U.S. Airline Industry Analysis - Essay Example

? U.S. Airline Industry Analysis Introduction Although European players dominate the aviation industry in general, majority of the large players operate in the United States. The US airlines industry had been struggling since its establishment until the government passed the Airline Deregulation Act in 1978 in order to eliminate the restrictions over domestic routes and schedules and thereby to foster reasonable competition in the industry. Although this strategic amendment assisted the industry to improve the growth at its initial stages, the revenues again declined by the beginning of 1990s. The US airlines industry again returned to profitability track by 1995 and continued this growth until the close of the 20th century. However, the 2001 terror attack together with a depressed world economy further worsened the growth status of the US airlines industry. This paper will critically analyse the US airlines industry using international business theories and other strategic frameworks. A critical analysis During the beginning stages of the US airline industry, three airlines namely United Airlines, American Airlines, and TWA were in charge of transcontinental routes. In 1938, the Civil Aeronautics Board (CAB) was established with intent to manage the structure of the industry (Dempsey, 1979-80). The CAB set flight fares on the ground of cost plus a fixed margin and hence aircraft operators could pass cost increases to customers. In 1970, rampant increase in fuel costs and political shifts towards economic liberalization created the impetus for a total reform of the airlines industry. The development of contestable market theory also contributed to this strategic shift. According to this theory, “industries did not need to be competitive structured in order to result in competitive outcomes” (Grant, 2002). Referring to this theoretical framework, economists argued that a deregulation approach would intensify competition and thereby the growth of the US airlines industry. The absolute advantage theory, which refers to an individual’s or country’s competitive advantage over another individual or country in producing a specific product/service, also supports the Airline Deregulation Act in 1978. At that time, the US had competitive advantages in technology over any other country. Hence, this strategic shift might assist them to operate more number of aircrafts using the same amount of resources. As regulators argued, the deregulation resulted in new entries and price competition. In the words of Grant (2003, p. 31), although the deregulation strategy was potential enough to improve the declining industry growth, some unexpected contingencies like oil shock of 1979 and the air traffic controllers’ strike of 1981 caused severe difficulties to the US aviation industry. In order to overcome these troubles, aircraft operators across the US widely adopted mergers and acquisitions approach as they believed that combined operations would trim down operating costs. As Heimlich (2011) argues, M&A approach significantly assisted the US airline industry to overcome several cultural barriers. The ‘hub and spoke’ system introduced in 1980 greatly benefited the US airlines industry to increase its operational efficiency, reduce maintenance costs, establish dominance in specific regional markets, and to place barriers to new entrants. The development of this new system can be linked to the strategic management theory, which argues that a “change creates novel combinations of circumstances requiring unstructured non-repetitive responses” (Kahn, 2010). Introduction of low cost carriers became a potential threat to the industry by the beginning of 1990s and hence the country’s major airlines extremely struggled to confront with such budget airlines. As discussed earlier, the deregulation Act directly led to the evolution of a competition era and the major aircraft operators offered almost similar facilities to their customers. As a result, travellers could not easily distinguish between the offerings of different service providers. This situation raised a quest for differentiation in the US airlines industry. As part of service differentiation strategy, major airlines offered distinct service packages such as free tickets and seasonal fare levels variations to their customers. While analysing the airlines industry, it is clear that ticket prices, passenger income levels, frequency of services, and degree of access to other modes of transportation constitute the demand drivers of the industry (Economy watch, 2010). Classical business theories greatly emphasise the element of customer income as this component plays a significant role in determining the market demand for a product or service. The US economy dominated the world throughout the 20th century and hence the individual income level was high at that time. Therefore, the US aircraft service providers had all favourable market conditions to succeed despite the existence of a range of operational barriers. By the beginning of the 21st century, air travel became a major mode of long distance transportation in the United States. Currently, the industry has totally restructured its business strategies, ticket distribution channels, and competition tactics. Furthermore, the US aviation industry brought modernisation to its all operational areas and hence it can effectively meet the passenger demands. Foreign direct investment The US airlines industry has invested huge amounts in foreign countries in different forms. While analysing the history of US aviation sector, it seems that the industry invests in foreign countries mainly in the form of joint venture projects. From the case study, it is clear that popularity of air travel increased in the United States by the beginning of the 20th century and this situation directly contributed to stiff market competition. Hence, service providers realized the need of reducing operating costs and subsequently they discovered that large scale operation would be an effective strategy to minimise expenses. This finding led them to joint venture projects. The joint venture business strategies assisted the US aircraft operators to get easy access to foreign markets and distribution networks (Dimanche & Jolly, 2006). Moreover, this policy greatly aided them to spread risks and to take advantages of various operational economies. Another major benefit the US aviation sector enjoyed from joint ventures is the increased accessibility to huge and potential sources, including human, capital, and technology. Similarly, the US airlines industry also followed Greenfield investment and franchising approaches as part of its foreign direct investment policy. Greenfield investment is a form of FDI through which a company begins new