Strategic Management at Lan Airlines - Term Paper Example

LAN AIRLIINES IN 2008: CONNECTING THE WORLD TO LATIN AMERICA Question Explain why Lan Airlines pursues a model that mixes passenger and cargo. What advantage does this provide to the airline? Be specific. According to Enrique Cueto, when Cueto Group acquired the airline, the airline was small and high level of services was being offered. Cueto Group wanted to do something different and the plan to start a strong cargo business was proposed. The aim of pursuing a model mixing passengers and cargo was to reach break-even more quickly as compared to other airlines. The set of individual choices made by management on how the company will operate is the primary component of a business model and three types of choices include assets, policies and governance of assets and policies (Cassadesus-Masanell and Tarzijan). Tangible assets of the airline also supported this model. The other large domestic airlines usually had single-aisle planes and they did not have capacity to start a cargo business, therefore, Lan Airlines’ expensive assets created an opportunity to introduce strong cargo business. Pursuing this strategy could ensure a better cost structure of the airline. Another good strategy of the company to manage cost structure of both the cargo and passenger business was the use of key cost measure “Cost per available ton kilometer (ATK)” rather than “Cost per available seat kilometer (ASK)”. Although airline was using ASK as a cost measure on some of its domestic routes however, as ASK excludes cargo business and Lan had to take into account both the availability of passengers and cargo therefore, Lan did not use ASK. Mix of cargo and passenger services is also because of the advantage of Lan over its competitors. Lan Airlines was carrying cargo in the belly of the passenger planes whereas the other airlines were not able to pursue this strategy because Lan had the specialized cargo planes to support the operations. The company had 83 planes, 43 on lease and 40 were owned. Out of 83, 73 planes were passenger planes and 10 were cargo only planes and the company tried to use the large cargo planes on the routes where the cargo demand was high. Another reason because of which Lan has been able to carry both of its services efficiently was the flexibility and work ethics of the staff of the airline. Within short period of time, Airline was able to bring changes in its schedule and plan. The combination of passenger and cargo business offered various advantages to the company. The airline was offering flights to 62 passenger destinations and 16 cargo destinations. By integrating cargo business with passenger routes, in 2007 Lan was able to generate 33 percent of its revenues from cargo business whereas, most of the other airlines like U.S. airlines and Delta were only generating 3 percent and 4 percent respectively. The Company was facing a huge difference between cargo and passenger business in terms of one-way or two way routes and demand. First, the passengers used to buy return tickets whereas, cargo used to travel one way, second, demand of cargo routes on specific routes were high and demand for passengers on other routes were substantial. However, the airline was able to manage the two businesses together because of the demand patterns such as the high-demand passenger route was from Santiago to Madrid and high-demand cargo route was from Madrid to Frankfurt, in this way, the passenger plane flying from Santiago to Madrid also flew from Madrid to Frankfurt after dropping off passengers at Madrid. The idea is that routes for passengers and cargo have been aligned in such a way that company was ending up with profits. Moreover, the integration of cargo and passenger services enabled Lan Airlines to reduce its average break-even load factor from 70 percent to 61.9 percent. The integration of passenger and cargo business benefitted the airlines from scale economies especially in scheduling, maintenance and pilot training. Question # 2: How would you evaluate the recent change to low-cost on domestic routes? How does it affect Lan’s business model? What are the main drivers of Lan’s decision of adding a low cost operation for short haul routes? The airline has dedicated 76 percent of its capacity to international routes and 24 percent of its capacity to domestic markets. The low cost model was started as a pilot program on three major routes in Chine during 2006. The adoption of low-cost model appears a very risky strategic step for Lan Airlines because of various reasons. First, the company established an image of high service quality airline and low-cost focus could change the image of the company. Second, low-cost business model gained attention in Europe however, in Latin America there were no secondary airports and internet access was also limited. Therefore, imitating the strategy of a low-cost airline like Ryanair was not appropriate for Lan Airlines. Therefore, the management aimed to increase airplane utilization from 8 to 12 hours, reduced prices by 20 percent on key route within Chile and added new flight times. With