Writing about running an airline is the easiest thing in the world. Actually running one is another story altogether. I had always suspected this, but recently had a chance to prove it conclusively. Of course, our airline wasn't real. It was a simulation game developed by Lufthansa Consulting as a training tool for airline managers who need to know - well, how to manage an airline.
The necessary ingredients are as follows. You have three teams of five people each. Each team starts with an identical airline. The three airlines have been operating in a regulated market with traffic and revenues split equally among them. Their financial performance has been identical. However, at the start of the game the airlines have been privatised and the industry has been deregulated. Each airline now has complete freedom to make decisions on frequencies, fares, marketing policies, fleet and so forth. And each airline has a share price whose level is determined by the market's view of its performance.
This may sound familiar to some people in the real world. It's about to get more familiar. The instructors running the course have the ability to simulate very accurately the effects of hideous external events like recession, terrorist attacks, see-sawing exchange rates, plagues of locusts, and just about anything else you can imagine. And they have a nasty habit of injecting something unpleasant just as you think you have control of whatever difficult situation they last presented you with. Just like real life, really.
Of course, some things have to be simplified to make the game work. You are not allowed to launch new routes, because the intention is to make you compete vigorously on the four routes you started with (although you can withdraw from markets). There is no provision for complex issues such as traffic feeding across the hub, or codesharing alliances with other carriers. And there are no face-to-face negotiations with labour groups, although labour unrest is simulated. But most of the day-to-day activities of running an airline are simulated with sufficient accuracy for the exercise to be worthwhile.
We played for eight half-year periods. At the start, we had to define the airline's strategy, decide how the management team would work, interpret the data presented from the last period, make some medium-term and long-term fleet decisions, decide frequencies, fares, marketing policies and so on for the next period, and enter our decisions into the computer. We were given six hours.
The disks from the three teams were then collected, the computer performed the simulation for Period 1, and the disks were returned. We could then print out our results, review them, and make our decisions for Period 2. The decision making time was reduced steadily. At the end of the game, we had just 90 minutes to make all our decisions for Period 8.
While our team did not return the worst financial performance over eight gruelling periods, our performance was certainly, as any airline chief executive might say at a press conference announcing his losses for the year, 'below acceptable standards'.
We started well, increasing our net profit in the first period by 25 per cent to DM30 million ($20.3 million). After that, things went downhill badly. Our profits fell for two periods. Then we sunk into the red, and stayed there for four consecutive periods. It was only in the last period, when the economy was recovering and we had got to grips with the marketing, that we returned to profit. Over the four years, we lost DM102 million on revenues of DM3.2 billion. Our share price started at DM100, rose to DM156, fell as low as DM29, and then recovered to DM83. Our balance sheet was decimated.
The game posed most of the management challenges present in real life:
1 Information overload. We had masses of data, but it was not presented very effectively and there were significant gaps in information. Market research reports could be purchased, but they were not always reliable. The trick was to establish systems to make sure you made the best of the data available.
2 Shortage of resources. With only five people and very limited time, there was immense pressure to make decisions quickly.
3 Communication. Our mini-airline demonstrated very effectively that every decision you take in one area affects something else. Most of the key decisions had to be taken collectively, yet the number crunching was best done singly or in pairs. Getting this balance right was crucial.
4 Competitive pressure. You had to be innovative in the marketplace and second-guess your competitors, especially on pricing.
5 Financial pressure. The combination of losing money on the operation and borrowing money to finance new aircraft was nearly lethal as cash flowed out of the company and the balance sheet position deteriorated rapidly. Once the downward spiral had started, it was very difficult and time-consuming to climb out.
6 Decision making. The most crucial decisions usually represented impossible dilemmas. If we bought new aircraft, we would assume massive debt and suffer hefty loan repayments and depreciation charges. If we kept the old ones, our punctuality would suffer, we would lose business, we would spend a fortune on maintenance and fuel, and eventually the aircraft would expire anyhow. Too much capacity and we would fly with empty seats; too little and we would lose business to others through overbooking. Getting these tradeoffs right was crucial.
We knew all this at the start, of course, but the actual experience brings home these points very strongly. We made some horrendous mistakes, most of which have been made in real life by actual airline chiefs. Take our fleet decisions. We started with 10 aircraft, mostly ageing, with a poor average utilisation, and providing too much capacity in the market. It was clear that we could cut costs by streamlining the fleet, and at least half of the fleet would need to be replaced quickly. So we sold unwanted aircraft and ordered new ones. The trouble was, we ordered too many new aircraft and they all arrived during the recession.
