Term Paper on "Air Tran Airways Is a High-Growth, High-Leverage"

Term Paper 13 pages (3295 words) Sources: 7 Style: APA

[EXCERPT] . . . .

Air Tran Airways is a high-growth, high-leverage company operating in the discount airline industry. They offer an attractive investment proposition in terms of a growth stock portfolio, but their high level of fixed obligations exposes them to significant financial risk, which makes them unsuitable for a debt portfolio.

Company Background

AirTran Airways is a discount airline based in Orlando, Florida. The current incarnation of AirTran was created in 1997 when ValuJet bought what was then a much smaller AirTran and adopted the brand. The company operates its main hub from the former ValuJet hub of Atlanta-Hartfield. The company today also has sizeable operations in two other airports, Orlando and Baltimore-Washington. AirTran services 52 markets (all but one in the U.S.), and operates over 700 flights per day, totals which are both growing at a steady pace. They operate a fleet of over 120 aircraft, with firm orders to take them over 180. AirTran serviced over 20 million passengers in 2006.

The basic business model of AirTran is to offer a discount flight with business-class perks. The perks include XM satellite radio, advanced seat assignments, reward programs and an affordable business class.

The target markets are twofold. First, the target customer is the cost-conscious business traveler. There is some ancillary targeting of similar customers who are engaged in leisure travel. This is primarily a result of the airline's strong presence in Florida. Geographically, AirTran focuses on markets on the east coast of the United States. This is in part because these markets are geographically close together, which fit well with the firm's earlier exclusive focus on commuter travel. It is also due to their opinion of company management that many of these markets are either underserved by competing airlines or that the service is overpriced, creating in either case a means by which AirTran can easily enter the market. Recently, AirTran has begun to explore other markets farther afield, introducing several coast-to-coast services.

Key Competitors

AirTran faces competition from within and without the airline industry. The industry is highly competitive, with several major airlines competing vigorously for market share. Among them are Delta, American Airlines, Continental, Southwest. Most major carriers operate subsidiaries in the discount, short-haul segment.

In the discount segment, key competitors include Spirit Airlines, a 35-plane company operating from a Fort Lauderdale hub. JetBlue is almost identical in size to AirTran and has focus cities (less than a full hub) including Orlando and Fort Lauderdale. U.S. Airways is a much larger competitor, but focused away from AirTran geographically. Southwest is a large discount carrier with one of its major hubs being Baltimore-Washington, one of AirTran's focus cities.

A major competitor for AirTran is Delta. Where AirTran is the second-largest airline at Atlanta-Hartsfield, Delta is the largest. They operate Delta Connection/Comair, a commuter airline. For Comair, Hartsfield is considered a focus city, rather than a hub. Another Delta Connection carrier, Atlantic Southeast, uses Hartsfield as a hub and is of similar size to AirTran.

Outside of the airline industry, there is competition from other modes of transportation and communication. In this context, it should be understood that the entire air travel market is dependent on several outside factors for its survival. This includes fuel prices and availability, a lack of terrorism, federal regulations, and the competitiveness of other forms of transport and communication.

In the discount segment, cost is a key decision-making factor for consumers. It is conceivable that rising prices, which could stem from fuel prices, the cost of enhanced security, or other federal regulations, could deter consumers from engaging in air travel. This is a particular risk in the short-haul segment in which AirTran primarily operates, with many distances easily traveled by car. In the months after the 9/11 terrorist attacks, the industry saw a steep decline in travel as many customers forgo travel altogether in favor of long-distance forms of communication.

Keys to Success

The airline industry is to a large extent commoditized. Therefore the two most important success factors are the degree to which an airline can differentiate itself from the competition and the degree to which it can control its cost structure.

AirTran has sought to differentiate itself by offering a unique value proposition. There are many facets to this. One is the in-flight perks, such as the XM satellite radio, that enhance the customer experience. Another is the price point of its business class. AirTran's strategy is to offer business class quality at prices more competitive to coach, presented in an easy-to-understand structure.

AirTran also differentiates outside of the in-flight experience. They take pride in their online service. They've developed an award-winning website and promote the use of the site, which allows customers to organize their travel more quickly. AirTran also has two loyalty programs to encourage repeat business, a+ for regular consumers and A2B for its corporate clients.

In the discount air travel segment in particular, management of costs is key to success. AirTran is competing largely on price, and its ability to do that is dependent on strict control of costs. AirTran approaches this on several fronts. First, it operates mainly in short-haul markets, which keeps fuel costs down. Fuel costs are the single largest cost for most airlines, and accounted for 36.5% of operating costs in 2006. AirTran manages this cost with a hedging program consisting of both fixed-price and cap arrangements.

AirTran's fleet is very young, averaging just three years as of February 2007. These planes are more efficient than older models, which helps AirTran keep both fuel and maintenance costs well within industry norms. AirTran also has a good working relationship with its unions, which for example allowed them to curtail expenses during the post 9/11 slowdown while retaining all of their workforce and maintaining union harmony.

Performance Measures

The two most important measures of success in the airline industry are load factors and profit. Load factors represent the percentage of available capacity that is filled, specifically defined as the number of revenue passenger miles divided by the number of available seat miles. Essentially, airlines view each flight as similar to a fixed cost - once the flight is scheduled certain costs will be incurred. The flight itself is a variable cost, but once the plane leaves that cost is fixed. There is no variable cost associated with each individual seat, only a variable revenue. At that point, the profitability of any given flight relates to the amount of seats that are filled. Unfilled seats represent an opportunity cost - the opportunity to gain revenue is lost and never recovered. For AirTran, they address the issue of load factor with their service levels, their pricing structure, and their loyalty programs.

The second key performance measure is profitability. Load factor represents seats filled, regardless of how much revenue was generated by each seat, or how much that flight cost. Profitability represents the ability of the airline to convert each passenger mile sold into the bottom line. For AirTran, operating in with a discount pricing model, this is related to their cost structure, their load factor and their competitive environment. AirTran addresses profitability by keeping their overhead low, and hedging their fuel costs. The net profit is the basic measure of profitability, but in the airline industry they also evaluate revenue per ASM (available seat mile) and cost per ASM, which relates profitability to the load factor.

SWOT

AirTran has a number of strengths that have allowed them to grow rapidly over the past few years. Key among these is their leadership team. The team has been able to successfully develop a degree of differentiation in their brand. They were able to smoothly guide the airline through the collapse of the air travel industry post-9/11, through shrewd negotiations with their unions to reduce one of their biggest fixed costs. The team has also been able to successfully identify routes with a high opportunity and negotiate with the relevant airport authorities to bring these routes on board. This combination of flexibility, shrewdness, and ability to identify opportunities for growth within the industry demonstrates the quality of the management team at AirTran and the benefits that flow from that quality.

Another strength is their fleet. Currently, their fleet consists of two planes, the B717 and the B737. In particular, the B717 gives them a competitive advantage. AirTran helped to develop the plane, which was designed specifically for the type of short-haul travel AirTran specializes in. This particular airplane gives AirTran cost savings in maintenance and training costs. As a source of competitive advantage, AirTran benefits from the recent discontinuation of this aircraft, as competitors will no longer have access to it as readily. The B737 is the aircraft AirTran switched to following the discontinuation of the B717. It lends advantages in terms of lower per-mile fuel costs and allows AirTran to expand its business by taking on longer routes.

AirTran has a low cost structure. This is based around an overall corporate philosophy of cost control, and manifests itself in many key ways.… READ MORE

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