Beruflich Dokumente
Kultur Dokumente
BLUE NOTES?
Airline Industry Challenges
For 2000 and Beyond
Christopher M. Boyle
August 9, 2000
Executive Summary
The U.S. passenger airline business reached $118.2 billion dollars in 1999 and
continues to grow faster than the economy. Since deregulation in 1978, the industry has
been cyclical, with periods of excess capacity and the accompanying pricing pressures.
In the last decade the industry has enjoyed high profitability and continued growth. A
recent jump in fuel prices in addition to continued labor concerns raise questions about
the sustainability of current profits. This report addresses the challenges currently facing
the industry along with the strategic responses of the airlines and some recommendations
follows:
The airlines continue to face intense public scrutiny. Strategic responses must keep pace
with the rapid change produced by forces such as technology and strong economic
growth.
-2-
Table of Contents
Executive Summary.............................................................................................................2
Table of Contents.................................................................................................................3
Introduction..........................................................................................................................4
Brief History........................................................................................................................4
Business Challenges.............................................................................................................6
Strategic Responses and Recommendations......................................................................18
Conclusion.........................................................................................................................21
References..........................................................................................................................23
Endnotes.............................................................................................................................25
-3-
Introduction
This report analyzes the dynamics of the airlines industry and reports on the
challenges and recommendation for strategy and action are provided. The report
provides a brief history of the airline industry, a survey of the business challenges to the
The airline industry has many segments that serve many different markets. This
report focuses on the U.S passenger airline business. As many of the airlines that are U.S
based have international routes and are expanding overseas, international issues such as
globalization and international alliances are important to understanding the U.S. markets
and are explored herein. While operations of major carriers include freight business,
Brief History
In 1903 Wilbur and Orville Wright made history with the first airplane flight. By
1920, KLM was founded as one of the first commercial airlines. The 1920’s also saw the
world’s first crop dusting service transformed into Delta Airlines. The competitive race
In 1978, the US commercial airline industry was deregulated, paving the way for
increased competition and a major shake up in the airline industry. As airfare and route
controls were lifted, airlines moved quickly to seize new routes and set market driven
-4-
rates. Airlines embraced a hub-and-spoke model and fought aggressively for control of
prime hubs.
pressures and heavy losses for many airline companies. Many players were forced to
merge or declare bankruptcy. Prominent mergers in the mid-eighties: include Delta with
Western; Northwest with Republic Airlines; and Texas Air with Eastern and Peoples
Express.
Following the intense consolidation, three airlines were left controlling over a
third of the RPMs. United, American and Delta’s combined market share of RPMs
reached 54.1% in 1998.1 Presently, the top ten U.S. airlines account for over $80 billion
The airline industry has seen business challenges and innovative responses in the
last quarter century. Facing increased competition, airlines developed plans to win and
retain customers. In 1980, American Airlines introduced the first frequent flier program.
Influences such as price competition and rising fuel costs due to the Gulf War resulted in
Smaller regional have come to challenge the established major airlines. While an
extremely high number have failed, some have become successful industry participants,
including Southwest which has been profitable every year since it started flying in 1971.
regulation and cramped seats round out the range of challenges the faced by airlines
today.
-5-
Business Challenges
Competitive Environment
The airline industry has over 60 airlines that operate aircraft with over 60 seats
but is concentrated with over 50% of the market share held by the top three players.2 The
largest US airline based on revenues and RPMs (Revenue Passenger Miles) is United
Airlines with revenues of $18 billion in 1999. Major airlines have been able to establish
control of the majority of business at many of the country’s major airports without a
challenge from major competitors. Smaller airlines are not able to compete when a major
airline has better access to gates and prime departure times, broader flight schedule
offerings and greater financial resources. The relaxed competition under the hub and
spoke system has permitted the major airlines to enjoy a decade of high load factors and
high profit margins. Examples of the high hub fare premiums can be see in the following
80%
64%
60%
51%
45%
34% 41% 1998
40%
1995
23%
20%
0%
Charlotte Cincinnati Minneapolis
-6-
The competitive position of these players and the current hub and spoke system is facing
several threats including the emergence of regional airlines, increased pressure against
the major carriers. Though most start-up airlines end in failure, a few have managed to
survive. Vanguard and Frontier are two regional players that have become profitable in
recent years. Regional competitor, Southwest Airlines is the only large carrier that does
not use the hub and spoke system. Southwest uses Dallas’s Love Field for regional
flights because of competitive pressure from Dallas hub giant American Airlines.
