Materials and Services: Indirect


By Daniel Maschoff

Actions Procurement Professionals Should Take Now
Market Buzz and Trends to Watch

Actions Procurement Professionals Should Take Now

By the time this is published, American Airlines (AA) will likely have left bankruptcy and be well down the path towards merging with USAir. Assuming the merger progresses as expected, this blockbuster deal has major implications for travel procurement professionals.

While many high level decisions and outcomes related to the merger may not be easily influenced, travel procurement and spend management professionals should consider certain facets of the merger that they can impact, including the following:

  1. Airline service disruptions related to a merger can occur from operational systems and process failures and challenges with workforce and culture integrations. It may take some time for substantial changes to occur in operational aspects including airport services, reservations systems and procedures. However as the recent challenges in the United Airlines and Continental Airlines UA-CO merger demonstrated, a material risk of service disruptions exists.

    It may be impossible for individual travelers to avoid service disruptions, but travel procurement professionals can use targeted communications to the most likely impacted travelers to prepare and advise on options. Worst case, periodically booking away from the supplier may be a necessary option. Supplier management programs should track and document service problems and be leveraged for compensation, including increased “waivers and favors” and other “perks” for the impacted travelers.

  2. Both AA and USAir frequent traveler programs will be rationalized to reduce duplication and to gain operating synergy efficiencies. This rationalization, occurring in an overall less competitive environment, will also present an opportunity for making changes that benefit the airline’s perspective. While merging these programs may also provide traveler benefits, it could include restructuring earnings rates, qualifying mileage, redemption rates and additional program perks that favor the airline rather than the frequent traveler.

    There may be limited opportunity for individual travel spend managers to impact the overall alignment of their frequent flier programs, but negotiating for the maximum frequent flier status upgrades in the immediate term may protect the frequent travelers’ allegiances and compensate for short-term service disruptions (and ergo, successfully protect the airlines’ market share long term).

  3. Another merger goal may be reducing the cases where AA and USAir overlap today. In general, it’s likely this merger will encourage the recent trend of declining airline industry capacity, and it will most likely impact the current AA and USAir duopoly markets. This implies some cities may lose non-stop flights to some destinations.

    While reducing the overall service value, shifting to a more competitive landscape of one-stop or connecting service may actually improve competitive pricing. Increasing travelers’ consideration and use (either by necessity or by policy controls) of one-stop and/or connecting flights can be powerful levers for travel-spend professionals.

  4. In general, reduced competition and capacity and solid demand will support increased prices, and this merger is no exception. For routes where only AA and USAir compete today, direct price increases are a high likelihood. However, in markets where AA and USAir compete along with other airlines, pressure for higher prices can be minimized, depending on market conditions and strategic initiatives. Those markets not served by AA or USAir today are potentially only going to see marginal impact on prices, but even those will likely be upward.

    To mitigate these upward pressures, the travel category professional must focus on initiatives to direct spend so that specific airline market share goals are achieved. This includes a potential strategy to shift new, incremental volume to AA/USAir as a “carrot” to mitigate these increases through negotiations. Alternatively, another scenario might warrant shifting volume away from AA/USAir to other competitive airlines as a “stick” to AA/USAir and “carrot” to the other airlines to induce incremental improvement in discounts they offer as a way to offset increases in AA/USAir prices.

In conclusion, partly based on the AA and USAir merger, and partly based on recent trends, changes to the airline industry are creating upward price pressure for the near term. Identifying those specific market opportunities to incrementally improve market share spread among the airlines, along with a fully leveraged negotiated discount program structure, can help mitigate price pressure.

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Airline Capacity

Among the key leading indicators for airline pricing trends are the changes to airline capacity. Airline capacity is determined by both flight frequencies and the size of aircraft. Coupled with even flat demand, increasing flights or upgrading to larger planes will quickly dilute pricing leverage. Conversely, reduced capacity highly correlates with increased pricing power, and recently with increased revenue and profitability for airlines.

IATA, the global airline trade association, reported in December that global air passenger demand grew by 5.3 percent in 2012 but capacity only grew by 3.9 percent. This helped power the airline industry to a forecasted $6.7 billion in profit for 2012, which is an upwards revision from October’s estimate of $4.1 billion.

A recent study from Morgan Stanley suggests that in 2013, airlines, especially in the North American market, will add only limited capacity. Domestic U.S. capacity will only increase by 2 percent and international capacity will not change. United Airlines targets up to a 5 percent reduction in system-wide capacity in 2013, and Delta expects between and 2 percent and 4 percent decline in total capacity.

Given that in its recent forecast for 2013 projected a 4.5 percent growth in passenger demand, it is not surprising that IATA also forecasts growth in profitability to $8.4 billion. This suggests airlines will remain cautious about growth in passenger capacity to maintain profitable performance with much more discipline than in the past.

Accenture’s Take:
An airline’s capacity is not a variable for travel category procurement professionals to control, and a company’s demand for air travel between specific city pairs is usually relatively “fixed” (and impacted only when travel doesn’t occur at all). Further, the data suggests that growth in demand for air travel is going to generally outpace capacity increases. So, how can travel category professionals respond?

First, understand which airlines fly on the top routes and their overall capacity profile. Then track changes in the competing carriers that fly these routes (i.e. “new entrants”), changes in the number of flights, and/or in type of aircraft equipment to identify those markets with increased capacity. The group of the top routes that have an increasingly competitive environment may also have a more favorable negotiating environment than markets with declining capacity. We suggest focusing on this group of markets with increased capacity for specific negotiation outcomes.

Airlines will generally set discounts for larger groupings of markets, but focused negotiations can include requests for increases to discount percentages associated with these specific city pairs, or potentially for “fixed fares” applicable to these routes. This kind of micro-targeting may be more successful than broader negotiating strategies impacting routes without capacity growth.

Buying in periods of declining supplier capacity is challenging, but with some detailed analysis, some points of advantage can be identified and used as leverage to offset pricing power in other markets and routes.

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