Is innovation essential for companies

with high-growth? A closer look at People Express.

Abstract: In this article, the growth of the low-fare, no-frills carrier People Express is explored to
understand innovation challenges associated with a high-growth strategy. This article aims to
address strategic questions about technological innovations that would be useful to managers and
organisational decision makers with high growth objectives by taking a closer look at the lowcoast
carrier People Express.

The need for innovation

Jeffrey R. Williams (1980) says, innovation can give a company a competitive advantage and profits,
but nothing lasts forever. Success brings on imitators, who respond with superior features, lower
prices, or some new way to draw customers away. Time, the denominator of economic value,
eventually renders nearly all advantages obsolete. In the airline industry, within a few years of
deregulation, innovative People Express(PE) started to encounter competition from other airlines
who started matching them on price through better revenue management, matched them on their
low cost structure by employing people strategies influenced by People Express and provided better
services or delivery options. The key question discussed in this article will focus on the strategic
choices made by the leadership team at People Express and their potential sustainable competitive
advantages. To maintain focus, the discussion will be around some the usual organisational suspects
(R. Waterman, 1980) – systems, structure and staff.

People Express’s(PE) initial success was based on a well-defined strategy which focussed on
operational excellence and service leadership. PE’s core strength was their low cost structure.
Exceptional operational excellence that maximised asset utilisation together with the quality of
people who ensured speed, safety and integrated service was a great advantage. PE obtained
discounted aircrafts that were fuel efficient and had 30% more seats than a normal Boeing 737. PE’s
hub in Newark contributed to its low cost-structure. Additionally, PE flew to second-tier airports
where cost of operating was much lower than those in major cities. Finally, the staff at PE were
hand-picked, many with minimal past experience in airlines. The ‘people’ were part of the core
strategy and provided People Express with a competitive advantage. They were trained to be the
best service minded people and higly motivated because they were shareholders of the company.
Even though their flights were strictly no-frills, PE aimed at providing the highest service quality
levels. However, the tremendous growth PE was going through made it very difficult to maintain the
high levels of service quality. Critics of the airline's spartan service have dubbed the carrier ‘People
Distress’. Many customers complained about late flights, an unreliable reservations system, and
unbearable congestion at the 50-year-old Newark airport North Terminal - People's home base. In
addition, People's low prices had kept its profits slim.

What could have People Express done better to leverage their initial competitive advantage that was
the product of a cost effective system? A look at academic literature on the subject provides much
needed insights. While stating that the “firm is a creature of its environment”, Ansoff(1965)
identified a major external force that he thought would influence the behaviour of firms in the 80s.
Ansoff(1965) said that the growing expenditure by businesses on research and development and its
increasing importance relative to investment in plant and equipment has resulted in accelerating
product change. He continued to state, “Triggered by accumulated technology and pent-
up consumer demand, product Innovation has become an increasingly important tool of competition
and growth”. People Express had minimal expenditure on R&D and product innovation suffered as
PE focussed on their low-cost structure and scale effects, which helped position PE as a premium
value product at an economy price.

Kim and Mauborgne (1997) explore the obvious questions of what happens after the company has
created a new value curve. Sooner or later the competition tries to imitate it and the value
innovator, obsessed with defending its market share, may fall into the trap of conventional strategic
logic and the shape of its value curve becomes very similar to its competitors. So what should be the
signal to the value innovator that it’s time for another quantum leap? The answer is found
through continuous monitoring of the industry’s value curves. This helps the company avoid pursuing
innovation when there is still a huge profit stream to be collected from its current offering, thus
enjoying uncontested dominance. So what should the companies do when its value curve is
fundamentally different from that of the rest of the industry? They should be looking at geographic
expansion and operational improvements to achieve maximum economies of scale and market
coverage. This approach according to Kim and Mauborgne (1997) will discourage imitation and will
allow companies to tap the potential of their current value innovation. People Express was doing
exactly what Kim and Mauborgne (1997) had suggested, they were expanding geographically and
focussing on operational excellence. However, the industry was changing and other airlines like
United, Continental, Eastern and many other players were copying some of the strategies that
People Express flowed with respect to non-unionised labor, stock ownership and profit sharing to
get the best out of their employees. Many of the new entrants in the industry and some of the
existing players had studied the core strategic options taken by People Express and were replicating
them. It was not long before a bloodbath would have started in the industry. What People Expressed
missed out on was innovating and taking a quantum leap to stay ahead of the competition.

