The above mentioned case pertains to a holistic view of the American Airline Industry with focus on a key airline service provide Delta Airlines. The case is written in the year 2005, when the airline industry of United States was in the midst of major changes taking place. The case evaluates various changes taking place in the external environment of airline industry and the response of prominent airlines to adequately cope with those changes. The airline industry has always been characterized by low margins on its business due to high financial leverage of the organizations and stiff competition both within the industry and with other modes of transport. The workers of the industry are traditionally organized in unions with a specific unit for each class of workers. Fuel costs and the cost of serving the debt leave minimal returns for airlines. Even though the growth of the market has been phenomenal, yet the industry has attracted more than enough airline services suppressing profitability for each player.
For quite some time, the fares of the airlines were set by a regulatory authority and every single airline carrier was protected by a competitive price war. The regulatory authority also evenly distributed profit-making and loss-generating routes between the airlines services which ensured a fair playing ground for each company and an assured profitability. Following deregulation in 1980’s, there was a sharp decline in airfares due to competitive pricing practices. The net outcome was suppressed profitability of each player while the costs of operations were sustained due to unionized labor force. Almost forty percent of the cost of operations comprised of human resource cost, which left little room for the airlines to maneuver their cost structure and, hence, profitability.
Several innovative practices were developed by airlines to cope with the challenges for suppressed profitability. Separate practices were adopted for long-haul and short-haul flights to maximize efficiencies. Hub-and-spoke system was consequently established by airlines to minimize waste and empty flights. Passengers from less frequently travelled areas were flown to a central hub, where they are distributed to their individual locations. This practice enhanced efficiency to a very high degree. However, the most prominent transformation in the industry was the creation of low-cost-carriers. Low-cost-carriers were specialized airlines created to provide no-frills cheap travel solution to the consumers. The objective of LLCs was to convert consumers of road, train and ship services to airline industry. Mainstream airlines were not able to compete with LLCs despite extreme efforts. Delta Airlines, which ranked second in terms of passenger traffic and annual revenue, lost considerable market share to LLCs. Delta Airlines decided eventually to start its own LLC airline service name Delta Express, yet failed to sustain its operations.
2. The ‘’hub and spoke’’ system is a major bottom-line determining factor for airlines. Do you agree with this assertion?
Hud-and-spoke system is not a major bottom-line determinant for airlines because the major cost component of the industry is human resource payroll, repayment of airplane rent, and food and other amenities to the customers. Fuel cost does comprise of a considerable proportion of airline costs, yet hub-and-spoke system has a mixed impact on the bottom line of the organization; instead of having only a positive impact. Hub-and-spoke system does provide airlines the opportunity to serve those customers who were otherwise uneconomical. For instance, those travelers who are travelling between infrequently travelled destinations can be grouped together at hubs for being transported to spokes. Yet, this centralized model is also responsible for causing discomfort for the travelers and causing the airlines to lose customers. The whole system of hub-and-spoke system is based around interconnecting airlines. This renders the airline service relatively inflexible. Delay in only a single airline can have unpleasant consequences for thousands of travelers from several interconnecting flights. Also, it makes is difficult to handle occasional period of high-demand period for the airlines. Hub majorly represents a bottleneck in the service of the airline. Disruptions in a single hub or spoke inevitably translate into delays for the entire chain of airlines. In fact, cargo and passengers require greater handling when travelling through hub-and-spoke system, which offsets majority of the cost=benefit associated with hub-and-spoke system.
Support for this argument can also be found within the text of the case itself. If hub-and-spokes model would have such a decisive impact on the bottom line of airlines, then large mainstream airlines like Delta Airline or American Airlines would have become hugely profitable. Yet, those airlines quickly grew in profitability and in market share which operated point-to-point LLCs like Southwest Airlines and Jet Blue.
The most prominent impact on the bottom line of airline service is of operational costs. Controlling of these costs has greatest impact on the bottom-line of the organization. Southwest Airlines was able to improve its bottom line by introducing flexible working hours and work-sharing for the airline staff which translated into payroll cost savings. Also, efficiency was created within the operations by turning airline operations completely paperless. Higher aircraft utilization was adopted by Southwest to distribute the fixed cost of airline rental over larger number of flights. For the above mentioned reason, hub-and-spoke system does not have any remarkable impact on the bottom-line of the airl
3. Explain the various components of airline costs according to the case. For each component, describe how each could be lowered by airline strategists.
