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McKinsey on Travel & Logistics Published by The McKinsey Quarterly May 2006 Lloyd Miller An in-depth look at the challenges facing senior...

1. What are the differences in the design models? Compare and contrast the standard airline organizational functional structure model with the hybrid structure based on independent business units. Does the hybrid structure provide too much differentiation? How would support structures be the same or different? To what extent are either models mechanistic vs. organic? Why?
2. What effect does the choice of a model have on managerial authority and control? Would there be a greater or fewer number of managers in one model versus the other? Greater or lesser span of control? How does this relate to the principle of minimum chain of command? Horizontal vs. vertical differentiation? Rational-legal authority?
3. Which model is better from the standpoint of work specialization and coordination? If one model is functional, what model aspects are present in the hybrid structure? How would you improve the hybrid model? Why? What are the advantages and disadvantages of each model as it pertains to coordination? Networking?

McKinsey on Travel & Logistics
Published by The McKinsey Quarterly May 2006 Lloyd Miller An in-depth look at the challenges facing senior managers A new organizational model for airlines
They should consider the business unit model, but independence must be balanced by coordination. Article at a glance
Over the past decade, traditional airlines have responded to heightened competition by diversifying,
which makes them more complicated to manage.
A good way to make these diversified companies more agile and competitive is to adopt a new
organizational model: semiautonomous business units that are responsible for their own profitability.
The transition is tricky, however, and companies that get it wrong will miss out on the advantages of
the new organization.
To get the greatest benefit from the new model and maximize overall profitability, a company must
balance the autonomy of the business units with the need to coordinate some of their activities. 1 A new organizational model for airlines Yael Heynold and Jerker Rosander at the top of some companies began to hinder their
ability to respond rapidly to shifting competition. Over the past decade, as competition in the The focus of top executives on the core passenger airline business has intensified, traditional carriers airline often diverted attention from emerging have pursued strategies to spur growth, trim opportunities in higher-margin businesses. costs, and improve profits. To counter the threat Performance suffered as parts of companies lost from low-cost competitors such as Southwest sight of the bottom line, and a lack of information Airlines and Ryanair, some have created their impaired both cooperation and oversight. own budget or regional carriers. The result: today
the world’s 20 largest aviation groups operate To avoid these difficulties, large, diversified about 50 airlines. In pursuit of higher profits, aviation groups should contemplate a major large traditional airlines have also diversified into overhaul to replace the functional organization related businesses. In doing so, they broaden with a number of business units that have their customer base to provide services (such as more autonomy and accountability for their aircraft maintenance and catering) to other airlines performance. Such fundamental change in and to other kinds of operators (for instance, air the shape of a company is a big step that can cargo space to freight forwarders and maintenance take three years or more to complete, but the services to the defense sector). To reduce costs, advantages of the business unit model can make these airlines have repeatedly sought concessions the shift worth undertaking. This model helps from their workers. companies respond more quickly to changing
market conditions, focuses middle managers on Such changes greatly increased the complexity of
managing aviation groups, which have traditionally �������
been organized along functional lines, with all
operations from sales services to flight operations
reporting directly to the CEO (Exhibit 1). As this
complexity increased, decision-making bottlenecks profitability, enables business unit managers
to negotiate more competitive labor terms, and
promotes the development of talented young
leaders. Indeed, the business unit approach has
already been fully adopted by several aviation
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���������� ����� 2 A new organizational model for airlines Canada, Qantas Airways, SAS, and Singapore operations. Functionally organized airlines often Airlines more recently. lack the flexibility to meet the varied needs of an
ever more diverse customer base—a problem that Aviation groups switching to the business unit crimps their ability to grow in ancillary businesses model must avoid several pitfalls that can erase and in the fast-expanding market for budget travel. the positive effects of the new organization. The Because managers in a functional organization, challenge is to balance greater autonomy for with the exception of the CEO, aren’t responsible business units with close collaboration among for profitability, costs can easily get out of line. them when coordinated efforts are essential for Moreover, labor agreements that cut across maximizing the group’s profit; poor coordination, several parts of a company can lead to higher for example, can hobble strategic functions wages and benefits as everyone from baggage such as planning for a company’s flight network handlers to the catering staff receives some of the and aircraft fleet. But if coordination efforts go same perks the cockpit crew gets. overboard, units will fail to embrace accountability
