Of Changing Airline Business Models & Urban Economics

As the economy is finally emerging what looks to be a period of sustainable growth, it’s interesting to take stock of the last few years, and see how the recession and upheaval of the last few years has affected a variety of industries, and the consequences that these changes have for society as a whole. The airline industry is one that’s particularly fascinating to think about in this regard, since it seems to have been permanently changed in a way that other industries haven’t. We’re curious to think about how some of these changes will affect the economic growth in larger and smaller cities throughout North America.

Broadly speaking, there are two dominant business models within the airline industry: 1) the hub-and-spoke model, utilized by American Airlines, United, and most of the flagship carriers of foreign countries; and 2) the “low-cost-carrier” or point-to-point model, favored by Southwest, RyanAir and others. The hub-and-spoke model requires aggregating passengers from smaller second-tier “spoke” airpports (say, Philadelphia, St. Louis, etc) at a larger hub airport (e.g. Chicago’s O’Hare, Heathrow) and in order to fly passengers to a similarly large hub. In general, hub-and-spokes usually break-even or take a small loss on at least some of the spoke-to-hub flights in order to maximize the the profits they can create on the lucrative hub-to-hub flights. Airlines can charge a premium—especially on business class and above—on some hub-to-hub cross-continent routes, and especially on some transatlantic or transpacific routes: hence, these routes are disproportionately important to a hub-and-spoke. Furthermore, since the fixed costs associated with building a hub-and-spoke are so high—aircraft, gates, landing rights—they create a powerful barrier to entry for potential competitors, thereby limiting further limiting supply, and raising the premium an airline can charge on these routes. Contrastingly, point-to-point low cost carriers (LCCs) try to fly shorter distances between secondary airports (Chicago’s Midway, Love Field in Dallas) where landing rights are less expensive. Crucially, these airports are less congested, enabling LCCs to turnaround aircraft much more quickly than competitors, thereby allowing for more frequent flights, more efficient aircraft usage, and most importantly, increase the amount of revenue they can generate per each aircraft seat by getting x many more flights per year out of each plane. LCCs generate barriers to entry by locking up gate rights at the airports they operate in, thereby keeping particular carriers out. (We’d guess this is ultimately the challenge JetBlue will face vs. Southwest, since the latter has a dominant position at the lion’s share of good secondary airports in the US.)

The consequences of the recession within the airline industry has been to validate one type of business model in the airline industry—the point-to-point low-cost carrier business model—while largely invalidating the previously dominant hub-and-spoke model . While the hub-and-spoke model can create huge profits during boom years—and we agree that it eventually will, as soon as corporate travel spending picks up again—the aforementioned high fixed costs of the model mean that it racks up huge losses during a bust period. This means that the hub-and-spoke model bears greater risk for investors, and therefore has substantially higher capital costs than a well-run LCC, further cutting into profits. (Moreover, in a post 9/11 and post-SARS world, the international destinations served by a hub-and-spoke have a greater risk associated with them, translating into added security and insurance costs for hub-and-spoke carriers.) In contrast, while the LCC point-to-point model offers slightly lower margins (since these carriers offer lower prices than hub-and-spokes), the flexibility of this model, and the lower prices, mean that it thrives in boom years as well as bust years, making it a safer investment over the long-run.

As hub-and-spoke airlines climb out of recession, they’re trying to trim their high fixed costs by offering a “leaner” version of themselves. In a nutshell, what this generally means is that smaller regional cities—the feeders of the hub in the hub-and-spokes, e.g. places like Pittsburgh (Brad’s hometown), Edmonton (my hometown), or Clevelands of the world now have many less flights connecting them to hubs than they did previously. Since these hub airports tend to be located in larger cities, and offer gateways to other larger cities either domestically or abroad, one potential consequence of changes in the airline industry is to reduce the connectedness of smaller regional cities to major hubs in the overall world economy. In short, it makes them less cosmopolitan and less global.

Being less connected to the world and national economy, and being less cosmopolitan and less global has significant competitive ramifications for smaller cities. Economically, this means that cities have less access to capital , since most capital tends to be clustered in what University of Chicago sociologist and urban studies guru Saskia Sassen has termed the “global cities,” e.g. larger first or second tier cities—London, New York, Chicago, Tokyo, Hong Kong. Less capital means less fuel for growth, and a less dynamic economy overall.

