USA aviation Industry


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Aviation Industry Case Analysis of USA in 2009

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  • The Great Depression was a severe worldwide economic depression in the decade preceding World War II. It is commonly used as an example of how far the world's economy can decline. The depression originated in the U.S., after the fall in stock prices that began around September 4, 1929, and became worldwide news with the stock market crash of October 29, 1929 (known as Black Tuesday).
  • Barnstorming was a popular form of entertainment in the USA in the 1920s, in which stunt pilots would perform tricks with airplanes, either individually or in groups called a flying circus. Barnstorming was the first major form of civil aviation in the history of flightRailroads:-Govt was concerned that railroads might muscle their way into aviation industry and possibly kill it off to protect their railroad investments.So ownership restrictions were required to keep railroads out of aviation fields
  • Regulation:-Application for new route delayedWorld Airways applied to begin a low-fare New York City to Los Angeles route in 1967; the CAB studied the request for over six years only to dismiss it because the record was "stale." Continental Airlines began service between Denver and San Diego after eight years only because a United States Court of Appeals ordered the CAB to approve the application.Airlines that flew only intrastate routes, however, were not regulated by the CAB. Those airlines were regulated by the governments of the states in which they operated.A flag carrier airline in a given state, enjoys preferential rights/privileges, accorded by the government, for international operations. It may be a state-run, state-owned or private but state-designated company or organization. Flag carriers may be known as such due to maritime law requiring all aircraft or ships to display the state flag of the country of their registryloss leader : selling at loss just to attract customers. Used my Major airline industries against new entrantsOil shock 1979: Iranian Revolution Protests severely disrupted the Iranian oil sector, with production being greatly curtailed and exports suspended. When oil exports were later resumed under the new regime, they were inconsistent and at a lower volume, which pushed prices up.Air Traffic Controllers’ strike 1981: strike violated a law so was banned. 11,345 striking air traffic controllers were fired who refused to go back to work. it took 3 years in to hire and train a new controllers
  • Planes Were Only Half Full - But Airlines Couldn't Offer Discounted Faresrestrictive rules about what fares airlines could chargeairlines saw their planes flying only half full, and wanted to be able to sell some cheaper fares to fill up the rest of their flights, and were frustrated that they couldn't do thisNo-one was benefitting from the artificially too-high airfaresAirlines Couldn't Add New RoutesCAB controlled the routes airlines would flycomplex process for applying for new routeany airline already flying that route could veto another airline's application to start competing service on the routeWorld Airways applied for permission to fly a new route between New York and Los Angeles in 1967.  After 6½ years of delays and frustrations, the CAB turned around and said 'This application is 6½ years out of date, it is no longer current or relevant' and dismissed it, even though it was the CAB's fault that the application was so oldAirlines Couldn't Remove Old RoutesThe Airlines Were Not Profitableprime purposes of airline regulation was to help ensure the airlines were profitable (the CAB considered a very generous 12% return on capital to be acceptable), this was not in effect occurring.New Airlines Couldn't Start UpCAB was not permitting any new entrants.  No new trunk carrier had been approved since 1938.Lessons from Southwest and PSACAB only regulated inter-state aviationnew carriers were starting to appear in the larger states, offering intra-state servicePSA in California and Southwest in Texasthese airlines offered excellent reliable service on a par with the inter-state airlines, but with fares that were about half the price that the regulated carriers charged for flights of comparable distancesLesson- Unregulated (or, to be exact, more mildly regulated) aviation was demonstrably working, tightly regulated aviation via the CAB was an abject failure.
  • Safety:-One of the strongest held views of supporters of regulation is that the airlines can't be trusted to enforce their own safety, and that the commercial and competitive pressures of deregulation would force the airlines to cut back on the costs of safety programs.The fatal accident rate, per departure, is 13 times lower in 2009 than in 1969.  There were 1.302 accidents per 100,000 departures in 1969; in 2009, there were 0.098 accidents per 100,000 departures The airlines are safety obsessed, not so much because they are 'good guys' but because the commercial consequences to them if they were seen to be operating an unsafe airline are unthinkably severe
  • Profitability = [yield X load factor] - costIn order to survive and profit in this tough environment, airlines attempt to manipulate three main variables: Cost, calculated as total operating expenses divided by available seat miles (ASM)Yield, calculated as total operating revenues divided by the number of revenue passenger miles (RPM)Load Factor, calculated as the ratio between RPMs and ASMs, which measures capacity utilization.