Utilizing new smaller and less expensive jets offered by Bombardier and Embraer of
Brazil in addition to offerings from Boeing and Airbus, regional airlines are making short
haul flights more economical. Smaller jets will give the regional airlines two competitive
advantages. First, smaller jets have lower load factors, permitting regional carriers to
undercut the major airlines on low-density routes. The second advantage for the regional
carriers is the ability serve new routes not served by larger carriers.
varying types aimed at producing a number of benefits. Alliances allow airlines to offer a
larger selection of routes often in under served areas of the U.S or in overseas markets
Alliances also provide their members with cost saving as a result of shared terminal
-7-
materialize from all the speculation in the first half of 2000. Airlines will increasingly
seek mergers as a way of cutting cost and improving airlines relatively small profit
margins.
With international markets outpacing domestic air traffic growth, airlines are
turning their attention toward this sector for expansion. As nations sign open skies
treaties we can expect to see more alliances and more transnational investments between
airlines. Globalization, coupled with the airline industry’s thin margins and
Market Size Global airline revenue was $306.5 billion in 1999.4 Total revenue
more, boosting leisure travel revenue. Leisure travel represents approximately 60% of
emplanements. Recent concerns, including Y2K and the drop in the stock market, have
lead to lower than expected leisure travel in the first half of 2000. Any future events that
-8-
Cost cutting and downsizing trends have reduced demand for air travel from the
business traveler, traditionally the most profitable segment for the industry. Additionally,
technological advances such as e-mail and teleconferencing increasingly chip away at the
demand for business travel. More recently, the broad economic prosperity in the United
States has led to an increase in business travelers’ purchase of premium fare tickets.
ways to attract new customers and more importantly, to build loyalty among existing
customers. American Airlines frequent flier program has been replicated by every major
airline. Subsequently, airlines have made agreements with rental car companies, credit
card issuers and long distance providers to enhance the value of the programs. “Miles”
earned in these programs have even become a currency that various companies use to
reward employees.
light of poor on-time records, high levels of cancelled flights and cabin service that often
amounts to a bag lunch. United faces all of these challenges and more as it seeks a
merger with US Air. Selling the public and antitrust regulators on a bigger is better
strategy will be difficult given the fact that it already holds the position of largest air
carrier and yet has a steadily deteriorating service record. Some smaller airlines are able
to offer quality services which succeed in attracting customers and building loyalty.
Midwest Express offer business class seating throughout all of its planes and offers such
perks as wine with each meal and fresh baked cookies. Start-up carrier JetBlue Airways
-9-
Operations & Financial
Expenses Employee
Jet fuel, the second largest cost for airlines and the most variable, has risen
dramatically in 1999 and 2000. Due to unforeseen resolve among OPEC members to
lower output, fuel prices began to rise in March of 1999. Every $.01 increase in the
price of kerosene jet fuel translates into a $34 million increase in fuel costs for the
industry.10 Airlines fuel costs are subject to forces far beyond their control including
OPEC, rogue nations and U.S foreign policy among other players in the world oil
markets. Fortunately, fuel costs as a percent of total have declined from approximately
30% in 1980 to the 10% range in recent years.11 Many airlines such as United have
implemented hedging plans that cover a substantial portion of fuel costs making costs
very predictable. Delta, which hedges up to three years on its fuel requirements, hedged
80% of its first half 2000 requirements during the first half of 1999, significantly
Weather and air traffic control delays are other factors over which the industry
has little or no control though they often contribute to billions of dollars in expenses each
-10-
year. Tornadoes and blizzards can cause delays in the cities where they occur or they
may cause a chain reaction of delay across the country. Smaller weather issues such as
temperature and wind speed can have a large impact of fuel consumption and related
costs.
for the air carriers. Purchasing planes outright is very expensive but cost effective for
those companies with the cash to do so. Most airplanes are leased from an intermediary
with better credit such as GE, thus reducing capital outlays while increasing operating
expenses. Additionally, substantial costs are incurred in the maintenance and servicing of
airplane equipment.
