STRATEGY CASE STUDY

MGMT 410- PR.MARTIN MATHEWS YOUSRA ACHERQUI MBA 2011-2012

[THE US AIRLINE INDUSTRY IN 2007]

ANALYSIS THROUGH MICHAEL PORTERS FIVE FORCES FRAMEWORK

[THE US AIRLINE INDUSTRY IN 2007] CASE STUDY - STRATEGY

CONTENTS
INTRODUCTION .............................................................................................................................................................. 2 ANALYSIS OF THE US AIRLINE INDUSTRY THROUGH PORTERS FIVE FORCES FRAMEWORK ....................................... 2 THREAT OF ENTRY...................................................................................................................................................... 2 1. 2. 3. 4. 5. 6. 7. CAPITAL REQUIREMENTS .............................................................................................................................. 2 ECONOMIES OF SCALE .................................................................................................................................. 2 ABSOLUTE COST ADVANTAGES .................................................................................................................... 3 PRODUCT DIFFERENTIATION ........................................................................................................................ 3 ACCESS TO DISTRIBUTION CHANNELS .......................................................................................................... 3 GOVERNMENT AND LEGAL BARRIERS .......................................................................................................... 3 RETALIATION BY ESTABLISHED COMPANIES ................................................................................................ 3

SUMMARY ............................................................................................................................................................. 4 ENTRY BARRIERS VERSUS EXIT BARRIERS .............................................................................................................. 4 THREAT OF SUBSTITUTES ........................................................................................................................................... 5 BUYER PROPENSITY TO SUBSTITUTE & RELATIVE PRICES AND PERFORMANCE OF SUBSTITUTES........................ 5 SUPPLIER POWER ....................................................................................................................................................... 5 BUYER POWER ........................................................................................................................................................... 6 INDUSTRY RIVALRY .................................................................................................................................................... 6 CONCENTRATION .................................................................................................................................................. 6 COST CONDITIONS EXIT BARRIERS ...................................................................................................................... 7 CONCLUSION .................................................................................................................................................................. 9 BIBLIOGRAPHY ............................................................................................................................................................... 9

Page 1

[THE US AIRLINE INDUSTRY IN 2007] CASE STUDY - STRATEGY

INTRODUCTION
The essence of formulating competitive strategy is relating a company to its environment. Porters five forces framework provides a wide understanding of the profit potential in a particular industry. By looking at the way the five forces influence profitability, tactics can be developed by the companies for countering the strength of the forces. Here is made a brief analysis of the US Airline industry through this framework.

ANALYSIS OF THE US AIRLINE INDUSTRY THROUGH PORTERS FIVE FORCES FRAMEWORK

THREAT OF ENTRY
Threat of entry depends on both barriers to entry and reaction from existing competitors. This industry force didnt exist before 1978. Indeed, under regulation established by the Civil Aeronautics Board (CAB), barriers of entry were high and there was no place for new competitors. Regulation had been based on arguments about traditional monopoly. (M.Grant, 2008) Since 1978, deregulation will on the contrary cheer up new entrants and the establishment of an intense competition with about 20 new airlines entering by 1980. This impact of deregulation will make the airline industry enter a new era characterized by price wars.

1. CAPITAL REQUIREMENTS
Capital requirements for an airline to set up can be low. A single leased plane will suffice

2. ECONOMIES OF SCALE
Prior to 1978, economy of scale was important in the airline industry. Indeed, the market share was definitely proportional to the size of the company. Since the deregulation, large companies dont gain systematic cost advantages over their smaller rivals. A high market share is more likely to be linked with a low cost position achieved. This ideal will be developed more accurately when dealing with customer power.

Page 2

[THE US AIRLINE INDUSTRY IN 2007] CASE STUDY - STRATEGY

3. ABSOLUTE COST ADVANTAGES
Due to long-term relationships between some airline companies and some suppliers (mainly BOEING in US), some of the companies could have cost advantages for the acquisition of new planes. This kind of relationships might exist but are likely to be rare. Besides, it wont really have a great impact as acquisitions of new planes dont occur every day. New entrants wont really suffer from such bare and uncertain cost advantages. Absolute cost advantages are not important when dealing with threat of entry in the airline industry.

4. PRODUCT DIFFERENTIATION
During regulation, companies werent able to compete on price and used to focus their energy on providing to customers differentiated services on board. Deregulation completely changed the equation, and customers have become strictly price-sensitive, thus not concerned by differentiation. For new entrants, it lowers more the entry barriers as they just have to provide the same services as the existing competitors without dealing with innovation, positioning and so on.

