Introduction

The airline industry is defined as scheduled domestic passenger airlines (no cargo

transport included) with competition based on ticket pricing, service quality, frequency and/or

capacity, and scheduling. The airline industry is comprised of two types of carriers: legacy

carriers, which operate on a hub and spoke network system and low-cost carriers, which utilize a

point-to-point, low-cost business model.

The airline industry has high labor, capital, and fuel costs that absorb a substantial

amount of each firm’s profits. Industry profits are also affected by several variables such as oil

price fluctuations, terrorist threats, bad weather, and federal regulations. The most common way

financial analysts gauge firm profitability and performance is by comparing revenue per

available seat-mile (RASM) with costs per available seat-mile (CASM). Other metrics to

consider include load factor (the percent of utilized capacity), revenue passenger miles (RPM),

debt-to-total capital, percent of on-time arrivals, and the percent of flights cancelled. The Air

Transport Association (ATA) releases these figures on domestic airlines on a monthly basis.

Industry Supply Chain

Suppliers Buyers

Aircraft
Aircraft Manufacturers
Manufacturers Leisure
Leisure
Passengers
Passengers
Food
Food Catering
Catering Services
Services
Airlines
Airlines Ticket
Ticket
Airport Sales
Sales
Airport Services
Services
Business
Business
Jet
Jet Fuel
Fuel Passengers
Passengers

The airline industry has two major suppliers of aircraft, Boeing and Airbus. The low

number of suppliers accompanied with a large amount of buyers gives the suppliers considerable

power in negotiations. The return on capital of the airline companies is affected by fluctuations

in jet fuel prices, in addition to airport service fees, and catering service fees. Ticket sales in the

industry have recently shifted away from travel agents and towards internet sales, a far cheaper

delivery system. The consumer market is categorized by travel purpose; leisure or business.

1
Macroeconomic Analysis
Domestic carriers are impacted by macroeconomic events such as government regulation,

exogenous shocks, and global oil economics. The Airline Deregulation Act of 1978 removed

government control from commercial aviation and increased competition1. This lead to

constraints on profitability for established carriers that now must match significantly lower rates

to compete with low-cost carriers. Carriers are also getting a smaller percentage of total ticket

revenues as taxes have risen from 7% in 1972 to 26% of the final price per ticket today2. Due to

highly leveraged operations, monetary policies such as interest rates have a large impact on fleet

financing decisions and bankruptcy risk; GDP and inflation are also affected by interest rates,

which impacts consumer disposable income and the overall demand for airline travel.

Exogenous shocks, such as September 11, 2001, significantly impact short term revenues

and have led to increased security costs. Although the government has subsidized many of the

added security costs, firms continue to be hampered by rising expenses. Fuel costs represent one

of the largest variable costs in the industry. From 2001-2006 jet fuel jumped 263% per barrel2.

Five Forces Analysis

Entry: Barriers to entry in the airline industry are high, thus posing a low threat to

incumbents. New entrants face large initial fixed costs due to economies of scale. Large cost

advantages independent of scale are achieved through a steep learning curve in operations

management and favorable access to airports and materials. High government safety regulation

posed by the FAA and EPA further restricts entry and increases startup costs.

Suppliers: Overall, suppliers pose a high threat. Suppliers can be divided into three

categories: aircraft manufacturers, fuel, and airports. Aircraft manufacturers pose a high threat

because the demand for aircraft exceeds supplier manufacturing capacity, and their market is

dominated by only two firms who produce unique goods. Fuel suppliers pose a moderately high

1
Domestic Airline Analysis. Marketline Research Reports. 2007.
2
Heimlich, John. Operating in an Era of High Jet Fuel Prices. Air Transportation Association, 2007.

2
threat because fuel purchases make up 30% of operating expenses, up from 10% in early 20003.

Since fuel accounts for a significant amount of expenditures, overall industry profitability has

suffered. Consequently, airlines have taken more aggressive fuel hedging strategies and entered

into derivative contracts to mitigate their risk of fuel price volatility4. Airport service suppliers

pose a moderately low threat because they lack alternative sources of revenue. Airlines are a

complement to airports and, thus, airports rely heavily on the success of the airline industry.

Substitutes: The threat of substitutes is moderately low. There are many substitutes for air

travel such as ground transportation (cars, buses, trains) and water transportation (boats, ferries,

cruises). Also, luxury or business travelers may opt for private jets. For regional travelers,

switching to a lower-cost substitute may be a viable option; however, for cross-country or

emergency travelers, sacrificing convenience for cost is not an option.

Buyers: The overall threat of buyers is moderate. Buyers can be divided into two main

travelers: leisure and business. Leisure travelers are price sensitive as airfare is a significant

percentage of the travelers’ final costs. They require lower fares which reduce industry profits,

thus posing a moderately high threat. Business travelers, who earn economic profits through

traveling for work, have more inelastic demand and are willing to pay higher fares for amenities

and flexibility of booking. Therefore, they pose a lower threat to the industry.

Rivalry: The threat of rivalry is high due to a large number of similarly sized competing

airlines. The domestic airline industry is mature with slow growth, and there is currently a lack

of differentiation in product offerings. While product loyalty does offer a source of

differentiation among business travelers, it is not significant enough to reduce the threat of

rivalry as business travelers are a small portion of buyers. Also, airline capacity is added in large

increments, which also leads to price-based competition between existing firms in the industry.

3
Scheduled Domestic Air Transportation in the US. IBISWorld Industry Report. 2007.
4
Corridore, Jim. Industry Analysis - Airlines. Standard & Poors. 2007.

3
Airline Trends
Throughout the history of the industry, major air carriers have largely relied on the hub-

and-spoke network system1. Recently, low-cost carriers have developed a point-to-point platform

to meet the demand of both leisure and business travelers. This platform is more convenient for

travelers because it doesn’t route them through multiple airports but rather allows for direct

flights3, which reduces the threat of substitutes. The majority of US passengers are price

sensitive, which has led to the emergence and success of no frills, discount airlines that have

decreased costs by eliminated most amenities. Regional jets represent the fastest growing

segment of the industry, expected to rise from 7.4% to 19% between 1999 and 2011, because

they benefit smaller communities and provide more frequent and direct services1.

Following September 11, industry revenue decreased by 45%, forcing five of the top 11

US air carriers into bankruptcy3. This has initiated a push toward consolidation or possible

foreign ownership. Terror related concerns have increased industry-wide security costs, which,

even with government subsidies, continue to hamper the profitability of domestic airlines.

Through technological advances like internet flight booking, self service kiosks, and

ticket-less travel, airlines have decreased the time and costs related to booking and checking in

for flights. Airlines are able to reduce CASM through higher capacity planes and greater fuel

efficiency, which has improved 20% since 2002. The lower demand for fuel will reduce the

threat of fuel suppliers to the industry. Further technological developments include next-

generation air traffic controls that allow planes to fly closer together, easing navigation issues

and reducing congestion among the highly traveled air routes5.

Average Industry Profitability

The airline industry has gained a reputation as one of the riskiest due to its cyclicality and

vulnerability to changes in the external environment. Since 2001, airlines have had difficulty

5
"NextGen." Next Generation Air Traffic Technology. 17 Nov. 2007 <http://www.jpdo.gov/nextgen.asp>

4
realizing profits; but in 2006, they finally posted $3 billion in profit6. Changing trends point to a

positive outlook:

• Reduced domestic capacity due to consolidation and the scaling back of fleets will
decrease the supply available to consumers and increase fares.

• Fuel efficiency will reduce costs to airlines and decrease the threat of suppliers.

• The Next Generation air traffic technology will allow for a greater number of
flights per day, increasing industry revenues.

• For leisure travelers, the increasing cost of gasoline makes it cheaper to fly long
distances than drive, increasing airline revenues and decreasing the threat of
substitutes.

Industry Attractiveness
Based on our above analysis, the airline industry is attractive for incumbents. The

projected long-term increase in demand and lack of comparable substitutes for air travel maintain

the endurance of the industry. Low threats of entry and substitutes allow staying power and

higher performance for incumbents. Although the threat of rivalry is high, the nature of the

industry allows many firms to coexist due to regional emphasis, segmented markets, and

increasing demand. And while fuel suppliers currently present a threat, efficiency advances will

mitigate this threat. In analyzing the forces acting on the industry, and considering the positive

outlook of increasing profit margins, it is attractive for incumbents to continue operating in the

airline industry. The following suggestions will maintain and further increase this attractiveness

for incumbents: (1) establishing financial health by improving credit ratings and decreasing

leverage such that firms can survive normal economic volatility, (2) simultaneously investing in

more efficient, cost-reducing technology and fleets, (3) increasing productivity levels through

higher aircraft utilization, and (4) restructuring essential operations to be more efficient. The

strategic choices made by each firm in this attractive industry will dictate its own profitability

and success.

6
2007 Economic Report. Air Transportation Association, 2007.

5
 
  1 Josh Bloom
Brief Company Overview

Alaska Airlines began business operations in 1932, and is currently a subsidiary company

that represents 81% of total sales 06’ of the Alaska Air Group (ticker: ALK) . Alaska Airlines

services destinations in the state of Alaska and throughout the western states of the US, western

Canada and northern Mexico. As of year-end 2006, their operating fleet consisted of 114 jet

aircraft, and the average passenger trip was 1,038 miles1.

