Competitive Advantage in the Us Airline Industry

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Major legacy carriers (United, American , Delta, US Airways)

Structure:

- High ratio of fixed to variable costs; Low operational efficiency

- Hub and spoke route network; short and long haul flights; Operation from major airports

- Older, larger, less fuel efficient aircraft fleet

- Poor labor relations; restrictive labor agreements

- Economies of scale not applicable; Poor financial performance

Strategy:

- Cost reduction; Selective price cutting and capacity discipline

- Consolidation and network alliances

- Set up subsidiaries to replicate the strategies and cost structures of the budget airlines

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Low cost carriers (Southwest)

Structure:

- Highly efficient cost structure; Operational excellence

- Point to point route network; short haul flights; Operation from secondary airports

- Newer, smaller, fuel efficient aircraft fleet

- Work sharing between employees; low salarys

- Stronger financial position

Strategy:

- Cost Leadership embedded in the corporate culture

- Aggressive fuel hedging reduces their exposure to volatile and potentially rising fuel costs

- Aggressive price competition and market growth

- Better use of information technology; Unbundling of fares

Competitor analysis

The US airline industry has a long tradition characterized by an unattractive financial performance. To better understand the current situation of the US airline market this document provides a competitor analysis based on Porter’s Five Forces framework. The five competitive forces will help to determine the competitive intensity and attractiveness of the US airline market. The outcome of this analysis will help to reposition the strategy of a medium sized airline, which currently offers both short and long haul flights in the US market.

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Rivalry between competitors

With the deregulation of the industry, fare pricing became the focus of gaining a competitive advantage and intense price competition took place between legacy carriers and low-cost carriers. As a result airlines adopted cutting ticket prices as one of their major strategies to increase their customers and achieve high capacity utilization rates for their aircrafts.

Price cutting

The ability of the major legacy airlines to compete against the low cost airlines is limited by the very high fixed costs.

The major legacy airlines are characterized by majors cost structures, including infrastructure, restrictive labor agreements, old large airplanes and commitments to extend route networks. For example the old larger aircrafts need more fuel and union regulations mandate higher salaries and specific working circumstances for their employees.

On the other hand the variable costs are low which makes the marginal cost of adding an extra passenger almost negligible. As major costs are fixed regardless of how full the planes are rates, every extra seat sold contributes directly to the margin. As a result intense competition took place on the form of aggressive price wars with fares approaching the marginal cost.

This type of activity (price cutting) has put a handicap on larger airlines, as the new low-cost firms are able to charge lower prices for fares due to their highly efficient cost structures. In addition their unique selling strategy allow them to exercise aggressive price competition on seat reservation as other services became optional and charged separately (entertainment, baggage handling and in-flight meals).

A key factor intensifying competition is related with loss-making companies being allowed to continue in the industry for long periods with the benefit of artificially lowered costs.

Two key exit barriers are responsible for this tendency:

- Contracts (give rise to larger closure costs)

- Chapter 11 of the bankruptcy code (allows insolvent companies to continue to operate)

The consequences of this development led to a near-continuous decline in fare prices which deteriorated the available profits of the major legacy airlines. As a result the industry became very unattractive as the overall profitability went down.

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Threat of new entrants

There is always possibility that another airline will be formed to service the existing market. The likeliness of another airline being formed, will depend on the barriers to entry and the lucrativeness of the business.

Entry Costs

The initial capital requirements for setting up an airline used to be very high. In particular the purchase of new planes represented a major source of financial strain for the airlines.

Nevertheless with the costs of leasing being lower than the costs of buying, the lack of financial resources to purchase planes is no longer a barrier to new entrants. A single leased plane will suffice, thereby defraying large initial capital investments.

Offering a scheduled airline service requires setting up a whole system comprising aircraft maintenance, food service, baggage handling services, and the marketing and distribution of tickets. Technology can create easier and cheaper access to distribution channels. -non-core services can be outsourced.

Access to airports facilities

Airports facilities are still a major barrier to new entrants.

The access to airports continues to be impeded by: