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# What Ails US Airline Industry

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An article on what ails US airline industry with discussion on possible success models to solve the problems.

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### What Ails US Airline Industry

1. 1. [2007] What Ails US Airline Industry and How to Overcome It PRITAM DEY pritam.dey@gmail.com
3. 3. What Ails US Airline Industry? Pritam Dey pritam.dey@gmail.com TABLE OF CONTENTS Industry overview ··············································································································· 4 Problem/Issue Formulation ································································································· 4 Model Building ··················································································································· 5 Model 1: Continental Airlines ··········································5 Problem/Issue ···················································5 Continental Airlines Today ··········································6 Key Success Factors ···············································6 Model 2: Hawaiian Airlines············································7 Problem/Issue ···················································7 Hawaiian Airlines Today ············································7 Key Success Factors ···············································8 Comparison of the two models ··········································8 Model Application ·············································································································· 8 Problem Solving ················································································································· 9 Labor ··························································9 Fuel ···························································9 IT/Reservations/Customer Service ······································10 External Distribution/Commissions······································10 Fleet/Maintenance ·················································10 Pension ························································10 Other Opportunities ················································10 Business Travelers·················································10 Alliance························································10 People ·························································11 Customers ······················································11 Strong Argument to support the Solution ········································································· 11 Claim ·························································11 Reason ························································11 Evidence ·······················································12 Reservations ·····················································12 Qualifiers·······················································12 Conclusion ························································································································ 13 Sources: ····························································································································· 14 3
4. 4. What Ails US Airline Industry? Pritam Dey pritam.dey@gmail.com WHAT AILS THE U.S. AIRLINE INDUSTRY AND HOW TO OVERCOME IT Industry overview In 2005, U.S. airlines recorded a fifth consecutive year of net losses, at \$5.7 billion – a five-year total loss of \$35.0 billion. The 2001-2005 period has been exceptionally challenging for airlines of all shapes and sizes. Airlines have been unable to recover their expenses and, in particular, have been over-whelmed by inflated fuel costs. Today, most of the major airlines have undergone cost restructuring, with United Airlines obtaining employee concessions in exchange for equity ownership. Some airlines, such as Northwest Airlines, sought the protection of Chapter 11 bankruptcy to restructure and reduce costs and then emerge as strong low-cost competitors. Problem/Issue Formulation The following are the symptoms currently seen on the U.S. Airline Industry: • Major U.S. Airlines consistently losing money. • The weak performance of the legacy airlines (airlines from pre-deregulation) over the last few years has significantly diminished their financial condition; as a result, some of these airlines are vulnerable to bankruptcy. • The overall volume of business air travel demand has decreased. • Labor productivity has been consistently low. • Emergence of low-cost airlines has been a significant challenge to legacy airlines. • Congestion and growing flight delays. • Issues of aviation safety and security. • Increased security checks and uncertainty of passenger processing times. • The new security procedures have increased operating costs and induced more security-related flight disruptions and delays. • External shocks (9/11, the Iraq war, SARS, etc) have depressed demand for air travel. • Intense pressure on airlines to cut costs. • High competition. 4
