Show me the Monetary Policy
Rising interest rates might render One Order & One ID irrelevant, but other technologies could do well
Economic theory is cleft in two. Macroeconomics studies growth, innovation, employment and money. It studies regions and nations over centuries. Micro tries to understand how individual families and firms decide what to do every day.
Modern macro theorists sanity check their ideas by figuring out whether or not they are consistent with micro theory. Consumption of plane tickets for example should be consistent with basic micro principles like the Law of Demand.
Macro has all the interesting questions like how much money should central banks print, how much debt should a government should get into and why is almost everyone richer today than they were 20, 200 or 2,000 years ago.
Following Kwasi Kwarteng’s mini-budget a few weeks ago, British people are now arguing about whether it is more important to grow the country’s total income or divide that income differently. A classic macro problem, the end result one way or the other will change the lives of everyone in the UK.
Micro on the other hand has all the answers but not many of the really important questions. It matters little whether or not an individual airline’s revenue management is optimised, save to the carrier’s shareholders. Airline revenue management, ancillary issues, loyalty and product development are at heart all microeconomic issues.
But aviation also has it’s own macroeconomy as industry bodies like IATA and ICAO help their members decide what standards to set and what objectives they should pursue.
Airlines are also heavily influenced by macro trends. Recent jumps in inflation and interest rates may have profound implications for the way the commercial side of industry works. Industry plans for offer management and distribution may be put on hold. Airlines may instead decide that investing in loyalty and the passenger experience is a better use of their capital. Read on to find out how…
The chart below shows Bank of England rates since 1973. It can be downloaded in an Excel sheet from the Bank’s own site.
Notice the recent jump in Bank Rate from 0.25% to 2.25%. The Bank has increased the interest rate to encourage people to buy it’s bonds. The idea is that when more people buy financial instruments like these they spend less on goods and services elsewhere, leading to lower aggregate demand, less pressure on prices and lower inflation.
But rising interest rates do not only influence inflation, they also impact the cost of holding cash or investing that cash in other projects. To see why imagine that you are an airline using cash from profits to buy a new revenue management system.
If the new revenue management system is going to generate returns of more than 2.25% buying it might be a good idea. If it generates less than 2.25% you are better off using the cash to buy bonds instead and not buying the system.
Now imagine you are a lender considering offering a credit facility that the airline can use to buy the system. You would not offer the money unless the airline were guaranteeing at least 2.25% back because otherwise investing in bonds would be better – the British Government has never defaulted on a loan.
The higher interest rates go, the harder it is to justify investing in a project. When rates are up putting your money in bonds earns more today than it used to. Returns materialising over a long time period are less interesting. This is why the so-called “present value” of future income goes down when interest rates are up.
So as interest rates increase airlines will tend to prioritise projects that deliver revenue in the short- to medium-term rather than the long-term.
Now let’s revisit the chart showing Bank Rates. This time your favourite revenue economist has marked it up with a few key events in British airline commercial, covering revenue management, product development and loyalty.
The golden age of flight (see article) corresponded with the era of high interest rates. Airlines invested in snazzy uniforms like Braniff’s Pucci’s ensemble and BA’s suits by Paul Costelloe. There were lobsters and sirloins, on-board lounges (see article) and first class cabins everywhere (see article).
In the context of high-rates/low-present-value economics, airlines were investing in products and services that generated revenue in the short term because they made flying glamorous and exciting.
In the early 90s things changed. BA bought Air Miles in 1986 when interest rates were, compared to the last ten years, relatively low. An Amex co-brand followed in 2001. Virgin Atlantic followed with Flying Club and, later, their Mastercard. In the cabin BA’s FIRST product launched at a time of mid-range interest rates in 1995 was the first convertible seat and bed. Emirates launched the first ever seat with doors in 2003 (see article).