investment venture in an overseas country by creating new operational facilities. The US airline giants such as Delta Airlines and United Airlines operate a number of Greenfield projects outside the country. Majority of the US airline companies operate their Greenfield projects in developing countries since those economies offer more favourable environments for such investment ventures. Finally, franchised route operation is another FDI strategy of the US aviation sector although it is not a prominent method as joint venture. Reduced risk is the most fascinating advantage of using franchising FDI strategy. Although the US airline operators possess huge amounts in foreign direct investments, the country’s aviation sector imposes strict regulations to foreign ownership in its domestic airlines (FIA). The nation’s aviation sector does not allow foreign players to attain more than 25% ownership in its domestic airlines with intent to preserve its long term objectives (ibid). Marketing Service Airline is a service sector industry. The US airline industry mainly deals with passenger carrying services and operates both domestic and international flights. This service sector possesses a range of competitive advantages over other modes of transportation and specifically assists passengers to meet their time schedules. The case study reflects that the US aviation industry has a number of well established service providers and they operate flights to all parts of the country. Price As Gillen et al (2003) point out, ticket demand for leisure travels is highly price elastic and hence passengers may switch their demand to other modes of transportation if ticket fares are high. In contrast, business travellers are not much sensitive to prices as they value time, and therefore they would be willing to accept even an increased fare rate (ibid). As a result, the US airline industry charges higher prices for business travellers whereas it sets lower ticket charges for leisure travellers. However, the US aviation sector has been following a competitive pricing approach since the enforcement of Airline Deregulation Act 1978. Place Majority of the service providers in the US airline industry operate internationally and have business interests across the globe. Such flight operators have business units outside the country. In contrast, domestic operators schedule their flights within the geographical boundaries of the country and do not possess subsidiaries outside the country. However, both domestic and international service providers have business units across the United States. Promotion Evidently, promotion and sales constitute 9.3% of the US airline industry’s total operating costs (Grant, 2002). Like most of the other industries, the US airline industry mainly employs advertising techniques for its promotion. However, the industry’s promotional expenses significantly reduced between the period 1991 and 2000. The US airline industry also gives online reservation facilities, promotional fare offers, and special holiday packages. Strategic operations While analysing the internal business strategies of the US airline sector, it seems that the industry gives specific focus on cost reduction policies. As the case study reflects, the industry had been trimming down commission paid to travel agents since 1996. The US airline industry uses the saved money (from such cutbacks) to improve the quality of services offered to its customers. In contrast to this strategy, the aviation sector offers relatively huge remuneration to its labour force mainly because of high union pressures. The external business strategies also focus on cost effective market operations. Fuel prices and equipment costs are two huge expenditure items for airlines. Evidently, longer flights have high fuel efficiency, and therefore, the leading players of the US airlines industry have planned to redesign its flight routes. In fact, the introduction of ‘hub and spoke’ system also meant to increase the fuel efficiency of aircrafts. While analysing the microenvironment of the company using Porter’s five forces model, it is clear that the cut-throat market competition, high supplier power, and increased availability and accessibility to substitutable modes of transportation can threaten the sustainability of US airline industry. At the same time, it is observed that buyer power is low in the aviation industry. In addition, there is only a low level threat of new entrants simply due to high entry costs. The US airline industry’s macro-environment also offers potential elements to achieve success (Blackwellpublishing). The country’s legal and political systems extremely support the airline industry although the economic landscape raises some challenges. Furthermore, the highly improved technologies and ongoing technological innovations promise a prosperous future for the US airline industry. Conclusion In total, the US airline industry underwent tremendous changes during the deregulation era. The company had been striving to reduce its operating expenses since mid 1990s. The deregulation approach contributed to the intensity of market rivalry and therefore the US airline industry adopted a competitive pricing strategy in order to sustain its growth. The industry significantly reduced its promotional expenses over the last decade so as to avoid financial deficit. In addition, various players formed wide varieties of service differentiation strategies during the same period. The micro as well as macro-environments of the US airline industry offer competitive advantages to aircraft operators. References Blackwellpublishing.com n.d, ‘Industry analysis: The fundamentals’, pp. 66-99, Viewed 27 January 2012, Dempsey, PS 1970-80, ‘The rise and fall of the civil aeronautics board- Opening wide the floodgates of entry’, Transportation Law Journal, p.91. Dimanche, F & Jolly, D 2006, ‘From endogamic to exogamic partnerships: The evaluation of alliances in the airline industry’, in L. Dwyer & P. Forsythe (Eds), The International Handbook on the Economics of Tourism, E. Elgar, London. Economy Watch 30 June 2010, ‘Aviation industry information’, Viewed 27 January 2012, FIA: Federation of Indian Airlines n.d, ‘FDI in airline industry’, Viewed 27 January 2012, Gillen, DW, Morrison, WG & Stewart, C 2003, ‘Air travel demand elasticities: Concepts, issues and measurement: Executive summary’, Viewed 27 January 2012, Grant, RM 2002, ‘The U.S. Airline industry in 2004’, pp. 1-12. Grant, RM 2003, ‘The US Airline industry in 2002’, in Cases in Contemporary Strategy Analysis, Wiley-Blackwell, USA. Heimlich, JP 2011, ‘The economic climb-out for U.S. Airlines’, Air Transport Association, pp.1-22, Viewed 27 January 2012, Kahn, J 2010, ‘Birth of strategic management’, Articles Factory, Viewed 27 January 2012, Read More