Delta Air Lines

Manh Hoat Nguyen

Delta Air Lines (A)

Why have most airline firms not been able to achieve profitability? (Hint: Do an industry analysis to show how industry structure has impacted profitability in the airline industry).

To understand why most airline firms have not been able to achieve profitability we need to understand the industry’s environment.

Bargaining power of buyer: high

• Low switching costs: customers can choose service from many carriers without any switch cost. Therefore, carriers must compete in prices and services, which lead to increase cost.
• Low loyalty: most customers choose carriers based on the prices. Therefore, competing in prices is intense.
• Web sites permit clients comparison shopping, so carriers have to compete on prices.
• Leisure travelers are price sensitive. These customers value prices as the important factor to choose the airline firm.

Intensity of Competition: high

• Many competitors in the market.
• Perishable product and high fixed cost which causes price-based competition.
• The industry is excess capacity.

Bargaining power of suppliers: high

• In the industry, the unions are strong, so they have the balance to negotiate with carriers.
• The industry depends on oil's price that fluctuates.
• Boeing and Airbus are two big airplane suppliers. Therefore, they have the power to negotiate with carriers.

Threat of new entrants: Low

• High in capital investment.
• Economic of scale.
• Retaliation from existing carriers.

Threat of Substitutes: Medium

• Compete from Buses, trains, boats, and cars in the short distance.
• Information technology leads to decrease in businesses' travel.

The five forces analysis implies that the competition in the airline industry is fierce. Airline firms who want to survive in this industry have to compete intensively in prices. It is the primary reason why most carriers have not been able to achieve profitability.

The question why most carriers have not been able to reach profitability can also be answered when we look closer to industry structure. In the industry, the unions are strong, so they have the power to ask for more benefits. Employee salaries and benefits were the largest expense for the typical major airline (about 40% of total costs). Fuel accounts for 10%-15% of total cost, and oil's price fluctuates. The carriers also incur costs in facility rental and service costs. While the carrier has to experience high cost, they cannot increase the price because the intense in the price-based competition. That is the reason why they cannot be profitable. Additionally, after September 11, carriers incurred more costs from enhancing security, suffered from the decrease in the customers' demands and affected by the global economic slowdown. All these reasons lead to the loss in the airline industry.  

Why did the major legacy airlines like Delta and Continental not do well but low-cost airlines like Southwest and JetBlue did well in the same industry environment?

By looking at the differences in the strategies and value chain activities of legacy airlines and low-cost airlines we can answer the question why the major legacy airlines like Delta and Continental did not do well but Southwest and JetBlue did.

When looking at Southwest and JetBlue, we can see they have clear strategies. Southwest choose to serve customers in secondary airports that were, on average, 515 miles apart, and it competes with the couch, the car, and the bus. JetBlue serves customers in the airports that were less traveled but not obscure; It wants to attract bankers, brokers, fashion models, and finance officers people who have to travel, so they attach social significance to the experience. These two low-cost carriers have specific customer segments in the market. In the contrast, legacy airlines like Delta and Continental did not have clear customer segments. They only response to the threat from their competitors but do not have specific strategies to do that.

Additionally, the value chain activities of legacy airlines and low-cost airlines also reflect the differences between two groups.

Low-cost Airlines’ value chain

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Legacy Airline’s value chain

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In infrastructure, low-cost carriers used single aircraft’s type, so operation and maintenance of the planes are easier and faster. They choose secondary and less traveled airports so that they can lower cost of landing. In the contrast, legacy carriers share their infrastructure with their low-cost subsidiaries, so their low-cost subsidiaries are harder to control their costs because they have to depend on their parent companies. In human resource management, both Southwest and JetBlue have flexible work rules. For instance, JetBlue permits their employee work at home, offer one-year contracts for students and job-sharing packages for people who want more time at home. These policies help to boost employee’s moral and to cut costs in salary’s payment. Both JetBlue and Southwest have balance when they negotiate with their unions. In JetBlue, all employees are nonunion so the company has the balance to negotiate with their staff. Southwest management uses flexible work rules as an exchange when they need to negotiate with the unions. Legacy carriers are in the different situation, they have strong unions, so it is hard to cut cost in salary payment. Additionally, the work rules are not flexible, so they prevent employees’ creativities and enthusiasm. In operation and service, low-cost carriers have short return times and high aircraft utilization so the cost per customer reduces. They also offer few classes of fare and few ticket restrictions to make their process simple and do not confused the customers. In the contrast, ticket policy of legacy carriers made consumers confused. Furthermore, even these carriers try to create subsidiaries to compete with low-cost carriers but the decisions in the children company still made by the same person. Besides, low-cost carriers are advantageous because they utilize application of technology. For instance, JetBlue uses application of the Internet to cut their cost in sale tickets and reduce operation cost (the world’s first paperless airline).