|
|
Athens University of Economics and Business Department of Business Administration Discussion questions for case three: The US Airline Industry in 2002 Alessio Arnetta AP. MHTP. 2030297 Athens, 10/11/2003 1. Use Porter’s ‘Five Forces of competition’ framework to show how the structure of the airline industry has caused low profitability during the past twenty years. Since domestic deregulation occurred in 1978, competition in the airline industry has intensified and become more concentrated. This situation can be analyzed through Michael porter’s framework of the five forces of competition. This framework views the profitability of an industry as determined by five sources of competitive pressure. These five forces of competition include three sources of “horizontal” competition: competition from substitutes, competition from entrants, and competition from established rivals and two sources of “vertical” competition: the bargaining power of suppliers and buyers. Ø Competition from substitutes: the price buyers are propense to pay for one product depends, in part, on the availability, and on price-performance of substitute products. The airline industry faces competition from other transportation modes, such as railroads, buses. For long distances, buyers may be more inclined to choose air travel to reach their destination. On the other hand, for short distances car is the airline industry’s main competitor: in fact, airline travel is neither practical nor economical for short trips. In the last five-year period, less obvious substitutes to airline travel in the business segment include teleconferencing, enabling virtual meeting rooms where participants can sit in different geographic locations. Ø Threat of entry: threat of new entrants presents new firms’ possibility to enter the industry and make its returns falling down through prices competition. In the airline industry, even if the capital cost of entry are fairly low, offering airline services requires airline and aircraft certification, gates, takeoff and landing slots, baggage handling services, and the marketing and distribution of tickets. Since the hub and spoke system has taken place, the barrier to entry are higher because new carriers find it difficult to obtain gates and landing slots at the major hubs, and so the new entrants have been forced to use secondary airports. Even with this unprofitable situation, many entrepreneurs are still attracted by the apparent glamour of owning an airline. Furthermore, there are few major economies of scale in air transportation, so that both large and small airlines could coexist. However there are economies associated with network density, so that the greater the number of routes within a region the easier it is for an airline to gain economies and utilization of aircraft, crews, passengers and maintenance facilities. The product differentiation is also a source of barriers to entry: in an industry were products are differentiated, established firms have got the advantage of brand recognition and customer loyalty, which was not so easy to be built up. Another big problem was the retaliation: indeed retaliation against a new entrant may take the form of aggressive price cutting, sales promotion litigation or increased advertising. For example, the famous British Airways “dirty tricks” campaign against Virgin Atlantic, which included accessing Virgin’s computer system and poaching its customers. In addition, governmental and legal barriers are the mostly effective barriers to entry: indeed, there is new policy adopted by federal aviation administration, that put caps on the number of aircraft a new airline can operate based upon carrier’s financial and managerial resources. This because according to a governmental accounting office study made many years ago, startup airlines’ accident rate was higher than the major airlines’ rate. Ø Competition from established rival: the airline industry can be characterized as an imperfect oligopoly, in which a few carriers dominate in long distance flights, while several dozen small carriers compete for short-distance flights. The airline industry has become more concentrated over the last 10 years. Two main factors have contributed to this concentration: several mergers and bankruptcies. Several mergers have taken place during the last decade: as traffic growth has slowed and carriers have exhausted the means to boost profits through conventional cost-cutting measures, mergers provide opportunities for saving by consolidating administrative, distribution and maintenance operations. Bankruptcies have also contributed to the increased concentration, especially in the early 1990s. Ø The bargaining power of suppliers: Labor is the airline industry’s largest single expense. Most airline workers belong to one of a dozen unions, which give the airline workers strong power in negotiations with the airlines, such as the Association of Flight Attendants, the Air Line Pilot Association, etc. despite of the falling of the real ticket price and the always increasing competition, the labor costs have never stopped to increase and in the future will continue their raising. Airline operations are also energy-intensive, and some carriers attempt to hedge their fuel costs by buying and selling futures. Jet fuel prices are currently high because oil refiners kept jet fuel production down in 1996 as they waited for crude oil prices to dive following the return of Iraq to the market. Ø The bargaining power of buyers: The customers can be broken down into two main segments: business and leisure. Because business travelers often book flights at the last minute and frequently have their organization pick up the tab, they tend to be relatively price-insensitive, so high inelastic; Instead, the demand for air tickets among leisure travels is fairly price elastic. Consequently, business travelers generate a larger portion of the industry’s revenues relative to their numbers. The frequent flier programs were originally targeted toward the business segment. We have recently seen a trend toward expanding the frequent flier programs to let members earn miles by conducting business with a variety of other organizations. This makes the frequent flier programs a powerful tool in the leisure market as well. An attractive frequent flier program will increase the power of the airlines in the customer relationship. 2. Which of Porter’s five forces has had the biggest impact in depressing industry profitability? Competition from established rival has had the biggest impact in depressing industry profitability: the airline industry has become more concentrated over the last ten years, because of mergers between airline companies and bankruptcies of many firms.
|
