Insight June 16, 2009, 1:43PM EST

What You Can Learn from the Airlines

The burdens they operate under are more extreme than those most businesses face—so they present a perfect opportunity to study and be prepared

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The airline business is truly the school of hard knocks. There is always something—high fuel prices, the threat of terrorism, epidemics, storms, cyclical passenger gluts and droughts, labor issues, accidents, and government intrusion—to upset operations, disrupt aviation economics, and spark a chorus of critics from consumers to government.

It's hard for deregulated airlines to make money, and if one does, within five years a cyclical downturn will likely drain away accumulated earnings. The airline business embodies much of the complexity, volatility, uncertainty, and challenge that more and more businesses are getting a taste of in the current economy, and that's why it offers some tough but helpful lessons for other industries about corporate governance.

• You are never completely in control of your business. You need to prepare for what you can't control. Airline executives are hardened early in their careers to expect the unexpected and respond accordingly. Few other industries live on the edge of virtual meltdown the way airlines do. For example, many well-reputed airlines hedged the price of jet fuel last year as it was rocketing out of control, only to see those hedges serve as loss-making ventures when oil prices tumbled in the recession. The losses, of course, happened at a time when all airlines were struggling for passengers, with business and leisure travel going into steep decline.

Boards should understand that business plans and strategy can be disrupted by uncontrollable events. CEOs and managers should plan well and thoroughly, but directors should be patient during implementation. The key is how management responds to the unexpected in order to keep implementation on course. This calls for operational flexibility and responsiveness at all levels. Directors should ask whether their companies have that kind of flexibility, and they should observe how well an organization responds to the unexpected. They should also insist on good contingency planning.

• Align key constituencies in a multi-stakeholder world. In the airline industry, it is important to coordinate and align the interests of customers, shareholders, employees, governments, regulators, suppliers, and special-interest groups. In the airline industry especially, stakeholder misalignment quickly spells trouble. For example, when airline employees oppose management, they take it out on customers, who in turn stop flying the airline, which, in turn, affects shareholder returns—a vicious cycle.

As Southwest Airlines (LUV) has demonstrated, aligning stakeholder interests can create a virtuous cycle. Despite being the most unionized airline in the U.S. and proudly offering nothing to eat or drink in the cabin, Southwest enjoys outstanding customer service ratings and loyalty as well as the best financial returns in the industry. The delicate balance between employees, customers, shareholders, and other stakeholders enforces good discipline on airline management. Boards should be asking whether their companies have similar stakeholder balance and alignment. Many CEOs focus sharply on short-term returns to shareholders without an equivalent focus on the long-term interests of all stakeholders. With the Internet and increasing transparency, CEOs can no longer isolate constituencies from one another, nor should they try.

• Sometimes, industry and company insiders are better choices. Over the past few decades, the airline industry experimented with CEOs coming in from outside the sector. With a few exceptions, most have not fared well. There is good reason for that. The airline industry requires specialized knowledge in a variety of important domains—labor relations, regulation, and even technology—and, simply put, it is impossible to learn it all quickly enough.