There are a number of different components of airlines costs. Each one of these cost components can be controlled through attention paid to specific areas.
Human Resource Cost
: Payroll and salaries of employees is the largest cost component of an airline service. Approximately forty percent of the cost of operations of an airline service comprises of this head. This component of cost is also least flexible amongst cost components of the airline because the industry is characterized by highly unionized workforce. This makes it highly challenging to reduce wage rate or other benefits associated with payroll. Workers stand united in their demand for lucrative wages and go on a strike. Bargaining power of airline’s ownership or management is quite low in this respect. The industry is also protected from entry of workers from out of the industry because of skill-set owned by trained staff cannot be easily duplicated. The other cost components of airline are fixed – like, rent of airplanes – which imply that strike by workers is highly detrimental to the airline. For this reason, this area of airline cost remains a challenge for the management to control.
Appropriate strategy to control this cost component of airline service should be to create friendly relationship with the staff. Their buy-in should be created to persuade them to give up some of their employment benefits to enable airline to sustain its operations. In return, employees should be given greater autonomy in carrying out their jobs and flexibility in their work hours. Also, staffs can be given a share in the profitability of the airline in return for certain concession in the benefits section of their payroll.
: Fuel Expense comprise of almost fifteen percent of the cost of operations in the airline industry. The strategy to control this cost component is to invest in improved technology. The age and type of aircraft is directly linked to fuel expenditure for an average flight. Long-haul flights and new aircrafts are much more cost efficient. Also, airlines can control this cost component by hedging against spikes in fuel prices.
: Aircraft rental is a fixed cost component of airline industry. The composition in total cost of the business is approximately fifteen percent. This cost component can be controlled by strengthening capital base and purchasing the aircrafts rather than renting them. Also, negotiating better deals with the lenders is another likely method to strategically control this cost component.
4. The 11 September terrorist attack was a turning point for the airline industry. Do you agree with this assertion? How will you assess the impact of deregulation in the airline industry?
I agree with the statement that September 11 terrorist attacks In 2001 were a major turning point for the airline industry of United States. There were both short-term and long-term repercussions for the aviation industry after Sep 11, 2001. Immediately following the terrorists attacks, all airlines in United States of America were grounded. Airline industry possesses massive interest, wages and rent expense. Only the two-day interruption in the schedule of flights caused millions of dollars worth of losses to the industry as a whole. The whole dynamics of the industry changed overnight. Insurance premiums, which historically used to be nominal, skyrocketed immediately. The cost structure of the company changed as well. Various security measured were needed to be taken by the airlines, which directly impacted the cost structure. For instance, airport security tax was levied on airlines which increased variable cost of serving the passengers. Bullet proof doors were needed to be placed on the doors of cockpit, which also entailed costs on the airlines.
The increased costs of operations might have been bearable for the airline companies had the demand for air travel wouldn’t have fallen sharply. Consumers were simply afraid to travel by air and chose other alternate mediums of transportation instead. The decreased propensity for air travel by the consumers was only a prelude. Terrorist attacks of 2001 caused a general slowdown in US economy. The recessionary impacts hit the airline industry as the second round of economic repercussions. Three major airlines came close to bankruptcy in the year 2002. The industry shed more than eighty thousand employees. Hence, It can be rightly said that September 11 terrorist attacks were a major turning point in airline industry.
The impact of deregulation on airline industry should be termed as positive. Even though, deregulation suppressed margins of airline companies, it served to reveal the hidden problems within the sector. There were more airlines and passenger capacity in the airline industry that the markets’ demand. The price war which followed deregulation prompted inefficient airlines to bring efficiencies in their operations. Previously, cost of these inefficiencies was borne by customers in the form of unnecessarily high prices. Absence of CAB’s regulations created differentiation between well-managed airlines and poorly-managed airlines, which was beneficial both for the industry, as well as, for the airline travelers.