Kim and Mauborgne (1997) also talks about the three platforms on which the innovation can take
place – product, service and delivery. They say often managers try to create value innovation focus
on the product platform and over time this approach is not likely to yield many opportunities for
value innovations. Just as customer and technologies change, all these three platforms present new
possibilities. Looking back at PE, it is hard to find evidence of any innovation on the service platform
as they were a no-frills airline. On the delivery platform, instead of innovating PE were trying to hold
on and not to fail miserably as customers concerns started growing over delayed flights, over-
crowded terminals and over-bookings.
Bower and Christensen (1995) says, one of the most consistent patterns in business is the failure of
leading companies to stay at the top of their industries when technologies or markets change. Their
research shows that most well-managed, established companies are consistently ahead of their
industries in developing and commercializing new technologies from incremental improvements to
radically new approaches - as long as those technologies address the next-generation performance
needs of their customers. However, these same companies are rarely in the forefront of
commercializing new technologies that don't initially meet the needs of mainstream customers and
appeal only to small or emerging markets. Bower and Christensen (1995) also says that the
processes and incentives that companies use to keep focused on their main customers work so well
that they blind those companies to important new technologies in emerging markets. Many
companies have learned the hard way the perils of ignoring new technologies that do not initially
meet the needs of mainstream customers. In 1981, when Donald Burr was creating the airline, he
and his management team had decided that they could not spend precious capital on a full-featured
computer reservation system anywhere near as sophisticated as American Airlines’ Sabre or United’s
Apollo systems – they needed money to buy planes. In an 1989 interview with CIO magazine Burr
says they decided to build a low-cost dumb system that would take a passenger’s name and that’s it.
This technological vision seemed to work just fine until January, 1985. However, the major airlines
had decided People Express was posing a serious treat to their revenues. “We were almost as big as
American Airlines, and we had half their costs,” noted Burr. “The press was saying we were the wave
of the future, and the other airlines were the old behemoths. The airlines decided that the only way
to deal with us is to underprice us- but not on a spot basis. To do that, they turned to their
information systems.” United’s Ultra Super-Saver fares were lower even than People’s fares. But
while People carried entire plane full of $29 fares, United offered a limited number of low price seats
at each plane. Burr said, “They were able to offer prices lower than ours at anytime, anywhere, a
year in advance; automatically adjust the number of low-fare seats, and throw in the aura of a 50-
year-old experienced airline with all the so-called free amenities the travelling public has become
accustomed to. “

Should PE have invested in innovations in technology?

The question we are faced with is should a company in high-growth stage like People Express
invested some of their limited revenues in information technology and innovation in revenue
management and reservation systems? Though we have a lot of evidence to point us to invest in
innovation, let’s look at some more academic research. Carr (2003) says that technology’s potential
for differentiating one company from the pack (in other words, its strategic potential) inexorably
declines as it becomes accessible and affordable to all. Although more complex and malleable than
its predecessors, IT has all the hallmarks of an infrastructural technology. In fact, its mix of
characteristics guarantees particularly rapid commoditization. A myriad of companies have gained
important advantages through the innovative deployment of IT. Some, like American Airlines with
its Sabre reservation system, Federal Express with its package-tracking system, and Mobil Oil with its
automated Speed pass payment system, used IT to gain particular operating or marketing
advantages – to leapfrog the competition in one process or activity. From a practical standpoint, the
most important lesson to be learned from earlier infrastructural technologies may be this: When a
resource becomes essential to competition but inconsequential to strategy, the risks it creates
become more important than the advantages it provides. In the long run, though, the greatest IT risk
facing most companies is more prosaic than a catastrophe. It is, simply overspending. IT may be a
commodity, and its costs may fall rapidly enough to ensure that any new capabilities are quickly
shared, but the very fact that it is entwined with so many business functions means that it will
continue to consume a large portion of corporate spending.