for profits, duplicate roles will emerge, To counter those shortcomings, aviation groups bureaucracy will proliferate, and costs will rise. should take a hard look at the idea of adopting Finally, the CEO and the corporate center may well a new form of organization structured around maintain too much decision-making authority, separate business units, each with broad decision- thus undermining the agility and accountability of making authority and responsibility for its own the business units. profitability. Such a structure resembles the
classic business unit model of many diversified Outgrowing the traditional model companies and of many retailers and banks, For airlines, the functional organizational model where individual units operate independently on worked well for decades. It promoted deep a day-to-day basis and set their own strategic technical expertise and economies of scale direction. For airlines, however, this structure by grouping specialists together and focused must differ in one significant way: units operating accountability for the direction and efficiency of as stand-alone businesses would quickly destroy all divisions on one person: the chief executive. the network value that comes, for example, from Peripheral businesses and small customer coordinating interconnecting flight schedules, segments typically got limited attention from efficiently allocating aircraft across a number of management, however, while the mainstream routes, and using the fare structure to maximize passenger business received most of the attention. revenue throughout a large network. Airlines thus This functional model probably remains the best need a hybrid structure that reaps the benefits choice for some aviation groups, particularly of independent business units while maintaining those that outsource most support functions strong links among them (Exhibit 2). (such as catering and maintenance), lack the
sophisticated information systems needed to This type of organization has substantial manage more complex structures, or serve only a advantages for diversified aviation groups. To few homogeneous customer segments. begin with, business units with independent
operating authority can tailor their strategies Yet many other carriers, like railroad and oil and respond more quickly to changes in the companies before them, have outgrown the marketplace. After SAS created separate traditional model. The rise of low-cost carriers is business units for Denmark, Norway, and altering the nature of competition in the industry Sweden in 2004, for example, each unit gained a by spurring some traditional airlines to expand better understanding of its unique competitive into businesses that offer higher margins or challenges. As a result, the Swedish unit moved require less capital than their core passenger swiftly to develop a tailored response to growing �������
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���������������������������������������������������� competition from local low-cost carriers: it can focus on strategy. The CEO of a traditional simplified the service offering on domestic flights, network carrier that recently switched to business added 12 direct flights from Stockholm to other units, for example, freed up several hours a week European destinations, and adopted pricing based by delegating to business unit leaders tactical on one-way travel. Overall, the tailored business decisions about the number and type of aircraft unit strategy, resulting from increased autonomy, that should be added to existing routes. In the past, shortened decision times, and entrepreneurial he had routinely mediated debates between the management, generated an eight-percentage- manager of the group’s fleet and network, who point increase in the utilization of available seats tended to recommend adding capacity, and the in the second quarter of 2005, to nearly 70 percent. more conservative sales manager. This CEO now Autonomy can also spur growth in neglected intervenes only when serious disputes arise and parts of a company. At Lufthansa, for instance, the spends the freed-up time on regulatory questions share of group revenue from ancillary business and other strategic issues. units such as Technik (the maintenance division)
and cargo increased by about ten percentage The new structure can help reduce costs too. When points, to 35 percent, from 1995 to 2004. business unit managers negotiate a labor contract, Once an aviation group’s top executives have less employee work rules and wages should be in line responsibility for day-to-day operations, they with those of direct competitors, especially in for instance, they can make a stronger case that 4 A new organizational model for airlines short-haul airlines and support services such as one of several traps—above all, a tendency to catering and ground handling. SAS, for example, underestimate the importance of coordination managed to negotiate labor unit cost reductions among the newly created airline business units. of more than 10 percent as part of its Turnaround In several companies where individual airlines 2005 program. The new business unit structure were given full control over their own networks made an important contribution because it and schedules, the parent organization failed to provided for the use of more direct benchmarks ensure that their efforts were complementary. from the labor arrangements of competing low- As a result, the airlines within these companies cost carriers. started to compete against one another. Although
these groups’ airlines did collectively gain market Furthermore, business units make companies share, yields declined and profits suffered. more transparent by allowing executives to
