty over their national Air Navigation Services, even though a more efficient organisation of European airspace would reduce fuel consumption of civil aviation by up to 10 percent.

Next generation aircraft and engines promise continuous improvements in efficiency and emission reductions. However, those improvements are introduced slowly and there is no ‘quantum-leap’ technology change achievable in the foreseeable future. Nevertheless, increased penetration of more modern and more efficient aircraft will certainly reduce overall emissions in the aviation sector. But given aircraft service lifetimes of more than 30 years, today’s aircraft are likely to remain in service well beyond 2020, and fleet renewals will only gradually introduce aircraft and engine efficiency gains into the mix. Accelerating fleet renewal can help, but its effect is limited by production capacity and airlines’ financial capabilities. Aircraft replacement raises difficult issues about funding and financing: the early replacement of aircraft has not been accounted for in the business models of airlines and would have a significant impact on their profitability and overall financial health.

All of these efficiency improvements—in infrastructure and aircraft fleets—require enormous amounts of money and will still not be able to offset the anticipated rise in emissions of the sector. Currently, the only known means to close the gap toward ‘carbon neutral growth’ is the introduction of sustainable aviation biofuels. The airline sector differs from ground transport in this respect: ground transport has options for several alternative energy sources, including alternative fuels (e.g. ethanol, bio-diesel, hydrogen) and electric batteries, while aviation is limited to synthetic paraffinic kerosene (SPK) derived from renewable sources. Biofuels for the ground transport sector are technically less demanding, easier to produce and cheaper than aviation biofuels. This fact favours the development of ground transport biofuels and virtually guarantees that aviation biofuel will not be available as quickly as it could be from a theoretical perspective. There are a number of reasons why the exploration and commercialisation of sustainable aviation biofuels is a major challenge:

The commercialisation of sustainable aviation biofuels is a major challenge.




1. The technical specifications of aviation kerosene are very demanding and can only be met by bio-derived SPK through using advanced processes that require further investment.

2. It is estimated that a massive investment of tens to hundreds of billions of dollars is required to build sufficient aviation biofuels feedstock supplies and to construct the production facilities and global supply chains required to meet global demand.

3. The current feedstock production and processing costs of aviation biofuels are significantly (four to seven times) higher than the cost of conventional jet fuel. For aviation biofuel to become competitive and to be widely adopted by the aviation industry, a substantial cost reduction is required.

This gives rise to many technical, regulatory and commercial questions about the feasibility of aviation biofuels, such as:

When will fuels from known conversion • technologies such as Fischer-Tropsch fuel from Biomass (‘Biomass-To-Liquid’, BTL), or Hydro-treated Vegetable Oil (HVO) become available in sufficient quantities? What are sustainable feedstock sources and where do the required quantities come from? Can new feedstock-fuel pathways and technologies (e.g. micro-algae, direct fermentation of sugars) be developed into viable alternatives? When would those new alternatives be available?

How can the industry, regulators and other • stakeholders develop a comprehensive but practical framework to assess and assure the sustainability of alternative aviation fuels? How sustainable are the envisaged options for aviation biofuels in such a framework considering their entire GHG life cycle from feedstock cultivation to combustion (‘well-to-wake’), including direct and indirect land-use change? What impact will the cultivation of sustainable feedstock have on local agro-economy and

food production? How can the sustainability of biofuels be assured in practice? What global standards are required and how can they be enforced?

How will aviation biofuels become more • economically viable in an industry that cannot afford to pay premium prices? How can the utilisation of and investments in aviation biofuels be promoted in the context of new carbon policy measures such as emission trading and potential carbon tax schemes?

Who will pay for the infrastructure required • to produce and distribute aviation biofuels to the consumers? Given the price volatility of conventional jet fuel and the demanding technical specifications of jet fuel, aviation biofuels are not a very attractive market for Oil & Gas and Chemicals industries to invest in, particularly compared to the opportunities offered in other sectors.

OutlookThe aviation sector must take the lead to foster the conditions necessary for accelerated investments in sustainable technologies and, specifically, in aviation biofuels. A global framework for carbon emissions policies must be developed that includes the required economic measures for the creation of a sustainable industry in the long term. These measures could include the establishment of an ‘aviation low carbon fund’ that is funded by ‘green aviation charges’. Such a fund should assure that emission charges are effectively invested in the development of viable global solutions for aviation. It should eschew individual, national regulations which bear the risk that emissions

The aviation sector must take the lead to foster the conditions necessary for accelerated investments in sustainable technologies.

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taxes are used for other purposes outside the aviation sector.

This fund should be used to incentivise high performers, thus accelerating innovation within the industry. It should prevent the appearance of additional financial burden without the return of corresponding benefits to the aviation industry.