Chris Zook (2001) from Bain says, “Companies that underexploited their core failed to appreciate the
importance of reinvestment.” Zook found that “companies with long-term growth and profits
invested at a rate of 15.3%, nearly twice that of rivals.” Zook says by focusing on your core and
continuously reinvesting in those businesses, you will crush your rivals. This may seem counter-
intuitive, especially in a climate in which companies are looking to cut costs. But if you don’t invest
in your future, someone else will.

Managerial agenda

Taking into consideration our review of academic literature, there is no doubt that People Express
could have maintained their competitive advantage had they invested in IT systems at the right time
and hence leapfrogged the competition. However, we need to understand the critical challenges
that People Express was facing that made this investment and introduction of variable pricing with
demand dependency for flights with high break-even load ratio, imperative. People Express’s break-
even point per passenger seat is 5.2 cents (total cost per passenger seat available on average). PE
therefore could introduce a limited number of heavily discounted fares as low as say US$1.
However, the breakeven load factor for PE flights was considerably high – 71.4%. This means PE
needed to fill up seats on their aircraft to remain profitable. Additionally, PE needed to evaluate
rationality for last minute tickets at a discount (to increase load factors) or at a premium (to
promote advanced booking).

In order to make the whole system work and avoid arbitraging PE could have introduced capacity
management to limit number of discounted seats and ensured that they targeted the right customer
segments. Implementation of yield management tools in PE’s operations could have increased their
revenues by approximately 5-6% (Talluri and Ryzin, 2004) and therefore support their overall growth
and share price. It would have also increased profitability of flights and provided an additional cash
flow, improving their debt burden. Furthermore, super saver fares would have created an additional
buzz around People Express which could have helped them to continue to surprise their customers
and provided competitive advantage as a low price carrier. Converting bookings into advanced
payments with introduction of a more complex automated payment system would have decreased
PE’s working capital requirements and no-show ratio. PE would have been able to decrease
overbooking which was a necessary part of their operations. This in-turn would have helped improve
passenger satisfaction, as we all know, overbooking causes high passenger frustration.
The diagram below shows the basic components of a revenue management system that People
Express could have adopted.

A typical revenue management model consists of the following modules –

1. Real time sales data – Gives an indication of the demand for tickets at a particular price. This real
time pricing data is constantly monitored and is linked to the inventory system, which helps in
predicting demand.

2. Demand model – The real time pricing and booking data is often archived. Over time this historic
data can be analysed to build demand models and forecast the number of tickets that can be sold at
a particular price. This forms the essence of dynamic pricing.

3. Pricing System – Based on analysis and demand forecasts, tickets can be variably priced. The idea
is to sell the right number of tickets at the right price.

A revenue management system starts working by analysing market data. It then predicts demand
elasticities and adjusts pricing accordingly.

From the evidence we have, innovating during high-growth to leapfrog the competition and
maintaining competitive advantage is not only a viable option but also imperative for survival in a
commodity business, such as that of the low-cost carrier People Express.
References

1. Joseph L. Bower and Clayton M. Christensen(1995), Disruptive Technologies: Catching the Wave,
Harvard Business Review (Jan), 43-53

2. Carr, N. G. (2003). IT Doesn’t Matter. Harvard Business Review (May), 41-4

3. Zook, C. (2001). Desperately Seeking Growth: The Virtues of Tending to Your Core. Harvard
Management Update. 1 (1), p3.

4. Ansoff, I. (1965). The Firm of the Future. Harvard Business Review. 43 (5), p162-178.

5. Kim, W.C. & Mauborgne, R. (1997). Value Innovation: The Strategic Logic of High Growth. Harvard
Business Review. 75 (1), p103-112.

6. Cancelled Flights, David H. Freedman, CIO Magazine, April 1989

7. Structure is not Organisation, R. Waterman, Business Horizons, June 1980

8. How Sustainable Is Your Competitive Advantage? Jeffrey R. Williams, California Management Review,
Volume 34, Number 3, 1994

9. http://www.airliners.net/aviation-articles/read.main?id=68

10. http://www.time.com/time/magazine/article/0,9171,1074935-2,00.html#ixzz0xV45YF9b

11. ASM report on People Express, Class 2011, Manchester Business School