5. 5. What Ails US Airline Industry? Pritam Dey pritam.dey@gmail.com • The U.S. Airline industry received \$5.0 billion in direct assistance from the U.S. government in 2001. • Extreme price-cutting to fill up seats. • Several carriers failed and ceased operations including such high profile operators as Pan American Airways and Eastern Airlines. • High oil price drove up operating costs of airlines. • Many legacy airlines remain highly leveraged. • Airline business highly responsive to economic cycles. • Labor costs are very high. All the symptoms mentioned above point to the fact that the U.S. Airline industry is going though a very tough phase. A series of significant changes and unforeseen events during the last several years has presented the airline industry with its most significant challenges since it was deregulated 25 years ago. These challenges have come from within the industry as well as from external factors affecting the demand for air travel. The problem that is being investigated here is, ‘What ails the U.S. Airline industry, and how to overcome it?’ Model Building In exploring appropriate solutions to the problem, two particular models seem relevant here. Model 1: Continental Airlines Problem/Issue In 1994, Continental was facing its third bankruptcy. Employees were disgruntled about their work environment, their pay, and their airline; they had even taken pay-cut in an effort to keep the airline afloat. Customers did not think much more about the company, as Continental was considered simply the worst among the nation’s ten biggest airlines. 5
6. 6. What Ails US Airline Industry? Pritam Dey pritam.dey@gmail.com Continental Airlines Today • Continental Airlines is now recognized as one of Fortune Magazine’s “100 Best Companies to Work for in America”, even moving up from the 40th position to a very respectable number 23 on the list in 1999. • Continental is also now considered to be a respected airline and company, not only in the airline industry but also across all industries both nationally and worldwide. • Continental can boast consecutive record and yearly earnings since 1995. • On-time bonuses were paid in excess of \$95 million to employees. • Absenteeism has been reduced by 31 percent, and employee turnover has dropped 52 percent. • Continental has won various awards and accolades from the prestigious J.D. Power, to the Fortune’s “100 Best” Frequent Flyer Program of the Year. Key Success Factors Continental Airlines came up with four plans to lead this turnaround: • Fly to Win Continental implemented the code-sharing strategy with other major airlines to attract more customers. It also entered into alliance with other airlines to attract customers. At the same time, it continued to eliminate the non-value-added costs. Frequent Flyer Program was restored. • Make Reliability a Reality The plan aimed to have an industry-leading product Continental would be proud to sell. Continental worked hard to consistently rank among the top in the industry in four key Department of Transportation (DOT) measurements: on-time arrivals, baggage handling, complaints, and involuntary denied boardings. In order to provide this service, the employees had to want to provide it. There were easily measured goals and the reward came in the form of cold hard cash. • Working Together Continental managed to improve the employee morale which took a deep dive because of constant cost-cutting measure. They were rewarded with hard cash 6
7. 7. What Ails US Airline Industry? Pritam Dey pritam.dey@gmail.com every month for their good performance. Expectedly, happy employees took good care of customers. • Fund the Future Continental lowered its debt level and reduced interest payments on loan and aircraft leases. It also developed franchise hubs to reduce costs. Increased focus was laid on the fleet plan, development of hub real estate and the generation of a strong cash flow and improved financial flexibility. Leases were renegotiated, payments were postponed, debts were refinanced, and pricing structure was changed. Model 2: Hawaiian Airlines Problem/Issue Hawaiian Airlines filed for Chapter 11 bankruptcy protection on March 21, 2003 with operations still continuing, and was overdue for \$4.5 million USD worth of payments to the pilots’ pension plan. Within the company, it has been suggested that the plan be terminated. Hawaiian Airlines Today • The turnaround of Hawaiian Airlines has earned international acclaim with the company’s management winning top honors for finance at the 2005 Airline Strategy Awards. • Hawaiian Airlines restructured while keeping its commitments and thereby set an example for the industry. • Hawaiian Airlines, the nation’s number one on-time carrier, is recognized as one of the best airlines in America. • Business travelers recently surveyed by Conde Nast Traveler rated the airline as having the best in-flight service and meals of any U.S. carrier. • Hawaiian was recently ranked fourth best in the nation overall by Travel + Leisure. 7
