In forecasting demand, the airline industry could be mixing apples with oranges
by: The Boston Consulting Group
Two rules of thumb often cited in the airline industry are "Demand for air travel grows twice as fast as gross domestic product" and "Airline yields always drop over time." Both statements are at least partly true. Yet a report by The Boston Consulting Group (BCG) argues that industry planners often overlook how fundamentally intertwined they are.
|Demand for air travel does indeed grow at a multiple of GDP, according to Understanding the Demand for Air Travel: How to Compete More Effectively. "However, managers often extrapolate from historical growth rates as the starting point for capacity planning," explained Ross Love, leader of BCG's travel and tourism practice and coauthor of the report.
In fact, the historical rate is the sum of two very different types of demand growth: underlying growth, which occurs naturally over time and is driven by external factors, and induced growth, which arises whenever airlines choose to increase a market's capacity. Once excess capacity enters the market, airlines often conclude that the economics of filling those extra seats with discount tickets are better than the economics of allowing the seats to go empty. The number of passengers (or demand) increases to fill the excess capacity, but at a lower overall price.
"Extrapolating from underlying demand makes more sense," said James Goth, a manager in the Sydney office and another report coauthor. "Extrapolating from induced demand runs the risk of building in overcapacity and accelerating yield decline, without necessarily having a clear strategic intention."
By understanding the difference between the two types of demand, an airline can predict future yields and economics for each of its routes with more accuracy and make better decisions on crucial strategic questions of where and how to compete. For the industry as a whole, a sharper focus on matching decisions about fleet size to the true outlook for underlying demand growth will help avoid the problems of overcapacity that have plagued it in the past.
More focus on understanding what influences customers -- and perhaps less on buying aircraft to fly them in -- could create a better outcome for airlines, their shareholders, and the industry.
This report is the first in a five-part series on the airline industry produced by The Boston Consulting Group's travel and tourism practice. Upcoming topics will include the impact of China and India on long-haul travel, the rise of Middle Eastern carriers, the potential decline of the megahub in airline traffic flows, and the importance of cost in long-haul flying.