A New Operating Paradigm

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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

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Airline crisis is unprecedented – current price levels appear consistent with long term trends

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Ce

nts

Pe

r A

va

ila

ble

Se

at

Mil

e(c

/AS

M)

(Ad

jus

ted

To

20

01

Do

lla

rs)

Unit Revenue and Cost Trend(U.S. Industry)

CASM decline:RASM decline:

1979–1992: 1.5%pa1979–1992: 1.8%pa

CASM increase:RASM increase:

1993–1998: -1.0%pa1993–1998: +0.6%pa

Note: CASM reduction Q3 2002 somewhat overstated due to accounting effects

Source: Company Financial Statements, Back Associates, BAH Analysis

Unprecedented cost-revenue gap, started before 9-

11

Risk that revenues will revert to “old”

trend line

Unit Revenue (RASM)

Unit Cost (CASM)

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Low Cost Carrier PotentialLow Cost Carrier Potential

The paradigm shift between point-to-point and network business models is far from over

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

~ 16-18% Small City Markets

TotalTotal

Non-StopService

Available

Non-Stop Service

Not AvailableTotalTotal

44% 6% 50%50%Major Hub Cities

7% 2% 9%9%Minor Hub Cities

10% 3% 13%13%Large Non-Hub

6% 2% 8%8%SWA Connection

9% 7% 16%16%Other

78%78% 22%22% 100%100%

U.S. Domestic Market Structure(O&D Passenger Trips Y2000)

~ 10% Over 2,000 Miles

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The fundamental threat to hub and spoke carriers lies in price realization

Average Yield(1) in Hub Markets

C/ASM

0

10

20

30

40

50

60

0 500 1000 1500 2000 2500

OA Yield No SWA preserve

OA Yield SWA conn

OA Yield SWA direct competition

SWA Yield non-stop

SWA Yield connect

Note: (1) Revenue per revenue passenger mile, including PFC and taxes

(2) OA: Other Airline

Source: DOT Y.2000 data, BAH Analysis

SWA non-stop competition reduces OA yields 25%-35%

SWA one-stop competition reduces OA yields 15-20%

SWA non-stop competition reduces OA yields 25%-35%

SWA one-stop competition reduces OA yields 15-20%

RANGE

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Total U.S. and U.S. - International O&D Market

Connecting Passenger Trips

Non-Stop Passenger Trips

The situation is complicated by an excess of hub capacity

Current Travel Structure(Passenger Trips, Y2000)

Source: U.S. DOT, BAH analysis

International

Domestic

No Non-Stop Service Available 22%

Inadequate Non-Stop Service 10%

Other Connections 9%

Connect In USA 30%

~70% Do Not Connect in US

~60% ofDomestic Trips Are

Non-Stop

Current Domestic Connections

~40%

~110 MO&D PAX

~410 MO&D PAX

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…resulting in an unsustainable revenue positions at hub-and-spoke carriers

Degree Of Price Sensitivity

Degree Of Price Sensitivity

Low:Individual chooses airline, travels on business or rich personal travel

Low:Individual chooses airline, travels on business or rich personal travel

Non-Stop Passenger Flight

Non-Stop Passenger Flight

20% - 30% revenue20% - 30% revenue

Connecting Passenger Flight

Connecting Passenger Flight

Medium:Corporation is principal decision maker, drives bargain

Medium:Corporation is principal decision maker, drives bargain

10% - 15% revenue10% - 15% revenue 10% - 15% revenue10% - 15% revenue

High:Mostly leisure travel and price sensitive business

High:Mostly leisure travel and price sensitive business

15% revenue15% revenue 10% - 15% revenue10% - 15% revenue

Generally Product Advantage

Significantly Higher Yields (Without LCC Price Impact)

Product Parity Or Disadvantage

Moderately Vulnerable

Vulnerable

Competitive Composition: Typical Mainline Carrier, Pre-Crash

20% - 25% of revenue

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Britannia

Average Stage Length (miles)

Cen

ts /

AS

MCASM Versus Stage Length

2000

Network carriers have a huge cost gap vs LCCs

BA

EasyJet

LH AF

KL

IB

Ryanair

SK

SWA ATA

AS AA

AWA

NW

DLCO

US

UATW

AirT

AZ

Source: BAH Analysis

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Financial Structure Work Rules, LaborRelations

Production Model Other

Drivers Of Unit Cost DifferencesU.S. Network Carriers and SWA

(737-300: Stage Length, Seat Density and Factor Cost Adjusted, Y2000)

c/ASM

7.2 12%

15%

70%

3%

Schedule

Process & Pace

Distribution

FrillsOther

Baseline(SWA)

-50%-50%

Much of this cost differential is a result of production model choices, not frills

Note: Average Airline based on Delta, United, and US Airways

G&A

Sales and Res

Other

Pax, Bag, Cargo Handling

Ownership Costs

Maintenance Costs

Fuel Costs

Pilot Costs

Onboard Costs

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Lower CostDifferentiated ServicesViability

Random hubbing Improved asset productivityReduce TAT and handling complexityAlter trade-off between efficient operation

and optimum connectivity

Random hubbing Improved asset productivityReduce TAT and handling complexityAlter trade-off between efficient operation

and optimum connectivity

Restructure Network / Hub Operations to Remove Scheduling Constraints

(“Below the Wing Processes”)Reduce

complexity, increase

pace

High service levels where needed or expected (local vs. connectivity)

Low-cost service levels where possible (high-value vs. low-value customers)

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”)

Separate simple from complicated tasks; apply tailored process streams

Reduce low-value interactions with staffSimplify reservation, ticketing, check-in

Separate simple from complicated tasks; apply tailored process streams

Reduce low-value interactions with staffSimplify reservation, ticketing, check-in

Simplify Customer Interface at the Airport and in Distribution(“Above the Wing Processes”)

Achieve pure business streams

Provide specialized

services and appropriate schedule qualities

A new business model may emerge that closes 70-80% of the cost gap and re-establishes product differentiation

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A new industry structure may emerge – or the next crisis will be a repeat on steroids

New Business ModelNew Business Model

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

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

Incremental EvolutionIncremental Evolution

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

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