US airline industry is listed at the bottom of the profitability table of industries in the country 2000-2013. The industry has struggled a lot to make profits. An American investor Waren Buffet once quoted that investors in this industry had cumulatively lost more money than it had made. During the first quarter of 2015, it was clear the strong upswing in the profitability of US airlines that had begun in 2012 was continuing into 2015. Airline profitability was benefiting from the fall in oil prices and the revival of the US economy. The US airline industry had been plagued by intense competition and dismal profitability since it was deregulated in 1978. Several airline were in chapter 11 bankruptcy for long period of time. Even with the recent revival, the profit margins of the major US carriers remained thin. The financial miseries of the airline industry were not restricted to the US: the global airline industry had consistently failed to earn returns that covered its cost of capital.
2. Current state of US airline industry
There are two eras in the history of US airlines, first was the ear of regulation which stayed until 1978 and second the era of deregulation. Following the act of deregulation airline industry is controlled by free market. This stimulated more competition in the business and stimulated the creation of many low cost carriers. Then consolidation came and network of airways formed which gave the industry a new structure. Several important mergers and alliances are also formed between big and small firms which more led to new industry structure.
3. Secure strategy and industry evolution
Changes in the strategies of the airline as they strive to adjust to the competition in the industry and gain competitive advantage has resulted in the firm structure of airline industry. Change in point-to-point route by hub-and-spoke route provided greater significance by increasing efficiency and allowing dominance of major carriers in regional market. The effect of continued new entry in reducing seller concentration in the industry has been offset by mergers and acquisitions between existing players. The rising of many low cost carriers had resulted in the need for major carriers to make many price cuts. Frequent-flyer-scheme was the most successful initiate to build customer loyalty.
4. Industries strategy analysis and evaluation
Airlines industry like any other business environment its decision and performance can be influenced by different factors. As it’s described on porters’ five forces that shape industry completion airline industry is one of the industries that can be influenced by this forces intensely. Knowledge of this this forces can help a company understand the structure of its industry and take out a position that is more profitable and less vulnerable to attack (Harvard business review p.80).
In the past some forces have had a more significant effect than others. For example, there was a low level of threat from new entrant to industry profitability since the barriers were relatively high. In more recent times, the competitiveness of the industry has seen the minimization of barriers such as capital requirements; technology has created easier and cheaper access to distribution channels and new and efficient business models direct an absolute cost advantage. Hence the US airlines industry may face challenges with foreign carriers or regional carriers start up. It is required to have substantial capital and high economies of scale, minimal product differentiation. The rivalry between the established competitors had caused a depression in the industry because of the larger airlines firms’ high ration of fixed in relation to variable costs. To establish and maintain their services, airlines have a high level of fixed operating costs such as labor, fuel, aircraft, engines, spare parts, IT services, airport equipment, airport handling services, sales, catering, training, insurance and other expenses. The majority of the proceeds from ticket sales are paid out to different external providers and internal cost centers. Most of the cost for airline are fixed. The variable cost associated with serving another passenger on the flight is often negligible compared to the fixed costs. Airlines will sell seats at anything over their variable costs. This means that revenues may not always be sufficient to cover the fixed costs. As mention above, after deregulation of the industry, pricing became an area used to try to gain advantage. Low cost carriers reduced service allowing them to charge low prices for fares. Given the large availability of substitution such as fast trains, boats and the belief from consumers that there was virtually no difference in the product, demand was elastic price. This in turn caused legacy airlines to reduce their prices on specific flights that had a high degree of substitution. When coming to bargaining power of suppliers, stratified price sensitivity is considered. Consumers that are price sensitive tend to buy on the basis of price. Vice versa consumers that are not price sensitive tend to buy on the basis of other factors such as convenience, comfort and amenities. Powerful suppliers capture more of the value for themselves by charging higher prices, limiting quality or services, or shifting costs to industry participants. Many key suppliers enjoy oligopoly or monopoly status and some have regulatory power. For instance, major airports, air navigation service providers and security services can essentially dictate the price they charge for use of their facilities and services. Powerful suppliers, including suppliers of labor, can squeeze profitability out of an industry that is unable to pass on cost increase in its own prices. Legacy carriers continue to be burdened by many of the characteristics of the pre-deregulation period: unionized work forces, high wages, comprehensive benefits, hugely expensive pension plans and restrictive work rules. Not surprisingly, airline unions resist reducing wages and benefits or easing work rules. Thus, union contracts, which have been negotiated and renegotiated over the legacy carriers’ long history, contain successive accretions, tradeoffs and concessions made by management over the years to avoid strikes and maintain labor peace.
In US airline industry, predominantly the capital intensive, key success factors are as follows; service promotion and in-flight services, efficient management of cost by focusing on the price during volatile periods and maintaining fuel procurement. Another key success factor is route system that is to organize the route where to fly and how frequently. As airlines experienced instability in capacity and profitability, they introduced new initiative that is frequent flyer miles a currency alternative between airline and consumers and a major turning point for airline. It also resulted in an increase in customer retention.
Fuel, labor and customer experience are the three main airline costs in general. Customer experience should be the main for airlines to increase retention and benefit. Furthermore the airline industry should create needs based segmentation, engage customer via two way communication channels and develop voice of the customer program to uncover customer and marketing insights.