Unlike catering and service which have a short-term payoff, seating, loyalty and cabin assets yield returns in the medium-term. This may be why airlines focused on these specific areas when interest rates were at high and medium levels respectively. Since interest rates became lower the amount of time and money airlines spend considering these ideas has reduced, so fewer innovations end up flying.
Impact of higher interest rates on NDC and IATA’s “One” family
In 2012 industry trade association IATA launched New Distribution Capability (NDC), a communications standard allowing airlines to become retailers of any other travel products, from hotels and rental cars to rounds of golf and meeting rooms.
Despite a few gremlins (see article) airlines loved the idea of NDC and put lots of resources into it. They could afford to, for although it has taken ten years and billions of Dollars, becoming general purpose travel retailers has potential to transform the industry (see article). Unfortunately it is taking time and treasure. Despite all the efforts that airlines made little has really changed in terms of the products and services that airlines actually sell.
Your favourite airline revenue economist reckons that NDC with it’s long term potential was only viable due to the low interest rates. High present value of distant returns made airline finance departments happy to invest.
Now that airlines have NDC they will probably stick with it. Their behaviour around these projects might change though. Most airlines have arguably focused on developing NDC capabilities rather than actually using the technology to create innovative products and generate revenue.
As interests rates go up the calculus might change. A focus on nearer returns may force airlines to focus more on actually using NDC to generate revenue rather than improving their technology. Recruitment, training and day-to-day management will have to change in response.
The next step from NDC is the “One” family of IATA products:
1. One Order holds everything to do with a passenger’s trip in one place
2. One ID holds all the information about every trip a passenger makes
3. One Record is like One Order and One ID but for cargo.
Given how difficult it has been to get NDC off the ground One Order, One ID and One Record could lose momentum in a world of higher interest rates and lower present value. Other products expected to pay off sooner will become higher priority. What might these be? Read on…
Impact of higher interest rates on other airline technology
Here at Airline Revenue Economics we love writing about how emerging technologies might help airlines raise revenue. Our assessment of how they might perform in a world of higher interest rates is as follows:
Premium cabin seat design: Flat beds and doors have already arrived (see article). Flexible seating is now a reality for business and premium economy longhaul (see article). We do not see a revolution in basic seat design for these cabins, although hopefully innovative ideas like Butterfly will start to get adopted.
Economy cabin seat design: These seats are so thin and lightweight it is difficult to see where they could go next. Weird options like standing room only seats or one-above-the-other products might get a look-in, but getting these certified by manufacturers, approved by regulators or accepted by passenger user groups will be tricky and we probably will not see them flying in the end.
No-brainers like Paperclip’s snazzy armrest that otherwise find it hard to get a look-in because airlines are too busy to think about them might finally get a chance to shine.
Revenue generating seats, galleys & lighting: Should do quite well as passengers will appreciate these enhancements to the on-board experience (see article).
Metaverse: The perfect tool for future pre-flight retailing and in-flight entertainment (see article), metaverse will help airlines monetise NDC like no other technology. We think metaverse will be extremely tempting for airlines. When it comes to developing products there may be potential too, as Boeing is already using metaverse to design cabins (more comments on that coming up in a future article).
Blockchain: There should be high potential for airlines to adopt NFT ticket trading as long as they earn a profit from the traders (see article).
Stauts match: Another potential big winner, status matching helps airlines capture high value passengers quickly, many of whom have some control over which airlines they fly (see article). When immediate revenue becomes a priority, status matching could be a top performer.
Catering: High quality in-flight services could do well if they deliver an immediate margin, potentially heralding a return to the golden age of flight (see article).
History suggests that present value of future revenue would need to be quite high for catering to be the top focus though. Here at Airline Revenue Economics we think that current macroeconomic trends are good news for innovators in the airline supply chain.
Getting into airlines will stay tough though (see this article and this article) and only the most persistent pitchers with the strongest revenue-based business cases will be successful. Is that you? Let me know how you get on.
oliver AT ransonpricing DOT com