Chairman and CEO
The Boeing Company
"Turbulent Times in Aviation"
Harvard Business School Club of Colorado
47th Annual Business Forum
September 23, 2003
Good evening. This is a forum, and to me "forum" means discussion, thought and contemplation. So, hopefully, after a few remarks and a little bit of conversation, we can turn it into a dialogue. You can ask some questions and we can talk about where the airline industry is going, because that's the subject, "The Airline Industry in Turbulent Times."
First off, I'd like you to note that half of our [Boeing] business today is in the defense industry, so just remember that. I'm not going to talk about it, just remember it, because it's important.
Let's talk about airlines and where they're going. Historically, the airlines have been a cyclic business; it's a capital-goods business. When the business is growing you buy capital goods; when it isn't you don't. When airlines are growing they buy airplanes; during downturns, when traffic is level, they don't need to buy any airplanes at all. That means we get big swings in production. But this discussion tonight is not about the cyclical nature of airlines; that's a fact, and it will remain a fact. It's more about the business model, where that business model goes, and what it tells us about the future and what the future will hold.
Today, I think it is very difficult to even imagine a world without an airline industry ? it is what moves us on a regular basis. It has grown steadily over the years. It is important to the global economy. So we can't step back and say, "This is an interesting industry, but they've never returned the cost of capital, maybe they should just go away." It's too deeply embedded. So, what are the issues? Why is this a turbulent time?
Let's start with the basic underlying facts. The first is: We did have a cyclic downturn. We had a boom through the late 1990s; every one of you understands that. Business travel was up, leisure travel was up, and then the bubble burst. All by itself, that cyclic downturn would have been there, and then there would have been a recovery, much like there has been in the past. But we began compounding that issue. One of the issues was 9/11. Airlines stopped flying; people stopped flying. Traffic today in the United States is about 8 percent below what it was in the year 2000. It's running at traffic levels that are about the same as those in 1997; that means we have gone almost 6 years with no growth. That's dramatic. It's even more dramatic that on an 8 percent reduction in travel, yield -- the average fare paid by the average passenger -- is down 25 percent. And in an industry with heavy fixed costs, revenues down 30 to 32 percent in total, traffic down, yields down, that's a pretty phenomenal impact all by itself.
But that's not all; we threw in a conflict in Iraq. But there was one part of global aviation that was doing okay: Asia. It was still growing. So then we introduced SARS, just to make sure that the scale was balanced across the world, and traffic declined 60 percent in Asia. That is the economic situation.
Interestingly, even that is not the real issue. The real issue is that the airlines began their life as highly regulated industries. In the United States their primary customer was the U.S. government; they carried air mail. When airlines began to expand to an international business, the rules were set in a highly regulated fashion. The routes that an airline can fly are governed by bilateral negotiations. The United States has an agreement with Germany, with the United Kingdom, with India, with Japan. Each one of those is bilateral, and every country has multiple bilateral agreements that fix the number of flights, who can fly, and what destinations they can serve -- not exactly an open market.
In 1978 the United States deregulated the U.S. airline industry, and the industry began to change. But that change has only just begun. Let me give you an example. Imagine a hotel that has a big central lobby. To the right of that lobby is the Ritz-Carlton wing, straight ahead is the Marriott wing, and to the left is the Motel 6 wing. All served by a common lobby. And if you happen to be staying in the Ritz-Carlton wing, the people staying in the Motel 6 wing walk through your room on the way to theirs, and if their bathroom is busy, they come and use yours. Now if that sounds vaguely familiar, you might recognize the airline business model.
Market segmentation is part of an open market system, and you had better understand what segment you are in. We've begun to see that with the advent of Southwest Airlines and JetBlue and AirTran -- each serving a segment of travelers. I think that it is a trend that will continue. If you look at almost any retail business, 80 percent of the transactions occur in the value segment with 50 percent of the revenue. It is the Wal-Mart model. Today value carriers carry about 20 percent of the travelers; that says there is likely to be enormous change. This is a market that will segment. It may take a while, but it will segment.
There are a lot of other changes coming as well. I mentioned the bilateral system. If we were to go to an open market system, a globally regulated open market system, where any airline could compete on the basis of its products and its cost and its service, you would see radical change from where we are. Today if you are Singapore Airlines and you fly from Singapore to Tokyo to Los Angeles and you want to fly on to New York, you can't pick up passengers in L.A. and carry them to New York -- that part of the market is not open, so it's not economic to do it. What would happen if that became an open market?
And one of the things that is extremely important to us as we look forward is: What is it that passengers really want? Would you rather fly directly, nonstop, from where you are to where you want to go? Or would you like to stop at several places you don't want to go and risk the fact that your connection might not work? Most of the time when I ask this question I get a very common answer. The data say that when given a choice people will always take the nonstop, and in fact, they will pay more for it. So we [Boeing] had to make a fundamental strategic choice: Do we make a big airplane that flies between hubs, or do we make an airplane that can go point to point? We have chosen the latter because we think that is where the market will go.
There is one last change. Because airplanes are of military value, the initial rules said that people in one country couldn't own an airline in another country. There are limitations to cross-border ownership. We have clearly seen those restrictions break down in industry after industry. They have not broken down in the airlines business. This is a business that today has incredible fragmentation on a global scale. Normally in a mature market-based industry, you would expect the market leader to have around 25 percent, maybe more, market share on a global basis. The biggest airline in the world has less than 6 percent market share. It is an industry that is ready for consolidation on a global scale, but that means cross-border ownership.
If you put all those pieces together -- markets that are segmenting and new business models developing, global open market capability, the capability for the best airline with the best service with the right price to serve, the potential of cross-border ownership -- and then add in the impact of information technology and access to pricing that allows anybody to see prices transparently and find the lowest cost fare that fits, this is an industry that will change radically over the next decade or two.
Our job is a really interesting one. We build products that last 30 to 40 years. We've got to understand where that market will be 20 years from now so when we design the product today, it will be one that a market that is very different will want 20 years from now.
Hopefully, this has been a bit of a challenge for you, an opportunity to think about an industry that we all use. I would now be happy to take questions.