The regulatory gap created by COP15 offers the aviation sector a limited window of opportunity to decide how to move forward and to preempt further isolated national/regional measures. If the aviation sector can successfully define and balance the multiple elements of a global framework, there is high probability that it can attain a sustainable future.

61

A New Airport Security ModelAndrew McClumpha and Adam Brownson



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New Security ModelOutside the US, the largest cost to an airport operator is typically the security process, and it therefore comes under regular scrutiny from management, shareholders and potential investors. Periodic terrorist events worldwide remind us not only that robust airport security processes are needed, but that they need to adapt to changing threats. In an industry as highly regulated as airport security, that is hard to achieve, and it is even harder to achieve cost-effectively.

The most prominent terrorist attempts in recent times have highlighted that the security process cannot be 100 percent effective. In each attempt, be it an explosive device concealed in a shoe (Richard Reid) or in clothing being worn (the Christmas Day bomber) or concealed in the form of innocuous liquids (August 2006 foiled plot), the standard security search process was found to have loopholes. Each case also demonstrates the role of security intelligence—successful in the case of the liquids plot, but disjointed and a failure in the other two attempts.

Any new airport security model therefore typically looks at how intelligence can be used to assess the level of risk posed by each passenger, and for the airport to then conduct body and baggage screening that is proportionate to the risk level assessed

for the individual. Certain elements of this intelligence-led process already exist: airlines use documentation and government watchlist checks; governments collect Advance Passenger Information and Passenger Name Record data and combine it with their own criminal records and intelligence databases; and some airports are experimenting with different security search intensities for different types of passengers.

This is not a new idea, and it is logically strong but practically challenging to implement; but what would it look like to the travelling public?

A regular business passenger, booked on a return ticket and with no history of travelling to certain high-risk countries, might be expedited through a baseline process involving standard x-ray screening of cabin baggage and body screening using an archway metal detector or body imager, but with a much lower probability of a random search.

A passenger booked on a one-way ticket, who is flagged on a watchlist, or who has connected with or recently visited a high-risk country, might be subjected to a 100 percent baggage search, explosive trace detection, compulsory body imaging and a physical pat down.

This risk-based model is considered by many to be an ideal, pragmatic way of expediting the throughput of low-risk passengers whilst applying proportionate additional measures to the remainder. But would it have prevented the past three terrorist attempts?

In the case of Richard Reid, the attempted • shoe bomber, the French authorities claim

An ability to adapt to changing threats is hard to achieve, and it is even harder to achieve cost-effectively.

Knivesand IEDs

ShoeIED

LiquidIED

Body-wornIED

Pre-2001 2001 2006 2009

Terrorist ThreatsExhibit 1: Progression of Threats




that both he and his baggage were searched more intensively than the average passenger, but no threat was detected.

Similarly, had the liquid explosive plotters • been subjected to the most thorough search available at the time, the concealed liquids would still have gone undetected.

Only in the case of the Christmas Day • bomber would the most thorough body search available at the time (a combination of millimetre wave or backscatter x-ray screening and pat down) have stood a reasonable chance of detecting the threat.

All of this highlights that there is no simple solution. And indeed the environment in which to create innovative solutions is becoming increasingly challenging in an industry strictly governed by regulation. In Europe, the adoption of European Commission regulation EC300 marks a shift in regulatory power from Member States to the European Commission, with Member States potentially finding it increasingly difficult to make changes to their security protocols. The capacity for innovations such as an intelligence-led risk-based approach to passenger screening could be jeopardised—the regulatory hurdles to seek approval or derogation from the European Commission might simply be too great.

Airport operators, whilst mindful of what the security model of the future might be, have more pressing challenges today and in the next few years. The challenge of balancing customer service, flow rates, and cost, whilst achieving security compliance, has always existed. What we are finding among airports and security providers is a renewed emphasis on doing it all better, not just on cutting cost. Across the industry there is acceptance that the inconvenience of divesting liquids, laptops, coats, belts and shoes is here to stay, at least in the near term. And so the focus is on doing it better, quicker, using fewer resources, working more effectively, and perhaps most importantly, in a way that is more acceptable to the airport’s customers.

One of the issues identified is that the pressure to reconcile these challenges—security, flow, customer service and cost—is being pushed down to frontline Security Officers who are often ill-equipped to make the best decision. Our recent work in North America has found an airport security operation in which the human part of the system is under continual pressure, with severe penalties for security non-compliance, with a resulting negative impact on passenger flow rates.

Overwhelmingly, what we have found are airport security workforces that are unengaged, disconnected from senior management, and that do not know what is truly expected of them. Commonly unionised, and in some cases with stronger allegiance to their union than to their employer, these security officers and team leaders are the resource that hold the key to an efficient, cost-effective and compliant security process. These people, then, should be the focus of the new security model.

