The US Airline Industry in 2004 - Essay Example

Introduction The US Airline Industry started off as an overwhelmingly fragile industry and had a serious need of developmental period before it became a little more stable than it was prior to the deregulation. As we look into the historical accounts of the airline industry in the United States of America, it was solely established to procure air transportation services for mailing materials. Prior to the airline deregulation of 1978, the industry was almost like a cartel with very few number of airline industries serving different American states. Nevertheless, an inevitable and unexpected competition arose which resulted into a dire instability in the industry; hence, the advent of the Civil Aeronautics Board was established to administer the industry’s structure and competition. Intestate routes were being admitted and were dispersed to some twenty three airline companies. Also, a promulgated establishment of guidelines of priorities and inter-firm agreements was created. (Anon., n.d.) Pre-Deregulation Era In the succeeding years, an industrial ordeal took place as cost increases on the fares were implemented causing an ossification to the structure of the airline industry. As a result, manifold airlines were not approved to conduct operations between the year 1937 and 1978. Nevertheless, the so-called “new entrants” have set up themselves as carriers in the local geographical areas in the form of intra-state routes. Due to some oil shocks in the 1970s, an accelerated increase on the ticket prices brought hysterics towards the consumers. The Civil Aeronautics Board decided to impose large increments on fares and a four year frozen activities on some newly acquired routes and delimitation on the capacity of routes. In addition, developing arguments regarding economic liberalism has caused less neither government regulation nor intervention on market practices, and in this case, the US Airline Industry. Until in 1978, an airline deregulation act was passed and took effect which resulted into a turnaround of events in the airline industry of the country. Part of this particular case study is to determine some of the most apparent impacts of airline deregulation as well as a thorough manifestation of its lingering effect on the US Airline Industry in 2004. Business Strategies The Hub-and-Spoke System As a matter of discussion and recollection, several changes have been made following the advent of the deregulation in 1978. The hub and spoke system was adapted which has both allowed more efficiency by traveller concentration and facility improvements and maintenance. The Hub and Spoke system is a specialized operation that would limit flights of large carriers to small ports; instead, larger airlines coordinate with smaller airlines to take the flight franchise on smaller airports and smaller towns and cities. Because of this, the erection of international airports has been limited overwhelmingly where in the case of the US, the only international airport that was added is the one in Denver since the deregulation era. The Direct Foreign Investment (FDI) According to (Izquierdo, Ribes and Rodriguez, 2010), in tradition, the theories relating to the internationalization of firms have been based on the behavior of manufacturing industries. However, there has been a marked shift towards the tertiarization of the economy on a global scale and direct foreign investment (FDI) in the service industries amounts to 50 – 60% of all FDI and the share is forecasted to rise further. Internationalisation, Mergers and Acquisitions Most of the world’s airlines, just like some of the US airlines, export their services to other countries. American, Southwest and Delta airways are involving its operation in the international market. Some of these internationalization movements are done in a direct manner but most of the time US Airlines are cooperating with foreign airline companies in a forged agreement. Several major US Airlines merged with international airlines or even acquires some of them with motives of establishing a hub in another location, which in this case, on another country. The purpose, perhaps, of merging with foreign airline companies is to protect these US airline industries from intense competition, of course, with the existence of LCCs or the Low Cost Carriers which at some point become the intercepting agent in the internationalization of the US airline industry Code Sharing Code sharing is one of the most common methods of airline internationalization. US Airlines are resorting to this kind of mutual business operation in the form of foreign alliances. According to (Borenstein, 1989), creating hubs is an enabling step that will allow airlines to access new routes, albeit, interception on entry manifested through the delimitation of slots, restrictive bilateral air service agreements, and the lack of capacity to indulge in cabotage makes it hard for airlines to achieve acquisitions in manifold international airports. There are menacing factors or forces that are produced by the new comers or the new entrants. The most horrifying threat among would be the aggressive prices. As these new entrants are mostly smaller compared to the old and major airlines, they offer lower fares which stirs up the competition between the large operators and the small operators. Added to that is the technology innovation that has slightly affected the demand for air transportation because of the reduced need to meet up in person. Marketing The Low Cost Carriers (LCCs) One of the most recurring events in the history of the US Airline Industry is the intense competition on ticket prices. Because of the emergence and the proliferation of LCCs or Low Cost Carriers which absolutely offered, by far, cheaper ticket prices, it has stimulated the competitive reduction of prices in the industry as large companies like Delta, American, and Southwest vie for the volume of customers. LCCs are the major competitors of the game which really set the tone of the rivalry. Large airline companies which offer business and first class services are most of the time jeopardized due to the falling leisure fares as LCCs are offering increasing price competition over more and more routes (Anon., n.d.). Subsidiaries Because of the overwhelming intensity of price competition, several large airline companies revamped their marketing strategies and ventured in subsidiaries. Hence, to meet the competition of low cost newcomers, several of the major airline companies set up new subsidiaries to