How 'Airline 2.0' generates more free cash - Lessons for Telcos

Our next Telco 2.0 event is coming up in April, and is sub-titled "Is there $250bn in new 2-sided telecoms business models?". As with all marketing, sometimes accuracy is an early victim at the altar of the gods of simplicity and clarity of the message. A more correct title would be "Is there $250bn in new platform-enabled rich wholesale models that allow telco assets and services to be re-packaged to reach new indirect retail distribution channels, as well as generate entirely new revenue streams from upstream partners, where some of these propositions also fall under the technical definition of '2-sided business models'".

Somehow I don't think we'd get the same interest and attendance. Our graphic designer would be less than amused too. The point, though, is that there are many flavours and shades of grey in business model design. We've been coming up with a long list of examples (more in our new report), and would like to pick two involving the airline industry to illustrate the range of possibilities.

A true two-sided model: airline miles

It's quite common in business to sub-divide a product and sell it at a higher margin in smaller quantities. A sachet of shampoo bought at the swimming pool costs a lot more per head of clean hair than a bottle bought in the supermarket. Airlines have found a clever way to master this principle.

As it happens, I'm typing this sat on a plane home from Mobile World Congress. The seat is a nice blue leather, and the arms appear firmly affixed. If I started to try to take the seat apart, the consequences would start with consternation from my fellow passengers, and rapidly descend into what I think the crew described as being "met by the appropriate authorities on arrival" when they told us not to get pissed or light up in the bogs. So an airline seat is a pretty indivisible thing.

Airlines don't sell seats. They sell transport from A to B (or in my case, B to E). That is achieved by selling tickets. A ticket is an "option to fly". Nobody makes me turn up at the airport at all. Subject to conditions of the ticket, I can choose to fly at another time. So tickets are then associated with a reservation, which matches the "option to fly" with a specific scheduled flight, which maps to a particular set of blue leather seats.
Airline seats are indivisible, but airline tickets are not. You can sub-divide one into, say, 25,000 pieces. Let's call each piece a "flyer mile". And then you can sell these to banks, supermarkets, hotels, credit card companies, and assorted other merchants.

The miles are sold at wholesale, but it's not a wholesale business in totality. That's more like someone who wet leases planes to charter airlines. No, in this case the miles have value to the upstream (wholesale) partner precisely because you have a (retail) relationship with the flying customer and have given them a frequent flyer account. This is a true two-sided business model.

A different kind of wholesale business

Most wholesale businesses are associated with squeezing some last cashflows out of mature products ending their lifecycle. In the airline business, it's bunches of old Boeing 727s converted to freighters chugging around the third world on charter hauling everything from artichoke spears to arms. In telecoms, it's MVNOs mining out the last hard-to-reach segments. The host who provides the capital equipment for the wholesale business sees this as a low-margin alternative to having your own retail business.

These are "bulk" one-sided wholesale business models. There is a range of possible models that take us towards the full "two-sided" model. These can be far more profitable than a standard retail business. For instance, those airline miles can only be redeemed on certain flights, meaning the cost of each exercised "option to fly" is low, since you never need to invest in additional capacity. Contrast this with when businessfolk turn up on Friday every week for the last flight waving their 'Y' class full-fare economy tickets. Users will perform all kinds of contortions and self-deceptions to convince themselves that this non-fungible airline currency is somehow of great value. (The head of Ryanair once quipped that his German customers would crawl over broken glass to get low fares, so just imagine what a "free" flight does to the psyche.) Indeed, customers ignore the huge switching costs that frequent flyer miles create, and the misalignment of incentives between the employer who pays and the employee who saves. And on top of all that, you get a massive float to work with, reflecting the period between the sale of the mile, and it's possible redemption.

In a way it's the flip-side of lean production. With lean, you reduce work-in-progress and inventory costs to free up money to improve cashflow. Here we create "revenue in progress" instead; if you can't sell a whole ticket, sell a fraction of one.

How much?

Frequent flyer programs earn over $2 billion a year for airlines from partners at outrageous margins. According to WebFlyer, the fastest growing segment of these programs are "mileage consumers" and not frequent flyers, with about 54% of miles earned from non-flying activities. About 18% of miles issued are never redeemed. With around 10 trillion million miles outstanding, at an average revenue of 1.7 cents, that's $17bn of operating cash airlines haven't had to raise from the markets.

More revenue, lower costs, higher cash flow, less churn. What is there not to like?

In our next post on airlines and telcos, we'll examine how these principles could be applied to our industry.