Performance

In their 2006 10-K, Alaska Airlines reported a RASM of 11.57 cents, and a CASM of

11.98 cents.1 This RASM level is the second highest in our group of airline companies, but the

difference between these two, which equates to operating profits, is one of the worst. In the same

year, Alaska reported revenues of $3,334.4 million, which was a 12% increase from 2005.

Revenues have historically grown throughout the past 10 years of operation by an average annual

growth rate of 7.25%. However, in this same period, Alaska Airlines reported positive net

income only twice. The high growth in revenue accompanied with consistent negative net

income suggests that Alaska Airlines cost structure is not competitive2.

Alaska Airlines largest expense category has consistently been aircraft fuel, reporting an

$873.5 million fuel expense for 2006. Though rising fuel prices have burdened the entire airline

industry, fuel hedging has been a successful strategy implemented by several airline companies.

Alaska Airlines currently has a fuel hedging strategy that has reduced their economic fuel costs

by around $100 million each year. Alaska Airlines is considered to have the second best fuel

                                                            
1
 Alaska Airlines 2006 10‐K Financial Report http://media.corporate‐
ir.net/media_files/irol/10/109361/Reports/2006AnnualReport2007ProxyStatement.pdf 
2
 MarketLine Research  
http://0‐library.marketlineinfo.com.lib.bus.umich.edu/library/iProduct_product.aspx?R=FEF3BEA1‐78EE‐42E9‐AD5F‐
FD195EA20C74&s=IDA25RUC 
 
 
  2 Josh Bloom
hedging strategy in the industry, next to Southwest3. The other strategy Alaska implements to

decrease their fuel expense is to replace their aging MD-80 aircraft with the 20% more fuel

efficient Boeing 737-800 series aircraft. Age of an airliner’s fleet is a major determinant of fuel

efficiency, and therefore fuel costs for an airline. Currently, Alaska Airlines is undergoing a

transition of their fleet and will have an all Boeing 737 fleet of 114 jets in 2008, which will

increase fuel efficiency. Also, average fleet age is expected to drop to 8 years in 2009, one of the

lowest in the industry4.

Alaska Airlines is regarded as having the second best balance sheet in the industry next to

Southwest. This is due to their low debt-to-capitalization rate of 57%, and their high current ratio

of 1.27 (06’ figures)5. Generally, the industry is characterized by companies that are highly

levered and have low current ratios. The low level of debt accompanied with a high current ratio

shows Alaska Airlines financial strength, despite reporting losses in net income. The 2007 loss in

net income is mainly due to extensive fleet transition costs. However, the fleet transition to the

more fuel efficient Boeing 737 aircraft will reduce annual fuel costs, and only represents a short-

term fixed cost. Despite having a competitive balance sheet position, I rank Alaska Airlines as a

middle-tier performer in the airline industry because of their low profitability.

Resources and Capabilities

The company holds a rare options contract with Boeing to purchase up to 49 aircraft

within the time period of now until 20136. This resource is rare because Alaska will have access

to Boeing’s production backlog ahead of other airliners in the industry. This allows Alaska to

take advantage of the 20% more fuel efficient Boeing 737’s faster than its competitors.

                                                            
3
 Bear Stearns & Co. Inc  Analyst Report: Frank Boroch, analyst 
4
 MarketLine Research  
http://0‐library.marketlineinfo.com.lib.bus.umich.edu/library/iProduct_product.aspx?R=FEF3BEA1‐78EE‐42E9‐AD5F‐
FD195EA20C74&s=IDA25RUC 
5
 Wall Street Journal Company Reports www.wsj.com 
6
McAdams‐Wright‐Ragen Incorporated Research Report: Mike Roarke, analyst 
 
  3 Josh Bloom
Through futures contracts with oil companies, they are able to purchase jet fuel at a

cheaper rate than most other airlines companies, giving them a distinct advantage. This

represents a rare resource for Alaska because few other airline companies have similar fuel

hedging programs. Although rare, this advantage is not sustainable as the hedging position

expires in 20098.

Alaska Airlines has a strong hold on its homeland market of the state of Alaska. This is a

valuable resource for Alaska Airlines because it provides consistent revenues to the firm. Also,

this resource is less imitable because other firms would face significant costs in setting up

operations in Alaska.

Another valuable resource to Alaska Airlines is their strong industry reputation for

customer service. From 2003-2006, they have won the prestigious Freddie Award, for best

frequent flier program website7. This award is given to the airline with the most votes from the

participating public. Also, in 2005, Inflight Online Magazine awarded Alaska Airlines their

Service of the Year Award8. Their reputation for high quality service allows them to enjoy high

customer retention rates, and is an important contributing factor to their sustainability over time.

Strategy

Historically, airline companies have been characterized as either seeking a product

differentiation or cost leadership strategy. However, the current competitive landscape in the

airline industry requires a focus on both. Legacy carriers that are highly differentiated are

desperately trying to reduce costs, and low-cost leaders such as JetBlue have found unique ways

to differentiate their product. Currently, Alaska is positioned as unsuccessful at differentiating

their product and/or achieving cost leadership in the industry (refer to conceptual map in industry

                                                            
7
 http://www.freddieawards.com/ 
8
 Alaska Airlines Homepage www.alaskaair.com 
 
 
  4 Josh Bloom
analysis). Alaska has several initiatives underway to re-position their company. Soon, they will

offer complimentary regional wines and microbrews to give passengers a taste of the pacific

northwest while on board. This will differentiate their product, as they will be able to offer

customers a unique, regional experience. Also, Alaska has highlighted a plan to achieve a profit

margin of 10% by reducing costs. Cost reduction will come from more fuel efficient aircraft and

their proven fuel hedging program.

The company has a considerable hold on the niche market of Alaska, which represents a

sustainable competitive advantage because of first-mover advantage and brand loyalty. The

company has a strategy of expanding routes and gaining market share in the pacific northwest,

which is an appropriate move considering their current geographical and financial position. They

will be able to utilize their existing customer base, and their new fleet of Boeing 737’s to gain

market share in this region of the country.

Alaska cares about sustainability by taking care of those that drive their internal business,

the employees. Due to Alaska’s high amounts of cash on hand, the company was able to

contribute $122 million to the employee pension plan, making it one of the best in the industry9.

Alaska’s proven commitment to its employees provides them with sufficient intrinsic

motivational factors to drive the business. They have business plans underway to create an easy

“curb to curb” customer experience by improving their web or kiosk check-in, baggage check

and retrieval, and a friendly on-board experience. Their business strategy of improving the

customer experience is in line with their historical emphasis on quality service.

Alaska has also began to expand their domestic coverage by offering service to Dallas,

Boston, Denver, and Chicago10. Although this increases Alaska’s product offerings, these

                                                            
9
 Alaska Airlines 2006 10‐K Financial Report http://media.corporate‐
ir.net/media_files/irol/10/109361/Reports/2006AnnualReport2007ProxyStatement.pdf 
10
 Hoovers Company Research  
 
 
  5 Josh Bloom
expansions are taking them away from their core business, which is the west coast of North

America. This expansion strategy is not advantageous to Alaska because they will have to

compete with other domestic airline’s niche markets. Also, overly extending their resources may

bring financial stress, potentially weakening their balance sheet.

Their overall strategy should be to achieve stable growth in their core market while

reducing costs, and to further differentiate their product by creating a unique customer

experience.

Future performance

As revenues will likely follow the company’s 10 year average growth trend of 7.5%,

future performance relies heavily upon Alaska’s cost structure. Alaska has a fleet transition plan

of having an all Boeing 737 fleet by 2008. This will reduce costs by increasing fuel efficiency,

and will reduce their average fleet age to 8 years, which is very low compared to their

competitors. The age of their fleet is a positive sign for future company profits, even though it

represents a substantial short-term fixed cost.

A young fleet accompanied with a reputation for high customer service in a niche market

off the west coast of North America signifies a positive future outlook for Alaska Airlines. As

long as they continue to develop their core business, focus on reducing costs, and do not overly

extend their resources into other airline’s niche markets, Alaska Airlines will utilize their

existing resources to achieve sustainable profits over time.

 
 1 David Gordon
Company Overview

Delta Air Lines has been consolidating and reorganizing its operations since emerging

from Chapter 11 bankruptcy in April. The company, which posted its first quarterly profits since

2000, offers service to 311 destinations in 52 countries. Delta started flying passengers in 1925, a

year after beginning its business as the world’s first crop-dusting service. Through its

comprehensive network system, it has become the largest airline in domestic destinations served

with over 51,000 full time employees. The airline has grown largely through the acquisition of

other network carriers, namely Chicago, Southern, Northeast, and Western Airlines. Delta also

pushed organic growth through the creation of the Delta Connection and Delta Express services.

Performance Statistics

Delta reported operating income of $58 million in 2006, excluding a one-time $6.2

billion charge related to reorganizing items1. This represents the first annual profit since 2000,

and a $2.1 billion improvement in operating results compared to 2005. The improvement is

attributable to cost reductions achieved during the Chapter 11 reorganization, which is expected

to provide annual financial improvements of over $3 billion, as well as recent revenue increases2.