Increased capacity from smaller regional jets has been a significant contributor to overall
capacity increases. As passenger traffic grows faster than capacity, load factors continue
to increase. Load factors have increased to a high of 71.0% in 1999, indicating an overall
improvement in asset utilization. With the advent of internet distribution, we can expect
to see a continued rise in load factors as the net allows airlines and to sell empty sees at a
discount. (See the Distribution & Technology section for further discussion.)
AS Boeing and Airbus Industries are the only producers of large jets, airlines have cause
for concern with a highly concentrated supplier base. Several carriers have expressed
concerns with the Airbus Industries proposal to build a superjumbo jet will reduced its
attention to the more popular models and undermine competition with its sole competitor
Boeing.13
-11-
Human Resources
Airlines, like the rest of U.S. employers, are facing major labor shortages as
unemployment remains very low. Midwest Express expects “recruitment of both skilled
and general labor to be a growing problem.”14 This environment will ultimately mean
that air carriers will have to pay more to attract and retain a qualified workforce,
especially for pilots and mechanics, which are in shortest supply. Labor already accounts
for 36% of costs and this number can be expected to increase if there is not a serious
attendants among others, have a long history of adversity and mistrust. While labor gave
many concessions in negotiations a decade ago when profitability was under pressure,
airlines are being forced to give up more now that times are good. In 1999, Delta faced
demands from pilots for a pay increase of 21% to compensate for a pay cut they took in
1996 when management argued that the airline was still experiencing financial trouble.
employee buyout in 1994, making it the largest employee owned company in the world.
Now employees own a majority share of the company, have board representation and still
following work procedures despite available shortcuts and efficiencies readily available.
Pilots refuse to fly overtime and taxi aircraft longer and slower than needed as a way to
-12-
The National Railway Labor Act regulates union contracts and negotiations.
Under these regulations, the terms of a contract remain in effect after the contract expires,
giving both sides additional time, sometimes two or three years, to settle the terms of a
new agreement. While this procedure may avert a strike, it does not prevent more overt
The challenges posed by labor relations occur not only at contract negotiation
time. Several other activities that airlines ordinarily engage in risk facing serious
As previously noted, there has been a shift toward using smaller aircraft for
regional flights because of improved economics. The economics of flying these small
aircraft may not be so good if the unions have their way. Most labor contracts have scope
clauses that limit the number and size of aircraft that regional affiliates may fly. These
affiliates pay lower salaries to their pilots than do the majors. By limiting the growth of
these affiliates unions are able to protect the much higher salaries paid to the majors’
pilots.16
over seniority rights in conjunction with the Reno Air acquisition. Merging two union
workforces requires more than just establishing agreeable pay standards; it also includes
the task of melding of two seniority plans. Inevitably, progress made with seniority
rights, unravels progress made on wage parity. Presently, United faces pilot concerns
over this seniority issue with its proposed acquisition of U.S. Airways.
-13-
Distribution & Technology
the same pressures that any information system faces as a result of technological change.
Distribution for airline tickets has traditionally had two intermediaries, travel agents and
commissions of 10% of the cost of the ticket. In recent years, the airlines have stepped
up pressure on agents and their commissions have fallen to below 5%. While travel
agents still account for a huge portion of the distribution of airline tickets, the airlines are
aggressively seeking ways to eliminate that 5% to travel agents in their distribution costs.
An additional cost to airlines is the CRS such as Sabre (spun off from American’s
parent AMR) or Galileo, which allow travel agents to make reservations on airlines
around the world. These systems provide great convenience to the customer comparing
schedules and pricing but represent a cost that may range from $3.50 to $10 a ticket or
more.