Somewhat myopic
We all know how many airlines have done this before, yet we still made the same mistake. Why? Like many airline managers, we allowed ourselves to be sucked into a situation in which we became incredibly optimistic, somewhat myopic and hopelessly unrealistic. 'Recovery is round the corner,' we kept saying. 'There is going to be incredible growth. We must be ready for this, or else we'll be turning customers away. We can't rely on leasing companies having the right equipment. Newly ordered aircraft take years to arrive, so we'd better make that downpayment now.'
We compounded this by not calculating our costs rigorously enough, but then again we were not able to employ teams of people to work for months on studies.
Then there was marketing. As competition intensified and a fares war prevailed, all three airlines pumped alarming amounts of cash into marketing. But we relied too heavily on gut instinct. Once we adopted a more scientific approach, we were able to cut our marketing expenses, redirect the remaining money into areas where it was most useful, and watch revenues increase.
Finally, finance. We knew we were in trouble, but we failed to appreciate how quickly we were sinking into a financial quicksand. The airline which won the game got into a worse financial situation than we did, but its managers reacted slightly more speedily, thus giving themselves more time to effect a recovery.
We know we would do it differently next time, given the benefit of our experience. However, with a different set of problems we would still make mistakes. The most valuable lesson to be drawn from the experience is that you must learn to condition your thinking along the following lines.
The number one priority in a competitive environment is obtaining and maintaining a competitive advantage. This might be through lower costs; a better product (such as fleet or service); better technology (such as booking systems); better marketing; or better financial control.
Second, information is power. Without information, you cannot possibly make the right decisions. A successful company obtains the right market data and ensures its accuracy.
Then there's communication. Making sure that all managers have the external information they need to take decisions, discussing the decisions with each other before they take them, and informing everybody else afterwards, is a tough challenge in a mini-airline with five staff. Doing it with 50,000 employees, many of whom never come to head office, is just that bit more difficult.
Customers' behaviour
Understanding how different items interact with each other is vital. For example, each segment of the market will respond in a different way to changes in frequency, fares, punctuality, advertising spend, sales promotion, corporate image, sales efforts and service, as well as to what competitors are doing. But none of these items can be treated in isolation. Under standing how these marketing instruments combine to change the behaviour of customers provides you with a true competitive edge.
A great deal of management is essentially a numbers game, and it is all too easy to become swamped in detail and miss the big picture. The devil may be in the detail, but a wider overall view is also needed. The most effective management team will have the ability to manage the detail successfully while keeping a broad perspective of how the company is performing overall, what its strategy is and should be, and what is happening in the marketplace.
In fact, maintaining a balance is the real key to success. A successful airline is good at almost everything - strategy, cost control, marketing, teamwork, motivation and financial control. There's usually some luck involved, too - no wonder there aren't too many successful airlines.
Running an airline poses a constant intellectual challenge. That makes it fun. As long as it isn't your own money, that is.
Take advertising. There are standard curves which model consumer reaction to advertisements, taking into account the effect of saturation. In Gams, these curves have been altered to take account of the real market experience provided by Lufthansa managers. The same applies to market sensitivity to other instruments, such as pricing, frequency and sales representatives, and to market behaviour following external political and economic effects.
In terms of strategic management development, Gams has three objectives:
1 Networked thinking. With so many variables, it is difficult to see the whole picture, yet this is essential for successful decision-making.
2 Business systems. Managers have to learn how to analyse the masses of available information in the appropriate way.
3 Team building skills. No company can succeed on the basis of one individual.
Gams is designed to reflect how airline managers operating in a free market have to deal with complex issues, unpredictable competitive responses, and a fast changing environment. They have a perishable product which is very expensive to produce, so capacity planning is crucial. And many decisions, such as on the fleet, are difficult and expensive to change later on.
All new Lufthansa managers take a Gams course, but the game is finding more widespread applications outside the airline. For example, Gams is particularly appropriate for carriers which are not used to operating in a free market environment, or those which are being privatised and are going to have shareholders who want a return on their investment. Other players include people who are changing responsibilities within airlines, those starting up new carriers, and industry suppliers who need to know more about how airlines function.
The next step for Lufthansa Consulting may be to develop the game into a decision making tool. If managers could simulate the effects of their decisions on the whole airline before they take them in real life, expensive mistakes could perhaps be avoided.
Source: Airline Business
