If 007 is taking cover for the next few months, what hope is there for us mortals left exposed to the economic ravages of the spreading coronavirus? The release of the next James Bond film, No Time To Die, has been postponed until November. There will be better profits made then, and film distributors can afford to wait.
Others can’t, though, they have to battle through some tough times ahead, and airline Flybe collapsed on Thursday, the first to fall because it had underlying financial health problems in the most exposed sector to the economic impact of coronavirus. This has been underlined with an announcement by Lufthansa that it plans to cut up to half its capacity in the next few weeks, while grounding its biggest aircraft.
There will likely be big differences in vulnerability and impact between sectors. There will be a shift to online shopping, but while household income is uncertain, big ticket expenditure could stop abruptly. But let’s look at Flybe, because in reality the sharp downturn in revenue in response to the global infection was the final straw that broke their business model, and offers insights to startups intent on an aggressive, high growth strategy.
Flybe carried 8m passengers a year between 56 airports in the UK and Europe, with over 210 routes across 15 countries, but had a very unstable fragile strategy, operating model and ownership history. The Flybe brand originated in July 2002, positioning itself as a full-service, low-fare airline. Various pricing and product introductions were made in line with this position, such as discounted one-way tickets, the abolition of overbooking practices, a customer charter of the airline’s service standards, as well as compensation for delays.
The company acquired BA Connect in 2007, increasing its route network in both the UK and continental Europe, making Flybe Europe’s largest regional airline. But there were turbulent times, and fast forward to 2013, and Flybe sold its slots at Gatwick for £20m – out of 158 routes flown, 64 did not cover the operating expenses of crew and aircraft.
Despite this downsizing, in April 2014, Flybe announced that it would launch domestic and international flights from London City Airport, signing a five-year deal. Into 2015, Flybe announced new routes from Cardiff and Sheffield Airport starting nine new European city routes, and twelve months later opened a hub at Dussledorf.
Despite this growth strategy, November 2018 saw a 75% collapse in the share price as Flybe announced that it was talking about a potential sale. Subsequently, the Connect Airways consortium acquired the business, which included Virgin Atlantic and Stobart Aviation, with £100m of new funding provided to support the business.
Flybe announced plans to be rebranded as Virgin Connect, but in January 2020, it emerged that Flybe was again in difficulties, and a deal was reached on 15 January, entailing a deferred payment for Flybe’s Air Passenger Duty debts and increased funding from Connect Airways.
As of 28 January 2020, Flybe operated 36% of all UK domestic flights, but on 5 March, they filed for administration and ceased all operations with immediate effect after the Government failed to grant a proposed £100m bailout loan. Virgin Atlantic refused to continue financial support despite its investment of £135m, and placed part of the blame on the negative impact of the coronavirus outbreak on Flybe’s trading.
Was Flybe too ambitious? For the past fifteen years Flybe has been trying to join the big boys of aviation and failing. The serious push came when it raised money with an IPO, and set out a plan to become Europe’s biggest regional airline, flying mid-sized planes between secondary cities. The model works brilliantly in America, where regional airlines, often flying as franchises of the larger network carriers, are a large and thriving business.
It did not work – or at least Flybe did not make it work. It retrenched, and was left in the farcical situation of paying for a fleet of aircraft that it could not fly. The remaining network was still too big, and cash resources dwindled.
So what are the elements of the Flybe business model that ultimately caused its failure, and what can startups learn from their mistakes?
1. Operating a market niche made it vulnerable Flybe dominated the regional UK market, so it was particularly exposed to anything that went wrong in this market – the recent fall in demand prompted by the coronavirus outbreak just added to its list of woes. It already had to contend with storms disrupting travel and the effects of Brexit creating sluggish UK consumer spending. The weak pound following the Referendum also worsened the impact of increased fuel and aircraft leasing costs.
Lesson: don’t put all your eggs in one basket; don’t get complacent when you have dominant market share, take a counter view of inherent vulnerability to apparent strength.
2. It operated in a highly competitive market Aviation is a highly competitive industry at the best of times, saddled with high-cost assets, and key costs that fluctuate uncontrollably – mainly fuel, which accounts for around a third of total airline costs. On top of that, they face high regulatory costs. The UK is particularly competitive, with Flybe squeezed between major airlines such as British Airways and the big low-cost carriers like Ryanair and EasyJet.
Lesson: Always keep a keen eye on your cost base when focused on a high-growth strategy, revenues can often not hit targets or market share be impacted by external margin pressures out of your control.
