Aviation Industry Case Analysis of USA in 2009

1. US Aviation Industry in 2009 –
Case Study presentation
Manoj Jhawar & Group
MBA , IIT Kanpur
2013

2. The U.S. Airline
Industry

3. “129 airlines in the past 20 years filed for bankruptcy. As of 1992, in fact-though the
picture would have improved since then-the money that had been made since the dawn
of aviation by all of this country’s airlines companies was zero. Absolutely zero.
Sizing all this up, I like to think that if I had been at Kitty Hawk in 1903 when Orville
Wright took off, I would have been foresighted enough, and public-spirited enough-I
owed this to future capitalists-to shoot him down. I mean, Karl Marx couldn’t have done
as much damage to capitalists as Orville did.”
-Warren Buffet, Chairman, Berkshire Hathaway

4. History
• 1920: scheduled airmail service started (aircrafts by US Army Air Service)
• 1925 Air Mail Act: offered twelve contracts for spur routes to independent bidders
• 1925: “Ford Trimotor(The Tin Goose)” with 12 passenger capacity
• Major Airlines: United Airlines, American Airlines, TWA(Trans World Airlines)
• Demand from Airline industry led to development of aircrafts with
– Higher speed
– Larger capacity
– Fuel efficient/ less refueling stops
• With Boeing 247 and Douglas DC-3, the US airline industry was profitable even
during the Great Depression (1920s).
Boeing 247 Douglas DC-3

5. Need for federal regulation into
Civil Aviation
– Aircraft accidents in 1920s specially during
Barnstorming(flying circus) led to safety regulations.
– Risk in US Mail System: delays, cancellations, and crashes
– Evolving aviation:
• Infrastructure needed
– Navigational aids
– Night flying support
– Emergency landing strips
– Ownership restrictions required to keep railroads out of
aviation field

6. Regulation and Deregulation
• 1938: Civil Aeronautics Board • 1978: Airline Deregulation Act
established • CAB’s power of regulation over fare,
• CAB’s Responsibilities route, market entry phased out
– Safety regulations • dismantled notion of a flag carrier
– accident investigation • aggressive free-trade practice of
– regulate airline fares, airmail loss leader strategy
rates along with reasonable • By 1980 20 new carriers (People
rate of return Express, Air Florida, Midway…)
– Allocate Routes used by • 1979-83 huge losses led to
carriers bankruptcies of over 100 carriers
– Approve new carriers – Oil shock of 1979
• 23 existing airlines. No new entry – Recession
• application for new routes or fare – Air traffic controllers’ strike
changes were subject to lengthy 1981
delays and often rejected

7. Reasons behind Deregulations
• Planes Were Only Half Full - But Airlines Couldn't Offer Discounted Fares
• Airlines Couldn't Add New Routes / Airlines Couldn't Remove Old Routes
– World Airways applied for permission to fly a new route between New York
and Los Angeles in 1967. After 6½ years of delays and frustrations, the CAB
turned around and said 'This application is 6½ years out of date, it is no longer
current or relevant' and dismissed it, even though it was the CAB's fault that
the application was so old
• New Airlines Couldn't Start Up
– No new carrier had been approved by CAB since 1938
• Lessons from intra-state carriers (Southwest and PSA)
– CAB only regulated inter-state aviation
– PSA in California and Southwest in Texas
– Offered excellent reliable service on a par with the inter-state airlines
– Lesson- Unregulated (mildly regulated) aviation was demonstrably working
better than tightly regulated aviation via the CAB.

8. Increased air travel
• 1978 - 275 million passengers.
• 2009 - 770 million passengers
Safety improved Airfares dropped
The fatal accident rate, per • Between 1976 and 1990 the paid
departure, is 13 times lower in fare dropped by ~ 30%
2009 than in 1969
Deregulation
Jobs increased Bankruptcy:
From 1979 to 1989, airline • Major Carriers
employment increased from 6 (1978)  3 (1991)
356,000 people to 556,000 • Since 2000 every major airline
people has filed for bankruptcy at least
once
Competition:
• Entry barrier decreased
• many new airlines entering the
market
• airline alliances

9. Firm Strategy and Industry Evolution

10. Hub-and-Spoke System
• Greater Efficiency by reducing no.
of routes and concentrating on
traveler and maintenance facilities
in fewer locations
• Efficiency benefits reinforced by
Dallas scheduling flights in a particular
Detroit way
• Allowed major carriers establish
dominance in major regional
markets and on particular routes
• Created a barrier to new entrants
• Alliances with local airlines
Ex: American Eagle, United
Express, Delta Shuttle
San
Francisco

11. Local market share of largest airline for selected U.S. cities, 2009
City Airline Share of
passengers (%)
Dallas-Forth Worth American 73
Miami American 71
Minneapolis-St. Northwestern 59
Paul
Detroit Northwestern 54
Houston Continental 62
Atlanta Delta 53
Charlotte U.S. Airways 55
Baltimore Southwest 53
Newark Continental 52
San Francisco United 37
Denver United 37
Source: U.S. Department of Transportation

