1 By Low Cost Airlines example essay topic

Strategic Discussion on U. S Airline Industry Discussion Question 1: Use the model of the general environment (Chapter 2, Table 2.1) to evaluate the opportunities and threats facing the U.S. airline industry and Southwest Airlines in particular. What are the key opportunities and threats? The health of the overall U. S airline industry is still tenuous in-spite of the passenger traffic volumes returning to pre-9/11 levels. A survey estimated that from 2001 through 2003, the US airline industry reported to have lost $23.2 billion dollars, compounded by an additional $1.6 billion in the first quarter of 2004. This $24.8 billion shortfall exceeds the total profits earned over the entire six-year period 1995-2000 Drastic changes in the Economic, Political / legal and technological segment of airline's external environment contributed to some of the major looses seen by the industry. The key factors that heavily contributed to the loses include Economic slow down in the country Massive decline in business travel SARS epidemic o Increase in competition o Availability of substitutes for air travel soaring fuel price so Weak dollar In response to the industry's financial crisis, Congress made available several forms of relief that amounted to over $20 billion.

This relief includes the payment of up to $5 billion in pretax cash assistance to reimburse air careers for losses incurred as a direct result of the 4-day government shut-down of air traffic after 9/11. However, relief measures were not enough to bring the airline industry out of hot water. Most of the airlines have accumulated vast amounts of debt which brought them on the verge of bankruptcy. The list includes Atlas / Polar Cargo, Midway, National, Sun Country, TWA, United and US Airways.

American and Delta airlines narrowly avoided bankruptcy but have warned about such possibility. "An average carrier is now well over 90% leveraged (net debt to equity ratio) compared to 60-70 percent historically. This means most airlines are now completely leveraged and unable to obtain capital. This has added to significant debt service costs and will make the industry even more vulnerable to any future economic downturns. With industry debt well over $100 billion, much of it due in the next 24 month. 11 of 12 airlines are rated "junk bonds" by S&P. Only Southwest remains at an "investment grade.

Almost all airlines are faced with the same challenges and threats in the external environment like rising fuel cost, weak travel demand etc. Some airlines like Southwest, Jet Blue and Air Tran which implemented a low cost structure remain profitable although the margins have suffered. Another factor that contributed to the profitability of these carriers is the higher productivity of their labor force and use of technology to improve operations and management. A recent survey of the airline economic health suggested that even though the industry hoped to return to some degree of stability, if not profitability, yet new costs beyond the airlines control wiped out recent efforts to cut costs and achieve new efficiencies. Record high oil prices and nation's on-going war on terrorism have presented new barriers to improving the industry's financial health. Another cost factor that is heavily contributing to the overall cost is the Aviation Security Infrastructure fee (ASIF).

This fee is enforced after Congress passed the Aviation and Transportation Security Act (ATS A) which necessitated additional security at the airports. This fee is expected to rise to $750 million in 2005 from $315 million in 2000. This fee is in additional to the additional federal security mandates imposed since 9/11. The industry argues that impact of federal security mandate and foregone revenue totals $2.8 billion per year. The statute that directs FAA to extend war-risk insurance to U. S airlines and air cargo carriers is set to expire on August 31st of this year. Since there is no commercial market for this type of insurance, the industry could obtain coverage for only limited utility that could potentially cost the airline industry several hundred millions of dollars annually in insurance costs.

The airline industry is lobbying with Congress for a extension of federal War-Risk insurance program. To summarize some of the opportunities and threats faced by the airline today are Rising fuel cost which impacts the profit margin of the industry. o Added security cost by govt. to enhance the safety of aircraft's and our airports. o The industry forecast an increase in tax on the operating income which will further reduce the net profit for the airline industry. o Rising short-term interest rate would add additional pressure on the airline industry. o Improving economy and travel demand is likely to bring legacy airlines in positive territory of profits. o Expiration of Federal War-Risk Insurance program Discussion Question 3: Use Porter's Five Forces Model to determine the attractiveness of the U.S. airline industry. The Porter's five forces model provides a framework for industry competition as 1) Threat of new entrants Based upon the analysis above #DQ 1, the airline industry is faced with several distinct threats and challenges. However, opportunities for new entrants exist in regional airline market where major airlines have retrenched their operations and other airlines have not pursued their operation. In mature market, the new entrant will face stiff competition from low-cost airlines and the legacy airlines.

