A fundamental role is played by the airline industry in the globalisation process of other industries as it is a strategic sector which helps in promoting foreign investment, world trade and tourism and thus leads to economic growth. However, every airline in the industry, operates in an environment which is highly dynamic and in which the different economic, technological, social and legal forces interact with one another and have an impact on their actions and decisions. The main question here is “what are the ways which are most attractive and feasible for accessing the market access to the airlines across the world?” the ingredients are provided by the competition policy as well as the policy of international trade. A condition that needs to be recognised by all the businesses is competition and it happens to be a vital factor in the determination of a business’s success or failure. The competitive intensity is the strength of competition that is faced by a business. The number of competing firms along with their competitive strategies and the competitive forces of the industry determine its competitive intensity. The intensity as well as balance of the tension that is +created by competition has large implications on the strategy. What can and what cannot be done by an airlines is impacted by the environment wherein the airlines competes (Nhuta, 2012).
This paper will conduct a competitive analysis of the airline industry of U.S. to find out the reasons for its low profitability and also analyse its economic performance. Strategies will be suggested for bringing improvements in the chances of it being profitable persistently.
An Overview of the U.S. Airline Industry
In the U.S. Airline industry, there are over 100 certified passenger airlines that are operating accounting for more than 11 million flight departures in a year. They carry more than one-third of the total air traffic of the world. Commercial aviation makes a contribution of approximately 8% to the GDP of the country (Airlines_Eric_Henckels, 2016).
The U.S. airline industry has been struggling for long time to make profits. A number of factors have been responsible for this. Through the years, there has been entry of “low cost budget carriers” like Virgin America, AirTran Airways, Jet Blue and Southwest Airlines into the industry which has hurt the larger carriers like American, Delta and United. Non-union labour has been utilised by such new entrants and they usually fly only a single kind of aircraft that helps to reduce the cost of maintenance. The focus of these aircrafts has been on the routes that are more lucrative and they usually fly from “point-to-point” which is dissimilar to the incumbents which have been historically routing passengers via the hubs. Low fares are offered by them in order to compete. The entry of the new players has led to the creation of a situation where excess capacity exists in the industry and share from the incumbent airlines has been acquired by the new entrants as the cost structures of incumbent airlines are high as a consequence of high costs of labour. The incumbents had no choice but of responding to fare cuts which resulted in protracting a price war in the industry. The matters were made worse with the rise of the travel sites like Orbitz, Travelocity and Expedia on the internet. This made it very easy for the consumers to compare the prices and assisted in keeping the fares low.
The matters were further complicated when in 2011, the prices of oil started increasing. In 2011, the costs of fuel formed 32 percent of total revenues while the cost of labour was 26% of the total revenue. Together they formed the two largest items of variable expense. During the 2000s several airlines become bankrupt which included the US Airways, United, Northwest and Delta. Even though the larger airlines were flying, reorganisation took place under the bankruptcy law of Chapter 11 and persistence of excess capacity continued in the industry.
The latter half of 2000s and the early part of 2010s witnessed a large number of mergers in the airline industry. Merger of Northwest and Delta occurred in 2008 and merger of Continental and United occurred in 2010 while plans were announced by Southwest Airlines to merge with AirTran. In the later part of 2012, the American Airlines was put under bankruptcy protection of Chapter 11. Subsequently, U.S. Airways started pushing for an agreement on merger with American Airlines and this was till early 2013 under negotiation.
A Competitive Force Analysis of the Industry
The origin of this model is in the 1980 book of Michael E Porter which was known as “Competitive Strategy: Techniques for Analysing Industries and Competitors” (Porter, 1980). From then onwards it has been a tool which is used frequently for conducting an analysis of the industry structure of the company and also its competitive strategy (Thimpson. & Strickland., 2003). Five competitive forces were identified by Porter in his book and these forces give shape to each and every market and industry. Such forces assist in the analysis of all the things including intensity of competition to industry’s profitability to its attractiveness (Magretta, 2011) (Porter, 2008).
