Delta air lines maria medvedeva dlemba2010 v2

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Strategy Case on Delta Airlines and their positioning in the industry

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Delta air lines maria medvedeva dlemba2010 v2

  1. 1. London Business School STRATEGY CASE: DELTA AIR LINES (A) Name: Maria Medvedeva Class: DLEMBA2010 Friday, July 17, 2009 WORD COUNT: 1,999 without EXHIBITS
  2. 2. London Business School Solution Analysis (1): Why low ROI persists in the airline industry in 90s? (Word Count without Exhibit: 504) The airline industry transported 620 million passengers by 2001. Its profitability is driven by a yield factor or amount of paying passenger per seat being closely linked to buyers’ price sensitivity, competition from rivals and limited suppliers with high power starting from aircraft providers to unionized workforce in maintenance, groundhandling, pilots and crew. Airlines traditionally operated with low profit margins due to high start up expenditures, unregulated airport fees and unpre- dictable labor and fuel costs. While the threat of entry is low, new airlines with lower fuel and labor cost coupled with targeted regional routes could become a destructive force. As labor is the highest expense, unions have extreme power in employment contracts negotiation. Additionally, there are only two suppliers of aircrafts and limited leasing companies available in the market, resulting in a wait time of 2 or 4 years for aircraft purchasing. Fuel is another component that increases costs and requires careful monitoring of the aircraft fleet utilization. Regional jets consume less fuel with higher yield and load factors. The supplier power represents a major cost driver in the airline industry. As the power is high, it reduces profitability but can be viewed as a source for differentiation if preferential agreements are signed. Airline profitability is also dependent on price sensitivity and demands of buyers. While leisure travelers are extremely price sensitive, business travelers focus on airline schedules, frequent flier program and ontime departures. High buyers’ power leads to the increased cost as all airlines strive to provide superior offering with extra amenities. There are few substitutes for air travel. Business travelers are not likely to substitute air travel for train due to limited railroad infrastructure and car due to low convenience and required focus on driving. Considering time, money and convenience, air travel is still considered as preference for both leisure and business. The airline industry is highly fragmented with a total of 10 airlines operating in 2002. Competitive rivalry exists between LCC such as Southwest Airlines, JetBlue, legacy airlines such as Delta and American and LCS of the legacy carriers such as Delta Express and Shuttle. While such rivalries impact ticket pricing in a downward trend, they drive establishment of alliances in a network linkage, thus sharing the costs of facilities in hub airports and providing the customer with greater benefits. 2
  3. 3. London Business School EXHIBIT 1: FIVE FORCE ANALYSIS of the AIRLINE INDUSTRY Buyers Power Threat of Entry (HIGH/POSITIVE) (HIGH/NEGATIVE) Slow Industry Growth Price sensitive leasure travellers High Cost to Start Up Cuts in business budgets increases sensitivity but the main focus in on airline Low profit margins frequency schedule and timely departures Unpredictable Labor and Fuel Costs Heavy discounting of fares in advance Challenging Route Structure with High Convenience, safety, reliability and brand Landing Fees at Key Airports name were secondary concerns Competitive Rivalry Service Quality, amenities, frequent flier (HIGH/NEGATIVE) and entertainment were tertiary concerns Depending on city of network competition ranged from LCC: JetBlue, SW, Airtran vs legacy airlines: Delta, Delta American, United, US Airways Suppliers Power vs LCS of legacy airlines: Delta Substitutes (LOW/POSITIVE) (HIGH/NEGATIVE) Express, CALite, Shuttle Only 2 Aircraft Manufacturers and limited Automobiles were common but lacked Lessors in the market convinience and required focus on the road and Labor Unions for Ground Handling, speed limits Maintenance, Catering and Crew were very Limited railroad infrastructure in only certain strong and required high pay packages and states eliminated this option for most business strict employment rules travellers Travel Agents required commissions for Bus system existed for leisure travellers but was each booking targeting college students and low class Airport rented facilities; charged landing population fees The industry changed drastically since deregulation of 1978 with the last being increased security costs and decreased air travel demands after September 11 attacks. By analyzing Five Forces it is evident that high supplier power leads to high fixed and labor costs, while high buyers’ power increases competition and fare discounting. To improve position in such environ- ment, airlines need to focus on managing suppliers while targeting niche buyers and fitting the cabin as well as selecting stra- tegic route schedule. The industry is changing toward low cost air transport with conveniences of legacy carriers. Airlines having smaller fleet with distinctive routes coupled with utilization of comfort chairs and In-flight perks are redefining the in- dustry by offering a new way of competing. 3