3. Flybe paid more tax than other airlines Airlines have to pay Air Passenger Duty (APD), a tax per passenger on flights taking off in the UK. For international flights, APD only has to be paid on the route out of the country, but for journeys within the UK, APD is paid both on departure and arrival. The levy is thought to have cost Flybe more than £100m a year, something it had long complained about. The government was considering adjusting the APD and helping Flybe.
Lesson: There are often specific compliance costs or costs of entry into a market, which should be recognised as a harsh burden on the business model, hitting your competitive agility, and factored into your day-to-day thinking.
4. It had too many planes A decade ago, Flybe had ambitious pan-European plan, placing an £850m order for 35 Embraer 175 jets to underpin its expansion. But for years after that it struggled with overcapacity. Flybe ended up putting planes on routes to use the planes, rather than buying a fleet to fly routes effectively. It was a burden, in reality it really was too big for what it’s trying to do.
Flybe’s overcapacity showed it needed to operate smaller aircraft over a slimmer network, and maybe switch its focus to concentrate on the corporate market and forget about endless retail seat sales at peppercorn prices. This would mean higher fares but hopefully a better quality, repeatable customer model.
Lesson: A relentless focus on charging forward can blindside the downside risks and adverse long-term impact of short-term errors. Don’t be blinkered by growth-for-growth’s sake, take a balanced view of opportunity versus risk.
5. There were conflicting shareholder objectives The takeover by the Connect Airways consortium failed because the partners had conflicting objectives and were strange bedfellows. Virgin was eager to feed its long-haul flights at Heathrow, and perhaps snaffle along the way some of Flybe’s valuable Heathrow slots, whilst Stobart was eager to keep regional flights at its main asset, Southend Airport. The third partner, Cyrus, was a VC and thought it might make money if the business was resuscitated. None of these were compatible with each other
Lesson: Ensure there is genuine compatibility and alignment of vision, purpose and strategy with your co-founders. Never let financial metrics convince you a long-term arrangement has merit, it simply masks the underlying paradoxes.
6. The pricing strategy must support the business model Coronavirus hastened its collapse, but Flybe’s pricing policy was flawed. For any form of travel, the operator with the fastest service generally charges the most. That used to be the case before the arrival of low-cost airlines, when domestic flying was considered a luxury. In Flybe’s case, although it held a monopoly over most of its mainland domestic routes, it was undercutting rail fares sometimes by as much as 50% – because the travelling public compared the cost of flying with surface transport.
However, at the same time as average fares have fallen, squeezing margins and leaving no room for mistakes, Flybe was posting annual losses of £20m.
Lesson: Price on purpose, and price for profit. After a period of entry pricing to gain new market share in a new segment, your value proposition has to fit around the competition and your business model. Don’t kid yourself demand v supply rules don’t apply.
7. Poor customer experience They had a mad hand baggage policy. I had a bag that was 5mm bigger than their cabin baggage guide at the gate. They charged £30 to check it in and, of course, I had to wait 45 minutes to get it back at the other end. The published dimensions of my hardsided case were within the Flybe size limits. I resolved never to fly it Flybe again and never did.
Lesson: Think about the critical non-essentials that can have an out-size adverse impact on the customer experience. Convenience, simplicity and ease-of-use are great customer experience virtues – introduce friction and it all unravels.
8. Dysfunctional culture Flybe acquired many rival’s routes, aircraft and staff and took many franchises into its brand, but wasn’t successful at integrating firms with different work cultures. Even though they were successful at operational integration of small companies, it failed to merge different work cultures.
High attrition rate in its work force compared to other organisations in the industry resulted in it having to spend a lot more than its competitors on training and development of its employees.
Lesson: Creating a diverse and inclusive workplace culture is vital as you scale a startup, ensuring there is a vibrant underlying set of values and philosophy that enables your business to build internally, besides fuelling external growth.
All of the above were factors before coronavirus came along, combining to trigger Flybe’s demise. They were not even able to maintain good revenues on unique routes. Flybe failed because it forgot what its core business was and an over ambitious strategy expanded it beyond it viable economic model.
Startups beware. The adrenalin of growth and soaring ambition can cloud your judgement and blindside some key signs that your model isn’t as unique as you expect.
Failure. We’re hypocrites about it. You find scores of pleasant aphorisms celebrating the inevitability of failure of underdogs and entrepreneurs, their determination to come fighting back and the importance of learning from it, but in real life failure is painful.
Optimism is key, as Friedrich Nietzsche said, That which does not kill us makes us stronger. A willingness to stumble during a quest gives the motivation to spur us onto success against all odds in the first place, so don’t let failure remove your spark, but embracing failure to encourage entrepreneurship is misguided. Keep an open mind as you build your startup strategy, and always be agile, alert and vigilante – euphoria, ego and complacency are virus-like killers to your startup business model.