U.S.

Airline Industry Case Study

Posted in: Research | July 17, 2007 | by: bryanaharmsen #495

Introduction
The following is a summary of industry forces in the U.S. airline industry and recommendations for viability of the industry moving forward. Industry deregulation has significantly changed the competitive environment for established traditional airlines. The adaptation of these traditional airlines is critical to the viability and success of the entire industry. Detailed assessment of the U.S. airline industry forces supports the need for change in the industry, particularly among large established carriers.

Recommendation
Analysis of the U.S. airline industry forces suggests that the airline industry in its entirety, and particularly the large traditional airlines, must focus on managing their cost structure and listening to the voice of the customer. Any investment or activity that does not add value for the customer must be eliminated from an airlines operating process. :ad200 It is recommended that large traditional airlines undergo a complete reengineering of their organization structure, rather than attempting to compete on different strategies with the launch of complementary low cost brands like Uniteds TED and Deltas Song. The structural inefficiencies of traditional large airlines is pervasive and they must overhaul their structure and operations to focus on activities that add value in the customers eyes. The evidence suggests that customers do not recognize differentiation in air travel and they value low cost and efficiency. Time and money invested in differentiation is ineffective. U.S. airlines should further focus on innovation that creates efficiencies, either directly for the customer, or indirectly through firm operations that will translate to competitive fares.

U.S. Airline Industry Forces

Supplier Power
Supplier power in the U.S. airline industry is high as passenger jets are the most significant cost for airlines and there are only a handful of suppliers. Additionally, planes must be ordered far in advance, leaving airlines with little choice but to place orders in anticipation of industry growth. Major U.S. airlines have only two primary choices for supply of their jets and there can be significant differentiation between products from the perspective of the airlines. The long-term nature of these purchases creates a long-term relationship whereby the airline is often motivated to purchase the same kind of jets to reduce maintenance and service costs, adding to the leverage held by major jet suppliers. For the major U.S. airlines, labor unions must be considered as a supplier with significant power. This force is held over from an era of regulation but remains a significant factor in successful performance in the industry. Major airlines that existed during industry regulation became involved in labor agreements that left them little flexibility.

Threat of Entry
While the airline industry is capital intensive and requires large upfront investment, there are also economies related to being new in the industry such as better fuel efficiency and lower maintenance

costs for new planes. The Civil Aeronautics Board did not approve any new passenger airlines from 1938 to 1978, during the time of industry regulation making this industry force virtually nonexistent prior to 1978. With deregulation came a flood of new entrants and intense competition with more than 20 new airlines entering the industry by 1980. The change in this industry force moved the once tightly controlled oligopoly much closer to perfect competition where price wars quickly became the norm. U.S. airline industry return on capital should be a deterrent to new entrants, but this impact has not been recognized as new firms have continually entered the industry.

Threat of Substitutes
The threat of substitutes in the airline industry is very low, primarily composed of passenger trains, buses, and personal automobiles. With no high-speed passenger train system in the U.S., the threat of this substitute has always been low since air travel became a viable option for U.S. consumers. Travel by train is significantly longer than by air while the price difference to the consumer is not similarly disproportionate. The fixed routes of train lines also put this substitute for air travel at a disadvantage. Travel by bus offers consumers some of the same trade-offs as train service except that the travel time is often increased again, for a comparable trip. Passenger cars as an alternative to airline travel is only viable to most consumers for very short distances, thus it is also an insignificant substitute. The lack of viable substitutes to the airline industry which effectively meet the travel needs of consumers is advantageous, though it has certainly impacted other industry factors like the threat of new entrants.

Buyer Power
Buyer power has changed significantly in the airline industry over the last 20 years due largely to industry deregulation and technological innovation related to the impact of the Internet. Prior to deregulation, the Civil Aeronautics Boards control over pricing and airline routes gave the consumer very little power as it did not provide the choices of unregulated competition. If consumers did not like the prices available for air travel, they were forced to look for substitutes, none of which offered a similar value proposition as the airline industry. With the advent of the Internet as a convenient method for the average consumer to search for the lowest airfare and complete the transaction without an intermediary, buyer power has increased as a significant industry force. This trend coupled with the lack of differentiation by the consumer between air carriers has commoditized the industry and made price the most important factor impacting buyer behavior.

