Term Paper on "Strategy Business Information and Analysis"

Term Paper 10 pages (3864 words) Sources: 10

[EXCERPT] . . . .

Airline Industry Analysis

The past decade has been a challenging one for the global airline industry. The terrorist attacks of September 11, 2001 sent the industry into a downturn in the first half of the decade, while the second half of the decade saw skyrocketing jet fuel costs and economic downturn send passenger numbers down and costs upward. In addition, the nature of competition within the industry has seen tremendous change. Discount carriers like Ryanair and Air Asia have reshaped the low end of the market while at the upper end several Gulf-based carriers have established themselves as global players at the expense of Europe and Asia's legacy carriers. As a result of these changes to the competitive and macroenvironments, the airline industry is in a state of creative destruction today, making it one of the most challenging industries in which to operate, yet also an industry in which there is tremendous potential for growth for companies with a good business model.

This paper will analyze the global airline industry in the context of its macroenvironment, including both a Five Forces and a PESTLE analysis. The life cycle of the industry will be analyzed, and the additional topic of security will be discussed, as this subject has also had a high impact on the direction of the industry in recent years. After this analysis has been conducted, an analysis of the industry using a resource-based perspective will be conducted. Air travel is a confluence of a number of critical resources, each of which can yield significant competitive advantage to a firm.

Five Forces Analysis

Michael Porter's Five Forces are supplier power, buyer power, threat of substitutes, threat of new entrants and intensity of rivalry. When put together, these forces can help understand the degree of attractiveness for the industry. For firms within the industry, their position within these forces may also dictate the industry's attractiveness (for example a firm with high power over suppliers in an industry with generally low power over suppliers). The five forces are graded on a low-medium-high scale, and the attractiveness will be determined by putting these five scores together (QuickMBA/Porter, 2007). The airline industry is generally unattractive at present, although for some firms the condition of the industry has resulted in significant opportunity to steal market share from weakened legacy carriers.

There are several suppliers to the airline industry -- key cost inputs include labor, airplanes and jet fuel. Supplier power is generally high. Labor suppliers are an exception as they have relatively low power over airlines. The airlines offer thousands or tens of thousands of jobs each. Much of the labor is not specialized, reducing its power. Even that labor which is unionized can be circumvented by the airlines if necessary -- ground crews have limited bargaining power when airlines can simply fly their planes to another country to have them serviced. Airplane manufacturers have only moderate power over airlines. The suppliers are more concentrated, which should give them buyer power but the intensity of rivalry between the two major players (Boeing and Airbus) is very high. In addition, the airplane manufacturers have high fixed costs, which means they must sell a sufficient number of aircraft to cover those costs. They need the airlines as much as the airlines need them. The result of this symbiotic relationship is that aircraft suppliers have moderate power. Jet fuel suppliers have high bargaining power over airlines. The price of jet fuel is determined by global commodities markets, which gives airlines almost no pricing control. As a result, airlines are compelled to use sophisticated hedging strategies in order to manage their fuel costs. Even with these strategies, fuel costs can be virtually the sole determinant of airline profitability, as was the case during the fuel cost run-up from 2004-2008 (ATA, 2006).

Power of buyers is moderate in the airline industry. Buyer volume is low, but other factors drive buyer power such as information, price sensitivity, substitutes and competition. Buyers have a high degree of information available to them, in particular online, that allows them to compare prices, routes and flight times of a wide range of carriers. For most major journeys, there are myriad options available, and since buyers can easily compare these options, it gives them some bargaining power -- not as much for negotiation but certainly for choosing one carrier's offer over another's.

Most airline buyers are price sensitive, not only in choosing between airlines but also in choosing between airlines and substitutes. There is evidence that price sensitivity of airline passengers, including business passengers, has increased significantly in recent years (Shane, 2004). That said, airlines set the prices. Most airlines use sophisticated algorithms to set their prices according to demand conditions, timing and a wide range of other factors. This allows airlines to maximize revenue for each flight -- a combination of load factor and price per passenger. The bargaining power of buyers is also dependent on substitutions. For trans-continental flights, airlines have significantly more bargaining power in the absence of land-based options such as railways and roadways. On routes within continents, airlines have reduced bargaining power, exceptions given to long-distance flights.

The threat of substitutes is moderate to low. This is dependent on the particular route -- intercontinental routes and long-distance routes within the same continent have a low threat of substitutes as alternate transportation modes are lengthy, time-consuming or downright impossible. On short and medium routes that do not cross large bodies of water, there is a moderate threat of substitution. Air travel is much faster than any other mode, giving it a distinct competitive advantage over other types. However, on these routes, price sensitive consumers may choose land-based modes of transportation. Air travel would then typically appeal more to time-sensitive consumers. An additional threat of substitution comes from forms of communication, in particular from business customers. It has been noted that during difficult economic times, companies will sometimes reduce their business travel expenses and utilize email, telephone, videoconferencing and other modes of communication in place of personal meetings. While evidence shows that videoconferencing is, of itself, a relatively low threat with substitution rates between 2.5-3.5% (Denstadtli, 2004), airlines often run flights where the profitability margin is only a few passengers, so at uptick in any substitution form could compromise profitability in the industry.

The threat of new entrants is relatively high. Despite would appears to be high fixed costs, economies of scale, a steep proprietary learning curve and high capital requirements, there appears to be no shortage of companies able to start airlines. Most of the industry's strongest competitors today have emerged in the past twenty years, including the majority of discount airlines and the Gulf airlines. The ready availability of surplus airplanes, access to secondary airports and the demand among consumers for improved airline service all contribute to the high treat of new entrants.

The intensity of rivalry is moderate. There is low concentration in the global industry and air travel capacity appears to be sufficient to allow for new entrants. Corporate stakes are relatively low, as is the diversity of rivals and product differences. Despite these factors, the number of competitors and geographic specialization of national-based airlines has allowed for the industry to develop without strong rivalry.

Overall, the airline industry is generally unattractive. It probably should not be, given the forces acting upon the industry, but the airline business is anomalous in many respects. The pricing power of suppliers is generally high, and the pricing power of buyers is moderate, meaning that airlines are limited in the degree to which they are able to pass price increases along to their customers, most notably on intercontinental flights were substitutes are almost non-existent. The high threat posed by new entrants is another factor that makes the industry unattractive.

PESTLE Analysis

The political environment has a strong influence on the airline industry. Airlines are heavily regulated, both for safety reasons and for strategic reasons. Many national carriers are subsidized or owned by governments and this assistance at times has a direct impact on industry competition, such has been suggested of the Gulf-based carriers such as Emirates, which was financed by Dubai's royal family (Pae, 2008). The political environment has also in recent years impacted the industry on the basis of its security procedures. Not only have airports been compelled to implement more sophisticated security measures, reducing passenger counts, but airlines have been forced to invest more in security themselves. In the U.S., increases in security costs since 2001 have run at an estimated $5.6 billion annually (Grossman, 2007). Due to the fact that airlines only have moderate pricing power over the customers, the industry has had to absorb part of these costs.

The economic environment has a strong influence on the airline industry. Air travel is strongly correlated to the global economy. As a consequence, the industry has faced a significant decline in demand since the outset of the economic downturn (Freeman, 2009). There are signs, however, that the economy is improving.… READ MORE

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