  4. 4. London Business School Solution Analysis (2): How do Southwest Airlines and JetBlue are earning valuable returns despite industry conditions? (WORD COUNT without Exhibit: 744) Airlines industry Five Forces model suggest that high supplier’s power and price sensitive buyers drive profitability down. To become profitable, two carriers undertook a different approach to air travel by focusing on targeted niche audience, simplify- ing fair rules and unifying fleet for faster plane turnaround, as well as working with employees to provide pay below industry standards but with higher flexibility. Higher flexibility in work rules and shift sharing packages lead to increased employee mo- rale and higher productivity. Southwest Airlines (Exhibit 2) started as a low cost carrier for leisure and low key business executives as a substitute to auto travel between regional remote airports in Southwest by utilizing: a) All Boeing 737 fleet increased load factor and simplified turnaround process. Maintenance cost at low 0.19c. b) Labor union workforce increased cost to 3.03c versus JB 2.16c. However, packages included profit sharing to give sense of ownership but employees expected to assume any work positions during shifts. It quickly grew to cover long distance flights to East and California, but not to exceed 515 miles on average. While SW load fac- tor of 68% was below JetBlue 77%, it obtained lower CASM at 7.53c having lower landing fees, no food offers and low aircraft rental expenditures. Business traveler demanded frequent flights leaving morning and returning at night at a budget price. Leisure travelers looked for low cost fair accompanied with ontime departures and effective luggage handling. SW offered set fair rules with no restrictions and schedules with hourly flights. In-flight crew was upbeat; and no seat assignments gave trav- elers’ ability to network. Since SW was flying from remote airports, ontime departures, security procedures, and luggage han- dling took far less rather than in a larger airport. Unlike SW being a substitute for auto travel, JetBlue’s (Exhibit 2) audience was high level executives that travelled to key desti- nations at a low air fare but in a high class social environment. JB flew Airbus 320 jets with coach only cabin fit out with leg space, leather seats, individual 24 TV channel system and light snacks between key airports of New York, Florida and California. These airports applied significant rental facility charges but they attracted high class crowd concerned with shopping and lounge experience. Comparing to the industry JB load factor was 77% above the average of 70% and its CASM was at 6.7c vs Delta 10.41c and Southwest 7.53c due to a combination of the following: a) High technology usage with online pilot manuals, maintenance reports and electronic tickets 4
  5. 5. London Business School b) Owned all Airbus 320 fleet purchased at low cost and low maintenance requirement c) Non-unionized workforce with and without industry experience; flexible work packages such as reservation agents working from home and job sharing packages for college students and mothers. EXHIBIT 2: “WHO< WHAT<HOW” SOUTHWEST AIRLINES VS JETBLUE •JebBlue provided prestigious low- fair air service •Southwest airlines is a provider of low cost to bankers, brokers, fashion models and finance air travel for leasure and business travellers on budget WHO officers WHO •Point to point service between primary airports •Frequest point to point service between in NY and Florida and California with ave secondary airports in Southwest, California, distance 985 miles. East (515 miles distances) •Booking on Internet; simple fair structures; •Set fair rules ; no restrictions, set schedule electronic tickets WHAT with frequest flights WHAT •Comfort of leather seats equipped with personal •Absence of meals; no seat assignments; video monitor with Live TV 24 channels system and no frills coach cabin •Absense of meals; but snacks available •Utilizing all Boeing 737 fleet that burns low •Bought 23 Aurbus 320 jets fuel and requires short turnaround time •Non-union labor force operating with few work from maintenance and crew rules, flexible schedules and employment HOW •Working closely with employee union to HOW packages (job sharing packages, college student 1 add profit sharing and flexible work rules; year package); working from home •Hiring pocess focused on enterprenuers •Paperless approach through high technology with enthusiasm for work. usage for pilots and maintenance crew From the the value chain analysis (Exhibit 3) the key cost drivers are InBound/OutBound Logistics Management consisting of plane turnaround time (refueling, maintenance, safety checks, landing fees and cleaning) and Infrastructure Management in- cluding the organizational design and workforce management (salaries). EXHIBIT 3: VALUE CHAIN of LCC 15% 20% 10% 15% 40% Costs Costs Costs Costs InBound Operations Marketing Infrastructure OutBound Procurement and Sales Logistics Management Management Management Management 5