5. What financial indicators strengthen Delta position to remain competitive in the airline industry.
There are a number of financial measures which bespeaks of competitiveness of Delta airlines. Firstly, in the year 2002 Delta airlines was ranked as third-largest airline carrier in terms of annual turnover. In terms of average fare comparison, Delta Airlines performed quite well. Its average fare was lowest in comparison to American Airlines, JetBlue, Continental Airlines and AirTran. Only, in the route to NYC – Atlanta, were Delta Airlines’ fares higher than other players in the industry. This should also be noted that Delta Airlines was amongst legacy carriers while, AirTran was a low-cost-carrier in the industry.
Another financial strength of Delta Airlines was its cost structure. Among legacy carriers, salaries and benefits per seat mile paid by Delta Airlines were lowest. This was achieved through greater involvement of staff and creating their buy-in; rather than focusing only on a transactional relationship with the members of staff. Even in fuel efficiency, Delta Airlines surpassed all other airline companies in legacy carrier segment. The reason for this achievement was a great emphasis placed on adoption of technological enhancements by the organization.
Planes of Delta Airlines were relatively new. Within financial books of Delta Airlines, depreciation expense was charged by a significantly lesser amount, even though; newer equipment is charged a higher depreciation. Rental cost of aircrafts per available seat mile for Delta Airlines is impressively low. The rental costs for Delta Airlines stands at 0.77 cents per available seat mile, while the closest legacy carrier is American Airlines which stands at 0.86. Even low-cost-carriers have higher rental costs than Delta Airlines. The Airline has achieved this through careful negotiation of terms with lenders and Boeing Company.
When income per seat available mile is calculated for all legacy airlines, Delta Airlines incurs least amount of loss at -0.68 cents per seat available mile. During the years 1997 to 1999, the operating margin of Delta Airlines has grown due to improved efficiency of operations. Only after external circumstances create severe problems for the aviation industry as a whole, the operating margin for the airline becomes negative at -11.5 percent. Florid Market Statistics exhibit that between the year 1994-2000, market share for Delta Airlines has grown steadily. During the same fiscal period, the overall trend for the air fare is downwards. The above mentioned financial details show strengthening of competitive position of Delta Airlines amongst competitive legacy carriers.
6. Discuss Delta’s strategy of remaining competitive in the airline industry OR what options are there for Delta if they are to remain competitive in the airline industry?
Delta Airlines should adopt a number of strategic measures to improve competitiveness in the airline industry. Foremost amongst these strategic alternatives is expansion into markets outside USA. Emerging economies represent a lucrative market for airline businesses because the economic activity and business travel is growing in these regions. Further, growing globalization is enhancing trade and transportation between developed and developing world. Emerging economies like Asian countries can support top-line growth of Delta Airlines, as well as, serve as a risk diversification medium.
Secondly, Delta Airlines can focus on the niche of business travelers in its domestic travel market. Business traveler is a segment of the market which is less sensitive to price differentials and is more concerned with service delivered by the airline. This is the market segment which does not have a high regard for no-frills low-cost-carriers. They will continue to prefer legacy airlines and Delta Airlines has a competitive edge among legacy airline services. The airline company can increase amenities in its long-haul carriers which has a high value for customers, and to keep certain kinds of passengers as its top priority rather than chasing all types of travelers.
Delta Airlines can endeavor to regain the lost market share in the post September 11 era by positioning itself as the safest airline. Delta Airlines can invest in installment of enhanced security features in its aircrafts beyond the mandatory requirements of civil aviation authority. Safety of airlines has assumed an important position in consumer decision making process. Therefore, the marketing endeavor can help Delta airlines to gain market share from both low-cost-carriers and legacy-airlines. Increased investment in advertising through targeted media use is likely to revive demand for Delta Airlines among consumers.
Delta airlines should also focus on improving its operational efficiency by investing in electronic equipments and eliminate paperwork from its operations. All processes from purchase of a ticket to communication within staff should be made paperless and be transferred online. The cost savings should be transferred to customers in the form of lower prices of tickets, yet lower prices should not turn airline into a loss-making operation. Delta Airlines can hedge against price fluctuations in fuel to control this component of its costs. This will also enable the organization to absorb price shocks in fuel markets. To sum up, several options are available for Delta Airlines to remain competitive in such a challenging environment.