The company’s debt-to-total capitalization is 47 percent, well below the industry average

of 76 percent3. Because interest on aircraft leases and debt obligations makes up such a large

percentage of industry costs, a strong balance sheet is imperative in order to cover interest

payments4. Delta also reported record passenger load factors of 78.5 percent, up 6.2 percent from

a year earlier with a capacity increase of only 2.9 percent5. While the load factor was quite high,

the company recorded a low passenger mile yield of 13.46 cents in 2006. This low yield is

1
10K - 2006 Annual Report. Delta Airlines. 2007.
2
Domestic Airline Analysis. Marketline Research Reports. 2007.
3
Corridore, Jim. Industry Analysis - Airlines. Standard & Poors. 2007.
4
Scheduled Domestic Air Transportation in the US. IBISWorld Industry Report. 2007.
5
"Delta Financial Information." Google Finance. 27 Nov. 2007 <http://www.finance.google.com>.
 2 David Gordon
attributable largely to the rise of low-cost carriers, which directly compete with Delta in most

domestic markets2. For the year ending November 2007, Delta’s on time percentage was 82

percent with 99.3 percent of flights completed, both of which are significantly higher than its

major rivals6.

The firm’s RASM was 11.60 cents in 2006 compared to its CASM of 11.56 cents,

representing only a 0.04 cent profit per available seat mile1. Passenger RASM increased 18% in

2006 largely due to fare increases implemented as part of the improved industry revenue

environment and the positive impact of strategic initiatives, including right-sizing capacity to

better meet customer demand and increasing point-to-point flying to achieve a greater local

traffic mix. However, Delta’s CASM has also increased due to rising fuel costs, with an increase

56 percent since 2004, largely offsets its advancements in RASM. The firm is not as highly

hedged against the recent volatility in fuel costs, which represents a significant cost disadvantage

to its major rivals.

Operating Strategy

Delta is able to leverage many of its resources and capabilities in pursuing its strategy of

providing a unique service to its passengers at a competitive price.

Strong Market Position Leveraging Network Strength. In 2007, Delta’s domestic market

share has grown to 11 percent6. Delta is the only airline to service all 50 states, offering service

to more destinations than any other carrier, and is second only to Southwest Airlines in terms of

domestic passenger’s carried1. Delta operates its network route system out of its main hub

airports in Atlanta, Cincinnati, New York and Salt Lake City, each of which gather and distribute

Delta flights to domestic and international cities as well as other Delta hubs. The company’s

6
Heimlich, John. Operating in an Era of High Jet Fuel Prices. Air Transportation Association, 2007.
 3 David Gordon
well-built presence in airports that accommodate the largest passenger traffic in the world gives

it a competitive advantage2.

Focus on Improving the Customer Experience. Delta is committed to continuous

improvement throughout its operations to earn customers’ preference. In 2006, JD Power and

Associates ranked Delta as North America’s Leading Business Class Airline for the second

year2. It has a renewed focus on improving its product and customer service through aircraft

cabin and airport improvements. Where others cut costs at every possible corner, Delta embraces

customer needs and desires, such as in-flight entertainment systems and airport lounges.

Business travelers, who are often more profitable ticket sales than vacation travelers, are also less

likely to book online because it is typically more time consuming than speaking to an agent7.

Delta recently completed an upgrade to its online booking process to a more sophisticated system

that increases the speed of booking and checking in, which both lowers its costs and attracts

more consumers.

Diversification. Along with its mainline carrier, Delta operates the largest regional jet

service in the United States as well as a point-to-point carrier that services the northeast corridor.

The Delta Connection program is its regional carrier service that operates flights serving

passengers in small- and medium-sized communities. The program enables Delta to increase the

number of flights it has in certain locations in order to better match capacity with demand and to

preserve its presence in smaller markets. Delta also operates a high frequency service targeted to

northeast business travelers known as the Delta Shuttle. The Delta Shuttle provides nonstop,

hourly service on business days between New York’s LaGuardia Airport and both Boston’s

Logan Airport and Washington, D.C.’s Ronald Reagan Airport. These services, along with

7
Domestic Airlines in the US. Mintel Research Report. 2007.
 4 David Gordon
Delta’s strong international presence, act as a hedge against a downturn in any specific niche of

the airline industry and provide a more constant cash flow to the company.

Cost Reductions from Chapter 11 Restructuring. Delta is able to compete much more

effectively due to the renegotiations it achieved during its Chapter 11 bankruptcy proceedings. It

now has one of the lowest unit cost structures in the industry due to:

• Maximizing a Streamlined and Upgraded Fleet. Delta is simplifying its fleet,

including retiring four types of aircraft. It is also right-sizing capacity to better meet

customer demand, including utilizing smaller aircraft in domestic operations that has

reduced domestic capacity by 16% in 2006. Delta is also restructuring its fleet by

selling approximately 188 aircraft1, which creates cash flow in the short term and cost

savings in the longer term. Delta is supporting the ongoing changes to its network by

bolstering the internationally-capable mainline fleet through the addition of high-

performance aircraft that will enable it to serve new destinations with appropriate

capacity1. Streamlining the number and type of aircraft decreases costs. Inventory

holding costs and the related maintenance staff drops significantly, and pilots, who

are certified to fly a limited number of aircraft, can be used more efficiently, which

allows for a decreased labor force.

• Labor Cost Reductions. Delta reached an agreement with the Air Line Pilots

Association under which it will receive approximately $280 million in average annual

labor cost savings from changes in pay rates, benefits and work rules. As of

December 31, 2006, approximately 17% of Delta’s employees were represented by

labor unions1. This is a lower percentage than its competitors and decreases the threat

of unionized negotiations and a strike.

 5 David Gordon
Through initiatives undertaken during the Chapter 11 proceedings and previous productivity

initiatives, Delta has been able to capture the benefit of a competitive cost structure. It now has

one of the lowest mainline unit cost structures of any full service carrier. These efforts have

resulted in reduced costs throughout the firm, including reductions in employment costs, pension

and healthcare costs and aircraft fleet costs. To succeed, the company must maintain its

competitive cost structure developed through these restructuring efforts and continue its push for

the lowest overall cost structure.

Potential Risks

The emergence of low-cost carriers poses a threat as these carriers have a very efficient

cost model and continue to take market share. Even with rising fuel prices, Delta can only raise

fares to a point due to the presence of low-cost carriers. A large rise in fuel prices may not

necessarily be passed on to customers. However, Delta can continue to rely on business and

international travelers who prefer comfort and amenities.

Delta’s Future Prospects

In the near term, Delta will leverage the cost reductions achieved during the bankruptcy

proceedings, its diversified services, and its strong market position to compete more effectively

with low-cost airlines. However, the continuing growth of low-cost carriers, such as Southwest

and JetBlue, has placed significant competitive pressures on network carriers. Delta can also

leverage its international presence to spread domestic costs throughout other markets. Delta’s

ability to compete effectively depends on its ability to maintain a competitive cost structure,

especially with fuel price increases. If Delta can maintain a competitive structure, it should see

continuing profits in the future.

 1 Lisa Huber
Background

Ken Gile, past Director of Operations for Southwest Airlines, first thought of creating a

new low-cost airline in the early 1990s, but did not succeed until years later. Skybus, founded in

2004, was to be modeled after the highly successful, ultra low-cost European carrier Ryanair.

Although he and partner John Weikle faced mass criticism for entering an industry with

skyrocketing jet fuel prices and high bankruptcy rates, they managed to develop and implement

an extremely low-cost, no-frills business model and began flying in May 2007 after receiving

approval from both the FAA and US Department of Transportation.

Performance

With annual sales of $20.9 million, a staff of 65 employees, and just seven months of

operation, Skybus, a privately held company, lacks the necessary hard data to compare to other

airlines in the industry. Skybus has, however, announced that its CASM (cost per available seat

mile) is projected to be 28%2 less than that of Southwest, which helps to explain how they can

keep the ticket price of each seat on average 25% less than Southwest. Although difficult to

compare financially to major airlines, Skybus is a high performer amongst low-cost carriers.

With 13.2 hours of usage per plane per day, Skybus is more effiecient than any other airline in

the U.S. including competitors Frontier (12.3), United (11.9), America West (11.9), and Spirit

(10.6).1 Skybus also maintains high utilization and efficiency with low turnaround time of 25

minutes1.

Operating Strategy

Skybus’s no-frills business model is almost identical to that of Ryanair. Although tickets

are sold for as little as $10 each way, passengers must pay for any extra amenities – priority

1
Rose, Marla M. "Taking to the Skies on a Tight Schedule." The Columbus Dispatch 16 Sept. 2007. 2 Dec. 2007
<http://www.columbusdispatch.com/live/content/business/stories/2007/09/16/SKYBUS_ROUTES.ART_ART_09-
16-07_D1_L17T4OD.html?sid=101>.
 2 Lisa Huber
seating, food or drink, checked baggage, etc. Skybus markets their no-frills policy as a

customization opportunity; customers can “control exactly what they pay for. You can

customize your experience and fly the way you like”.2 By ridding the extras, Skybus is able to

offer fares 65% lower than the average airline, and still 25% lower than Southwest.3

Eliminating extras is not the only way to cut costs, however. Skybus employs a number

of other strategies to keep costs and prices down. Skybus automates everything including

ticketing and check-in at the airport to cut costs on employees, travel agents, and other

operational expenses. They do not even have a phone number for customer service – everything

is online. Skybus, like Ryanair, uses secondary airports to keep planes running on time for much

less. Even though the New Orleans destination airport is actually 74 miles from New Orleans,

customers have responded well due to such enormous savings.

Although cutting costs on-board and at the airport are beneficial, the biggest expense for

any airline is its fleet. Skybus’s fleet is currently made up of 7 Airbus A319s, with the rest of its

65-aircraft order (total retail price of $3.7 billion2) to be delivered over the next 12 years. To

maintain their fleet, Skybus bought a Total Support Package from Airbus, which will fix all costs

associated with technical operations.4 Fixing these costs offers predictability for future

budgeting, which gives Skybus a valuable and rare asset.

