Hives & Hubs
Hives & Hubs
Airline hub & spoke systems and emerging climate regulation: an intersection with traffic lights
(Image source: bikeradar)
Emperor Liu Bang, in the third century B.C., became the first ruler to consolidate China into a unified empire. He was seen as somebody who didn’t have the knowledge comparable to that of his chief advisors, including Chen Cen, his master who guided him through his campaign. What puzzled people was how he could become emperor.
“Why is he the emperor?” many asked. To which Chen Cen responded with the question: “What determines the strength of a wheel? Is it in the sturdiness of the spokes? Then why is it that two wheels made of identical spokes differ in strength?” asked Chen Cen.
Sturdy spokes poorly placed make a weak wheel. How their full potential is realized depends on the harmony between them. The essence of wheel making lies in the creator’s ability to conceive and create the space that holds and balances the spokes within the wheel.
Which is what emperor Lui Bang did in his team by placing individuals in the right positions that would fully realize their potential and between them. By enabling each individual, they grew and gave back to Bang with devotion. As an emperor, he flourished.
In many ways, the sturdiness of the wheel and position of spokes applies to airline hubs. It is where the industry derived the name “hub and spoke” system. But in aviation, the hub and spoke system may reach its peak in the current structure and could be challenged from a completely different angle.
Read on to find out how.
Since the late 1970s, deregulation in aviation markets has enabled new Air Service Agreements (ASAs) and even open skies agreements. Airlines with small home markets, such as Icelandair, Singapore Airlines, Swiss, and KLM, were able to build global networks through 6th freedom traffic, the combination of picking up passengers in one foreign country (3rd freedom of the air) and connecting them through their hub to another third country (4th freedom). This has brought many direct and indirect economic benefits, especially when the goal was around capitalizing on the positive economic multipliers of this model.
Passengers love choice, and access to discounts. It’s all about trade-offs. Lower fares by detouring and tackling connections are common - because that’s how airlines generate customers from other catchment areas. Or non-stop, e.g., AMS-JFK, at a premium. The transatlantic and Kangaroo routes are full of competing options. And some people enjoy layovers in Amsterdam or Dubai and have some fun. There is plenty of choice, and plenty of frequency.
The fortress hub and spoke (H&S) system became the prevailing industry competitive model through powerful alliances. In my very first job in the mid 1990s, we worked on the KLM-Northwest joint venture, often cited as the first of its kind. The H&S system is maintained through KPIs such as ‘quality of network’, which refers to the network breadth and density in terms of connectivity reach, transit efficiency, gate proximities, aircraft capacity and frequency levels. There are yield, passenger and seat load factors as well as cost and market share metrics to benchmark to assess this quality. Over 20 years ago while working at KPMG, I did my PhD in the economies of scope, economies of density, and economies of market dominance related to airline strategic management using reach and depth of H&S and the impact on airport economics. But times are changing. My own perspectives have, too.
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The intersection of where H&S will get challenged is around emissions, inefficiencies, and duplication of effort at industry level. These externalities were casually ignored in the old purely economic frame of reference. The externalities of multiple hub and spoke systems across nations and continents lie in the many detours passengers make, the peaks around departure waves at congested airports and the imbalances in resource requirements it creates, including staff and equipment, plus the overall increase in takeoff and landings because many Origin-Destinations (ODs) are combined through feed and hinterland operations multiple times a day.
Flexibility for passengers is not necessarily in mother nature’s interest.
Airports such as Amsterdam Schiphol in the past actually encouraged transfers. The fee airlines pay per transit passenger is now euro 13.50 while it is euro 28 for an originating passenger. This will increase to euro 18.50 and euro 38 by 2024 respectively. Over the years, it has in part made Schiphol the 3rd busiest airport in international pax count. But the future depends on shifting sands to areas where there is such a phenomenon.
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What would climate regulation do in combination with declining support for the fortress hubs elsewhere?
Climate regulation to curtail inefficiencies and penalize unnecessary emissions could include:
Imposing a Jet-A1 kerosene and even SAF fuel tax, currently exempt
Levy transfer passenger fees and departure taxes that exceed originating passenger fees
Taxing airlines and passengers per miles flown under “the polluter pays principle”
Reregulation of fares related to distance flown instead of market forces (raise floor levels)
Taxing airlines and passengers in proportion to the emissions of aircraft and engine equipment used (Cat. 1, 2, 3, etc.)
Reducing the number of airline AOCs and incentivizing mergers safeguarded by consumer protectionist fare regulation
A combination of all of the above.
All of this is controversial. But none of it is irrational from a climate perspective. Who manages the balance between individual business, national, and industry interests?
No market regulation is favored by airlines. No reregulation is likely welcome. However, a scheme beyond emission-trading that tackles the actual industry’s operating structure in light of emission impacts can only work at global level. National attempts to do so fail because markets shift and mother’s Global nature does not benefit.
The economic impact of smaller nations with (very) small home markets is likely to be the most detrimental to them. Can they participate in global economic benefits of a sustainable industry through consolidation and compensation? Is that the future of KLM, for example? It would require Air France-KLM to merge with another airline group and rationalize part of the Europe’s continental market as a hub with other regional mobility.
Shrinking fortress hubs by undermining the economics of density and market dominance underpinned by quality of network will lead to loss of connectivity due to lack of overall volume, which in turn will result in a loss of aircraft density and lower seat economics (large capacity wide body aircraft have better cost per passenger mile performance on long range, provided you can fill them). Airlines such as KLM would shrink to fewer point-to-point routes with smaller (narrow-body) aircraft.
This also does not solve the problem that when traffic does grow because of organic population growth, competition is still around frequency, creating potentially multiple daily departures (e.g. AMS-JFK) with narrow-bodies, thus increasing emissions compared to a daily widebody.
So, what are the most likely outcomes driven by the industry itself? I believe they are fourfold:
An acceleration in effort to replace short-haul, regional, operations by electric aircraft
Lobby to rationalize airport hubs and enable larger aircraft (medium-haul, long-haul) by revisiting multi-lateral air service agreements (e.g. EU-Americas or EU-Middle-East)
Influence market forces to reduce frequencies (e.g. 2D>1D) in favor of larger aircraft and streamlined airport processing and/or improved entertain-retailing to deal with more dwell times
Further consolidation among airline alliance groups as well as between airline alliance groups to enable between 6-10 global air transport companies under close multi-lateral governmental oversight.
With reduced frequencies and longer airport layovers, there may be a renewed case for ultra-large capacity aircraft like the A380 or its potential (unlikely) successor.
It’s just not how the industry wants to compete. Can regulators make them?
Also, does the traveling public accept this?
None of the above happens overnight and may not even be realistic. But from an industry competition model, something clearly will need to be doctored and brokered between nations.
Maybe the Airbus A380 was ahead of its time. Maybe another ULC aircraft will be revisited in a few decades.
What do you think?
Wishing you all a wonderful day.
Ricardo
Montreal, Tuesday, 22 November 2022
Feel free to contact me for questions, comments, or a chat: ricardo DOT pilon AT millavia DOT com or for startup and VC assistance, ricardo AT pomonaworld DOT com.
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