Targeting these intermediaries with their associated costs and inefficiencies, the
airlines and others are looking to cut costs, speed transactions and improve efficiencies
through the use of e-commerce technologies.17 In addition to the airlines, several online
travel organizations have sprung up streamline the travel process through expanse online
offering, including the resale of airline tickets. Travelocity (recently acquired by Sabre)
and Expedia (owned by Microsoft) dominate this space with approximately 80%of all
Leading U.S. Airlines, in addition to selling tickets through their own web sites,
have joined together to compete with other online travel services for the $5.8 billion in
-14-
airline tickets to be sold over the web in 200018. The new service, which is named Orbitz,
is expected to be able to search the flights of hundreds of air carriers and provide
Airlines can increase load factors by marketing on interenet seats that would otherwise go
unfilled. The economics of filling the over half a million seats that fly empty each day
are very appealing to airlines as there is a large incremental profit on each of these seats
that is sold.19 Priceline.com, the highly acclaimed web commerce company, offers a
system that improves efficiencies by letting travelers bid on seats, primarily unsold
inventory.
Airlines are developing systems that put a service kiosk on site of a corporate
client. The employees of the client are then able to book reservations in accordance with
corporate travel policies, print baggage tags and then initiate an electronic transaction so
Technology will also provide great opportunities in the area of customer service.
Functions such as checking in from your wireless device or automatically having a page
to a travelers spouse with flight delay information are already being implemented by
major airlines.
opportunity for technology than some of the “gee-whiz” applications. These applications
will be able to store a customer’s flying habits and make suggestion based on previous
preferences. Recognizing that a traveler suffered a cancel flight the previous week and
then offering a free upgrade on this week’s flight, airlines can significantly improve
-15-
customer service. Additionally, these systems will be able to provide the airline with
valuable data such indicating which customers produce the most revenue.
significant savings from the use of online supply exchanges. According to Henrik
Schroder, former president of Saab Aircraft of America, “The aviation industry’s supply
chain today is too expensive, too slow and much too inefficient.”20 Goldman Sachs
estimates that this represents a $100 billion opportunity for airlines, manufacturers and
parts suppliers, in addition cost saving of more than 10% per transaction.21 The challenge
for airlines is to capture the largest portion possible of those savings for themselves. To
meet this challenge, six major U.S. airlines have joined to form an unnamed supply-
exchange while Northwest has joined with Lufthansa and JAL to develop their own site
called AeroXchange. Challenges also exist from “established start-ups” AviationX and
TradeAir.com.22
Airlines have had to contend with heavy regulation and legal issues for decades.
One of their newest challenges is a result of their internet travel and supply exchange
initiatives. Orbitz, the travel service site owned by several airlines as well as the join
supply exchange will come under anti-trust scrutiny from the Department of Justice and
perhaps European and other regulatory bodies. These same anti-trust concerns will rise
from the recently proposed mergers among various large airlines. As airlines have
already come under fire from the Department of Transportation for unfair practices
relating to pricing under the hub and spoke system, it is likely that any proposed merger
activity will face rigorous scrutiny.23 Airlines will be forced to demonstrate that they are
-16-
acquiring complimentary routes and terminals, which will not increase their dominance in
already uncompetitive markets. While customers and small airlines have complained
about the problems caused by hub dominance, congress may be getting more serious
about passing legislation that changes the system, especially in light of public outcry
Not all anticipated regulatory activity would impose obstacles on airline activities.