12. Mergers
Deregulation Reduced Seller Concentration Mergers and Acquisitions
2005
America West + US Airways US Airways
Concentration in the U.S. airline industry
Year CR4(%) Year CR4(%)
1935 88 1987 64.8
1939 82 1990 61.5 1986 TWA
1949 70 1999 66.4 2001 TWA
Ozark
1954 71 2002 71.0 American
American American
1977 56.2 2005 55.4
1982 54.2 2008 49.1
Source: U.S. Department of Transportation

13. Prices and Costs
After deregulation, airlines adopted cutting ticket prices as one of their major
strategies to increase their customers
• Low cost entrants played a critical role in stimulating the price wars which
characterized competition after deregulation
• Aggressive expansion through rock-bottom fares made possible by highly efficient
cost structures and a bare-bones service
• Price initiatives of low-cost airlines Selective Price cuts of major carriers
• Prices cuts selective by routes
• Majors set up subsidiaries to imitate the strategies and cost structures of the budget
airlines
Continental’s Continental Lite (1994), UAL’s Shuttle by United (1995), Delta’s Song
(1993) and United’s Ted(1994)
• Cut costs through renegotiating union contracts, terminating inefficient working
practices, abandoning unprofitable routes and reducing employment numbers

14. Quest for Differentiation
• Deregulation brutally exposed the myth of customer loyalty - Travellers became more
indifferent as to which airline to use
• Primary focus upon business and first-class travellers
• Leisure travellers’ choice was unclear – low prices or quality services. Also low margins
on these travellers
• Frequent flyer schemes to gain customer loyalty (1981) – to encourage using a single
airline
• Involving other companies as partners – car rental, hotel chains, credit card issuers -
Frequent flyer programs became an important source of additional revenue, worth over
$10 billion annually

15. The Southwest Way
• Reduce Operation costs Maintenance
• One type of jet plane – the Boeing 737 Spare parts
Training
• Manage customer expectations
• “No frills” approach helps Southwest Airlines keep costs down
• Create a unique culture
• “first come, first serve” - unique boarding procedure
• “Bags Fly Free”

16. Another success- Jet Blue
• Operational excellence
• cost leader - cutting down on unnecessary frills and wasteful expenses.
• more amenities than other airlines - creating a feeling of luxury.
• strategy to identify and eliminate non-value adding costs and use the
money so saved, to provide service of better quality.
• Differentiation
• leather seats, satellite TV, and more leg-room at a bargain price - still
makes profit.
• exceptional customer service experience
• one of the first airlines to present online baggage checking.

17. Overview (2011)
• Industry grew in 2011 by 3.5 %
• 730 million passengers
• 2 – 3% growth per year projected by FAA over the next 20
years
• Passenger carriers generated an operating profit of $3.8
billion in 2011
• Major 11 domestic players

18. Airline Fuel Prices
Source: Energy Information Administration
(U.S. Dept. of Energy)

19. Cost per Available Seat-Mile (CASM)
With and Without Fuel
• The recent changes in fuel price
has pushed fuel expenses to 35
percent of airline operating cost in
2011 against the 10 percentage of
total operating cost in year 2001
•The fuel cost was highest in year
2008 and accounted for 40.4% of
total operating cost of Airline
• Except fuel cost Airline industry
has been able to maintain rest of
the operating cost almost at the
same level
•The total airline spending on fuel
is $31 billion in year 2011 which is
triple of the same in Year 2000
Source: Bureau of Transportation Statistics

20. Per Capita Disposable Income
(Inflation Adjusted to year 2000)
• Demand of the air travel has dropped
considerably due to consumers in U.S.
experienced the impact of growing
unemployment and rising expenses for
basic necessities
•As shown in fig. per capita disposable
income for U.S. consumers has
considerable drop in year 2008-09 and
after that it is growing but at a slower
rate
Source: Bureau of Economic Analysis (Census Bureau)

21. Passenger Enplanements and Flight
Reduction
• Passenger ridership is recovering slowly from
its lowest in 704 million in year 2009
• At the same time there has been reduction
in travel opportunities due to cut in flights by
the airline industry.
In June 2012 the no. of scheduled domestic
flights of less then 250 miles was 24 percent
lower then that of the same in year 2007.
For 250-499 flight miles range this no. was 16
percentage. These combines to total of 3000
flight reduction per day from in this 5 year
period
Source: Bureau of Transportation Statistics

22. Domestic Operating Profit and Loss of
Major U.S. Airlines
• Mergers, cutting flights, Raising
fares etc. have produced positive
financial result
•Despite the pressure of rising fuel
cost, airlines are able to restore
profit from year 2009 onwards
•Major U.S. Airlines as per their
market share
(1) Merged United-20.6%
(2) Merged Delta- 20.3%
(3) Merged South west-18.6%
(4) Merged American-14.8%
Source: Bureau of Transportation Statistics (5) Merged U.S. Airwaus-9.8%
Total Market share:- 84.2%