The main aspect of utilising the Porte’s Five Forces for the U.S. Airline industry is that the industry has been constantly battered by strong headwinds from a number of factors externally which consist of a decline of passenger traffic, increase in the operating expenses, high process of fuels and higher costs of maintenance and landing in addition to the immense competition posed by low cost carriers that has resulted in an intense price war and has had a severe impact on it (Rahman et al., 2015). The airline industry especially in case of the U.S. is said to be in a “death spiral” as the major carriers had to either merge with some other airlines or was forced into bankruptcy for staying afloat.
In the U.S, airline industry, the suppliers have an immense power due to the three inputs in form of labour, aircraft and fuel all of which are impacted by the external environment. Firstly, the prices of the fuel are subject to any fluctuation which might occur in the oil prices in the global market. There might be high fluctuations due to geopolitical as well as other factors. Secondly, labour is often subject to the union power and they usually bargain with the airlines in order to obtain concessions which are often costly and unreasonable. Thirdly, aircrafts are needed by the airlines either on the basis of wet lease or outright sales meaning that there is dependency of the airlines on Boeing and Airbus for their requirements. Due to these reasons, the bargaining power of the suppliers is high as per the framework of Porter’s Five Forces.
The growth of the online ticketing as well as distribution systems, the fliers are no longer dependent on the intermediaries and agents or the airlines for purchasing their tickets. Additionally, with the low cost carriers making their entry and the price wars which have resulted due to that has provided the carriers with several benefits. Apart from this, the presence of tight regulation on the side of demand in case of the airline industry has meant that fliers and passengers have got protection by means of regulators indicating a “balance of power” in their favour. The power is ceded to the airline industry by a combination of all the factors and therefore there is a presence of moderate to high power of the buyers in accordance with the methodology of Porter’s Five Forces. Additionally, the buyers can also be engaged in “price discovery” which means that fluctuations in price cannot stop them as there is availability of multiple channels for booking tickets.
Entry and Exit Barriers
There is a requirement of huge capital to enter the airline industry and even while exiting the sector, the airlines have the need of writing down as well as absorbing several losses. This is an indication that the barriers of entry and exit are high in this industry. Since, entry requires a big capital infusion; it is not possible for everybody to make an entry in the industry. It requires expertise along with sophisticated knowledge on the part of the companies which proves to be a deterrent. The barriers for exiting are also subject to regulations since in case of the U.S., the airlines are not permitted to exit the industry by the regulators till they get the satisfaction that a “genuine business reason” exists for it. Additionally, the synergies as well as the efficiencies from scale are leveraged by the industry and there is an existence of high barriers for entry as per the Porter’s Five Forces.
Threat of Substitutes and Complementarities
In the U.S., the airline industry does not face threat from substitutes as well as complementarities as consumers often do not take the journey through trains or buses as seen in the developing world. This indicates that for the consumers flying happens to be phenomenon which is natural and hence there is minimum impact of the substitutes. However, cars are used by several Americans which shows that a threat exists from this substitute. As far as complementarities are concerned, full service airlines offering services such as passenger amenities, a la carte meals, free Wi-Fi, etc. does not increase the number of passengers as recently it has been observed that low fares induce passenger more than these aspects.
Intensity of Competitive Rivalry
Intense competition exists in the U.S. airline industry due to several reasons that consist of low cost carriers making their entry, presence of tight regulations within the industry which makes safety paramount resulting in higher operating expenses along with the fact that the operations of the airlines occurs as per a slightly outdated business model particularly when the industry is facing rapid turnover as well as churn. Additionally, there is more regulation on the side of supply in comparison to the side of demand in the airline industry. This signifies that rather than the airlines having the freedom to select the markets where they can operate and which segments can they target, the regulators are pampering the fliers. Due to this reason, the full service airlines have been literally grounded by the low cost carriers. When this is put together with the intense competition which has always been observed in the markets of the U.S., it makes airline among the most competitive sectors of the U.S.
Economic Performance of the airline industry of the U.S.
