Lufthansa Systems Goes to Market with iPad In-flight Entertainment Systems: EVM Case Study

Lufthansa Systems has recently begun marketing BoardConnect as a Wi-Fi-enabled iPad in-flight entertainment (IFE) systems alongside traditional wired and seatback entertainment systems.  In developing a wireless BoardConnect solution, Lufthansa Systems worked with Axinom to enable the distribution of movies and music with proper digital rights management (DRM) over content.   OpenSkies (part of British Airways LON:ABAY) is reported to have purchased a Wi-Fi iPad in-flight entertainment system from Lufthansa Systems for their all-business-class transatlantic flights.

Does handing out iPads to passengers and going Wi-Fi make sense for other airlines or is this a frivolous luxury for the elite that commoners will never see?  A modeling of the Exchange Value can determine.

Exchange Value

The Exchange Value calculates the value of a product or service to a customer in comparison to the next nearest competing alternatives.  This approach relies on a model, sometimes named an Exchange Value Model, that captures the relevant economic impact of selecting one solution over another.  Such models can be used by pricing analysts to price new offerings (sometimes referred to as Exchange Value to Customer), salespeople for communicating the value of new offerings (commonly referred to as Business Impact Model), or financial analysts for evaluating new solutions (commonly referred to as a Business Case Analysis).

For pricing and marketing purposes, exchange value models are extremely useful for market segmentation purposes.  Change a few input parameters in the model to reflect one segment versus another, and entirely different exchange values will be identified.  If price segmentation can be enforced, this approach will indicate the most economically efficient price structure for a new offering.  If prices must be constant across all market segments, this approach can indicate which price level will engage the most appropriate market segments at the most profitable price.

This case study will demonstrate how exchange value models can be used to evaluate the attractiveness of a novel solution across to market segments (For more information on Exchange Value, read Pricing Strategy by Tim J. Smith).

OpenSkies

OpenSkies is an all-business-class carrier operating Boeing 757s between New York and Paris.

Providing business-class passengers luxuries such as free iPad in-flight entertainment could be positioned as an approach to differentiating OpenSkies service from their competitors.  If it is a pure marketing ploy, any cost differential between an iPad and traditional in-flight entertainment systems could be evaluated against expectations of either higher ticket prices, load-factors, or both.  In this case, the story would quickly end and we would strongly suspect that common coach travelers only discover it in advertisements.

But if an iPad Wi-Fi in-flight entertainment system actually saved the airline money over a traditional wired seat-back in-flight entertainment system, then the business case for adapting such a system becomes more interesting.  In this case, we would conclude that OpenSkies is a trailblazer ushering in a new approach to the in-flight entertainment industry.

iPad Wi-Fi In-Flight Entertainment System Exchange Value to OpenSkies

To evaluate the exchange value of iPad Wi-Fi in-flight entertainment systems over traditional solutions, we need a unit of analysis, a few facts and assumptions, and a model to put all the pieces together into a cohesive whole.

The unit of analysis relevant to businesses is the net present value of the whole-product differential between the comparable solutions.  By whole product, we mean not only the initial cost differential between the two approaches, but also the ongoing cost differentials and other economic factors that may make a material difference between the impacts of selecting one approach over another.

For OpenSkies, we have the following baseline facts relevant to the analysis:

• In terms of the initial in-flight entertainment systems equipment and installation savings, the Wall Street Journal reports that a traditional system costs $3 million per plane while OpenSkies spent only $250,000 per plane for an iPad-based system.  This factor alone accounts for a potential $2.75 million savings against which other factors will need to be applied.
• In terms of ongoing savings, the Wall Street Journal reports that the added weight of cabling required for a traditional system costs a typical airline operating Boeing 767s with 260 seats up to $90,000 per year in additional fuel at current fuel prices.  Since OpenSkies typically flies 757s with less than 84 seats, their annual fuel savings might be expected to be only one-third as much, or $30,000.
• In terms of ongoing costs increases, we can suspect some level of iPad shrinkage (lost or stolen) and some level of iPad replacement due to device end-of-life failure.  Critically, if shrinkage and replacement rates are too high, the iPad-based system may be a financial loss for OpenSkies.  Hence these two parameters will be key input parameters in our analysis.
• Since a traditional in-flight entertainment system lasts 5 to 10 years, we will evaluate the net present value difference between the two solutions on a time period relevant to current standard.  For this analysis, we will use a 7-year lifespan since OpenSkies is a premium carrier and we can anticipate their entertainment systems to be “refreshed” on a faster cycle than the average.
• Assume that other ongoing maintenance cost factors are unchanged.  This assumption is likely to underrepresent the savings of the simpler Wi-Fi and iPad system over a traditional hard-wired and seatback system, but will suffice at this level of analysis for the sake of determining if the iPad in-flight system could reasonably be expected to save customers like OpenSkies money.