  • Fuel hedging by LCCs
  • USA aviation Industry

    1. 1. US Aviation Industry in 2009 –Case Study presentationManoj Jhawar & GroupMBA , IIT Kanpur2013
    2. 2. The U.S. Airline Industry
    3. 3. “129 airlines in the past 20 years filed for bankruptcy. As of 1992, in fact-though thepicture would have improved since then-the money that had been made since the dawnof aviation by all of this country’s airlines companies was zero. Absolutely zero.Sizing all this up, I like to think that if I had been at Kitty Hawk in 1903 when OrvilleWright took off, I would have been foresighted enough, and public-spirited enough-Iowed this to future capitalists-to shoot him down. I mean, Karl Marx couldn’t have doneas much damage to capitalists as Orville did.” -Warren Buffet, Chairman, Berkshire Hathaway
    4. 4. History• 1920: scheduled airmail service started (aircrafts by US Army Air Service)• 1925 Air Mail Act: offered twelve contracts for spur routes to independent bidders• 1925: “Ford Trimotor(The Tin Goose)” with 12 passenger capacity• Major Airlines: United Airlines, American Airlines, TWA(Trans World Airlines)• Demand from Airline industry led to development of aircrafts with – Higher speed – Larger capacity – Fuel efficient/ less refueling stops• With Boeing 247 and Douglas DC-3, the US airline industry was profitable even during the Great Depression (1920s). Boeing 247 Douglas DC-3
    5. 5. Need for federal regulation into Civil Aviation– Aircraft accidents in 1920s specially during Barnstorming(flying circus) led to safety regulations.– Risk in US Mail System: delays, cancellations, and crashes– Evolving aviation: • Infrastructure needed – Navigational aids – Night flying support – Emergency landing strips– Ownership restrictions required to keep railroads out of aviation field
    6. 6. Regulation and Deregulation• 1938: Civil Aeronautics Board • 1978: Airline Deregulation Act established • CAB’s power of regulation over fare,• CAB’s Responsibilities route, market entry phased out – Safety regulations • dismantled notion of a flag carrier – accident investigation • aggressive free-trade practice of – regulate airline fares, airmail loss leader strategy rates along with reasonable • By 1980 20 new carriers (People rate of return Express, Air Florida, Midway…) – Allocate Routes used by • 1979-83 huge losses led to carriers bankruptcies of over 100 carriers – Approve new carriers – Oil shock of 1979• 23 existing airlines. No new entry – Recession• application for new routes or fare – Air traffic controllers’ strike changes were subject to lengthy 1981 delays and often rejected
    7. 7. Reasons behind Deregulations• Planes Were Only Half Full - But Airlines Couldnt Offer Discounted Fares• Airlines Couldnt Add New Routes / Airlines Couldnt Remove Old Routes – World Airways applied for permission to fly a new route between New York and Los Angeles in 1967. After 6½ years of delays and frustrations, the CAB turned around and said This application is 6½ years out of date, it is no longer current or relevant and dismissed it, even though it was the CABs fault that the application was so old• New Airlines Couldnt Start Up – No new carrier had been approved by CAB since 1938• Lessons from intra-state carriers (Southwest and PSA) – CAB only regulated inter-state aviation – PSA in California and Southwest in Texas – Offered excellent reliable service on a par with the inter-state airlines – Lesson- Unregulated (mildly regulated) aviation was demonstrably working better than tightly regulated aviation via the CAB.
    8. 8. Increased air travel • 1978 - 275 million passengers. • 2009 - 770 million passengersSafety improved Airfares droppedThe fatal accident rate, per • Between 1976 and 1990 the paiddeparture, is 13 times lower in fare dropped by ~ 30%2009 than in 1969 DeregulationJobs increased Bankruptcy:From 1979 to 1989, airline • Major Carriersemployment increased from 6 (1978)  3 (1991)356,000 people to 556,000 • Since 2000 every major airlinepeople has filed for bankruptcy at least once Competition: • Entry barrier decreased • many new airlines entering the market • airline alliances
    9. 9. Firm Strategy and Industry Evolution
    10. 10. Hub-and-Spoke System • Greater Efficiency by reducing no. of routes and concentrating on traveler and maintenance facilities in fewer locations • Efficiency benefits reinforced by Dallas scheduling flights in a particular Detroit way • Allowed major carriers establish dominance in major regional markets and on particular routes • Created a barrier to new entrants • Alliances with local airlines Ex: American Eagle, United Express, Delta Shuttle San Francisco
    11. 11. Local market share of largest airline for selected U.S. cities, 2009 City Airline Share of passengers (%) Dallas-Forth Worth American 73 Miami American 71 Minneapolis-St. Northwestern 59 Paul Detroit Northwestern 54 Houston Continental 62 Atlanta Delta 53 Charlotte U.S. Airways 55 Baltimore Southwest 53 Newark Continental 52 San Francisco United 37 Denver United 37Source: U.S. Department of Transportation