assess any unit’s profitability with an accuracy Managers in a business unit that is accountable and level of detail that often can’t be attained for its own profitability also tend to optimize its in functional organizations. This transparency costs or revenues, even at the expense of the promotes accountability for performance as group. Business units may, for example, want to well as a better allocation of capital and talented purchase call-center services from a low-cost managers within the group. In one aviation outside supplier even if the group is left with company, for instance, the creation of business excess capacity. The new structure can also lead units made possible simple comparisons of to wasteful duplication of support functions, with returns on capital that had previously been out each business unit establishing unnecessarily of reach. As a result, the top management of large independent staffs for human resources, the group increased its investment in regional accounting, or other functions. Although business airlines that not only fed passengers to the core units do need small staffs for these functions, airline hubs but also generated attractive margins larger head count reductions in the corporate because returns in those regional businesses center should more than offset the numbers. were several percentage points higher than the
returns of the core airline. Nonetheless, giving business units too little
freedom can be just as troublesome as giving By creating more positions with profit them too much. Under a functional structure, responsibility, the business unit structure the CEO and other top managers have hands-on helps airlines to retain stars and groom future operational responsibility. It can be hard for them leaders who can serve in “CEO-in-training” roles to cede decision-making power to the newly (where promising young managers run their appointed heads of business units. Indeed, for top own businesses). In one group, for example, managers, the transition to a different leadership the freight division was seen as boring until it style can be among the most difficult aspects of became an independent unit with an attractive reorganizing. In some companies, executives who CEO role. An up-and-coming executive was failed to adapt had to leave. appointed to run the business, which then
became one of the most desirable parts of the To avoid these traps, companies must make two company for high-performing managers. It is now fundamental changes when they reorganize: they growing profitably by more than 15 percent a should establish a clear division of responsibility year, twice as fast as it had been earlier. between the business units and the corporate
center as well as create formal links among Making business units fly business units to ensure smooth cooperation. The shift to a business unit structure is a
delicate, complex operation. Experience shows Defining roles that aviation groups tend to get caught in For business units to function autonomously, 5 A new organizational model for airlines they must play clearly defined roles within the strategic objectives. When each business unit’s group. Airlines constitute one type of business annual profit targets are in line with the expected unit, with each airline typically targeting related profitability of its routes, units that have been customer segments that together are big enough told to fly less profitable ones are not penalized. to justify its own fleet of aircraft. These airlines O f course, the more each airline operates in are supported by services business units, such distinct geographic markets or serves unique as maintenance and catering, which compete customer segments, the less the corporate center in distinct subindustries and are organized needs to intervene. around their specialized assets—for example,
aircraft hangars and repair equipment. All of the In addition, the center must manage the group’s back-office functions of these business units brands, determining, for example, which business should be as decentralized as possible. Support units are allowed to use the parent company’s activities (including accounting, budgeting, and name. A group’s airlines and support businesses performance evaluations of middle managers) may need its brand to attract customers. Other should shift to business units. Where substantial units, including ground handling, may benefit from economies of scale exist, in activities such as the image of independence conferred by a name payroll and revenue accounting, operations with no connection to the group. The corporate should be centralized under a separate business center must also ensure that business units unit that handles shared services. To ensure that using the name of the parent adhere to its brand the total number of back-office employees in the attributes, such as quality and safety standards. group decreases under the new model, the CEO’s
reorganization plan must include head count Financial controls must remain firmly centralized, targets for business units, shared services, and with a team to ensure accounting integrity, the corporate center. to measure the performance of business units,
and to allocate capital or divest businesses. In the new structure, the corporate center Whether business units should purchase catering, handles tasks for which central control remains maintenance, ground handling, and other services most effective. One such task is fleet strategy: internally or externally also is a question for the determining the optimum number of aircraft, the center. Similarly, it should decide whether units are best mix of aircraft types, and the appropriate free to seek external customers, as some airline balance between purchased and leased planes. groups’ maintenance units are doing. These are the company’s biggest capitalinvestment decisions, and they affect all business Coordinating business units units. A coordinated fleet strategy also permits Business units need guidelines on how to interact. top management to shift aircraft among units To create the right economic incentives, the according to demand. group should establish transfer prices for major
