of the airline. And, in common with other industry sectors, elements of IT and business functions such as finance and accounting or payroll may have been outsourced to a third party.
So what factors have encouraged this wide-ranging level of outsourcing in the airline industry?
Although the airline sector is one of the most international of industries, it has paradoxically had some of the most restrictive rules on ownership and control. Since the 1944 Chicago Convention, air traffic rights between countries have generally been regulated by a web of bilateral governmental agreements which cause each home country to defend hard-negotiated rights of access to the other country by prohibiting third country carriers from operating on those routes.
In most countries, in order to qualify for the home country’s international routes, an air carrier must have an operating licence from the home country (which is issued once the airline has proved, among other conditions, that its ownership and control is in the hands of investors from the home country). This system creates a powerful disincentive to merge international carriers as the ensuing loss of control could cause the loss of valuable international routes.
The European Union (EU) has made inroads into this system, the most significant being the recent EU-US ‘Open Skies’ Agreement which will come into force on 30 March, 2008, and allow any EU airline to operate to the US from anywhere in the EU and US airlines to operate to any EU destination from anywhere in the US. As a result there has been much speculation about tie-ups between EU carriers.
The inability to merge and achieve the scale that companies in other industries have achieved has caused the airline industry to develop some interesting outsourced service provision characteristics.
First, the capital intensive nature and perceived strategic importance of airlines meant many started life as state-owned carriers. In many cases this allowed the build-up of large in-house capabilities across the whole range of service functions with the potential to be outsourced.
However, as early as the 1960s the more forward-looking airlines looked to defray the costs of such services either through procuring them elsewhere or by providing them to third parties. For example, in this period Lufthansa’s engineering division obtained authorisation from the US Federal Aviation Administration to service the engines of American airlines. The engineering division, renamed Lufthansa Technik, grew to become one of the world’s largest aircraft maintenance service providers gaining sufficient business and economies of scale to become a profitable subsidiary of Lufthansa.
Second, the inability to merge led to the creation of joint ventures or alliances between groups of airlines to facilitate the provision and procurement of certain services from more friendly service providers where a particular airline was becoming dominant. An example of this was the formation of the Amadeus global computer reservations system joint venture between Air France,
The joint venture was formed to counter the increasing dominance of the larger US airlines’ own reservations systems which offered access on unattractive terms to certain competitors or displayed the owner airlines’ less competitive flights to travel agents more prominently than those of other carriers. As with Lufthansa Technik, the Amadeus company grew to offer a broader range of services, such as sales, reservations and e-ticketing systems to other allied airlines such as BA and Qantas.
Some services logically lent themselves to the widest outsourced collaboration between all major airlines. So, for example, in 1949 International Air Transport Association members set up SITA (Societe Internationale de Telecommunications Aeronautiques) to provide direct communications between the main European airports and airlines on a not-for-profit co-operative basis. SITA continues to be controlled by its 600 members and provides essential communications network services to and between airlines and airports worldwide.
Collaborating, joint venturing, receiving or providing services to competitors has accustomed the airline industry to interdependence and the circumspect partnering qualities required for successful outsourcing. Another key reason why airlines have been at the vanguard of outsourcing has been that they were very early users of automation technology. American Airlines contracted IBM to install SABRE, its first computerised reservation system, in 1960. Early adoption of technology has meant airline management has been familiar with the project management and contracting pitfalls in procuring complex third-party technical services which are also present in most outsourced service provision and are therefore better able to implement outsourcings successfully today.
The advent of online booking in the late 1990s, followed by e-ticketing and e-kiosks, heralded a new wave of technological upgrades to allow airlines to achieve the cost savings and efficiencies that these technologies bring. It also spurred them into replacing and extending some of the early back-end IT systems that had been rather neglected up to this point. These factors presented an opportunity for established and new specialist providers to strike a new wave of headline-grabbing systems and business process outsourcing deals. The extent and apparent success of this outsourcing was highlighted in a recent airline industry survey (SITA 2007 IT Trends Survey of the Top 200 Carriers), which found that the majority of larger airlines have already outsourced their data centres and check-in and reservation systems and that more than 90% of those surveyed were either satisfied or very satisfied with the outsourcing (which contrasts with much lower reported satisfaction levels in other industries).
More depressingly for the industry, this decade has seen extreme swings in passenger demand and insurance premiums caused by SARS, 9/11 and other terrorist threats. Oil prices are at the $100 (£51) per barrel mark and environmental groups are calling for higher pollution taxes on air transport. Coupled with the successful growth of low cost airlines and other new entrants, pricing has fallen while costs have risen. This has put immense pressure on margins thereby leading many airlines to more aggressive outsourcing to achieve cost savings, resource flexibility and improved service.
Looking to the future, if anticipated mergers following the EU-US ‘Open Skies’ Agreement do occur, some deals and suppliers may consolidate and some services may come back in house, where the merger parties are customer and supplier. However, similar patterns of outsourcing are emerging in new aviation hotspots with carriers such as Emirates providing a range of outsourced, IT-enabled business process services and aircraft maintenance services to airlines in the Gulf and beyond through its Mercator services and Emirates Engineering divisions.
Jitters in the markets and the prospect of recession will, in some cases, lead to increased outsourcing to squeeze greater cost reductions and in others to the failure or renegotiation of deals where volumes or pricing are no longer sustainable. Against this background, the necessity for well-planned and resourced outsourcing is likely to be maintained. n
Marcus Evans is a senior associate in the international outsourcing group at Norton Rose.