Fostering customer serviceAirport security was traditionally a form of authority, executing procedures set by the transport security regulator. Customer service was not an alien concept, but nor was it considered particularly important. Increasingly among commercial airports with non-federalised security, we are finding a shift in mindset towards ‘helping the customer demonstrate compliance with the security rules’. The change in language is important. Airport operators recognise that their passengers have a choice, particularly transfer passengers. However, for a number of reasons, airport management’s values and emphasis on customer service are rarely filtering down to frontline staff.

Airport management’s values and emphasis on customer service are rarely filtering down to frontline staff.

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Our analysis indicates there are several dimensions to this problem. The first is that customer service does not fit perfectly with the need to assert strict security protocols, to carry out time-consuming procedures such as bag searches and trace detection, and to confiscate items that the passenger considers harmless. The second is that the Security Officer role has diverse requirements involving verbal and physical interaction with passengers, combined with expert image analysis and fine attention to detail. Many airports find the local pool of candidates that are strong in all of these areas to be quite small. The third is that the recent economic climate has led to significant reductions in employee turnover at many airports. To put it bluntly, the opportunity to refresh the security workforce with new customer-focused talent has all but disappeared for the time being. On the other hand, at least one airport in the UK has benefited from the high number of employee redundancies in the local area during the recession and was able to recruit much more talented candidates than had previously been available.

Informal data suggests that training the existing workforce in customer service, or including it as a bolt-on to technical training, will not comprehensively deliver the desired results. Our assertion instead, is that airport security management should foster a sense

of professionalism and pride amongst their security workforce; they should share with staff how commercial success or failure depends in part on providing a positive experience for passengers; and dispel the idea that security and customer service are in any way contradictory.

Creating an engaged security workforceDuring a major airport security research programme Booz & Company undertook for the UK Department for Transport, one of the major issues we identified concerned the engagement of Security Officers and their attitudes towards security. Building upon a framework of organisational characteristics associated with high-reliability environments and human performance, we worked with Aston University to develop a Security Culture Assessment Tool. The 52-item questionnaire addresses seven factors that collectively represent security culture: climate for well being, training, climate for security, management values, goals and rules, communication, and feedback and recognition. When we first piloted the tool at two UK airports, we found significant differences in several categories that helped drill down into areas that collectively contribute to organisation performance and efficiency. The tool is coupled with an interventions framework that sets out the actions that the airport should work through to address any issues identified through the survey analysis.

Communication and management values are two of the strongest themes emerging from our recent work in Europe and North America. Security Officers are much more likely to be engaged with the airport and the security function if they have regular contact with their nominated line manager and if they receive regular communications from management that involve them in the business and its objectives. It is widely understood by Security Managers that pre-shift briefings are extremely valuable in providing an opportunity to communicate the daily plan to Security Officers, convey messages of reinforcement around behaviours and goals, and provide feedback on performance and areas of required improvement. Our finding




though, is that these briefings rarely take place, principally because of the nature of shift-working and staggered start times, and the roster alignment between supervisors and their staff.

Certainly line management contact is critical to certain elements of employee engagement, but our work has found that Security Officers are more likely to feel engaged and involved if they understand the expectations of the organisation upon them and their individual contribution to its success.

Managing performanceThe need to measure various aspects of the airport security operation has emerged principally through the requirement to demonstrate compliance with security and with service quality agreements and to track cost. Many airports in Europe operate Threat Image Projection (TIP) on X-ray machines. TIP is a system that periodically projects fictional images of threat items such as guns

and improvised explosive devices into the images of real passengers’ bags, providing on-the-job training, and helping to improve motivation, by providing instant feedback to the Security Officer if they detect or fail to detect the threat item. The data from the TIP system provides valuable insight into the threat detection performance of the ‘system’ and the individual.

Objective, outcome-based measures of operational performance are difficult to achieve for many of the other elements of the security process. Thus, Security Managers and Compliance Managers rarely have a complete picture of their officers’ performance at tasks such as body search, bag search, and explosive trace detection.

For this reason, as part of our work for the UK Transport Security Regulator, Booz & Company developed a set of observable key performance indicator tools—straightforward paper or

Exhibit 2: Assessing security task performance

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computer-based tools to help compliance monitoring staff to collect consistent, objective, and robust diagnostic data on the performance of the Security Officers at these tasks. With the data fed into a performance management system, a holistic picture of the performance of individuals, teams, and the system as a whole emerges.

Assessing security task performanceAirports find such data immensely valuable: to provide assurance over the level of security compliance and performance being achieved; to identify training and coaching requirements for individual officers; and to support the provision of evidence-based feedback to Security Officers, to set performance expectations and to provide a basis for rewarding high performers and addressing low performers (and ultimately evidence to support dismissal).