The economic performance of the airline industry in the U.S. looks at the way the industry has been adding value to the consumers, the investors, the wider economy as well as the Governments (IATA, 2016). Cost reductions due to declining energy prices, consolidation of the industry along with capacity discipline has resulted in the US airline industry enjoying a high of 15 year in terms of operating margins which is healthy for airlines deprived of profits in the recent years. This was despite the revenue challenges present recently. In the 2015, during the second quarter, there was an increase in margins by 6.8 points and 6.2 points of network as well as value carriers. This is when yields and revenue were declining and thus reflected a favourable environment of costs along with skilled management of airlines. The decline in yields has coincided with a capacity growth that is creeping systemwide for US carriers especially in domestic markets and slight relaxations in capacity restraints recently in the industry. Capacity growth recently in domestic markets has put it closer to growth estimates in terms of the GDP. Recent years have also witnessed a strong focus of the industry to constraint capacity either at or below the GDP growth.
Capacity growth in “available seat miles” exceeded GDP growth in 2015 and the overall growth of ASM in the domestic market was 3.3%. The increase in capacity along with high competition in fares in the domestic markets softened the yields. There was a decline in systemwide passenger yields. Revenue also declined after peaking in mid-2014. However, despite the challenges of revenue, airlines have been able to sustain and also show increased profit margins as “unit cost declines” have outpaced “unit revenue declines”. The cost declines have been due to lowering of fuel prices and also other costs like maintenance and ownership. Labour costs were however, high. The overall decline in costs has been largest since 2009 (Wyman, 2016).
Identifying strategies for airline profitability
Differentiation, cost as well as agility can be used as strategies for increasing competitive advantage. differentiation can be in form of positive reputation of the company, high value and superior quality. Costs include lowering costs to make products cheaper to the competitor’s products and agility comprises being agile in terms of speed of responding to demands of the market (Eller & Moreira, 2014). Besides this, increased financing can be used along with price cuts in the form of sales and programs of frequent flyers, offering new services and improving the quality of existing services.
In 2008, the fuel prices had reached 40% of the operating costs while in 2015, they declined. The volatility in the prices of oil in the recent years have made it necessary for the U.S. Airline to develop new strategies for the purpose of increasing revenues and reducing costs. Strategies such as charging baggage fees helped it in offsetting the effect caused by rise in fuel prices. Charging this ancillary fee was used for offsetting the impact of the decrease in demand due to economic recession and financial crisis. The ancilliary fees comprised fees for priority seating, cancellation of reservation and excess baggage fees. The fuel inefficient aircrafts were retired along with discontinuing “unprofitable flying” in case of city pair markets where the costs of fuel render the routes as being unprofitable (Leigh Fisher, 2011). These strategies can be continued with. The focus should be also on low unit costs for getting an increased market share (Embraer, 2013).
The competitive analysis shows that entry and exit in this industry involves huge investments and is thus high, the supplier and buyer bargaining power are also moderately high. There is intense competition from rivals but not so much from substitutes. The unit costs in the airline decreased in 2015 due to ASM increase and greater density of seats. The industry has been marred by low profitability in the recent years. However, the airlines are showing improvements in matching their capacity to the demands of the consumers and have maintained “high load factors” in peak as well as off-peak times. The last two years saw load factors at a record level because of the stimulation of off-peak demand and either maintenance of or reduction of non-peak capacity. Even though the ASM growth was the lowest in North America, it exceeded the estimates of GDP (Wyman, 2016). The above mentioned strategies should be implemented for increasing profitability.
It is an encouraging sign that the airline industry has been able to maintain profits which are healthy even though intense competition exists but it is debatable if the profits will be able to outlast the “low fuel cycle” and will the costs of the industry be affected by the renewed focus on the customers. In addition will the carriers give in to the temptation of flooding the market with an unsustainable capacity given the estimates of economic growth and will the weaknesses that have been covered by low prices of fuel be exposed ultimately. In light of this, it is recommended that the airlines implement the above mentioned strategies so as to increase their profitability even more in the coming years.
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