Auckland Bangkok Beijing Boston Chicago Five Reasons the Airline Industry Could be London Profitable Los Angeles Melbourne March 12, 2010 Milan Mumbai Munich New Delhi The materials contained in this document are intended to supplement New York a discussion at the Massachusetts Institute of Technology on March Paris 12, 2010. These perspectives are confidential and will only be meaningful to those in attendance. San Francisco Shanghai Singapore iKbKhK=`çåëìäíáåÖ=ääÅI=OU=pí~íÉ=píêÉÉíI=NSíÜ=cäççêI=_çëíçåI=j^=MONMVI=rp^ Sydney íW=SNTKVRNKVRMM===ÑW=SNTKVRNKVPVO===ïïïKäÉâKÅçã Tokyo Wroclaw
Agenda Agenda L.E.K. Consulting - Company overview Introduction to airline industry Why the airline industry could be profitable - Ancillary revenue - Industry consolidation - Frequent flyer program - Mitigate downside risk - Reinvention Summary CONFIDENTIAL 1
L.E.K. company overview L.E.K. Consulting is a leading global strategy consulting firm Overview Global Network Established in 1983 Clients include 25% of the largest 200 companies globally, as well as innovative start-ups and leading private equity firms Areas of expertise include: London Wroclaw San Paris Munich Strategy Chicago Francisco Milan Boston Beijing Transaction Services New York Tokyo Los Angeles Finance Shanghai Marketing and Sales New Delhi Mumbai Operations Bangkok Organization Singapore Worldwide over 1,000 staff, led by 104 Vice Presidents in 20 offices Sydney Melbourne Auckland CONFIDENTIAL 2
L.E.K. company overview L.E.K. is the #1 strategic advisor to the aviation industry Airlines Airports Investors Aerospace Manufacturers Other Industry Players CONFIDENTIAL 3
L.E.K. company overview L.E.K. is at the forefront of all the key strategic moves in the industry Company Assignment Global News Coverage Industry-leading Ancillary revenue strategy and implementation Diagnosis of high-profile irregular operations event Major strategy review of all aspects of its business On Time Performance (OTP) Turnaround World’s largest airline merger Frequent Flyer program spinoff analysis Major Global Airline Blue Chip PE Investor Maintenance division spinoff analysis Support for acquisition of ACTS (MRO division) CONFIDENTIAL 4
Agenda Agenda L.E.K. Consulting - Company overview Introduction Why the airline industry could be profitable - Ancillary revenue - Industry consolidation - Frequent flyer program - Mitigate downside risk - Reinvention Summary CONFIDENTIAL 5
Introduction While the airline industry generates an economic deficit, others in the travel eco- system such as government, customers, and labor are significant beneficiaries Average Annual Global Economic Surplus and Profit Distribution across the Air Travel Value Chain (2003-2007): Net Surplus: Net Deficit: Net Surplus: $567B $4B N/A (U.S. = $197B) Downstream Customer Government Participants Society Net Deficit: Net Deficit: $1B* $8B (U.S. = $5B) Airport Airline Net Surplus: Net Surplus: $1B External $8B (U.S. = $3B) Factor Cost Labor CONFIDENTIAL 6 Note: *This deficit includes only international airports
Introduction However, over the past 10 years there have been successful airlines that have generated significant shareholder value Top 5 Airlines by 10-yr Average Annual NOPAT Less Capital Charge 10-Year Average Annual NOPAT “Winning” Airlines* 2007 Total Revenue Less Capital Charge $212M $32.7B $204M $3.8B $201M $11.6B $84M $9.9B $69M $9.7B CONFIDENTIAL Note: * Top 5, excluding airlines with fewer than 8 years of data 7 Source: CapIQ, Compustat, L.E.K. analysis
Agenda Agenda L.E.K. Consulting - Company overview Introduction Why the airline industry could be profitable - Ancillary revenue - Industry consolidation - Frequent flyer program - Mitigate downside risk - Reinvention Summary CONFIDENTIAL 8
Ancillary revenue Due to price transparency and intense competition, airlines have very limited ability to capture higher yields by increasing published fares Estimated revenue impact of higher fares for a leading U.S. carrier % impact on total revenue Published fare Published fare +$2 Published fare + $5 Published fare +$10 Illustrative 0.0 (1.0) (1.0)% (1.2)% (2.0) (2.1)% (3.0) Airlines generally cannot raise prices without losing revenue and market share; other revenue opportunities are essential CONFIDENTIAL Source: APGDat, Online survey of consumer marketing panel using average published fare of $354, L.E.K. analysis 9
