Strategic Discussion On U.S Airline Industry

Strategic Discussion on U.S Airline Industry

Discussion Question 1: Use the model of the general environment (Chapter 2, Table 2.1) to evaluate the opportunities and threats facing the U.S. airline industry and Southwest Airlines in particular. What are the key opportunities and threats?

The health of the overall U.S airline industry is still tenuous in-spite of the passenger traffic volumes returning to pre-9/11 levels. A survey estimated that from 2001 through 2003, the US airline industry reported to have lost $23.2 billion dollars, compounded by an additional $1.6 billion in the first quarter of 2004. This $24.8 billion shortfall exceeds the total profits earned over the entire six-year period 1995-2000

Drastic changes in the Economic, Political/legal and technological segment of airline's external environment contributed to some of the major looses seen by the industry. The key factors that heavily contributed to the loses include

* Economic slow down in the country

* Massive decline in business travel

* SARS epidemic

* Increase in competition

* Availability of substitutes for air travel

* soaring fuel prices

* Weak dollar

In response to the industry's financial crisis, Congress made available several forms of relief that amounted to over $20billion. This relief includes the payment of upto $5billion in pretax cash assistance to reimburse air careers for losses incurred as a direct result of the 4-day government shut-down of air traffic after 9/11. However, relief measures were not enough to bring the airline industry out of hot water.

Most of the airlines have accumulated vast amounts of debt which brought them on the verge of bankruptcy. The list includes Atlas/Polar Cargo, Midway, National, Sun Country, TWA, United and US Airways. American and Delta airlines narrowly avoided bankruptcy but have warned about such possibility. "An average carrier is now well over 90% leveraged (net debt to equity ratio) compared to 60-70 percent historically. This means most airlines are now completely leveraged and unable to obtain capital. This has added to significant debt service costs and will make the industry even more vulnerable to any future economic downturns.

With industry debt well over $100 billion, much of it due in the next 24 month. 11 of 12 airlines are rated "junk bonds" by S&P. Only Southwest remains at an "investment grade.

Almost all airlines are faced with the same challenges and threats in the external environment like rising fuel cost, weak travel demand etc. Some airlines like Southwest, JetBlue and AirTran which implemented a low cost structure remain profitable although the margins have suffered. Another factor that contributed to the profitability of these carriers is the higher productivity of their labor force and use of technology to improve operations and management.

A recent survey of the airline economic health suggested that even though the industry hoped to return to some degree of stability, if not profitability, yet new costs beyond the airlines control wiped out recent efforts to cut costs and achieve new efficiencies. Record high oil prices and nation's on-going war on terrorism have presented new barriers to improving the industry's financial health.

Another cost factor that is heavily contributing to the overall cost is the Aviation Security Infrastructure fee (ASIF). This fee is enforced after Congress passed the Aviation and Transportation Security Act (ATSA) which necessitated additional security at the airports. This fee is expected to rise to $750million in 2005 from $315 million in 2000. This fee is in additional to the additional federal security mandates imposed since 9/11. The industry argues that impact of federal security mandate and foregone revenue totals $2.8 billion per year.

The statute that directs FAA to extend war-risk insurance to U.S airlines and air cargo carriers is set to expire on August 31st of this year. Since there is no commercial market for this type of insurance, the industry could obtain coverage for only limited utility that could potentially cost the airline industry several hundred millions of dollars annually in insurance costs. The airline industry is lobbying with Congress for a extension of federal War-Risk insurance program.

To summarize some of the opportunities and threats faced by the airline today are

* Rising fuel cost which impacts the profit margin of the industry.

* Added security cost by govt. to enhance the safety of aircraft

and our airports.

* The industry forecast an increase in tax on the operating income which will further reduce the net profit for the airline industry.

* Rising short-term interest rate would add additional pressure on the airline industry.

* Improving economy and travel demand is likely to bring legacy airlines in positive territory of profits.

* Expiration of Federal War-Risk Insurance program

Discussion Question 3: Use Porter's Five Forces Model to determine the attractiveness of the U.S. airline industry.

The Porter's five forces model provides a framework for industry competition as

1) Threat of new entrants

Based upon the analysis above #DQ1, the airline industry is faced with several distinct threats and challenges. However, opportunities for new entrants exist in regional airline market where major airlines have retrenched their operations and other airlines have not pursued their operation. In mature market, the new entrant will face stiff competition from low-cost airlines and the legacy airlines.

2) Power of suppliers

High fuel and maintenance cost will significantly influence the profit margin of the industry in future. Increase in supplier price could potentially increase the cost as well.

3) Power of buyers

With the availability of online ticket retailing, customers are always looking for