23. The Accelerating Consolidation of the
U.S. Airline Industry
•In order to restore Profitability there
has been series of mergers in past 12
years.
•In 2000, 10 airlines accounted for
slightly more than 90 percent of
available seat-mile capacity in the
United States. By early 2012, those 10
airlines, through mergers, were
reduced to 5 airlines controlling about
85 percent of the domestic passenger
market .
•These mergers have helped airlines to
cut their cost by reducing competing
flights and by reducing Hub Operation
Source: Bureau of Transportation Statistics

24. Domestic Passenger Traffic and
Capacity
• Airlines had reduced the no. of flights
since last 11 years and increased the load
factor
•Approximately 13.9 percent of domestic
flights had been reduced from June 2007
to June 2012
• Airlines have started full utilization of
seats per flight and increased the load
factor considerably from 71% to 82% over
the last 11 year period
• This has increased revenue per flight for
the Airline industry also discount offer on
seats are reduced due to increasing load
factor
Source: Bureau of Transportation Statistics

26. Average Fares By Flight Length (2000–2011)
• Airlines have been able to increase the
price for short haul flights as the no. of
short haul flights have reduced
considerably over the last 11 years
•Airlines have also increased revenue by
implementing additional fees for services
like bag checking, seat selection, food etc.
Source: Bureau of Transportation Statistics

27. POLITICAL
ENVIRONMENTAL ECONOMIC
PESTLE
LEGAL SOCIAL
TECHNOLOGICAL

28. POLITICAL ECONOMIC
•Ecological/Environmental issues •Price Elastic industry: In US, supply has
•Government control of airports exceeded demand
•Government term and change: •Effect of monetary and fiscal policies
Stable environment in US •World economic conditions
•Home market lobbying •Rising fuel prices
•Wars and conflicts •Air traffic control charges and track
•International pressure groups access charges
•Funding and grants •Trade improvement and Boosts
investments
•Business efficiency
•Improves other aspects of the economy

29. TECHNOLOGICAL ENVIRONMENTAL
•Higher safety, better navigation, surveillance •Noise and air pollution
and air traffic management systems. •Environmental costs not included in cost of
•Higher efficiency and faster speed, and operations.
better airport operations •Pressure from environmental agencies.
•Technology to operate flights in adverse
climatic conditions
•Informed customer
LEGAL SOCIAL
•Contracts conditions for entry, operations and •Obesity
exit. •Security
•Chapter 11 of bankruptcy •Ethnicity
•Regulatory bodies and processes •Lifestyle trends
•Labor issues

30. Threat of New Entrants Buyer Power
• Deregulation • Buyer Information
• Resale market of Aircrafts • Price Sensitivity
• Glamour of owning an Airline • Group/Corporate Bargains
• Substitute Products
Supplier Power Industry Competition
• Oligopoly (Airbus, Boeing) • Price Wars
• Access to capital (Airports) • High cost of operations
• ATF suppliers • Congestion on Major routes
and Airports
• LCCs
• Chartered Flights
Threat of New Substitutes
• Telecommunications
• Video Conferencing
• High speed rail roads

31. Legacy Carriers
• Major airlines such as American, Delta, United
• Low operational efficiency
– older, cumbersome work structure
• Older, less fuel efficient aircraft fleet
– Huge impact of fuel price fluctuation
• Economies of scale not applicable
– Cost differences more due to managerial, institutional and historical
factors
– Negligible influence of economies of scale, scope, or density
• Huge network
– Cannot abandon unprofitable routes in order to maintain route
integrity

32. Low Cost Carriers (LCC)
• Minor airlines such as Southwest, Jet Blue, Airtran
• Operation from secondary airports
– Difficulty in getting gates, landing, and takeoff slots
– De facto ownership of takeoff, and landing slots by major airlines
• Newer, fuel efficient aircraft fleet
– Fuel price fluctuation invariant
• Highly efficient cost structure (operational excellence)
– Confronted labor unions: gained concessions on pay & working practices
– Work sharing between employees
– Efficiency benefits from outsourcing; better use of information technology
– Bare-bones services (economized on in-flight meals, entertainment, and
baggage handling)

33. Present and The Way Ahead….

34. Various Stakeholders- Government
•Believes in market forces – some voices of regulation.
• Very hard to regulate various aspects of airline business.
•Liberal on mergers and alliances policies.
•Taxes and fees now represent 20% of a US ticket. The
Administration’s 2013 budget proposal heaps even more
taxes on aviation.
• Manage Competitiveness

38. Airline
• Mergers – heading towards oligopoly (Continental
merged with United in 2010-12).
• Emphasis on increasing load factor.
• Short to medium term survival.
• Limit Capacity Growth.
• The industry wants the government to invest in ATC
modernization and airport expansion.
• Tie up with regional aircrafts.
• Consolidated routes.

45. Labors
• Labor intensive industry.
• Union intensive.
• Labor costs are high.

47. Recommendation on Labor side
• More flexible union agreements.
• More concession on compensation and benefits side.

48. Customers
• Reaped the benefit – Lower prices(table 3.2)
• Very less choices- effect of mergers.
• Technology Upgrades.

51. References
• http://www.oig.dot.gov
• http://www.faa.gov