    12. 12. MergersDeregulation Reduced Seller Concentration Mergers and Acquisitions 2005 America West + US Airways US AirwaysConcentration in the U.S. airline industry Year CR4(%) Year CR4(%) 1935 88 1987 64.8 1939 82 1990 61.5 1986 TWA 1949 70 1999 66.4 2001 TWA Ozark 1954 71 2002 71.0 American American American 1977 56.2 2005 55.4 1982 54.2 2008 49.1Source: U.S. Department of Transportation
    13. 13. Prices and CostsAfter deregulation, airlines adopted cutting ticket prices as one of their majorstrategies to increase their customers• Low cost entrants played a critical role in stimulating the price wars which characterized competition after deregulation• Aggressive expansion through rock-bottom fares made possible by highly efficient cost structures and a bare-bones service• Price initiatives of low-cost airlines Selective Price cuts of major carriers• Prices cuts selective by routes• Majors set up subsidiaries to imitate the strategies and cost structures of the budget airlines Continental’s Continental Lite (1994), UAL’s Shuttle by United (1995), Delta’s Song (1993) and United’s Ted(1994)• Cut costs through renegotiating union contracts, terminating inefficient working practices, abandoning unprofitable routes and reducing employment numbers
    14. 14. Quest for Differentiation• Deregulation brutally exposed the myth of customer loyalty - Travellers became more indifferent as to which airline to use• Primary focus upon business and first-class travellers• Leisure travellers’ choice was unclear – low prices or quality services. Also low margins on these travellers• Frequent flyer schemes to gain customer loyalty (1981) – to encourage using a single airline• Involving other companies as partners – car rental, hotel chains, credit card issuers - Frequent flyer programs became an important source of additional revenue, worth over $10 billion annually
    15. 15. The Southwest Way• Reduce Operation costs Maintenance • One type of jet plane – the Boeing 737 Spare parts Training• Manage customer expectations • “No frills” approach helps Southwest Airlines keep costs down• Create a unique culture • “first come, first serve” - unique boarding procedure • “Bags Fly Free”
    16. 16. Another success- Jet Blue• Operational excellence • cost leader - cutting down on unnecessary frills and wasteful expenses. • more amenities than other airlines - creating a feeling of luxury. • strategy to identify and eliminate non-value adding costs and use the money so saved, to provide service of better quality.• Differentiation • leather seats, satellite TV, and more leg-room at a bargain price - still makes profit. • exceptional customer service experience • one of the first airlines to present online baggage checking.
    17. 17. Overview (2011)• Industry grew in 2011 by 3.5 %• 730 million passengers• 2 – 3% growth per year projected by FAA over the next 20 years• Passenger carriers generated an operating profit of $3.8 billion in 2011• Major 11 domestic players
    18. 18. Airline Fuel Prices Source: Energy Information Administration (U.S. Dept. of Energy)
    19. 19. Cost per Available Seat-Mile (CASM) With and Without Fuel • The recent changes in fuel price has pushed fuel expenses to 35 percent of airline operating cost in 2011 against the 10 percentage of total operating cost in year 2001 •The fuel cost was highest in year 2008 and accounted for 40.4% of total operating cost of Airline • Except fuel cost Airline industry has been able to maintain rest of the operating cost almost at the same level •The total airline spending on fuel is $31 billion in year 2011 which is triple of the same in Year 2000Source: Bureau of Transportation Statistics
    20. 20. Per Capita Disposable Income (Inflation Adjusted to year 2000) • Demand of the air travel has dropped considerably due to consumers in U.S. experienced the impact of growing unemployment and rising expenses for basic necessities •As shown in fig. per capita disposable income for U.S. consumers has considerable drop in year 2008-09 and after that it is growing but at a slower rateSource: Bureau of Economic Analysis (Census Bureau)
    21. 21. Passenger Enplanements and Flight Reduction • Passenger ridership is recovering slowly from its lowest in 704 million in year 2009 • At the same time there has been reduction in travel opportunities due to cut in flights by the airline industry. In June 2012 the no. of scheduled domestic flights of less then 250 miles was 24 percent lower then that of the same in year 2007. For 250-499 flight miles range this no. was 16 percentage. These combines to total of 3000 flight reduction per day from in this 5 year periodSource: Bureau of Transportation Statistics
    22. 22. Domestic Operating Profit and Loss of Major U.S. Airlines • Mergers, cutting flights, Raising fares etc. have produced positive financial result •Despite the pressure of rising fuel cost, airlines are able to restore profit from year 2009 onwards •Major U.S. Airlines as per their market share (1) Merged United-20.6% (2) Merged Delta- 20.3% (3) Merged South west-18.6% (4) Merged American-14.8%Source: Bureau of Transportation Statistics (5) Merged U.S. Airwaus-9.8% Total Market share:- 84.2%