Other low-cost carriers such as Southwest have opted for Boeing in the past, mostly using

737-700s priced between $57-67.5 million5, whereas Skybus was able to purchase each Airbus

A319 for just under $57 million. A319s also offers 335 more nautical miles of range, directly

2
"About Skybus." Skybus. 2007. 27 Nov. 2007 <http://ask.skybus.com/about/skybus-story.shtml#s-difference>.
3
"Skybus Airlines." Wikipedia. 2007. 27 Nov. 2007 <http://en.wikipedia.org/wiki/Skybus>.
4
"Press Releases." Airbus. 6 Nov. 2006. 27 Nov. 2007
<http://www.airbus.com/en/presscentre/pressreleases/pressreleases_items/06_11_06_skybus_airbus_support_packag
e.html>.
5
"Commercial Airline Prices." Boeing. 2007. 27 Nov. 2007 <http://www.boeing.com/commercial/prices/>.
 3 Lisa Huber
supporting Skybus’s efforts to provide non-stop flights across the country. The A319 Aircraft,

however, has a maximum fuel capacity of 575 fewer gallons than the 737-700’s 6,875. All other

specifications including seat capacity and engine thrust range are relatively similar. By

purchasing a standardized fleet, Skybus also reduces employee-training costs and increases

operational efficiency and turnaround time.

In order to increase profitability, Skybus has not only focused on the cost side of the

equation. The airline also generates revenue from on-flight sales of food, drinks, clothing,

electronics, model planes, Skybus gear, and many other products. Skybus’s corporate strategy

involves alliances with specific companies who supply the products for sale on flights or place

advertisements in and on the plane itself.

VRI Analysis

Although Skybus is new to the airline industry, they have already managed to achieve

great success by aligning their assets with their business strategy. In addition to basic cost-

cutting techniques mostly copied from Ryanair – thus proving these assets imitable – Skybus has

many valuable, rare, and inimitable assets that will provide much success in the near future.

Skybus’s management team is comprised of a number of individuals with prior

experience in the airline industry. President and COO Ken Gile was previously a U.S. Air Force

pilot and flight instructor, and worked for Southwest Airlines for 25 years. Charlie Clifton,

member of the Board of Managers, spent 16 years helping to develop Ryanair’s operations and

has served as interim CEO of Tiger Airways.6 These two men have over 40 collective years of

experience managing ultra low-cost airlines – experience which cannot be duplicated.

6
"Our Management Team." Skybus. 2007. 27 Nov. 2007 <http://ask.skybus.com/about/skybus-story.shtml#s-
management>.
 4 Lisa Huber
Skybus has been able to gain a first-mover advantage. While the airline is not necessarily

the first discount flyer on the market, it is the first in a new class of aggressively low cost airlines

in the U.S. Although this may have been Southwest’s initial strategy, they have been forced to

increase prices due to surging jet fuel prices. With tickets an average of 25% less than

Southwest, Skybus is able to attract a new market – low-income travelers who consistently

choose lower cost substitutes such as rail, car, public bus, or boat. For example, for just $10,

Skybus offers a number of tickets flying Columbus, OH to Chattanooga, TN. For the 460 mile

trip, it would cost $61.53 by car ($3.09/gal*460 miles÷23.1mpg)7, or $36-$798 for a non-stop

greyhound ticket. Consumers shopping on price will choose Skybus. In addition, as long as

Ryanair stays in Europe, American consumers only have one option for extremely cheap

domestic air travel. Gaining this type of first-mover advantage will build brand loyalty while

competition is low, enabling Skybus to create, capture, and retain market share in the future.

This capability is clearly valuable, rare, and inimitable as well.

Potential Risks

Although Skybus’s assets are in line with their business strategy, they could still face

problems in the future due to the volatile dynamics of the airline industry. Airlines face rising

fuel prices, unmanageable debt, domestic turf wars and increased competition leading to price

wars9. Pressure from labor unions can be especially detrimental to an airline’s success.

Discount airlines, in general, pay lower salaries than other airlines to keep costs down and

increase profitability, “which in turn allows them to retain more employees, making them

attractive employers even if they pay less overall.”6 Skybus is, obviously, following this model

7
Carr, Brian. "Average Gas Mileage Relatively Flat Between 1980 and 2004." Daily Fuel Economy Tip. 19 Oct. 3
Dec. 2007 <http://www.dailyfueleconomytip.com/?p=195>.
8
http://www.greyhound.com/home/
9
MINTEL
 5 Lisa Huber
of low wages. Skybus pays flight attendants only $9/hour, and captains receive an annual salary

of $90,000 – 25% less than a 1st year captain at a major airline.2

While at any other discount airline, an employee may be willing to sacrifice pay for job

security, Skybus is just starting operation and is an incredibly risky venture, thus offering little

security for employees. Because Skybus has already invested in 65 new aircrafts – an

aggressively presumptuous purchase – they will need to take extra steps to maintain enough

employees to fully service their airplanes so they can create more flights and recover costs faster.

If employees can receive better salary at other airlines that offer more job security, Skybus will

suffer huge losses and may be forced to increase wages and ensure their growing fleet will be

staffed.

Recommendations

Increasing wages contradicts Skybus’s low-cost business model. If Skybus had not been

so overconfident to order 65 new planes – an investment which could easily lead the startup to

bankruptcy – the company would not have been perceived as such a volatile endeavor and would

have been able to retain employees while offering lower wages like other discount airlines.

Because Skybus has already attempted to grow too fast too soon, and cannot renege on its

contract with Airbus, the airline must find another way to retain employees at low-cost. Skybus,

which plans to go public in 2009, should offer stock packages to employees in the future as part

of salary. This strategy will allow them to keep down wages, while giving each employee a

personal incentive to make the company succeed, thus increasing value and profitability of the

company as a whole, which will in turn offer more security to employees and support such

aggressive growth.
 6 Lisa Huber
In general, Skybus has been overconfident in terms of growth projections like many other

startups. As long as the company hedges their $3.7 billion aircraft investment by utilizing their

most important inimitable assets – management expertise and creating new markets – they will

be a high performer in the future.

 1 Jessica London
AirTran Airways

AirTran Airways is a low-cost scheduled airline established in 1992. It operates in short-haul

markets primarily in the eastern United States. AirTran is one of two consistently profitable

airlines in the United States, providing a superior product at a low cost.1 Their slogan, “Go,

There’s Nothing Stopping You,” represents AirTran’s commitment to offering customers an

extensive number of convenient destinations and value at an affordable price. Currently the

service operates 700 daily flights to 56 domestic destinations. As a young competitor in the

domestic airline market they have experienced substantial growth in their business and profits.

Performance Statistics

In 2006 AirTran earned operating profits of $574.5 million, a huge increase over the $464.3

million posted in 2005, marking their eighth consecutive year of profitability2. Their current P/E

ratio of 15.05 is slightly higher than the industry average of 14.62, indicating future growth

potential3. Revenue per average passenger mile (RASM) increased 22.4% since 2005, while unit

operating costs (CASM) has been steadily decreasing, resulting in higher margins and increased

profits. Analysts project that 2007 will mark the sixth consecutive year of cost reductions for the

firm4. In 2006 their load factor, a measure of asset utilization, was respectably 71.8%, but does

offer some room for improvement relative to competitors. Being a younger airline they flew a

modest 13.84 billion revenue passenger miles, an increase over 2005¹.

In the first quarter of 2007 AirTran had an on-time completion rate of 86.2%, ranking it fifth in

major carriers. They scored second behind only JetBlue in overall airline quality measured by

1
Airtran Holdings Inc. Form 10-K/A, August 09, 2007
2
IBISworld Report: Airtran Holdings Inc. 2007
3
YahooFinance.com (29 Nov. 2007)
4
“AirTran Airways Today” Bear Stearns: Global Transportation Conference (9 May 2007)
 2 Jessica London
on-time performance, denied boardings, mishandled baggage, and customer complaints4. These

statistics are a clear indicator of excellent customer service. AirTran’s balance between financial

and operational performance is favorably positioning them for future growth and profitability.

Operating Strategy

AirTran has been able to sustain profitability through its strategy as a high value low-cost carrier.

AirTran’s ability to maintain low operating costs, and its development of innovative in-flight

features have been essential in the execution of this strategy. The heart of their operation stems

from a modified hub and spoke operating strategy, one that has proved profitable in the past.

Low Cost

Low cost initiatives throughout the airline have resulted in substantial cost decreases over the

past several years. Two areas that have had a significant impact on the firm’s ability to cut costs

are fleet standardization and automation.

Standardized fleet: AirTran’s new and modern all-Boeing fleet is comprised of 87 Boeing B717

and 41 B7371. Currently their average fleet age is 4.4 years, one of the youngest in the industry5.

Fleet standardization has allowed AirTran to benefit from operational efficiencies including; a

reduction in the costs of employee training, faster turnaround times, and increased fuel

efficiency. With a fast turnaround time the airline is able to obtain higher asset utilization and

thus fewer planes are needed in inventory. Fuel efficiency is extremely important because it

accounts for a large portion of an airline’s operating costs. Not only does AirTran fly a highly

fuel efficient fleet, it has also used hedging techniques to mitigate the risk of increasing fuel

prices4. Further, as the launch customer for the B717, designed specifically for efficient short-

haul service, they endure an additional advantage. AirTran’s fleet offers a short-term

competitive advantage because it is unrealistic that other airlines would be able to update and
5
“AirTran Fleet Age” http://www.airfleets.net/ageflotte/airTran.htm (29 Nov. 2007)
 3 Jessica London
standardize in the near future. In the long term this advantage will be imitable, and thus the

airline must remain on the cutting edge of innovation in order to sustain this resource advantage.