Other baseline facts and assumptions required to complete the model for OpenSkies include

• A typical OpenSkies aircraft completes 2 transatlantic flights per day, or 730 flights per year.
• A typical OpenSkies aircraft seats 84 or fewer business class travelers, and each traveler uses 1 iPad per flight.
• An iPad costs OpenSkies $399 or less, where the price has been taken to be that of a retail 16 GB Wi-Fi iPad 2.

If we assume a 5% per flight shrinkage (1 out of 20 iPads “walk away” each flight) and a 1-year lifespan for most iPads (heavy usage and abuse causing an accelerated lifespan) we can calculate that a typical OpenSkies plane faces up to $48,000 in additional ongoing iPad costs for a Wi-Fi iPad system. These are pretty high shrinkage and replacement rates, hence it forms what I would call the “upper bound of reasonableness” on the ongoing maintenance cost increases.

Given the initial cost savings of $2.75 million, ongoing fuel savings of $30,000 per year, ongoing incremental iPad costs of $48,000, and a reasonable discount rate of 6%, we calculate the net present value of the iPad Wi-Fi in-flight entertainment system over a traditional in-flight entertainment system to be $2.6 million.  Even with the potential losses of iPads, the exchange value model demonstrates that OpenSkies is better off choosing an iPad Wi-Fi in-flight entertainment system (See the OpenSkies tab on the iPad In-Flight Entertainment System Exchange Value).

Furthermore, now that the model is developed, we can explore the robustness of the business case.  For instance, consider the possibility that all iPads are stolen on every trip, would OpenSkies be left better off with an iPad Wi-Fi in-flight entertainment system?  Or, if travelers destroyed the iPads at an even faster rate, would OpenSkies be left better off with an iPad Wi-Fi in-flight entertainment system?    (Who says business-class customers are the most virtuous or careful?)  Changing a shrinkage parameter from 5% to 100% or the lifespan from 1 year to 6 months in the Exchange Value Model, and the new Exchange Value is calculated. Even under these horrendous conditions, OpenSkies is still better off with iPads than traditional seatback entertainment systems.

iPad Wi-Fi In-flight Entertainment System Exchange Value and The Rest of Us

It is one thing to demonstrate that this approach makes economic sense for the niche segment business-class carriers like OpenSkies.  It is completely different issue to consider a more mass-market carrier like Luftansa, United, or Aeromexico.  Does an iPad Wi-Fi in-flight entertainment system have positive exchange value for more plebian carriers?

Making a few more parameter changes in the exchange value model, and we calculate that this approach once again makes sense even for more typically configured 767s (See the Industry Average tab on the iPad In-Flight Entertainment System Exchange Value).

In fact, the exchange value model demonstrates that unless large economic issues have been overlooked in the analysis, an iPad Wi-Fi in-flight entertainment system provides significant savings to airlines over traditional approaches.  Other derivative approaches, such as charging customers for entertainment, choosing a Microsoft or Google Android enabled tablets, or simply providing servers and Wi-Fi and letting customers stream movies to their own devices, may increase the value of this approach  but at an added cost related to digital right management and software licensing fees..

Since the exchange value is positive under most reasonable scenarios, we can suspect Lufthansa Systems will sell many of these solutions and competitors will soon copy much of their approach, as is currently rumored with Panasonic Corp. (PC) and Thales SA (EPA:HO)

Corrections and Clarifications: 

An early version of this article incorrectly indicated this system was being marketed by Thales SA and Panasonic Corp.  Upon reviewing other press releases and discussions with industry insiders, we have learned that this system is being marketed by Lufthansa Systems. Despite attempts to contact them, Lufthansa Systems, Panasonic Corp, and Thales SA were unavailable for comment.