5. ACCESS TO DISTRIBUTION CHANNELS

Unlike food industry where the battle for supermarket is an important issue, airlines can have an easy access to customers. This easy access has been emphasized with new technologies and internet since customers can but their tickets without an intermediary and through an easy process. Other channels as offices in airports or travel agencies still exist but unlike ancient times, a company which has numerous offices wont necessarily have the biggest market share. This very easy access to customers will definitely encourage start-ups to enter the industry.

6. GOVERNMENT AND LEGAL BARRIERS

As dealt with before, regulation used to impose heavy legal barriers not allowing new competitors to enter the market. The deregulation cancels all this barriers, and entry barriers can be said to be free.

7. RETALIATION BY ESTAB LISHED COMPANIES

Established airlines cant really demonstrate ability to retaliate the potential entrants. In fact, enhancing marketing brand or image cant be effective as long as consumers are not brand sensitive. Alliances with associated products (hotels, transports and so on) wont have a sensible impact and setting a product price that deters entry is not an easy issue. Page 3

[THE US AIRLINE INDUSTRY IN 2007] CASE STUDY - STRATEGY

Retaliation in airlines industry is not a barrier for new entrants.

SUMMARY
Threat of new entrants is really high because of the following reasons: Customers little brand loyalty Start-up costs are low for new businesses entering the industry Products provided in the airline industry are not unique. No innovation needed and assets are easy to be liquidated.

Switching costs for customers are low The access to inputs is easy The access to customers is easy There is a minimal economy of scales

ENTRY BARRIERS VERSUS EXIT BARRIERS

While entry barriers are low, exit barriers in the airline industry are likely to be high on account of contracts with employees and compulsory credits (chapter 11 of bankruptcy code). The following matrix (PORTER, 1980) shows us that airline industry tends to be a mediocre investment.

Exit barriers

Low

High

Low

Low, stable returns High, stable returns

Low, risky returns High risky returns

Entry barriers

High

Page 4

[THE US AIRLINE INDUSTRY IN 2007] CASE STUDY - STRATEGY

THREAT OF SUBSTITUTES

BUYER PROPENSITY TO SUBSTITUTE & RELATIVE PRICES AND PERFORMANCE OF SUBSTITUTES

The threat of substitutes is composed of trains, buses and autos. In US, there is no high-speed passengers train. Travels by trains are hence longer than by air while the price difference is not similarly disproportionate. Travels by buses are even longer than by trains. Cars are alternatives for short distances but dont really threaten the airline industry. Prior to 1978, when there was no low cost airline ticket, those substitutes even if they are less confortable than travels by plane were attractive for consumers. Yet, after deregulation, and in the context of price wars, propensity to substitute planes by other means is likely to be very low. This statement is not only true for business travelers who are highly time sensitive but also tourists who seek comfort. A notable disadvantage for trains is the fact that there are fixed routes. During regulation times, it was the case for planes too but since the eighties the hub-and-spoke system enabled an efficient reorganization of airlines route maps. Because threats of substitutes are low, threats of entrants are higher as the airline industry is seen as very attractive.

SUPPLIER POWER
Supplier power is very high in airline industry. This is mainly due to the existence of few exigent suppliers. Indeed only a handful companies supply airlines with planes (AIRPLANE industry has very high entry barriers due to high R&D needed). Planes must be ordered in advance which force airlines to align their schedules with suppliers ones which creates a notable relationship of dependency on the suppliers. Switch costs are not high for airlines but switching from a technology of plane to another one induces new processes and thus new trainings and costs lot of time and money for companies. Airlines should thus have longterm relationships with suppliers. Besides, purchasing the same jet makes the company avoid extra costs for maintaining and services. Another kind of suppliers put pressure on companies: labor unions. Indeed, labor is one of the major costs for companies. It represented 23.8% of total operating expenses in 2006. Companies would better have great agreements with labor unions as they have a significant power in US. Page 5

[THE US AIRLINE INDUSTRY IN 2007] CASE STUDY - STRATEGY

A way for companies to reduce the strength of this force would be the flexibility that they could learn to have in order to adapt easily to new technologies and to be able to switch from a jet supplier to another one but it is definitely not easy to be done.