Automation: The implementation of online flight booking, self-service kiosks, and online check-

in has created large cost cuts for airlines. Currently it costs AirTran $8 to book a flight through a

travel agent, while only $.25 to book online6. With its award winning website airtran.com, the

airline has aggressively been taking advantage of the internet, increasing online flight sales to

60%, and in-house sales to 80% of total business1. This is important because when a passenger

books through “fare-finder” websites such as Expedia and Orbitz, the airline is required to pay a

commission, thus increasing marginal costs.

Amenities

AirTran is able to differentiate itself in the low-cost carrier market by offering convenient and

unique amenities. Three sources of differentiation include: affordable business class, pre-

assigned seating, and XM Satellite Radio. They are currently the only airline to offer business

class on every flight. This affordable business class option has helped grow their business by

appealing to business travelers who currently comprise approximately 60% of their customer

base2. Business travelers tend to be less price sensitive and frequent flyers, helping AirTran

maintain a consistent stream of revenue. Pre-assigned seating is an additional source of

convenience for both business and leisure travelers, and something that not all low-cost

competitors currently offer. Lastly, AirTran offers 100 channels of XM Satellite Radio in all

aircraft in both business class and coach. XM offers a form of in flight entertainment which has

been highly popular with customers1. While currently these amenities allow AirTran to offer a

differentiated and rare product, legacy carriers, who are moving towards cost decreasing policies,

pose a large threat in the future.

6
Susan, Donofrio M., and Poliniak Allison. "AirTran Holdings Inc." Deutsche Banc Alex Brown.
 4 Jessica London
Modified Hub and Spoke Strategy

AirTran’s hub and spoke strategy is centered at the Hartsfield-Jackson Atlanta International

Airport, with secondary hubs at Orlando International Airport and Baltimore-Washington

International Airport1. Over the past few years AirTran has been executing an aggressive growth

strategy focused on growing the Atlanta hub, while simultaneously expanding their network

system. Analysts project 19% annual growth in capacity for the next five years4. Currently, they

are the second largest carrier in Atlanta, and in 2007 have expanded service to seven new cities

and launched over 20 new non-stop routes7. One main focus has been an increase in their point-

to-point operations. By the beginning of 2007 AirTran had increased their proportion of non-

Atlanta related flights to 34% from only 10% in December 20011. As they expand, cost

advantages allow them to operate at a sizeable profit while still pricing competitively, and

effectively competing with major carriers in new markets.

With a clear low-cost dominance at their Atlanta hub, a steady stream of revenue is highly likely.

Atlanta is currently the world’s busiest airport, and the metro Atlanta area is projected to

continue to offer growth potential for the airline4. In general, this dominance provides an

extremely valuable competitive advantage to the airline. AirTran’s reliance on the Atlanta

market is protected with long-term gate contracts at the Hartsfield-Jackson airport. The limited

number of gates at the airport makes this advantage not only rare, but also inimitable. Further,

the airline continues to maintain a close relationship with the airport and a change in their

position is highly unlikely in the future.

7
AirTran Holdings, Inc. Company Profile. Datamonitor (6 Jun 2007)
 5 Jessica London
AirTran’s focus on the eastern U.S. has allowed them to satisfy a market not previously

dominated by the industry leader Southwest. As they continue to grow and expand new routes,

Southwest’s low-cost dominance is a potential threat. AirTran, offering a higher value product,

compared to Southwest’s “no frills” model, will likely be able to withstand this competition.

Most of this growth will take place in point-to-point operations. These operations offer an

excellent growth and diversification opportunity for the airline. They will decrease their reliance

on the Atlanta market, while providing customers the added convenience of additional routes.

AirTran’s Future Prospects

While AirTran does not rank first in every area of cost performance, they have been able and will

continue to be profitable because of the nature of the airline industry. Demand for air travel is

increasing and currently there is no one carrier, low-cost or legacy, that can satisfy the entire

market. AirTran will continue to coexist with major carriers, and the sources of their short-term

competitive advantages will allow them to remain profitable. In the future product loyalty could

be an additional source of differentiation. With a clear focus on satisfying the business traveler

market, the airline should actively seek to cultivate corporate relationships and contracts. These

contracts can offer the airline a source of steady revenue that can help combat the cyclicality of

the industry.

Looking into long-term strategic choices they should continue to keep a strong hold on the

Atlanta market while expanding into new networks intermittently. This will allow them to test

new routes, without needing to endure a huge investment cost at a single time. While new

markets will introduce new competition, strictly maintaining their low-cost structure and product

differentiation will allow them to compete successfully as they have been for the past eight years.
 1 Brian Rabinove
Company Overview

Northwest is a legacy carrier that has been in existence throughout the development of

modern aviation and air passenger traffic. Over the past 80 years Northwest has developed into

one of the nation’s most successful airlines, but has recently regressed into the ranks of

bankruptcy. Northwest operates the world’s fourth largest airline in terms of revenue passenger

miles1. Its legacy status has been successful throughout the 20th century, since its founding in

1926. The company was originally started using biplanes to transport mail for the US Postal

Service and began passenger transportation in 1927. Since then, Northwest has grown to serve

over 240 cities in 26 countries worldwide. With over 30,000 employees and a 10.9% market

share, Northwest is one of the major players in the industry2. However, recently Northwest has

been struggling. Facing steep competition in the industry from traditional, incumbent legacy

carriers as well as new, discount airlines, Northwest has failed to keep costs under control. In

September 2005, Northwest filed for bankruptcy protection after amounting multiple years of

financial losses.

Performance Statistics

Following the terrorist attacks of September 11th 2001, the entire airline industry faced

troubled times. However, while the entire industry has been struggling, Northwest’s issues were

more severe. Northwest reported an operating net loss of $2.8 billion in 2006, compared to a net

loss of $2.6 billion in 2005 due to restructuring charges3. In addition, Northwest reported net

losses in the hundreds of millions of dollars in the previous five years before declaring

bankruptcy. Northwest reported a 2006 RASM of 11.44¢ and a passenger load factor of 84%;

however the company has been plagued with high costs, as evident in its CASM of 10.95¢.

1
(DATAMONITOR Report).
2
(IBIS World Report)
3
(MarketLine Business Information Center Report).
 2 Brian Rabinove
Since 2001, five of the major eleven air carriers went through bankruptcy protection

proceedings4. Then again, all of these firms have recently emerged from bankruptcy protection

except for Northwest Airlines. Northwest is currently undergoing massive restructuring in order

to return to profitability. In 2001, in the wake of the terrorist attacks, Northwest experienced a

13.7 % decrease in passenger traffic as well as a 16% decrease in cargo revenue. In response

Northwest terminated in excess of 10,000 employees to remain solvent2. With this cost cutting,

Northwest is making strides. Operating expenses decreased 10.4 % from the previous year and

the size of Northwest’s fleet was reduced. Aircraft rentals decreased 47.3% due to restructured

or rejected lease agreements. Available seat miles were trimmed by 6.7% resulting in an

increase of unit revenue of 11.1%3. A significant portion of these cost cutting improvements are

made up of salaries and benefits with a 28.5% decrease in these costs due to new collective

bargaining agreements with its labor unions3. Due to this restructuring, Northwest took unusual

and nonrecurring operating charges in magnitude of a $3.2 billion write-down in 2006 and $1.2

billion in 2005.

Bankruptcy

Northwest is in a period of transition however, over the past few years Northwest has

identified its weaknesses. The firm’s goals when emerging from bankruptcy will be to: (1)

achieve annual cost reductions of $2.4 billion (2) resize and optimize it fleet to better serve its

markets and (3) Restructure and recapitalize the company’s balance sheet by reducing debt level

and lease obligations5. These are management’s goals to improve the firm, and there are several

business strategies in place that will help the firm achieve its goals.

4
(S+P REPORT).
5
(2006 10-K filing).
 3 Brian Rabinove
Weaknesses and Inability to Imitate Low Cost Strategies

While Northwest was unable to control costs before bankruptcy, it must attempt to

achieve lower costs in the years to come. Low-cost airlines have changed the landscape of the

airline industry, and Northwest can not offer the fare decreases to match these carriers.

Northwest’s failure to control costs has been evident in its weak margins as well as financial

returns. Northwest has achieved an abysmal negative 10.3% return on its assets over the past

five years compared to an industry average of negative 3.5% over the same period3. Even large

legacy carriers such as AMR have matched the industry average, showing that Northwest is not

even competing with the firms most similar to them. This shows that the management at

Northwest is not using its assets towards profitable projects. Northwest’s operating margins are

also significantly weak which is why despite solid revenue growth over the past few years; they

still fail to return to profitability. Northwest’s margins of negative 3.4% are far behind those of

discount airlines such as Jet Blue, who generates margins in upwards of 8%3. Northwest’s

failure to control costs internally has led to the inability to handle external economic shocks

beyond their control. Following the decrease in air traffic due to terror concerns, Northwest

began to experience financial hardship. More significantly, the price of jet fuel has doubled

since 2000, from $0.78 per gallon to $1.813. This severely impacts Northwest, as fuel purchases

account for 30% of the total costs of operations2. In fact, Northwest reports that a once cent

increase in the price of a gallon of jet fuel impacts the operating expenses of the firm by

approximately $1.6 million per month2. This further encroaches on Northwest’s already weak

margins. To mitigate this factor, Northwest participates in managing price risk by utilizing the

trading of oil futures and options contracts.