The U.S. has been very aggressively signing “open skies” whit other countries which
makes progress toward lifting many protectionist barriers that countries have erected to
protect state run airlines. Additionally, ownership restrictions are being relaxed allowing
volume of air traffic has increased to such a level that gates, runways and airspace are
heavily and, some would argue, dangerously overloaded. Air traffic control (ATC)
suffers from technological and systemic antiquation that simply cannot keep pace with
the volume of air traffic. United Airlines blames 21% of its recent cancellations on ATC
related issues.24
Airlines are large consumers of petroleum based fuels which means large amounts
of air polluting emissions. While the U.S has forced auto manufactures to steadily reduce
emissions, it is possible the aircraft manufacturers may see increases in such regulation
and therefore passing these cost on to the airlines. There is also reaction to other types of
air travel pollution. For example, homeowners in Seattle have formed groups to lobby
for changes in flight patterns to reduce noise over their neighborhoods. Subsequent
regulations may increase fuel costs related to compliance with new routes.
-17-
Strategic Responses and Recommendations
Competition
at cost savings and related synergies. Alliances aimed at boosting load factors and
proposed mergers and acquisitions. While part of the industry focuses on the “bigger is
better” strategy, smaller players have emerged to fill the need for low cost alternatives to
Airlines must be careful to avoid many pitfalls associated with consolidation and
globalization. If mergers are approved by U.S. regulatory agencies and public opinion,
there are still foreign regulatory, accounting and cultural issues that could have a serious
customers. The frequent flier programs have evolved into travel point programs and are
now taking on a new role with internet shopping. Airlines must continue these types of
programs and expand them into new areas to retain fickle airline passengers. Airlines
have made a significant step in adding in flight movies on personal monitors on many
international flights and first class sections. Airlines have the option of creating a total
entertainment experience for passenger, perhaps making the air travel one of the
highlights of vacation travel. Another avenue would be to sell advertising time on the
video programming. Advertisers might be willing to pay large amounts to pitch their
-18-
products to a highly captive audience that can afford to travel, as they do in with the
inflight magazines.
Another innovate industry response has been the creation of business class and
other segmentations between coach and first class. These classes provided an option for
those who want to travel more comfortably but have corporate travel budgets that
large and small airlines to compete vigorously. But airlines’ meager margins require that
they look to internal cost cutting measures to boost profits. Airlines are trying various
strategies such as hedging fuel costs to better manage costs and smooth earnings.
federal government on foreign policy as it relates to oil exporting nations. Airlines would
benefit from U.S pressure on these nations to maintain reasonable oil prices and moderate
the rate that oil prices change. Given that coercing OPEC into action when there is rarely
unity among its members, this policy faces some obstacles. Even though, the U.S.’s
influence over allies such as Saudi Arabia and Kuwait may be a worthy target of
lobbying efforts.
Human Resources
The airline industry has a long history of adversarial labor relations and it seems
that there has been little change in managements approach to labor. Management has had
few successes in regards to these challenges though a few notable exceptions stand out.
-19-
Southwest Airlines has excellent employee relations and has employee productivity of
almost twice that of the industry average. Employee relations are a key element to the
organization’s excellent customer service record and status as one of the most profitable
airlines. Frontier, relishing in its recent profitability also claims strategic resource
“take care of the employees, so they can take care of each other, then they will take care
of the customer.”25 The example set by Southwest and Frontier suggests that the major
airlines need to reconsider human resource management and adopt less adversarial
start-up travel sites and supply exchanges is a strategic move to capture a greater portion
of the cost savings brought about by technology. While airlines have the resources to
create these e-commerce programs to match those of the start-ups, they must continue to
heightened anti-trust activity. Microsoft’s arrogance has been cited as pivotal reason for
anti-trust rulings against the company. The airlines should avoid any appearance of
-20-
Airlines need to begin raising public awareness of the need for improvements in
air traffic infrastructure. The problem already exists and yet public policy in this area has
yet to get much public attention. Perhaps United should consider using its disastrous
service record this year to highlight problems with the FAA and the air traffic control
system. It seems like they could not do any additional harm their public image at this
time and other airlines my pick up the issue as well. Perhaps supporting a movement to
privatize the FAA would be the best option for bringing about changes and efficiencies.