  6. 6. London Business School Purchase or lease Fueling/Refueling On-board Service Agents Promotion Labor Union and Non aircraft from Boeing Aircraft Mainten- Catering and Advertising Union Workforce or Airbus ance, Safety Checks Route Selection Ticket Counters Management Fit out and custo- Parts Check Crew Scheduling Ticket Offices Org Structure De- mized design Repairs Pilot Scheduling Online booking sign (Top to Bottom) Facilities Rental Landing Fees Lost Baggage Han- Marketing Research Pilot Training Parts Reorder Cleaning service dling New Product Design Crew Training Baggage Tracking Reservation Schedul- and Launch Safety Training and Handling ing System Communication Accounting, Legal Gate Operations Complaint Handling Hotel and Rental Car Facilities Planning Connections Yield Management Online booking Sys- tem In-flight TV System IT Systems Both SW and JB strategic capability is ontime departure, achieved through fast turnaround time by utilizing efficient operation- al procedures, flexible crew, newly purchased/leased and unified fleet of planes with minimum maintenance requirements (Ex- hibit 4). JB achieves advantage through non-unionized workforce as a VRI resource. While hypothetically it is possible to im- itate it, airlines traditionally have unpredictable labor union demands. Additional resources that built the capabilities in cost advantage include: a) Smaller planes to decrease landing fees linked to plane weight and standardized operational procedures to lower maintenance costs. b) Online booking systems to decrease travel agent commissions with JB being a leader with 1.16c vs 1.26c in SW. EXHIBIT 4: RESOURCE and CAPABILITIES ANALYSIS SOUTHWEST AIRLINES JETBLUE All Boeing 737 fleet for low cost Owned all Airbus 320 fleet for cost con- maintenance and faster turnaround trol of amortization and simplification in on the ground, and low staff training maintenance, and low staff training costs costs Simplified internal operations and High technology utilizing computers for maintenance procedures maintenance reporting and pilot ma- RESOURCES Enthusiastic workforce on flexible nuals profit sharing packages interested in Work from home reservation agents the success of airline with online access Finance: CASM of 7.53c per mile with Non unionized workforce from inside key advantages in low landing fees, and outside the industry under flexible low facility rentals, and low advertis- pay packages and shift sharing 6
  7. 7. London Business School ing expenditures Finance: CASM of 6.69c per mile with Organizational structure from bot- differences in low salary and benefits, tom up focused on cost control lower maintenance fees and low amor- tization Organizational structure from bottom up focused on cost control Regional point to point flights to low Long distance flights to key airports cost remote airports that reduce with prestigious leather seat, individual landing fees, and allows for faster entertainment system cabin to increase security procedures, frequent flights passenger load and provide for a niche and effective luggage handling target market accustomed to lounge, CAPABILITIES Fast on the ground turnaround and food and shopping network access timely departure Fast on the ground turnaround and Maintaining low transparent pricing timely departures to the customers with few fair Maintaining reasonably low fair with set classes and few restrictions schedule and no restrictions Online booking and check in As a conclusion, LCC carriers were able to maintain low cost air fares through optimization in operational aspects of In- Bound/OutBound Logistics and Infrastructure Management. Specifically, they minimized labor expenditures and reduced hours spend on maintenance for faster plane turnaround leading to higher utilization of planes and passenger load factor. The other core operational aspects for JB were advanced technology and comfort plane fitting which helped to maintain high class clien- tele demands. While having higher labor costs, SA frequent flight schedule, timely departures and no seat assignments pro- vided a good substitute for auto travel and a sense of community. Finally, these organizations were designed bottom up with a mission of controlling costs and having a fun atmosphere. This allowed for all divisions to clearly communicate the same mes- sage and operate with the same premise of cost savings being passed to customers. 7