Industry Rivalry
U.S. airline industry rivalry is extremely fierce, driven by changes that have increased buyer power and the threat of new entrants. While the threat of substitutes is low and the power of suppliers has remained largely unchanged, these forces have been offset to changes in buyer power and new entrants, resulting in overall poor industry performance. High exit barriers have always existed in the industry but the flood of new entrants has exacerbated this issue and increased its impact on competition. Further, cost structures composed primarily of fixed costs has spurred price competition and negatively impact most carriers.

Industry Key Success Factors

Two key success factors are paramount in the U.S. airline industry:

Cost Structure. With the commoditization of air travel, cost structure is now a key success factor in the industry. Effective management of fuel, maintenance, and labor costs is mandatory in the current environment of deregulated competition. Voice of the Customer. Customers do not recognize differentiation in air travel and are price sensitive. There is less delineation between leisure and business travel as it relates to price elasticity. A determined focus on the features and benefits that are valuable to the customer today is a key success factor in the industry.

The first airlines

Failed attempt at an airline before DELAG

American aviation pioneers, such as Rufus Porter and Frederick Marriott, attempted to start airlines using airships in the mid-19th century, focusing on the New YorkCalifornia route. Those attempts floundered due to such mishaps as the airships catching fire and the aircraft being ripped apart by [3] spectators.DELAG, Deutsche Luftschiffahrts-Aktiengesellschaft was the world's first airline. It was founded on November 16, 1909 with government assistance, and operated airships manufactured by The Zeppelin Corporation. Its headquarters were in Frankfurt. The four oldest non-dirigible airlines that still exist are Netherlands' KLM, Colombia's Avianca, Australia's Qantas, and the Czech Republic's Czech Airlines. KLM first flew in May 1910, while Qantas (which stands for Queensland and Northern Territory Aerial Services Limited) was founded in Queensland, Australia, in late 1910. [edit]U.S.

airline industry

[edit]Early development

TWA Douglas DC-3 in 1940. The DC-3, often regarded as one of the most influential aircraft in the history of commercial aviation, revolutionized the aviation industry. [4]

Tony Jannus conducted the United States' first scheduled commercial airline flight on 1 January 1914 for [5] the St. Petersburg-Tampa Airboat Line. The 23-minute flight traveled between St. Petersburg, Florida and Tampa, Florida, passing some 50 feet (15 m) above Tampa Bay in Jannus' Benoist XIV biplane flying boat. Chalk's International Airlines began service between Miami and Bimini in the Bahamas in February 1919. Based in Ft. Lauderdale, Chalk's claimed to be the oldest continuously [6] operating airline in the United States until its closure in 2008. Following World War I, the United States found itself swamped with aviators. Many decided to take their war-surplus aircraft on barnstorming campaigns, performing aerobatic maneuvers to woo crowds. In 1918, the United States Postal Service won the financial backing of Congress to begin experimenting [7] withair mail service, initially using Curtiss Jenny aircraft that had been procured by the United States Army Air Service. Private operators were the first to fly the mail but due to numerous accidents the US [citation needed] Army was tasked with mail delivery. During the course of the Army's involvement they proved [citation needed] to be too unreliable and lost their air mail duties. By the mid-1910s, the Postal Service had developed its own air mail network, based on a transcontinental backbone between New York and San [citation needed] Francisco. To supplant this service, they offered twelve contracts for spur routes to independent bidders. Some of the carriers that won these routes would, through time and mergers, evolve into Pan Am, Delta Air Lines, Braniff Airways,American Airlines, United Airlines (originally a division of Boeing), Trans World Airlines, Northwest Airlines, and Eastern Air Lines. Service during the early 1919s was sporadic: most airlines at the time were focused on carrying bags of mail. In 1925, however, the Ford Motor Companybought out the Stout Aircraft Company and began construction of the all-metal Ford Trimotor, which became the first successful American airliner. With a 12-passenger capacity, the Trimotor made passenger service potentially profitable. Air service was seen as a supplement to rail service in the American transportation network. At the same time, Juan Trippe began a crusade to create an air network that would link America to the world, and he achieved this goal through his airline, Pan American World Airways, with a fleet of flying boats that linked Los Angeles to Shanghai and Boston to London. Pan Am and Northwest Airways (which began flights to Canada in the 1919s) were the only U.S. airlines to go international before the 1940s. With the introduction of the Boeing 247 and Douglas DC-3 in the 1930s, the U.S. airline industry was generally profitable, even during the Great Depression. This trend continued until the beginning ofWorld War II. [edit]Development since 1945

In October 1945, the American Export Airlines became the first airline to offer regular commercial flights between North America and Europe.[8] Shown here is Am Ex Boeing 377 Stratocruiser in 1949.