Ancillary revenue Ancillary Revenue streams, such as baggage fees, have enormous ROI and rapid payback Key Benefits of Ancillary Revenue Low Investment Not Competed High Margin Quick Uptake Required Away High ROI Rapid Payback 100x ROI in first 12 months post- A L.E.K. engagement resulted in launch of an “unbundling” project pay-back within three strategy for a Legacy days of launch 140x ROI in first 12 months post- In addition, the incremental launch of an “enhancement” annual profit from one single strategy for an LCC “launch initiative” was US$70m Source: L.E.K. analysis CONFIDENTIAL 10
Ancillary revenue And its not all about takeaways…products and services that enhance the customer experience, while not as high margin, still have very healthy economics Illustrative Margins for Select Ancillary Revenue Products (Blinded) Percent 95 95 95 100 90 85 80 80 75 60 50 50 40 40 30 30 20 10 0 Bag Fees FF Mile Seat A B C D E F W X Y Z Reduction Select 3 rd Party Product Basic Product Premium Product Unbundling Unbundling & Enhancements Enhancements CONFIDENTIAL Source: Company financials, Press releases, L.E.K. analysis 11
Ancillary revenue Merchandising represents a ‘game-changing’ opportunity for the airline industry that is still in its infancy but requires a fundamental shift in the mindset and skills deployed by the industry B2B B2C Illustrative Enhanced B2B Enhanced Mix of B2C & B2B Enhanced B2C Repackaged B2C 2 Enhanced Advertising 2 “Window Shopping” Internet On-Board Subscription Services for 3 2 (On-line stores) Amenities 3 Consumer Trials 2 In-Flight Entertainment 2 2 On-line Gambling FF Gaming Bundles Food/Beverage On- 2 2 Board Entertainment Packages Core B2B 3 Upscale Amenity 2 IFE/Web Advertising On-vessel Packs On-vessel Off-vessel Off-vessel Enhanced B2C Enhanced B2B Repackaged B2C Core B2B Core B2C Core Product 1 Premium Seating* 5 Vacation Packages 2.0 Airport Lounge Packages Traditional Advertising Baggage Fees 4 3 1 4 Lounge Access Booking over the 3 1 5 Family Traveler Packages Hotel Partnerships Phone 4 Priority Baggage 5 6 Confirmed Seat Child Traveler Packages Product Mileage Redemption 1 4 Priority Security 1 Assignment Flight Experience 2 Priority Check In and 5 7 4 1 Business Traveler Packages Fee to Stand by B2B Rental Cars 3 Boarding Airport Experience 4 1 Ticketing Fees 6 7 Elite Status a la carte Experience Packages Financial Services 5 Current Implementation Mileage and Status 6 6 Miles Rationalization 6 Mileage Purchase Customer Service 7 High Realization 7 Unaccompanied Minor 7 Trip Protection Insurance Low Realization CONFIDENTIAL 12
Ancillary revenue L.E.K. expects ancillary revenues to continue to transform the airline industry in the coming years Sample Products 2014 Revenue Expectation U.S. Global Baggage fees Product ~$6B - $7B ~$23B - $26B Seat selection Unbundling Phase Booking fees Internet on-board Product ~$2B - $3B ~$7B - $9B Lounge Access Enhancement $40B - $50B Phase Priority security of high-margin revenue Entertainment package Repackage / ~$1B - $2B ~$4B - $6B Business traveler package Rebundle Phase Luxury vacationer package On-board retail Non- ~$2B - $3B ~$6B - $8B customer Surveys B2B Phase focused initiatives Focus groups Source: Company financials, press releases, L.E.K. analysis CONFIDENTIAL 13
Ancillary revenue But for the airline industry to fully realize the benefits of ancillary revenue it must embrace the merchandising prowess of other industries Airlines Retail Branded Consumer Media & Entertainment CONFIDENTIAL 14
Agenda Agenda L.E.K. Consulting - Company overview Introduction Why the airline industry could be profitable - Ancillary revenue - Industry consolidation - Frequent flyer program - Mitigate downside risk - Reinvention Summary CONFIDENTIAL 15
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