2) Power of suppliers High fuel and maintenance cost will significantly influence the profit margin of the industry in future. Increase in supplier price could potentially increase the cost as well. 3) Power of buyers With the availability of online ticket retailing, customers are always looking for cheaper rate and high value tickets. Since customers have lot of options available it puts extra pressure on the airline industry to keep the cost down. 4) Product substitutes In mature markets, multiple airlines compete to attract scarce resources (customers) which increases the product.

In regional markets where demand is low product is low 5) Intensity of Rivalry As demand has declined in last couple of years, intensity of competition has increased greatly. Airlines are faced with unprecedented challenges due to emergence of low-cost airlines in the market and how they operate and market their products. The low cost airlines I mean those that emerged after the industry was de-regulated in 1978. These low-cost airlines generally operate point to point service using fewer types of aircraft's. They do not offer international service outside Canada, Central America and Caribbean.

These airlines generally have lower unit cost than the legacy airlines. After 9/11 when legacy airlines sought to cut costs and reduced seats, these airlines expanded. It is reported that legacy airlines reduced their seating capacity by 12.5% shifting traffic to regional airline partners. At the same time these airlines increased their capacity by 26% as they expanded their operation.

These legacy airlines are Alaska, American, Continental, Delta, Northwest, United and US Airways. The low-cost airlines are Air Tran, America West, ATA, Frontier, Jet Blue, Southwest and Sprit. Some of the vivid comparisons between legacy airlines and low-cost airlines are In last few legacy airlines sort to cut costs, while low-cost airlines took advantage of legacy airlines retrenchment and expanded. o Legacy airlines cut costs in almost all areas of operation to reduce cost up to $12.7 billion (14.5%) between 2001 and 2003. Conversely, legacy airlines operating cost increased by just over $1 billion (9.8%). o Legacy airlines reduced their seating capacity by 12.6% whereas capacity was increased 26... 1% by low cost airlines as they expanded their operations. o The legacy airlines collectively lost $24.4 billion from 2001 to 2004 whereas low-cost airlines made $1.3 billion in profits. o Despite the cost-cutting effort by the legacy airlines, low-cost airlines still maintain a significant unit cost advantage over legacy airlines. o Neither legacy nor low-cost airlines have been able to significantly improve their revenues owing to weak fare growth and economic conditions. o Legacy airlines have high labor costs owing to a highly tenured and unionized work force.

Low cost airlines are able to keep labor cost down because of younger and lower paid workers with higher levels of productivity. o Legacy airlines have higher asset-related costs than low-cost airlines because legacy airlines have older fleet and more types of aircraft's versus low-cost airlines. Discussion Question 4: What are Southwest's tangible and intangible resources? Which are more important as a source of competitive advantage? Some of Southwest's tangible and intangible resources that act as a source of competitive advantage are; Tangible resources: o Low cost operation through the use of o Fewer aircraft types that reduces maintenance costo Point to point service unlike hub-spoke architecture used by legacy airlines. o Advance technology employed in operations and the use of total quality management (TQM) o No reserved seat approach o Ticket less travel to reduce back-office costs and operates its own ticket reservation system. o High employee retention and employee participation at all level so Employee ownership stake in the company Intangible resources: o Employee productivity and knowledge Trustworthy and reliable supplier so Customer loyalty and brand image.

South west has enjoyed 32 straight profitable years. o Efficient and innovative culture foster by the management Discussion Question 5: Does Southwest have a sustainable competitive advantage? Yes, I do feel that Southwest has a sustainable competitive advantage as long as the company creates unique value to the customer through its low-cost / differentiated strategy. To sustain the competitive advantage, it is imperative that the company constantly monitors its external environment as described by Porter's five forces framework and take necessary action to adapt and sustain its competitive posture. Discussion Question 6: Discuss Southwest's business-level strategy. Is this strategy appropriate to offset the forces in the industry? Do you recommend any changes?

Southwest employs integrated low-cost and differentiated strategy which enables the firm too Adapt quickly to environment change so Learns and implement new skills and technology quickly Effectively utilize its core competency while competing against rivals. To sustain a competitive advantage and to seek above average returns, Southwest implements this strategy to produce relatively differentiated service at lower cost compared to its rivals. Yes this strategy is appropriate to offset the forces in the industry. Discussion Question 7: Should Southwest expand internationally?

Or should it exhaust its domestic expansion opportunities first before expanding internationally? Yes, I feel Southwest should grow internationally as the demand for air-line travel has substantially declined domestically in the last couple of years and will continue to decline further in some segments like business or corporate travel. The major reason I feel is the growth in communication technology enabling people to work remotely without the need to be present in the office. Voice and data over IP, Live meeting and communication services have substantially reduced the need for corporate executive and divisional managers to travel thus lowering the demand further.