As governments met to set the standards and scope for an emergent civil air industry toward the end of the war, the U.S. took a position of maximum operating freedom; U.S. airline companies were not as hard-hit as European and the few Asian ones had been. This preference for "open skies" operating [citation needed] regimes continues, within limitations, to this day. World War II, like World War I, brought new life to the airline industry. Many airlines in the Allied countries were flush from lease contracts to the military, and foresaw a future explosive demand for civil air transport, for both passengers and cargo. They were eager to invest in the newly emerging flagships of air travel such as the Boeing Stratocruiser, Lockheed Constellation, and Douglas DC-6. Most of these new aircraft were based on American bombers such as the B-29, which had spearheaded research into new technologies such as pressurization. Most offered increased efficiency from both added speed and greater payload. In the 1950s, the De Havilland Comet, Boeing 707, Douglas DC-8, and Sud Aviation Caravelle became the first flagships of the Jet Age in the West, while the Eastern bloc had Tupolev Tu-104 and Tupolev Tu124 in the fleets of state-owned carriers such as Czechoslovak SA, Soviet Aeroflot and EastGermanInterflug. The Vickers Viscount and Lockheed L-188 Electra inaugurated turboprop transport. The next big boost for the airlines would come in the 1970s, when the Boeing 747, McDonnell Douglas DC-10, and Lockheed L-1011 inaugurated widebody("jumbo jet") service, which is still the standard in international travel. The Tupolev Tu-144 and its Western counterpart, Concorde, made supersonic travel a reality. Concorde first flew in 1969 and operated through 2003. In 1972, Airbus began producing Europe's most commercially successful line of airliners to date. The added efficiencies for these aircraft were often not in speed, but in passenger capacity, payload, and range. Airbus also features modern electronic cockpits that were common across their aircraft to enable pilots to fly multiple models with minimal cross-training. Travel Concepts, Inc., founded by William J. Tobin in 1971, developed the first travel kits to be distributed in First Class and Business Class cabins, and also provided in-flight educational games for children. The travel kits and the educational game programs have been utilized by most major airlines for 25 [9][10][11] years.

Pan Am Boeing 747 Clipper Neptune's Car in 1985. The deregulation of the American airline industry increased the financial troubles of the iconic airline which ultimately filed for bankruptcy in December 1991.[12]

1978's U.S. airline industry deregulation lowered barriers for new airlines just as a downturn occurred. New start-ups entered during the downturn, during which time they found aircraft and funding, contracted hangar and maintenance services, trained new employees, and recruited laid off staff from other airlines. As the business cycle returned to normalcy, major airlines dominated their routes through aggressive pricing and additional capacity offerings, often swamping new startups. Only America West Airlines (which has since merged with US Airways) remained a significant survivor from this new entrant era, as dozens, even hundreds, have gone under. In many ways, the biggest winner in the deregulated environment was the air passenger. Indeed, the U.S. witnessed an explosive growth in demand for air travel, as many millions who had never or rarely flown before became regular fliers, even joining frequent flyer loyalty programs and receiving free flights and other benefits from their flying. New services and higher frequencies meant that business fliers could fly to another city, do business, and return the same day, for almost any point in the country. Air travel's advantages put intercity bus lines under pressure, and most have withered away. By the 1980s, almost half of the total flying in the world took place in the U.S., and today the domestic industry operates over 10,000 daily departures nationwide. Toward the end of the century, a new style of low cost airline emerged, offering a no-frills product at a lower price. Southwest Airlines, JetBlue, AirTran Airways, Skybus Airlines and other low-cost carriers began to represent a serious challenge to the so-called "legacy airlines", as did their low-cost counterparts in many other countries. Their commercial viability represented a serious competitive threat to the legacy carriers. However, of these, ATA and Skybus have since ceased operations. Increasingly since 1978, US airlines have been reincorporated and spun off by newly created and interally led manangement companies, and thus becoming nothing more than operating units and subsidiaries with limited financially decisive control. Among some of these holding companies and parent companies that are the relatively well known, are the UAL Corporation, along with the AMR Corporation, among a long list of airline holding companies sometime recognized world wide. Less recognized are the private equity firms which often seize managerial, financial, and board of directorscontrol of distressed airline companies by temporarily investing large sums of capital in air carriers, so as to rescheme an airlines assets into a profitable organization or liquidating an air carrier of their profitable and worthwhile routes and business operations. Thus the last 50 years of the airline industry have varied from reasonably profitable, to devastatingly depressed. As the first major market to deregulate the industry in 1978, U.S. airlines have experienced more turbulence than almost any other country or region. Today, American Airlines is the only U.S. legacy carrier to survive bankruptcy-free. [edit]The Airline Industry Bailout Congress passed the Air Transportation Safety and System Stabilization Act (P.L. 107-42) in response to a severe liquidity crisis facing the already-troubled airline industry in the aftermath of theSeptember 11th terrorist attacks. Congress sought to provide cash infusions to carriers for both the cost of the four-day federal shutdown of the airlines and the incremental losses incurred through December 31, 2001 as a [13] result of the terrorist attacks. This resulted in the first government bailout of the 21st century. Between