BUYER POWER
Buyers used to have no power prior to 1978 when CBA used to control the pricing. Because buyers have little power, the threat of substitutes was higher. Indeed, when customers couldnt afford the prices, they simply chose other means of travelling. Deregulation and the new wave of entrants in the market coupled with the intensified use of internet empowered the buyer who has become able to choose between plural companies, compare their offers and make an easy transaction online. Consumers have also become price sensitive while they used to pay attention to differentiation when prices were high. The new lack of differentiation couples to the rude competition make the importance of war prices continuously increase. Buyers are able to evaluate the market information instantly thanks to internet, and because there is no unique service among airlines companies, switching from a company to another is extremely easy and only depends on time and money sensitiveness of the buyer. Had companies had to reduce the power of buyers, they would have to build new loyalty programs or select customers who have little knowledge of the market, but they dont seem to be effective solutions.

INDUSTRY RIVALRY
We focus here on the following question: To what extent the value created in the industry will be dissipated through head-to-head competition?

CONCENTRATION

The four-firm concentration ratios showed in table 3.5 show that the ratio has decreased from 1935 to 2005, this means that competition is definitely going up. When the ratio increases, this means that the trend is to move from monopoly to oligopoly. We notice however that in 1987, the ratio has increased, this might be explained by the consolidation in the US airline industry in the eighties (mergers and acquisitions). The spectrum of airline industry shows that competition is intense which is explained by the free entry barriers and the increase of buyers power. Page 6

[THE US AIRLINE INDUSTRY IN 2007] CASE STUDY - STRATEGY

COST CONDITIONS EXIT BARRIERS

Threat of rivals is definitely high in airlines industry. Airlines companies provide services which have to be sold quickly (perishable services). Seats are perishableonce the aircraft leaves the gate, all unsold seats are gone forever. They sell undifferentiated services. Customers can easily switch from a company to another. Due to these reasons, businesses will be vying for market share. High exit barriers create extreme methods of competitions as any liquidation will lead to a loss. The cost structure for airline companies has itself an impact on competition. Very high fixed costs spurred price competition. This rivalry has leaded companies to adopt several changes among them the outsourcing of IT services, the creation of low-cost subsidiaries, and the yield management system and so on. Because competition is rude, it has lead companies not only to undertake this price war but also to adopt new strategies. Yield management is a great example of cost conditions threats consequences. The objective was to keep the highpaying traffic at its current level while selling the otherwise empty seats at a discount. This trade-off is the core challenge of revenue management. Ideally an airline would book its tickets and fill an airplane with the high fare-payers first. Highpaying passengers, however, tend to appear last, and there is uncertainty regarding whether and when they may appear. (BENYOSEF, 2005) Airline competition under regulation focused on increasing market share and not on maximizing profits. The graphs below made out of the data provided in the case study emphasize this idea. The curve showing the ROI shows that the industry is very sensitive to the economic cycle, to oil prices, and to world security crises.

Page 7

[THE US AIRLINE INDUSTRY IN 2007] CASE STUDY - STRATEGY

ROI
16

14
12 10

8
6 4

2
0 1975 1980 1985 1990 1995 2000 2005 2010

Available seat miles in the US Airline industry

1000,3 800,3 billions 600,3 400,3 200,3 0,3 1975

1980

1985

1990

1995

2000

2005

2010

In fact, the airlines practiced a brand of destructive competition even then. Since market prices were fixed, the major decision variables were cost-related, including capacity, flight frequency, and quality of service.

Page 8

[THE US AIRLINE INDUSTRY IN 2007] CASE STUDY - STRATEGY

CONCLUSION
While the threat of substitutes is low, the power of suppliers is high, the buyer power and the threat of entrants are very high, airline industry is not performing very well.

High threat of entrants High buyer power Poor industry performance

Price war

Airline companies face plural challenges as they must remain customer focused and same time manage well their cost structure. They all seem to adopt complementary low cost brands while reengineering could be a great solution as well. No successful airline is immune from losing its market position and therefore must constantly fight a strategic battle for survival. This requires continuous learning and discovery of new opportunities focusing on passengers, new technology, and rivals and an airlines own strengths and weaknesses. This is a challenging task for a management that is usually busy running day-to-day tasks and putting out never-ending fires.

BIBLIOGRAPHY

M.Grant, R. (2008). CONTEMPORARY STRATEGY ANALYSIS. THE US Airline Industry in 2007, 26-39. OXFORD: WILEY. PORTER, M. E. (1980). COMPETITIVE STRATEGY. 22. NEW YORK: THE FREE PRESS. BENYOSEF, E. (2005). THE EVOLUTION OF THE US AIRLINE INDUSTRY. 215. Dordrecht: Springer.

Page 9