Implementing a comprehensive performance management systemCustomer service scores, infiltration tests, and flow rates also form an integral part of the overall security performance management system; however, the challenge is in linking the contribution of an individual Security Officer or team leader to performance on these metrics:

Customer service scores can reasonably • be attributed to a particular checkpoint, but many of the Security Officers before and during the process have an influence on the passenger’s perceptions of service.

Infiltration tests provide a valid measure • of system performance but there is often insufficient data to make assessments about individual Security Officers.

Flow rate is also impacted by numerous • variables that make it almost impossible to identify the contribution of an individual Security Officer.

The solution is to assemble building blocks of metrics with targets assigned to those who have influence over them. But a performance management system can only be truly effective if it includes a commitment to provide feedback and incentives to those whom it is used to manage.

A performance management system can only be truly effective if it includes a commitment to provide feedback and incentives.

FeedbackPerformanceMeasurement

Process

Follow Up

Performance Tracking, Reward and Training

1 2 3 4Criteria and

ProcessDefinition and

Communication

Identification ofevaluation criteriaand metrics, processdefinition, andcompany-widecommunication

Management ofperformancemeasurement process (data collection tools,techniques andanalysis)

Individual feedbackdelivery, identificationof training requirements,and objective setting

Communicatingperformance resultsto relevant HRprocesses: training,reward, payroll,benefits, recruiting

Corporate Vision and Strategy

Exhibit 3: Corporate Vision and Strategy




TechnologyAny discussion of a new airport security model would not be complete without mention of the role that technology can play. What is abundantly clear from initiatives over the past few years in airports throughout the world is that technology does not provide all of the answers. Our work has positioned us with practical insights into how various technology solutions have the potential to make an important contribution to effectiveness and efficiency. But in many cases they have failed to deliver the full benefits or cost savings expected. Advanced X-ray machines with the capability to detect explosives are already deployed at many airports worldwide; but the challenge for security managers and regulators is in equipping Security Officers with the skills to use that capability without placing complete reliance upon it to detect all threats.

Automatic tray return systems potentially reduce the manpower requirement at the checkpoint, but in doing so, a human touch

point between the customer and the security process is also lost. For the frequent flyer, this might be a welcome development, but for less regular travellers, the first human contact at the security checkpoint provides important reassurance and assistance in what is for many a pressured and intimidating process.

ConclusionVisions of a new security model understandably place heavy emphasis on technology being combined with security intelligence to screen passengers and their bags with minimal interference and inconvenience.

The reality is that any technology-based solution must be built around the human factor—the frontline Security Officers, the environment in which they work, and their supporting management structure. Our work leads us to believe that in the short term, the greatest gains in security compliance, customer service, flow rate and cost-effectiveness can be found in the security workforce.

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Authors

Daniel Bonsemeyer [email protected]

Adam Brownson [email protected]

Toby [email protected]

Martin [email protected]

Elizabeth [email protected]

Volkmar Koch [email protected]

Philip Lee [email protected]

Gwyneth MacLeod [email protected]

Andrew [email protected]

Dr. Jürgen [email protected]

Daniel Roeska [email protected]

Rainer [email protected]

Hanno Schulz [email protected]

Stefan [email protected]

Booz & Company is a leading global management consulting firm, helping the world’s top businesses, governments, and organisations. Our founder, Edwin Booz, defined the profession when he established the first management consulting firm in 1914.

Today, with more than 3,300 people in 61 offices around the world, we bring foresight and knowledge, deep functional expertise, and a practical approach to building capabilities and delivering real impact. We work closely

with our clients to create and deliver essential advantage. The independent White Space report ranked Booz & Company #1 among consulting firms for ‘the best thought leadership’ in 2010.

For our management magazine strategy+business visit www.strategy-business.com.

Visit www.booz.com to learn more about Booz & Company.

Executive Editor

Reed [email protected]

http://www.booz.com




Michael BurnsBooz & Company7 Savoy CourtStrandLondon WC2R 0JPUnited KingdomTel: [email protected]

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Booz & Company Aviation Capabilities & Team Booz & Company, a strategy consulting firm, has been serving clients since 1914. Our purpose is to serve the senior agenda of the world’s leading institutions, public and private. We are recognised for the relevance of our ideas, the practical impact of our contributions, the collaborative spirit of our people, and the intrinsically global nature of our firm. Since our first aviation assignment for United Airlines in 1930, Booz & Company has worked with clients across the aviation industry providing both technical and management consulting

expertise. We have completed more than 1,000 successful engagements for clients in the airport, airline, aerospace, and travel industries, as well as air navigation service providers and government and regulatory agencies worldwide. This experience has provided us with in-depth knowledge of the entire aviation infrastructure value chain. For more information on Booz & Company’s capabilities in air transport and aviation infrastructure, please see www.booz.com.

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