 4 Brian Rabinove
Strengths and Resources: VRI Framework

Northwest’s status and position as a legacy carrier has been developed and solidified over

the past 80 years, and this strong industry position is a key asset. Northwest not only has an

established name in the industry, but also a strong network. Northwest operates a hub and spoke

system with hubs in Minneapolis, Detroit, Memphis, Tokyo and Amsterdam. This gives the firm

access to a very large customer base. While other legacy carriers have this resource, the location

of Northwest’s hub cities is particularly valuable due to their geographic nature, giving them the

capability to offer over 240 destination cities. With its hubs in Amsterdam and Tokyo,

Northwest is able to offer connections to cities throughout Europe and Asia. In addition,

Northwest is a member of SkyTeam Alliance, which gives its customers access to 658

destinations in over 130 countries3. Combining this factor with the location of its hubs

internationally, Northwest has shown to be a truly global airline. Northwest partakes in code

sharing agreements with a number of airlines giving its clients the capability to use their frequent

flier miles on different carriers or a variety of amenities and airport lounges throughout the

world. It is clear that Northwest’s strategy does not stop at cost cutting, and that providing this

product differentiation is an essential part in its business strategy. The firm also has a strong

fleet base. Northwest is the service launch airline for the new Boeing 787 plane, scheduled for

rollout in 20083. Having a strong fleet gives Northwest the capability to better serve its domestic

markets, and also provides for more fuel efficiency in the form of newer technology.

Going Forward: Utilizing Strengths and Resources

Over the past decade Northwest has experienced hardships as well as bankruptcy. Going

forward, the company looks to emerge from bankruptcy in a financial position that would allow

them to operate profitably. It is then up to the firm to make strategy choices that will
 5 Brian Rabinove
demonstrate success in the industry. Northwest’s key strength is its international presence. In

the early part of the decade Northwest’s international revenue base was harmed due to terror

related concerns including the SARS outbreak in Asia, as well as the weakened Asian economy.

With the recent strengthening of the global economy and the emergence of new developing

economies globally, Northwest should see an increase in international revenue which currently

makes up 25% of the airlines route structure6. Northwest currently has the capability to access a

large client base and deliver these clients to any destination they choose worldwide. It is this

competitive advantage that can best serve the firm going forward. In addition, Northwest has

shown through bankruptcy it can in fact control its costs, and this will definitely be the most

important strategy after emerging from bankruptcy some time in the near future. The

competition in the industry has forced Northwest into bankruptcy, but in doing so it is now better

positioned to demonstrate lower cost operations that will allow it to be profitable into the future.

Baring unforeseen economic events, Northwest as an incumbent can find a niche role as a

worldwide carrier who attempts to control costs and who offers the convenience of a hub and

spoke system that is truly global.

6
Fulcrum Global Partners Report
   
1 Daniel Rohlman
Brief Overview

Founded in 1934, Continental Airlines (NYSE: CAL) is currently the fourth largest

domestic airline with 10.5% market share1. As of December 31, 2006 the company serves 136

domestic and 126 international destinations using mostly a hub-and-spoke system1. CAL’s

domestic route system is operated through major hubs at Newark International, George Bush

Intercontinental in Houston, and Hopkins International in Cleveland1.

Operating Performance

With operating income of $468mm, 2006 marked just the second time CAL has reported

a profit since 20012. Operating revenue for CAL increased 17.1% in 2006 largely due to

industry-wide domestic capacity reductions that helped CAL increase RASM by 7.5% to 11.17¢

and their flight load factor to 81.9%2. While the load factor was rather high, the company

recorded a weak passenger mile yield of 12.29¢2. This is attributable to low cost carrier’s ability

to take away market share by undercutting fares in the regional domestic market. Since CAL did

not file bankruptcy post 9/11, they were unable to restructure under Chapter 11 and as of

December 31, 2006, the company had approximately $5.4 billion of debt2. Furthermore, their

debt to equity ratio of 15.7x is substantially larger than the industry average of 2.7x2. With an

interest coverage ratio of 2.5x vs. the industry average of 6.6x, CAL has a weak debt service

capacity resulting in higher bankruptcy risk2. CAL’s highly leveraged balance sheet may be a

hindrance to future growth and profitability. This is evident from the markets P/E valuation; 6.9x

compared to an industry average of 12.6x3. Although Continental’s future outlook is improving

through initiatives explained in this paper, they are currently a moderately low performer due to

their weak balance sheet and sub-par profitability.

                                                            
1
 One Stop Report for Continental Airlines, Inc. One Source, 2007. 
2
 Continental Airlines, Inc. DataMonitor Business Information Center, 2007. 
3
 Finance.yahoo.com
   
2 Daniel Rohlman
Business Level Strategy

Firms in the airline industry have historically been characterized as either cost leaders or

product differentiators; however, to compete in today’s market, carriers must be conscious of

both. Low cost leaders have found ways to provide the cheapest fares while offering optional

amenities, and the differentiated legacy carriers have been forced to reduce costs. Continental, a

legacy carrier, has struggled to balance product differentiation and cost reduction in the past, but

has taken initiatives to improve.

For many years CAL maintained a 13% labor cost advantage in the industry, but this

non-sustainable advantage ended in 2002 when they were forced to renegotiate contracts to

market levels4. Although Continental has implemented $1.1 billion of annual cost-cutting

initiatives through employee layoffs, fleet standardization (three aircrafts), outsourcing IT

services/ground support/aviation maintenance, and improved fuel efficiency, their 2006 CASM

of 10.56¢, cannot compete with cost leaders like Southwest (8.80¢)5. Continental understands

that they cannot provide the lowest fares, so they have focused on further differentiating their

product while being conscious of cost reduction.

Product differentiation allows Continental to create profits through premium pricing.

From 2002-2006, CAL was able to achieve a revenue CAGR of 11%5. Continental’s extensive

international offering, as well as its emphasis on business travelers allows the firm to focus on

less price-sensitive customers. To appeal to this class of traveler, airlines must provide frequent

flights, reliable on-time performance, and offer superior amenities; CAL’s fleet, hubs, and

culture are aligned to do this. Continental’s fleet now offers in-flight amenities such as: faxes,

telephones, power outlets, and personal entertainment systems with audio/video on-demand.

                                                            
4
 Continental Airlines, On The Eve of Negative Change. JPMorgan, 2002. 
5
 Continental Airlines. 10‐K, 2006. 
   
3 Daniel Rohlman
CAL’s hubs offer luxurious airport lounges, expedited baggage handling, and priority check-in.

Continental’s hubs are not only state-of-the-art, but they’re also convenient gateways to global

destinations as their Newark hub serves Europe and Asia, and their Houston hub serves Mexico

and South America.

Another way CAL differentiates their product is with first-rate customer service. Through

programs like the perfect attendance award, profit sharing, and on-time performance bonuses,

management has created a culture where employees are passionate about their work6. This has

translated over to superior customer service. Continental currently ranks fourth best out of 20

domestic carriers in percent of arrivals-on-time at 88%. Further, at only 1.13 complaints per

100,000 enplanements, CAL beats out all legacy carriers7. Continental’s outstanding

management has been recognized by Fortune magazine as one of the Top 100 Companies to

work for from 1998-20056.

Continental’s physical assets (hubs, fleet, and amenities) are valuable and rare, but are

also imitable. As technology becomes cheaper and more readily available, these assets become

easier to replicate and thus do not provide Continental with a sustainable competitive advantage.

However, Continental’s culture dedicated to high quality service is inimitable and provides a

sustainable advantage.

Corporate Level Strategy

Continental’s growth has largely been through mergers and strategic alliances. Airlines

such as Texas International, Frontier, People Express, and New York Air have been acquired by

CAL. In addition, Continental has established strategic alliances such as: joint technology

development, airport handling, shared reciprocal frequent flyer benefits/lounge privileges, and

                                                            
6
 Continental Airlines. The Vault. 2007. 
7
 Air Travel Consumer Report. US Department of Transportation, 2007. 
   
4 Daniel Rohlman
code sharing agreements with major transportation partners5. Currently, CAL has alliances with

six domestic carriers, over 14 international carriers, and is a member of the SkyTeam alliance5.

These alliances enable Continental to reduce their costs, offer an increased number of flights, and

provide new standards of convenience. Low cost carriers, which focus on serving domestic

markets, are unable to imitate this strategy and thus global alliances provide an advantage for

Continental.

Future Strategy

Continental’s strategic choices have aligned their assets to take advantage of the

expanding international market. The international market faces far less competition from low

cost carriers therefore making it easier to pass along costs such as fuel to less price sensitive

travelers.

With 638 airplanes, it is remarkable that CAL’s fleet averages only 7.4 years5. This

young fleet is the most fuel efficient of all major domestic carriers and provides a competitive

advantage on long-haul flights5. Further, Continental’s hubs are well positioned for global

expansion. The Newark hub is a premier domestic gateway to Europe and Asia, while the

Houston hub serves the Mexico and South America markets. With 126 international destinations

and many global alliances in place, Continental’s strong worldwide presence makes it easier to

penetrate rapidly expanding markets such as in Asia and South America. Additionally, the “open

skies” aviation deal which becomes effective on March 28, 2008 will open up restricted trans-

Atlantic routes and allow US airlines to fly anywhere in the 27-nation European Union8.