There are also economic disadvantages stemming from the cultural consequences to being less cosmopolitan and “worldly.” One result of removing some of the connections between a city like, say, Cleveland to that of New York, London, Paris or Tokyo is that smaller regional cities offer slightly less variation than their big city counterparts, making them less interesting on the whole. This lowered access to culture is far from trivial, if you subscribe to the Creative Class argument (which we do) proposed by Carnegie-Mellon economist Robert Florida, there’s a strong desire on the part of “knowledge workers” to locate in cities that offer greater cultural amenities and a dynamic environment. Knowledge workers—the computer programmers, consultants, analysts, venture capitalists and so forth—create and attract disproportionate amounts of wealth and capital, and therefore growth, and are therefore of pivotal importance to any city’s long-term future. For a small regional city, having less access to these workers only dims growth prospects.

So given that shifts in the airline industry seem likely to result in a new set of challenges for the economies of smaller regional cities, what should they do? While this is definitely a topic for another blog, we do have some high-level thoughts on the subject. One potential option would be for smaller regional cities to make the world come to them, either by playing up their unique resources (be they economic or cultural resources), to ensure that the world comes to them. For example, smaller cities like Austin, Portland or Vancouver have ensured that they’ve remained connected to the larger world either through adopting policies to develop or stress their cultural amenities (physical beauty and a vibrant downtown core in the case of Vancouver and Portland). An even more effective strategy for these smaller cities is to use the cultural amenities as a platform from which to drive future economic growth—coupling cultural policy that attracts knowledge workers with economic policy that encourages firms and workers to locate in a particular region. Austin, Texas is a case study in this regard, since it combines an eclectic local culture (South by Southwest) with a dynamic technology industry (Dell et al). In short, despite the fact that smaller cities will probably face a growing array of economic challenges, smart strategic planning can provide some templates for sustainable future growth.

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Traditional Market Research

We bill ourselves as a "non-traditional" team of market scientists. To understand "non-traditional" one must first understand the perceived value of "traditional market research". Many thanks to British designer Andy Foulds and Creativegeneralist.

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What It Means To Be Thirty

The uber-hip Brooklyn/NYC blog Gothamist.com (thanks Jen) has brought a new book to our attention, Book Of Ages 30. The book, which was launched yesterday, is the brainchild of mulitmedia collaborators (and NYC lifestyle bloggers) Joshua Albertson, Lockhart Steele and Jonathan Van Gieson. The first in a series of "landmark birthday" books, "30" has some interesting insights into the lives of American 30-somethings from the "big day" to the decade that leads up the the big four-oh.

This year about four million people in the United States will turn 30. If you’re one of them, the bad news is that you’re older than 42 percent of Americans. You’ve already lost 10 percent of your muscle mass. And, on average, you’re almost $20,000 in debt. But don’t despair. At 30, Harrison Ford was working as a carpenter, and neither Oprah nor Jane Austen had found fame. Edvard Munch’s famous painting The Scream? Created at 30. And, most heartening, you’re still gettin’ it on—2.24 times a week.
These are but a few of the factoids, demographic stats, quotes, biographical sketches, and sage and not-so-sage observations in Book of Ages 30, an illustrated book that chronicles this landmark birthday and the decade that follows. Featuring everything you ever wanted to know about your 30s—and a few things you probably didn’t—Book of Ages 30 offers a chance to reflect on past accomplishments, look ahead to future successes, and completely freak out —all at the same time.

Check out Book Of Ages 30 and the website both for curiosity's sake and a "sneak peak" at what the future of effective book promotion.

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Subterranean Homesick Blues in Neo-Tokyo

Due to a lack of space to facilitate future growth, urban planners in Tokyo are creating plans to move Tokyo underground. A recent Newsweek article reveals (in almost slack-jawed copy, no less) that:

Forget concrete jungles. Think glass-and-steel icebergs – huge, complex, structures hidden largely beneath the surface. That, say urban planners in Tokyo, is the future of the city.

WITH 27 MILLION residents, Tokyo is both the world’s most populous metropolis and, in many places, one of its most densely packed. That leaves little room for further expansion; already the average commute time is 56 minutes, with some salarymen traveling like sardines on local trains for as long as two hours. The solution? Build down instead of up. “To me it’s obvious that, in Tokyo, we have no choice but to go underground,” says Nobuyuki Takahashi, an engineering professor at Waseda University. “We have been studying the possibilities of deep-underground space for nearly 20 years.”