imitate the strategies and cost structures of the budget airlines. This was evident when the Continental launched Continental Lite in 1994, followed by the UAL’s “Shuttle by United” while American Airlines sought to compete with Southwest and other budget airlines by forging agreements with smaller airlines like Midway and Reno Air in which it ceded some of its most price competitive routes to its smaller partners (Anon., n.d.). Relevant International Trade Theories The application of the international trade theories is a critical step in presenting a thorough analysis of the business strategies and pertinent actions of the airline industry as well as its relative effect on the airline industry as a whole. The international trade theories shall procure concrete definitions and explanations for the model and pattern of international business and the dispensation of the gains from trades. It is to be expected that in this case study, the different international business theories will closely be related to the topic at hand: the US Airline Industry Policies. The Comparative Advantage Theory “Buy low, sell high” logic leads economists to comparative advantage theory. Comparative advantage means the comparison of relative price differences between nations to explain the pattern of trade. For example, compare the relative price of wheat in terms of cheese at home to the same relative price in the foreign company in a hypothetical equilibrium with no trade (autarky) or with restricted trade (Anderson, n.d.). As of the present time, the solid model of trade theory commenced as being questioned from different periods of the year. Further, there was a clear manifestation of the edging of smaller aircrafts. This is because despite their low fares, the quality of their services and their aircrafts itself were not being sacrificed. Differentiation on the prices of goods or services creates a big impact on the cash flow. Due to the sensitivity of the economic aspect of this industry, any slight change on the price of the good would result into a widespread and monumental derailment with respect to the seller concentration. In fact, in a recent report, some major airlines have raised the bar by increasing their prices in recent months. American Airlines, the world’s largest carrier, started such an effort last week. However, the low-price competition which includes new and old entrants with smaller capacities made it a certain difficulty for some traditional airlines to implement incremented prices on their fares (Outen, 2004). The Porter’s Model As part of this study, a thorough analysis of the sectored structure and the varied forms of expansions that have been used and implemented by US Airlines and some foreign counterparts – both large and small – with the application of international business theories will further be implicated in order to prove or to show that there is an appropriateness for evaluating or explaining the present condition of the US airline industry with relation to its foreign and local competitors. In examining the economic structure of the US airline industry by the use of Porter’s model, the competition within the industry is being determined by the new comers or the new entrants, the presence of the bargaining power as well as the menacing factors of alternative service or products just like trains and buses. This come to view, during the period when there was an intense competition on the airline industry so as the gradual influx of the growing threat of alternative transportation like trains, buses and other means of transportation. Nonetheless, this has not totally disturbed the rapid growth of need for air transportation and the chance for passengers in resorting to these alternative transportations was very slim. Following the theory of Porter, the menacing factors of the new comers in the market is reliant on the capacity of the industry’s barrier on its entry and exit points. The international air transportation markets have been put under the administration of forged agreements among governments. In other words, the negotiations that have taken place or that might take place between any two or more given airlines take a little effect as any liberal agreement would create a threat affecting the airline’s strategy. The Theory of Oligopolistic Reaction Furthermore, the rivalry between large companies and the new entrants is defined under the theory of oligopolistic reaction. When large companies such as Delta, American and Southwest were on a tough competition with the LCCs, what the larger companies did was that they imitated the pricing structure of the low-cost carriers. They are doing this in order to preclude their own company from being pushed out of the market due to the variations on costs, the dispensation or the distribution, and the demand. Conclusion Albeit, things have already been evaluated and explained yet there are still questions that arise. Despite the industry’s success in reducing the costs, is it safe enough to say that it will then regain profitability? If the major airlines would adapt the same strategy of reducing costs on airline fares, chances are, the favour would go more towards the LCCs or the low cost carriers. For so long as the intense competition in the US Airline Industry will remain strong as it is now, it would always turn out that the major beneficiaries of the reduction of cost would be the customers, passengers who will receive low fares. That said, manifold industry associates and insiders strongly submit to the possibility that the best chances of the US Airline Industry for sustained and long run profitability is dependent on the initiatives that would cool down the fiery competition in the US Airline Industry. This can be done through mergers or government regulation. References: 1 Anderson, J., n.d. International Trade Theory [pdf] Available at: < https://www2.bc.edu/~anderson/PalgraveTrade.pdf> 2 Anonymous, n.d. The U.S. Airline Industry in 2004 [pdf] Available at: < http://www.blackwellpublishing.com/grant/docs/03USAirline2004.pdf> 3 Borenstein, S., 1989. Hubs and high fares: dominance and market power in the USAirline industry. RAND Journal of Economics 20, 344 – 365 4 Izquierdo, L., Ribes, J., Rodriguez, A., 2010. Growth and internationalisation strategies in the airline industry, Journal of Air Transport Management, [online] Available at: [Accessed 05 Febuary 2012] 5 Outen, G., 2004. ECONOMICS REPORT - Changes in the Airline Industry. Voice of America, [online] 2 October. Available at: [Accessed 05 February 2012] Read More