2000 and 2005 US airlines lost $30 billion with wage cuts of over $15 billion and 100,000 employees laid [14] off. In recognition of the essential national economic role of a healthy aviation system, Congress authorized partial compensation of up to $5 billion in cash subject to review by the Department of Transportation and up to $10 billion in loan guarantees subject to review by a newly created Air Transportation Stabilization Board (ATSB). The applications to DOT for reimbursements were subjected to rigorous multi-year reviews [15] not only by DOT program personnel but also by the Government Accountability Office and the DOT [16][17] Inspector General. Ultimately, the federal government provided $4.6 billion in one-time, subject-to-income-tax cash payments to 427 U.S. air carriers, with no provision for repayment, essentially a gift from the taxpayers. (Passenger [18] carriers operating scheduled service received approximately $4 billion, subject to tax.) In addition, the ATSB approved loan guarantees to six airlines totaling approximately $1.6 billion. Data from the US Treasury Department show that the government recouped the $1.6 billion and a profit of $339 million from [19] the fees, interest and purchase of discounted airline stock associated with loan guarantees.

Strengths

A major strength of any airline is the product itself--air travel. Despite downturns, over time air travel continues to grow, not only due to population growth, but also due to an increased propensity to fly. Another strength is the safety record, and the associated public acceptance of air travel as both a fast and safe way to travel. Both traditional, brand recognized airlines and new low cost carriers share this strength. Airline staff is highly trained and experienced, from pilots and flight attendants to mechanics and ground staff. Businesswise, airlines have the ability to segment the market, even on the same routes. This allows airlines to establish different levels of service and make associated pricing decisions.

Weaknesses

Airlines have a high "spoilage" rate compared to most other industries. Once a flight leaves the gate, an empty seat is lost and non-revenue producing. Aircraft is expensive and requires huge capital outlays. The return on investment can be different than planned. Large workforces spread over large geographic areas, including international points, require continual communication and monitoring. This can be exacerbated during operational irregularities, such as bad weather. While the business climate can change quickly, airlines have difficulty making quick schedule and aircraft changes due to leases, staffing commitments and other factors.

Opportunities

Airline market growth offers continual expansion opportunities for both leisure and business destinations. This is particularly true for international destinations. Technology advances can result in cost savings, from more fuel efficient aircraft to more automated processes on the ground. Technology can also result in increased revenue due to customer-friendly

service enhancements like inflight Internet access and other value added products for which a customer will pay extra. Link-ups with other carriers can greatly increase passenger volumes. By coordinating schedules, airlines can offer service to destinations via a code share agreement with a partner carrier.

Threats

A global economic downturn negatively affects leisure, optional travel, as well as business travel. The price of fuel is now the greatest cost for many airlines. An upward spike can destabilize the business model. A plague or terrorist attack anywhere in the world can negatively affect air travel. Government intervention can result in new costly rules or unexpected new international competition.

Considerations

When reviewing industry SWOT analyses, take note that each airline will approach the analysis differently. For instance, an airline that "hedged" fuel purchases will find a fuel price increase much less of a threat than an airline that must purchase fuel on the open market.