An underground Tokyo certainly appeals to the inner-14 year old comic/science fiction geek that lurks deep inside our collective subconscious’—how could we read this and not be reminded of the Morlock storyline in The X-Men, or think of the cool BladeRunner-esque possibilities of a subterranean city? However, it should be noted that the possibility of subterranean cities is a little less prosaic than Newsweek would initially like us to imagine. Most of the rationale behind an underground city is less about moving living/work space underground (so much for the Matrix: Reloaded-esque Zion that we’d hoped to live in) than moving the “guts” of the city (e.g. freeways, roads, etc.) beneath the surface so as to create more green space for city residents. In short, the underground city will probably consist of “Big Dig”-esque projects designed to free urban denizens from smog and congestion, rather than to provide goth kids a dystopian world in which to hang out and be misunderstood in.

Perhaps the whole plan to move Tokyo underground is just another massive Japanese public works project run amok, but from an urban planning perspective, the prospect of seeing freeways and infrastructure move underground sounds pretty cool. Alternatively, maybe we’re just interested in this article thanks to movies like Lost in Translation which highlight how bizarre Westerners find Japanese culture. Or maybe it was this great series by Seth Stevenson in this week’s Slate about Japanese culture that spurred our sudden interest in Tokyo. Or maybe it was our friend Sam’s obsession with all things Japanese that has Tokyo engrained on the brain. Either way, we can’t help but think about the thrilling prospects of having plenty of green space in a city, while who knows what lurks beneath.

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Mirco-surveys Are On The Horizon

The hardest product to sell?
Try selling an early morning Biology 101 class to 300 Freshman.
UMass has implemented a "personal response system" this year that ensures that students are not only attending lectures, but also that its professors are "connecting" with the bodies filling the seats.
At the beginning of the semester, UMass required its students to pay $36 for a small, wireless handheld transmitter that is supposed to facilitate more immediate feedback and question answering:

To connect with students in vast auditoriums, professors sprinkle multiple-choice questions through their lectures. Students point and click their transmitters to answer, pushing blue buttons numbered 1 through 9 on their keypads. A bar graph appears on the professor's laptop, showing the number of right and wrong answers; teachers can slow down or backtrack when there are too many wrong answers.
There is one major downside, at least for students. The transmitters are registered and assigned a number, so it's possible to keep track of who is showing up and who is skipping class. As we dimly recall from our raucous university days, one of the few upsides to taking one of those huge lecture courses with 800 people in them is that you're able to miss a class and remain unnoticed.
One has to wonder about the value that an 800-student survey class delivers. However, learning-environment aside, this micro-surveying method is an interesting development both for higher education and beyond.
With the advent of broadband and Wi-Fi, expect to see micro-surveying evolve from the classroom to the livingroom and beyond. In the living room, we have already seen micro-surveying taking place via Tivo's "thumbs up/down" preferences. Invariably, this information will be packaged, sold and shipped off to media companies in aggregate...and in real time. Could this be the end of pilot screenings? Furthermore, expect to see advertising change with the advent of micro-surveys. Web-enabled, and Wi-Fi compatible phones will be a marketer's dream, allowing media to be measured on the basis of effectiveness rather than awareness/impressions.
Not to get too sci-fi, but imagine a billboard with an offer for a local business. The billboard prompts interested passers-by to dial a number or hit a website to take advantage of a special offer. People with cell-phones call in or log in, get their digital 'coupon' and redeem it at the nearest retail location...which happens to be within a two block radius. But then again, the coupon-collector knows this..because walking/driving directions were piped to their GPS-enabled phone.
We can even take this hypothetical one step further. what if, all Nextel customers were real-time, research respondents. They would be paid for their opinions on various topics--piped directly to their cell phones. You are walking by a wi-fi billboard and the advertising wants to know what you think. Presto. A survey question pops up on their web-enabled cell phone. You give it a "four" on a one to five scale, keep going about your business and receive a $5 payment via Paypal. Or perhaps, you pass a billboard and, five minutes later, receive an awareness or purchase intent question via your phone. Finally, to make it really interesting, what if the billboard consisted of "smart paper" and it changed its message throughout the day...and measured each message's effectiveness?
We agree that it does sound a bit far-fetched, but we think that this is a scenario that is just around the corner...and one that drastically changes the way advertising is tested and marketing programs are implemented. In short, it doesn't bode well for the mall-intercept facilities around the nation. In the long-run micro-surveys will enable the agile marketer to act locally and succeed globally.

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