  8. 8. London Business School Solution Analysis (3): Why do all low cost subsidiaries of legacy airlines failed including Delta Express failed? (WORD COUNT without Exhibits: 364) When launching Delta Express, Delta focused on key Florida regional market by introducing a low cost carrier achieved through low labor cost and high aircraft utilization. Management negotiated 32% pay-cut with the union and simplified aircrafts to Boe- ing 737 fleet for ease of maintenance. As infrastructure management and inbound/outbound logistics are the key to the airline profitability (Exhibit 3), Delta Express achieved its target initially. After 4 years of operations the position was lost due to hikes in salaries with union waging a “jihad” war with management. Another aspect leading to the failure was inability of Delta to clearly separate this subsidiary into a functional organization. Since Delta shared its marketing, controlled pricing, routes, and frequency of both airlines from centralized location, and shared the same maintenance, pilots and flight attendance, it created a cognitive dissonance in the organization. Employee enthusiasm with high flexibility in their roles and responsibilities were essential for low cost airlines to maintain cost advantage. Delta personnel lacked a clear vision of company differences and required the same benefits. The key competitor that entered Florida route and even further declined Delta Shuttle profitability was JetBlue. According to the value curve below (Exhibit 5), Delta Express was known for its low cost fares but JetBlue differentiated itself by offering higher cabin comfort and in-flight entertainment system. As price and schedule differential were low, buyers looked for added convenience and extra perks. JetBlue clearly targeted high level executives with reasonable price sensitivity, while Delta Shut- tle focused on leisure travelers. EXHIBIT 5: VALUE CURVE of JETBLUE VS DELTA EXPRESS 12 10 8 6 4 JetBlue 2 0 Price Cabin Inflight Light Flight Timely Comfort Perks Snacks Schedules Departures 8
  9. 9. London Business School By analyzing all of the LCS of legacy airlines, including Delta Express, CALite by Continental and Shuttle by United, it is apparent that these subsidiaries did not operate as independent organizations but rather as business units of a large company under the same cost structure applied as overhead to smaller operations. This centralized control and management complicated opera- tions and logistics, confused passengers, created cognitive dissonance in the minds of personnel, confused overall organiza- tional positioning and drove additional overhead for LCS. Another key point is that LCSs are not able to control labor unions, and cost differentials were eliminated in a long run, thus decreasing the entire premise of LCS in the first place. 9
  10. 10. London Business School Solution Analysis (4): What are strategic options available to the cross functional team? What course of action for the Delta Express business would you have recommended? (WORD COUNT without Exhibits: 387) As Florida represents 30% of Delta revenues, it is important to continue operating there but considering reputation damage and poor employee morale as related to Delta Shuttle, my recommendation would be to modify Delta Shuttle operations by structuring it as a separate company under a new brand name with low fixed and labor costs, focused on the business profes- sional audience and target markets where competitive LCC are not present by combining core capabilities of both SW and Jet- Blue. Creating a new structure would require high capital investment but allow for decreased labor costs under a non-union agree- ment focused on providing high quality customer service to passengers and flexible work hours for employees. Paperless op- erations, online booking and electronic tickets would also lead to cost reductions. Entering into an alliance agreement with Delta would allow this LCC to outsource a significant portion of operations through sharing passenger terminal facilities, main- tenance and administrative operations and information technologies used in flight scheduling and joint procurement as well as sales/marketing organizations. As the Delta Shuttle Old was only focused on providing low cost airfare for Florida holiday travelers, the target audience of the Delta Shuttle New should be: 1) Senior executives in key regional business routes of Washington DC, Boston, Pennsylvania, New York 2) Leisure travelers between Washington DC and North Carolina, and Florida EXHIBIT 6: GENERIC STRATEGIC OLD VS NEW DELTA SHUTTLE Narrow DELTA SHUTTLE NEW Focus DELTA SHUTTLE (OLD) Broad Low Cost Differentiation 10 Z Gap
  11. 11. London Business School By scheduling in strategic business routes, Delta Shuttle New differentiates itself by offering a service in the unserved loca- tions by SA and JB. It also provides combined benefits of extra leg space and in-flight perks adopted from JB and no seat as- signment, frequent departure timing and set fares adopted from SA. Inflight perks could include newspapers, soft drinks, alco- holic beverages and branded cookies. Additional recommendation is to simplify aircrafts by offering 30/70 split of business vs coach classes with preferential upgrades for Delta Skymiles members. Since major focus is on business travelers, it is impor- tant to retain an alliance with Delta corporate for mile accumulation. Analyzing the industry dynamics, my overall recommendation for Delta would be to focus on buying regional airlines in Califor- nia and West Coast to continue its diversification of fleet to a lower regional grade that can consistently produce higher load factors and lower CASM. Keeping these subsidiaries under their own management would allow for a common mission among employees and decreased salary expenditures. 11

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