Continental’s hubs, global alliances, fuel efficient fleet, and top-notch customer service and

amenities provide an ideal opportunity to leverage these assets and expand internationally.

                                                            
8
 Industry Surveys Airlines. Standard & Poor's, 2007. 
   
5 Daniel Rohlman
Another viable corporate level strategy is to merge with United, the world’s second

largest airline. Although anti-trust laws have limited consolidation, there is increasing pressure

on the government to allow such transactions as the dollar has weakened, foreign carriers have

strengthened, and legacy carriers continue to be susceptible to market downturns. In 2002 United

went bankrupt, but since then they have resurfaced with significantly lower costs and a much

more effective business model. Internationally, United has an outstanding Pacific operation that

compliments Continental’s strong Atlantic and Latin American operations. Domestically,

United’s hubs in Chicago, Denver, Los Angeles, and San Francisco compliment Newark,

Houston, and Cleveland as there are minimal territorial overlaps that would cannibalize revenue.

United offers amenities such as XM Satellite Radio, in-flight entertainment systems that dock

with iPods, and lumbar support9. These physical assets match Continental’s emphasis on high

customer service and product differentiation. A merger with United would likely help both firms

boost profitability through cost synergies, increased pricing power, and extended alliances.

To ensure future success, Continental should divest from regional markets, which are

dominated by low cost carriers, and focus on expanding long-haul domestic and international

flights. Passengers on these flights are less price-sensitive as they care more about convenience,

customer service, and amenities. These attributes match Continental’s resources and capabilities,

thus providing a well aligned strategic position that focuses on what Continental does best: offer

a superior experience at a premium price.

                                                            
9
 www.united.com/ir 
 1 Jonathan Weiss
Company Overview

Branding itself as the low-fare, low-cost PLUS airline, JetBlue Airways has consistently

built a reputation, five years running, as Best U.S. Airline, Best Airline for Customer

Satisfaction, and Top Low-Cost Carrier by Load Factor1. Putting customer satisfaction above all

else, entrepreneur and low-cost market veteran David Neeleman launched JetBlue’s first flight in

2000 under the maxim to, “bring the humanity back to air travel.2” Recruiting heavily from the

executive management and very diligently studying the model of market leader Southwest

Airlines, JetBlue has enjoyed tremendous success by targeting underserved or overpriced

markets while also offering a highly differentiated product with new aircraft, pre-assigned

leather seating, reliable performance, the most legroom in the industry and 30 channels of live

satellite TV at every seat, all at a low fare. JetBlue operates both short and long-haul

geographically diverse point-to-point routes in 502 daily flights to 50 destinations in 21 states,

Puerto Rico, Mexico and the Caribbean—the only U.S. low-cost carrier flying internationally.

Strategic Assets and Choices

Neeleman built the foundation for accurately imitating the competitive strengths of

leading Southwest by recruiting finance and operations management directly from the

competitor. The highly valuable experiences of these members would otherwise have been

costly and time-intensive for Neeleman to gain from scratch, but collectively allowed JetBlue to

jump ahead of the learning curve. JetBlue broke from the Southwest model, however, by

differentiating its product as the low-cost PLUS airline, choosing to resolve customers’ most

common complaint about Southwest, the lack of pre-assigned seating, as well as being the only

low-cost provider to service long-haul vacation destinations that the increasingly large segment

1
“Rankings,” JetBlue Airways, Business & Company Resource Center, November 2007.
2
JetBlue Airways Annual Report, 2006.
 2 Jonathan Weiss
of cost-conscientious families seek out. JetBlue also added a few low-cost frills to the frill-less

competition with all new aircraft at an average age of only 2.6 years2, leather seating, more

legroom than any other airline and individual satellite TVs. This choice positioned JetBlue

above other competitors in customer preference, creating more demand and strengthening the

brand, while at the same time creating a competitive advantage that would be very costly and

would take years for existing incumbents to imitate, necessitating the retrofitting or replacement

of their fleets. To reap more revenue from the competitive advantage of its satellite televisions,

JetBlue bought the provider and patent rights to the technology, such that as other airlines try to

imitate, they will have to pay JetBlue to do so. To push customer preference and demand even

further, at a time when customers are growing increasingly dissatisfied with air carriers, JetBlue

chose a first-rate commitment to reliability and unheard of customer-friendly policies such as

reusable tickets3, never overbooking, and paying customers $50 for an hour of ground delay4.

Where the major competitor Southwest saves costs by shortening turnaround times with

unassigned seating, JetBlue saves costs and boosts profit with a high utilization of less frequent

flights that is unmatched by any other airline, filling 85.2% of all seats2. JetBlue also shortens

turnaround and lowers maintenance costs with a standardized fleet, choosing two aircraft

however, the Airbus A320 and the Embraer 190, using the smaller, more fuel efficient Embraer

on short-hauls to lower cost per seat mile5. The A320 is a more fuel efficient, reliable and

versatile aircraft than the Boeing counterpart used by Southwest and other competitors, allowing

JetBlue to also be the only point-to-point, low-cost carrier that flies long-haul and internationally

to vacation destinations in Mexico and the Caribbean. JetBlue’s access to a valuable fleet of

brand new A320s was historically unique in its timing, allowing the airline to contract the

3
“JetBlue Airways Corp: Initiating Coverage”, 2 May 2002, Global Equity Research, UBS Warburg.
4
“JetBlue’s Customer Bill of Rights,” <www.jetblue.com>
 3 Jonathan Weiss
aircraft and future options at a steep discount from the overseas manufacturer. The standardized

fleet leads to increased cost savings as maintenance issues are simplified, spare parts inventory

requirements are reduced, scheduling is more simplified and training costs are lower.2” Lastly,

JetBlue further lowers costs by leading the industry in online sales, the lowest cost form of

distribution, selling an unparalleled 80% of its tickets online.

But perhaps JetBlue’s most important strategic asset is its position at JFK International in

New York—where it is the popular airport’s only low-cost carrier and the largest carrier by

passengers—providing the firm with access to 27 million potential customers in and around the

metropolitan area5. Other low-cost carriers are forced to operate out of second-rate airports that

customers don’t prefer and don’t have access to the highly demanded, conveniently located JFK

airport. JFK is also the least delayed, least congested airport in NYC, strengthening JetBlue’s

ability to be first-class in reliability and customer satisfaction, completing 99.6% of all flights,

85.7% of all flights on-time. Access to capacity-filled JFK was also a historically unique, rare

and valuable asset, as TWA abandoned its terminal at the airport just at JetBlue’s founding.

Performance Analysis

JetBlue’s low-cost statistics are evidence of its solid foundation. JetBlue’s seat mile costs

are more than 30% below industry averages, and second only to Southwest. Its young, fuel

efficient fleet, low unit labor costs at less than half the industry 4.5¢, and the highest asset

utilization of any carrier, 85.2% of seats and 13 hours per plane versus industry 10.52, are the

“primary factors driving JetBlue’s below industry cost structure. This alluring combination of

low costs and very reliable service enable JetBlue to post [some of] the highest operating

margins in the industry,3” as much as 16.8% in 2003. However, after several years of double and

triple digit net incomes, JetBlue reported a loss of $20M in 2005 as it slipped from its cost-
5
JetBlue Airways Prospectus, 2002.
 4 Jonathan Weiss
saving strengths and fell victim to a shocking 1-year 24% increase in fuel costs2. But after

launching a “Return to Profitability” initiative in which it improved capacity management,

revenue optimization and cost reductions, JetBlue seems to have recovered, posting only $1M

loss in ’06. Nevertheless, JetBlue still maintains a healthy balance sheet with a satisfactory

current ratio of 1.08, but not a lot of wiggle room to weather shocks to inputs or demand.

Strategic Weaknesses and Threats

Much of JetBlue’s success as a low-cost carrier is due to its unusually high utilization of

available passenger miles and serving those miles with fuel efficient aircraft. In 2006, however,

JetBlue voluntarily chose to reduce this utilization statistic, opting for slightly higher revenues;

this may prove a poor decision if fuel prices continue to remain and/or grow at record levels,

damaging the air carrier’s ability to make a profit. Although JetBlue does hedge against them,

the airline’s operating results are highly sensitive to fuel prices while it is not in a position to

raise fares when gas prices go up. JetBlue should build more conservative projections of fuel

costs into its budgets such that it has more margin of safety against volatility, where it currently

forecasts $1.93/gallon for ’07 even though ’06 averaged $1.99 and costs have been increasing.

Furthermore, JetBlue has significant financial obligations of $2.84B, and is choosing to take on

$1.07B more in ’07 and $2.13B each year after. The firm is pushing its growth strategy too

quickly and is hastily destructing its financial strength and ability to weather the volatility that

pushed so many of its predecessor low-cost startups into bankruptcy. JetBlue should slow this

growth and postpone as much of its scheduled liabilities as possible until it can build a sturdier

financial base that (a) allows room for profitability even with fuel price volatility, and (b) better

guarantees its ability to meet its already high obligations at 75% debt to market cap.
 5 Jonathan Weiss
Similarly, JetBlue commands its valuable brand equity because of its commitment to

reliability and customer satisfaction. Inconsistent with its this strategy, however, in expansion,

JetBlue has set up a major portion of its operations at the nation’s 3 most congested airports2,

decreasing its control over reliability ratings and creating the potential to significantly damage its

reputation and customer base if conditions get worse with continually increasing levels of total

air travel. Though its unparalleled access, as a low-cost carrier, to the NYC is important to its

success, it has likely already entered itself into too much risk in this factor and should refrain

from further setting up operations at airports with high congestion and poor reliability.