    23. 23. The Accelerating Consolidation of the U.S. Airline Industry •In order to restore Profitability there has been series of mergers in past 12 years. •In 2000, 10 airlines accounted for slightly more than 90 percent of available seat-mile capacity in the United States. By early 2012, those 10 airlines, through mergers, were reduced to 5 airlines controlling about 85 percent of the domestic passenger market . •These mergers have helped airlines to cut their cost by reducing competing flights and by reducing Hub OperationSource: Bureau of Transportation Statistics
    24. 24. Domestic Passenger Traffic and Capacity • Airlines had reduced the no. of flights since last 11 years and increased the load factor •Approximately 13.9 percent of domestic flights had been reduced from June 2007 to June 2012 • Airlines have started full utilization of seats per flight and increased the load factor considerably from 71% to 82% over the last 11 year period • This has increased revenue per flight for the Airline industry also discount offer on seats are reduced due to increasing load factorSource: Bureau of Transportation Statistics
    25. 25. Average Fares By Flight Length (2000–2011) • Airlines have been able to increase the price for short haul flights as the no. of short haul flights have reduced considerably over the last 11 years •Airlines have also increased revenue by implementing additional fees for services like bag checking, seat selection, food etc.Source: Bureau of Transportation Statistics
    27. 27. POLITICAL ECONOMIC•Ecological/Environmental issues •Price Elastic industry: In US, supply has•Government control of airports exceeded demand•Government term and change: •Effect of monetary and fiscal policiesStable environment in US •World economic conditions•Home market lobbying •Rising fuel prices•Wars and conflicts •Air traffic control charges and track•International pressure groups access charges•Funding and grants •Trade improvement and Boosts investments •Business efficiency •Improves other aspects of the economy
    28. 28. TECHNOLOGICAL ENVIRONMENTAL•Higher safety, better navigation, surveillance •Noise and air pollutionand air traffic management systems. •Environmental costs not included in cost of•Higher efficiency and faster speed, and operations.better airport operations •Pressure from environmental agencies.•Technology to operate flights in adverseclimatic conditions•Informed customer LEGAL SOCIAL•Contracts conditions for entry, operations and •Obesityexit. •Security•Chapter 11 of bankruptcy •Ethnicity•Regulatory bodies and processes •Lifestyle trends •Labor issues
    29. 29. Threat of New Entrants Buyer Power• Deregulation • Buyer Information• Resale market of Aircrafts • Price Sensitivity• Glamour of owning an Airline • Group/Corporate Bargains • Substitute ProductsSupplier Power Industry Competition• Oligopoly (Airbus, Boeing) • Price Wars• Access to capital (Airports) • High cost of operations• ATF suppliers • Congestion on Major routes and Airports • LCCs • Chartered Flights Threat of New Substitutes • Telecommunications • Video Conferencing • High speed rail roads
    30. 30. Legacy Carriers• Major airlines such as American, Delta, United• Low operational efficiency – older, cumbersome work structure• Older, less fuel efficient aircraft fleet – Huge impact of fuel price fluctuation• Economies of scale not applicable – Cost differences more due to managerial, institutional and historical factors – Negligible influence of economies of scale, scope, or density• Huge network – Cannot abandon unprofitable routes in order to maintain route integrity
    31. 31. Low Cost Carriers (LCC)• Minor airlines such as Southwest, Jet Blue, Airtran• Operation from secondary airports – Difficulty in getting gates, landing, and takeoff slots – De facto ownership of takeoff, and landing slots by major airlines• Newer, fuel efficient aircraft fleet – Fuel price fluctuation invariant• Highly efficient cost structure (operational excellence) – Confronted labor unions: gained concessions on pay & working practices – Work sharing between employees – Efficiency benefits from outsourcing; better use of information technology – Bare-bones services (economized on in-flight meals, entertainment, and baggage handling)
    32. 32. Present and The Way Ahead….
    33. 33. Various Stakeholders- Government•Believes in market forces – some voices of regulation.• Very hard to regulate various aspects of airline business.•Liberal on mergers and alliances policies.•Taxes and fees now represent 20% of a US ticket. TheAdministration’s 2013 budget proposal heaps even moretaxes on aviation.• Manage Competitiveness
    34. 34. Airline• Mergers – heading towards oligopoly (Continental merged with United in 2010-12).• Emphasis on increasing load factor.• Short to medium term survival.• Limit Capacity Growth.• The industry wants the government to invest in ATC modernization and airport expansion.• Tie up with regional aircrafts.• Consolidated routes.
    35. 35. Labors• Labor intensive industry.• Union intensive.• Labor costs are high.
    36. 36. Recommendation on Labor side• More flexible union agreements.• More concession on compensation and benefits side.
    37. 37. Customers• Reaped the benefit – Lower prices(table 3.2)• Very less choices- effect of mergers.• Technology Upgrades.
    38. 38. References••