this testing strategy, Lan Airlines surprised the people by attracting significant number of passengers on the routes where a less number of passengers was being reported for many years. The low cost-model for domestic routes adopted by Lan Airlines is created originally by the management of company without imitating the low-cost models of other airlines. The management introduced a new fare structure with up to 35 percent discounts. Management focused on demand stimulation and attracted 40 percent more passengers and load factor increased to 75 percent. To serve the new passengers the capacity was increased by 20 percent and more seats from 126-168 were added, 70 percent more direct flights were offered and utilization was increased from 8 hours to 12 hours. Moreover, low-cost strategy enabled the company to reduce its costs by 30 percent. The new low-cost business model of the Airline enhanced the profitability of the company. For example, as reported in case study, the reduction in fair prices added 500,000 passengers and many of them were the first-time travelers. Although various small local and large airlines appeared as the competitors of Lan Airlines however, the high quality services and low prices positively influenced the operations. The results of 2007 of Lan Airlines show that domestic passenger traffic has increased by 23.5 percent and the significant growth in domestic passenger traffic is attributed to low-cost approach on domestic routes or short-haul flights. However, low-cost business model on domestic flights is just opposite to the business model on long-haul flights. Therefore, by adopting low-cost business model, Lan Airlines has adopted a hybrid business model. In future, maintaining hybrid business model can appear as a major challenge for the company. Four features including alignment to goal, virtuousness, robustness and reinforcement determine the effectiveness of business model (Cassadesus-Masanell and Tarzijan). Through low-cost model Airline increased profitability by increasing customers and reduced costs, which is consistent with the objective of the airline thereby, showing alignment to goals. Second, a significant reinforcement is reflected by complementary choices in low-cost business model for example, through low-cost model Airline aimed to reduce its cost and another aim was to offer low prices to customers. Third, hybrid business model can create various challenges in long run therefore; low-cost business model appears to be a challenge for company in terms of virtuousness. Finally, business model of airline appears to be less robust as various other airlines are already following a different level of low-cost models and in future the probability of imitation is significantly high. The increasing number of low-cost airlines into World’s Airlines Industry is because of various key drivers. Most of the airlines have been influenced by business model of Southwest Airlines such as Ryanair and EasyJet and they are now operations as low-cost airlines offering no-frills, point-to-point and inexpensive flights. Although these airlines have varying degree of business models however, their core business model is low-cost. Actually, in mid 1990s, low-cost business models of airlines gained attention and in 2001, a Brazilian Airline also adopted this model and in 2004, this airline became the second most profitable airline after Ryanair. By adopting low cost model, airlines usually seek to reduced their costs and give benefit to customers by offering low prices such as by selling tickets online, airlines are paying less commission to intermediaries, which further reduce their costs. According to Cueto when the idea of low-cost model was presented in front of board of directors, they considered it as a strategy of the company to stimulate its demand and increase capacity. However, the focus of the company on needs of the customers on short-haul flights shows that Lan Airlines was actually struggling to come up with a new low-cost business model. As mentioned in the case study, two-third is airline travel in world’s airline industry was domestic which shows that passengers prefer convenience, time and weighed cost on other transport alternatives. Therefore, safety, efficiency and lowest possible prices were considered as the major demands of the customers on short-haul flights. The objective of passenger business is also consistent with the needs and wants of customers. As stated by Enrique Cueto, “In the passenger business, we think in terms of three legs of a table: security, efficiency and quality service”. Therefore, the main drivers of pursing a low-cost business model on domestic flights include the changing industry patterns, increasing competition, changing customer demand patterns and strategic aim of increasing customer base. Bibliography Casadesus-Masanell, Ramon, Jorge Tarzijan and Jordan Mitchell. "Lan Airliines in 2008: Connecting the World to Latin America." Harvard Business School (2009): 319-342. Cassadesus-Masanell, Ramon and Jorge Tarzijan. Business Models and the Interaction Between Corporate and Competitive Decision. n.d. Read More