Future Outlook

In its mission to further penetrate the low-cost market, JetBlue projects its operating

capacity to increase 11-14% in 20072, though it is wisely choosing to hold off on any expansive

additions to its destinations until it has regained unscrupulous control of its cost structure.

JetBlue optimistically expects its operating margins to rebound to from its current 5.4% closer to

its ‘03 and ‘02 16.8%, projecting an operating margin in the range of 10-12% for 2007. This

margin, though extraordinarily high for the industry as a whole, has been consistently achieved

and surpassed by JetBlue in the past and should not be written off too quickly as unachievable

daydream. JetBlue must just be diligently rigorous about cost control and revenue management,

while cautiously establishing its presence in markets yet to be tapped. Further, it would be wise

for JetBlue to jump on the opportunity of first-move advantage as the first air carrier, much less

the first low-cost carrier, to offer in-flight wireless internet, which would be a fantastic

compliment to its current differentiating amenities and would likely capture a massive proportion

of business and leisure travelers who, for whatever reason, currently opt to fly other airlines.
 1 Danielle Wieder
Company Overview

Southwest Airlines is the most consistently profitable domestic passenger air carrier in

the United States and most successful low-cost airline1. It has seen success from its founding

ideals “[To] get [its] passengers to their destinations when they want to get there, on time, at the

lowest possible fares”2. Southwest established a strategy as a point-to-point, short haul, low-cost

carrier offering low-fare air transportation to business and leisure travelers. Southwest uses 481

aircraft to serve 63 cities in 32 states and holds a 7.8% market share1. Southwest does not focus

on increasing its market share to increase profits, but rather focuses on serving its niche market,

families flying short distances rather than driving and short-haul business travelers.

Performance Statistics

With net income of $499 million, 2006 marked 34 consecutive profitable years for

Southwest, a record unmatched in the industry3. Measures of financial performance for

Southwest Airlines are: high load factor of 73.1%, RPMs of 67.69 billion, RASM 9.81¢, and a

low CASM of 8.80¢ (6.49¢ excluding fuel)3. Southwest carries a strong balance sheet with only

15.5% debt to capitalization4. Southwest’s strong balance sheet affirms its abilities to continue to

meet its payment obligations, and continue profitably and success despite trends of loss in the

industry. Other indicators of Southwest’s superb performance are the high percentage of on–time

arrivals, 85.8%, and low cancellation percentage, 0.6% over the past year, which result in high

customer satisfaction5.

1
Industry Report: Scheduled Domestic Air Transportation in the US. IBISWorld Inc, 2007.
2
"About Southwest." Southwest Airlines. 1 Aug. 2007. Nov. 2007 <http://southwest.com/about_swa/>.
3
Southwest Airlines Co. Annual Report 2006. Southwest Airlines, 2007.
4
Corridore, Jim. Airlines Industry Survey. New York: Standard & Poor's, 2007.
5
Air Travel Consumer Report. U.S. Department of Transportation, 2007.
 2 Danielle Wieder
Operating Strategy

Southwest has been able to sustain competitive advantage by leveraging its resources and

capabilities in pursuing a cost leadership strategy. Southwest has found its source of cost

advantage through its policy choices of flying its standardized fleet of Boeing 737s with a single

class on point-to-point, short haul flights through less congested secondary airports for low fares.

Cost Structure

Use of secondary airports allows Southwest to simplify scheduling, have high asset

utilization and reduce turnaround time(TAT), approximately 25 minutes3. This fast TAT reduces

delays and total trip time for passengers, and also keeps operating costs at a minimum as it

reduces the number of aircraft and gate facilities needed. The choice to use a standardized fleet

reduces costs for maintenance, flight operations and training activities, and also expedites gate

processes. Additionally, Southwest has been able to take advantage of low rental costs, 1.7% of

revenues in 2006, compared with the 3.5% industry average4. Southwest took a first-mover

advantage as a low-cost airline and its success is evidence of a competitive advantage achieved

by mastering expert cost reduction strategies early. Keeping basic operating costs under control

gives Southwest the ability to offer low fares and also room to absorb increased costs, such as

fuel. Southwest mitigates the risk of fluctuating fuel prices through substantial hedging positions

and derivative contracts on fuel.

Organizational Culture

Southwest has been able to sustain its competitive advantage through its low-cost

strategy, complimented by its unique organizational culture. The people of Southwest dedicate

themselves to high levels of customer service and operational efficiency, as these are the airline’s

points of differentiation. In this service oriented business founder and former CEO, Herb
 3 Danielle Wieder
Kelleher, believed in retaining happier employees who would deliver better service. According

to their mission statement2, “Employees will be provided the same concern, respect, and caring

attitude within the organization that they are expected to share externally with every Southwest

Customer.” Additionally, Southwest makes an effort to hire only people with a good attitude and

great teamwork abilities, which enhance the airline’s culture. This culture has produced

“hardworking, innovative, and highly productive employees” who work hard to carry out

Southwest’s low cost strategy3. Kelleher defined Southwest’s culture in a way that cannot be

imitated by any other firm, as the culture is a product of this outstanding leader. Southwest’s

dedication to its people has allowed the company to grow and succeed as they encourage

employees to constantly work to improve the airline. Southwest realizes the business risk it faces

from the costs associated with employee retention, contracts and benefits, but mitigates that by

maintaining strong relationships with employees.

VRI Analysis of Strategy

The resource of Southwest’s unique culture and its capabilities to maintain efficient low-

cost operations has brought value to the airline through 34 consecutive years of operating profit.

Although policy choices are less likely to be rare, in the case of Southwest Airlines, the unique

dynamics of the company’s culture in its effort to pursue cost leadership have created a socially

complex asset that is difficult for other firms to imitate. However, the policy choice of

maintaining a standardized fleet, flying point to point and keeping operating costs low is a

strategy that is and has been easily imitated by other firms.

Southwest’s low-cost strategy has provided the company with success and outstanding

performance in comparison to its peers, particularly when competitors filed bankruptcy and

suffered great losses following 9/11. As a result of their bankruptcies these firms were forced to
 4 Danielle Wieder
reorganize and as a result have also developed lower-cost strategies. Additionally, Southwest is

disadvantaged compared to its peers as it lacks the extensive alliances competitors have with one

another, which enable them to more easily expand to new destinations.

Future Outlook

Low-cost carriers are now focusing on either competing on price or product6. On one end

of the spectrum are airlines competing on price. With this absolutely no-frills strategy passengers

are charged for everything from checked luggage to on-flight beverages (even water). On the

other end are the low-cost carriers focusing on differentiating through their on-flight amenities

such as in-flight, seat-back entertainment and first-class cabins. Southwest tries to maintain a

focus on its niche market of short-haul business travelers and families choosing to fly short

distances. However, with other low-cost carriers differentiating themselves, Southwest needs to

determine which part of the spectrum it will compete on, and alter part of its strategy in order to

maintain its long standing competitive advantage, and still focus on its target market.

Southwest has focused on capacity expansion domestically, which has proven successful

in serving their niche market. Additionally, Southwest can expand on code-sharing, with

agreements like that with ATA Airline, to help further expansion and remain competitive against

its competitors’ more extensive networks. Some analysts recommend Southwest expand its fleet

by adding different aircraft aside from the 737 and looking into servicing international

destinations. This would not fit with their strategy of serving short-haul travelers, point to point

with high quality service and efficiency expertise and take advantage of Southwest’s most

valuable assets.

6
McCartney, Scott. "From Luxury to Bare-Bones: Discount Airlines Specialize." The Wall Street Journal 16 Oct.
2007.
 5 Danielle Wieder
To maintain its focus on its niche market, Southwest has begun taking steps to change its

strategy by beginning to offer business travelers priority seating and a complimentary cocktail

for a higher price through its “business select” fare category. Business travelers, who account for

45% of Southwest’s customer base, are turned off by the open seating of Southwest, and drawn

to the amenities and assigned seating of competitors, but this new fare structure will return these

customers to Southwest.

Southwest is also looking into opportunities with in-flight amenities, such as wireless

internet. Other areas Southwest may focus on is the boarding strategy, currently an organized

open seating policy, may be changed to assigned seating to bring in customers that are turned off

by the current “cattle-call” boarding technique.

As Southwest focuses on its business passengers through its new “business select,” they

may also consider horizontal diversification into other services that may appeal to business

travelers and bring in additional revenue. Southwest can utilize its expertise in low-cost

operations to offer ground transportation to and from the airport for business travelers. Often

business travelers choose to use an expensive car service to get to and from the airport, but may

choose to use Southwest for this service because they are already familiar with Southwest’s

reliability, high quality customer service and reputation for low prices. By pursuing this

diversification strategy, Southwest can still focus on their niche market and work to increase

revenues so they can hopefully hit their goal of an additional $1 billion by 20103.

As the first-mover into the low-cost sector of the market, Southwest has reaped

significant benefits, but as the low-cost market becomes more saturated, it is important for the

company to consider other strategic options as mentioned above in order to maintain its

competitive advantage and success.