products and services traded internally. Pricing The design of the route network should be should balance accuracy with practicality and coordinated centrally as well. Although each be detailed enough so that airlines can make airline in a company should propose its own intelligent trade-offs between the level of service optimal network, invariably several will want to they provide and the costs they incur. Take the fly the same attractive routes during times of case of the customer service agents who handle peak demand or to exit cities where the point-to- passenger check-ins. An airline “buys” this service point economics are unattractive. In such cases, from the ground-handling unit, and premium the center, in deciding which business unit flies benefits should cost more than the basic service. where, must take into account the profitability For example, airlines offering their passengers of the overall network or the group’s broad short waiting times with a number of check-in 6 A new organizational model for airlines options—at the main service counter, in the embodied in simple, practical documents, of ten frequent-flier lounge, at the departure gate, and at pages or fewer, that are developed by business the valet-parking drop-off—would pay more than units—without help from lawyers. airlines requiring passengers to tolerate a single
long queue. Other interactions not related to products and Ideally, prices should be based on the cost of category involves decisions that are made in buying products and services on the open market, one business unit but impinge on the processes an approach that works well where there is a of others—for example, the creation of the choice of service providers. Sometimes, however, flight schedule, which has a bearing on most aviation groups dominate their region, and no operations. Activities (such as corporate sales, competitive market exists for some services. In call centers, and fuel purchases) that could that case, transfer prices should be based on benefit from economies of scale make up another the company’s actual costs plus a fair return of these categories. Finally, activities such as on capital. Because there is no competitive yield management, marketing, and safety can services must also be considered. A major downward pressure on prices, the corporate benefit from shared skills. For all these activities, center should set annual improvement targets— airlines need mechanisms that coordinate the for instance, by benchmarking costs at similar work of the business units. The mechanisms may companies when possible. include rigorous processes that cut across them,
routine information exchanges, and committees Establishing transfer prices can be tedious that meet regularly. because many airlines lack detailed financial
data and benchmarks. To avoid lengthy internal One Asian aviation group’s experience with arguments, the corporate center should establish scheduling illustrates the importance of close clear standards for both the required level of coordination. After the group was restructured detail in the price structure and the step-by- into business units, each of its airlines developed step process that business units must follow to flight schedules. These were passed on to the determine prices. Once they have been set, the business units responsible for maintenance, corporate center should regularly review whether ground handling, and other services so that they they are up to date and reflect actual costs or could develop their own plans. One airline in the market prices. The main effort to set internal group scheduled very late departures from its prices typically takes about a year. Because main hub. After a year of poor profitability, the transfer prices require such effort to put in place, airline and other business units began to explore business units often resist them at first. Before ways of jointly reducing costs. Only then did the long, however, business units tend to embrace airline learn from the ground-handling unit that them because they show, for the first time, what it if its last planes departed just 20 minutes earlier, takes to make the business profitable. two shifts of workers instead of three would
suffice, significantly lowering labor costs. Business units must also formalize their
performance expectations for the products That experience inspired changes in the and services they exchange internally. They scheduling process for all of the group’s airlines. should strike agreements that focus on the most Now they ask the business units to give them important elements, such as quality, delivery feedback on draft schedules, thereby allowing times, penalties for any failure to meet previously the group to make scheduling trade-offs that agreed standards, and joint initiatives to improve take into account the influence of departure performance. These agreements should be times on revenues and costs. The new process 7 A new organizational model for airlines dramatically increased the number of participants with the need to coordinate their efforts. in the scheduling process but reduced the airlines’ Meanwhile, the corporate center must relinquish ground-handling costs by around 10 percent. most operating roles in order to focus on
strategic activities and on oversight of the business Experience shows that switching to a business
unit structure benefits aviation groups with a
number of airlines and well-developed services
businesses: it helps these airlines to become more
competitive in a market where the growing rivalry
from low-cost carriers and high fuel prices are
squeezing margins. To reap the benefits of the
new organizational model, aviation groups
must balance the autonomy of the business units units’ performance. Q
Yael Heynold is a principal in McKinsey’s Sydney office,
and Jerker Rosander is a principal in the Stockholm office. Copyright © 2006 McKinsey & Company.
All rights reserved.

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1. What are the differences in the design models? Compare and contrast the standard
airline organizational functional structure model with the hybrid structure based on
independent business units....

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