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A New Operating Paradigm

A New Operating Paradigm. Booz Allen Hamilton. Leading strategy and technology consulting firm 11,000 employees, $2.2B Founded in 1914 Our clients in air transportation: Governments, airports, air navigation providers

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A New Operating Paradigm

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  1. A New Operating Paradigm

  2. Booz Allen Hamilton • Leading strategy and technology consulting firm • 11,000 employees, $2.2B • Founded in 1914 • Our clients in air transportation: • Governments, airports, air navigation providers • Airlines, logistics, GDSs, travel agencies, equipment and service providers • A global team: USA, Europe, Asia, Latin America, Africa • Breadth: • Strategy, operational restructuring, organizational design • Systems design and implementation support • Policy and regulatory advice RPUS1747-0126-011303v1.ppt

  3. Unprecedented cost-revenue gap, started before 9-11 Airline crisis is unprecedented – current price levels appear consistent with long term trends Unit Revenue and Cost Trend (U.S. Industry) Unit Revenue (RASM) Unit Cost (CASM) Cents Per Available Seat Mile(c/ASM) (Adjusted To 2001 Dollars) CASM decline: RASM decline: 1979–1992: 1.5%pa 1979–1992: 1.8%pa CASM increase: RASM increase: 1993–1998: -1.0%pa 1993–1998: +0.6%pa Risk that revenues will revert to “old” trend line Note: CASM reduction Q3 2002 somewhat overstated due to accounting effects Source: Company Financial Statements, Back Associates, BAH Analysis RPUS1747-0126-011303v1.ppt

  4. Low Cost Carriers (LCCs) can conservatively participate in 70% of the US market LCCs now participate in 43% of O&D market Significant growth potential remains Eastern U.S. Increased breadth in existing strongholds Increased depth in O&Ds currently served The paradigm shift between point-to-point and network business models is far from over U.S. Domestic Market Structure (O&D Passenger Trips Y2000) Low Cost Carrier Potential Non-StopServiceAvailable Non-Stop ServiceNot Available Total Major Hub Cities 44% 6% 50% Minor Hub Cities 7% 2% 9% Large Non-Hub 10% 3% 13% SWA Connection 6% 2% 8% Other 9% 7% 16% Total 78% 22% 100% ~ 10% Over 2,000 Miles ~ 16-18% Small City Markets RPUS1747-0126-011303v1.ppt

  5. The fundamental threat to hub and spoke carriers lies in price realization Average Yield(1) in Hub Markets 60 OA Yield No SWA preserve 50 • SWA non-stop competition reduces OA yields 25%-35% • SWA one-stop competition reduces OA yields 15-20% OA Yield SWA conn 40 OA Yield SWA direct competition C/ASM 30 SWA Yield connect 20 SWA Yield non-stop 10 0 0 500 1000 1500 2000 2500 RANGE Note: (1) Revenue per revenue passenger mile, including PFC and taxes (2) OA: Other Airline Source: DOT Y.2000 data, BAH Analysis RPUS1747-0126-011303v1.ppt

  6. The situation is complicated by an excess of hub capacity Current Travel Structure (Passenger Trips, Y2000) Connect In USA 30% ~110 M O&D PAX International ~70% Do Not Connect in US ~60% ofDomestic Trips Are Non-Stop ~410 M O&D PAX Domestic Other Connections 9% Inadequate Non-Stop Service 10% Current Domestic Connections ~40% No Non-Stop Service Available 22% Source: U.S. DOT, BAH analysis RPUS1747-0126-011303v1.ppt

  7. 20% - 25% of revenue …resulting in an unsustainable revenue positions at hub-and-spoke carriers Competitive Composition: Typical Mainline Carrier, Pre-Crash Degree Of Price Sensitivity Non-Stop Passenger Flight Connecting Passenger Flight Low:Individual chooses airline, travels on business or rich personal travel 20% - 30% revenue Medium:Corporation is principal decision maker, drives bargain 10% - 15% revenue 10% - 15% revenue High:Mostly leisure travel and price sensitive business 15% revenue 10% - 15% revenue Generally Product Advantage Significantly Higher Yields (Without LCC Price Impact) Moderately Vulnerable Product Parity Or Disadvantage Vulnerable RPUS1747-0126-011303v1.ppt

  8. Network carriers have a huge cost gap vs LCCs CASM Versus Stage Length 2000 SK AZ AF LH US BA KL Cents / ASM EasyJet IB AA AS UA NW TW AirT CO AWA DL Ryanair ATA SWA Britannia Average Stage Length (miles) Source: BAH Analysis RPUS1747-0126-011303v1.ppt

  9. Much of this cost differential is a result of production model choices, not frills Drivers Of Unit Cost DifferencesU.S. Network Carriers and SWA(737-300: Stage Length, Seat Density and Factor Cost Adjusted, Y2000) 7.2 12% c/ASM Other 15% G&A Sales and Res 70% Schedule Pax, Bag, Cargo Handling -50% Process & Pace Ownership Costs Onboard Costs Distribution Maintenance Costs Fuel Costs Frills 3% Other Pilot Costs Baseline(SWA) Note: Average Airline based on Delta, United, and US Airways RPUS1747-0126-011303v1.ppt

  10. A new business model may emerge that closes 70-80% of the cost gap and re-establishes product differentiation • Random hubbing • Improved asset productivity • Reduce TAT and handling complexity • Alter trade-off between efficient operation and optimum connectivity • Separate simple from complicated tasks; apply tailored process streams • Reduce low-value interactions with staff • Simplify reservation, ticketing, check-in Restructure Network / Hub Operations to Remove Scheduling Constraints(“Below the Wing Processes”) Simplify Customer Interface at the Airport and in Distribution(“Above the Wing Processes”) Reduce complexity, increase pace • Lower Cost • Differentiated Services • Viability Provide specialized services and appropriate schedule qualities Achieve pure business streams • High service levels where needed or expected (local vs. connectivity) • Low-cost service levels where possible (high-value vs. low-value customers) Create Separate Business Systems for Distinct Customer Segments(“Product Differentiation”) RPUS1747-0126-011303v1.ppt

  11. A new industry structure may emerge – or the next crisis will be a repeat on steroids New Business Model Incremental Evolution • 2-3 new network based carriers emerge by continent • 1 or 2 random hubs each • Many centers of mass a la SWA • Greater focus on non-stop services • 1-2 low costs carriers by continent • Regional carriers that perform two missions • Feed for limited number of random hubs • Point to point flying in business and smaller markets • Network carriers stick to current business model • Continued share loss to LCCs • Low cost subs fail again • Regional operators take over larger proportions of network • 1-2 low cost carriers succeed by continent • Regional carriers pick up failing routes, remain more focused on feed • Next crisis is an amplification of current one RPUS1747-0126-011303v1.ppt

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