The airline industry must take care in balancing their purpose as for-profit
business with serving the good of society. While the airlines have done a very good job
of promoting public safety, as evidenced by an exceptional safety record, they have done
a poor job in fulfilling their responsibility to the public in other ways. First of all, they
have failed the community by their inability to have amicable relations with their work
force. Additionally, the airlines have exploited the hub and spoke system to obstruct
Conclusion
The airline industry gone through many changes since it’s beginning early in the
twentieth century. The pace of change has accelerated at the turn of the millennium due
to forces such as technology and a strong growth in the U.S. economy. The changes
bring about several opportunities and several challenges for the airlines, but the rate of
change presents a problem in itself. Airlines must adopt to changes such ticketless travel
The industry participants must also initiate change to overcome several existing
challenges. Continuing conflict with unions persists because management has not
-21-
changed its adversarial approach to dealing with labor. Challenges exist in the
competitive landscape with the growth of alliances and several proposed acquisitions.
This leads the observer to wonder if the industry will consolidate down to three or four
The formation of alliances has helped increase load factors and efficiencies for
many airlines. The airlines must continue to develop new strategies to build loyal
travelers paying premium fares while attracting other flyers to low fare seats that would
otherwise fly empty. Meanwhile, airlines must control expenses carefully through such
means as the hedging of fuel prices. Labor expenses can be kept down through improved
Technology has opened up new avenue for the distribution of tickets promising
great efficiencies and cost savings for the industry. Meanwhile, air traffic challenges
remain for technology to solve through improved traffic management systems and
Finally, airlines play a critical role in our society from which the traveling public
expects economical, reliable and safe air travel. The industry will continue to experience
intense public scrutiny in all of its activities and must respond with skillful management
of the challenges presented in the regulatory, public policy and ethical arenas.
-22-
References
Airline Business (2000, July) 101
Air Transport World (2000, January) Forecast: Blue Skies, Another Good Year, 37: 1
Air Transportation Association, Annual Report 2000: Airline Industry Review, (2000),
Available: http://www.air-transport.org/public/2000ap/ (2000, July 11)
Carey, Susan (2000, June 5) American Explores a Deal for Northwest, The Wall Street
Journal p.A3
Carey, Susan & McCartney, Scott (2000, July 12) AMR, Northwest Talks Turn Serious
As Pressure Rises for Decision on Merger, The Wall Street Journal p.C16
Dallas Morning News, (2000, April 28) Rival Airlines Unite to Form Supply-Exchange
Web Site, Cut Purchasing Costs
Interavia Business & Technology (2000, May) New market, new tools, 55: 642
Michaels, Daniel (2000, July 24) Enlarged United Faces Marketing Challenges in Deal,
The Wall Street Journal,p. B2
Office of the Assistant Secretary for Aviation and International Affairs, Competition in
the U.S. Domestic Airline Industry: The Need for a Policy to Prevent Unfair
Practices (1999, May) [Online] Available:
http://ostpxweb.dot.gov/aviation/domav/comp_rev.pdf
Rosen, Cheryl, (2000, June 26) Transforming travel, Information Week :50
White, Erin & Kranhold, Kathryn (2000, May 25) Enlarged United Faces Marketing
Challenges in Deal, The Wall Street Journal,p. B2
-23-
Williamson, Richard (2000, July 23) United they aren’t, Denver Rocky Mountain News,
p. G1
-24-
Endnotes
-25-
1
Standard & Poor’s (1999)
2
Standard & Poor’s, (1999)
3
Department of Transportation (1999)
4
Airline Transport World (2000a)
5
Air Transportation Association (1999)
6
Ibid
7
Ibid
8
White (2000)
9
Johnson (2000)
10
Air Transportation Association (1999)
11
Standard & Poor’s, (1999)
12
Airfinance Journal (2000)
13
Michaels (2000)
14
Airline Transport World (2000a)
15
Williamson (2000)
16
Interavia (2000)
17
Rosen (2000)
18
Airfinance Journal (2000b)
19
Transforming travel
20
Air Transport World (2000b)
21
Ibid
22
Dallas Morning News (2000)
23
Department of Transportation (1999)
24
Williamson (2000)
25
Sam Addoms, private lecture