8. 8. What Ails US Airline Industry? Pritam Dey pritam.dey@gmail.com Key Success Factors Critical success factors for the turnaround of Hawaiian Airlines are: • The newly acquired fleet produced savings of \$41 million in aircraft maintenance. • Increased use of Hawaiian’s web site and direct booking saved some \$10 million in distribution costs. • Hawaiian Airlines also introduced several technology-based initiatives that improved its operational efficiency including a full conversion to e-ticketing, the installation of Self Check-In Hele On (Hurry Up) terminals at all Hawaii airports to speed transits, and the introduction of Web Check-In Hele On at HawaiianAir.com allowing customers to check in from home or the office up to 24 hours before departure. • Revamped its customer service. Today, Hawaiian is the nation’s most punctual airline as well as one of the most profitable. Comparison of the two models The comparison of the two above models shows that the Continental Airlines model is a better one suited for this situation. This is because, firstly, Continental Airlines incorporated a grander turnaround model that had an impact on each operational aspect of the airline. Secondly, to be successful, an airline must be effective in four general areas: 1) attracting customers, 2) managing its fleet, 3) managing its people, and 4) managing its finances. Continental’s turnaround plan touched each of these above areas. On the other hand, the Hawaiian model touched only a few aspects, namely, the fleet, people, and customers. Furthermore, the enormity of the problem Hawaiian faced was a small fraction of what Continental actually faced. Therefore, the Continental model seems to be better model in this case. Model Application The situation currently faced by major ailing U.S. Airlines such as Northwest Airlines is similar to the one Continental Airlines faced years ago. In fact, these airlines are going through the same bankruptcy plan that Continental went through earlier in its history. Therefore, the Continental model is apt for the current U.S. Airline industry. However, it 8
9. 9. What Ails US Airline Industry? Pritam Dey pritam.dey@gmail.com must be noted that blindly copying a model is not going to guarantee success. A model must be modified to suit the present circumstances. Even though the Continental Model is good enough for the problem under investigation, nevertheless, it needs to be revised to increase the chances of success. We can implement key success factors from other profitable airlines to complement our solution. The model needs to be modified in the following aspects to make it sounder for the current situation. • Profitable airlines are prerequisite for recovery in the aircraft industry. Bring unit costs closer to those of low-cost airlines and align their services with fares that passengers are willing to pay for “anywhere to everywhere” networks. • Adjust operations by establishing and improving yield-management systems, which price seats in a more discriminating way, and by outsourcing more services. • There are two alternative strategies that have succeeded in keeping costs considerably lower and have been good at attracting leisure travelers. o Highly efficient utilization of aircraft. o Purchase of low-cost used aircraft. Problem Solving A detailed plan for implementing the proposed solution is described below: Labor Management should negotiate contracts with labor union in order to reduce labor costs. Currently, labor costs account for a bulk of the cost of operating an airline. Currently, 40 percent of an airline’s expenses are used to pay pilots, flight attendants, baggage handlers, dispatchers, customer service, and others. Fuel Fuel savings initiatives such as single-engine taxing, more efficient fuel-reserve practices, and installation of winglets can result in significant cost savings. 9
10. 10. What Ails US Airline Industry? Pritam Dey pritam.dey@gmail.com IT/Reservations/Customer Service Technology-driven enhancements to airline websites and self-service kiosks can reduce the cost of bookings and passenger handling. External Distribution/Commissions Renegotiate contracts with global distributions systems (GDS), reduce travel agent commissions, encourage travelers to book directly with carrier websites. Fleet/Maintenance Continue the fleet rationalization program. Replace older, maintenance-intensive, fuel- guzzling fleets with new aircrafts. This can reduce training, spares, and maintenance expense. Pension Even though this sounds difficult, airlines need to explore whether they can reduce the pension expenses. Adopt the Pension Benefit Guaranty Corporation (PBGC) to shift the burden of funding the airline workers’ pension. According to the PBGC, airline pensions today represent at least 38 percent of PBGC claims – but airlines paid just 2.6 percent of premiums. Other Opportunities Explore opportunities to earn more revenue from transporting cargo, selling frequent flier miles to other companies, and ‘up-selling’ in flight services. Business Travelers Value your business travelers because they are more likely to travel several times throughout the year, and they tend to purchase the upgraded services that have higher margins for the airline. Alliance Increase alliance with other airlines to improve the load factor, i.e. fill up the empty seats. 10
11. 11. What Ails US Airline Industry? Pritam Dey pritam.dey@gmail.com People Focus on improving the employee morale. A motivated employee is the key to have a happy customer. Customers Improve customer service. Improve the on-time arrivals, improve baggage handling, reduce complaints, and reduce involuntary denied boardings. In order to do so, airline guidelines might need to be modified so that managers are empowered to use their heads, rather than manuals, to solve customer’s problems. Strong Argument to support the Solution A strong solution should have the following components: 1. Claim 2. Reason 3. Evidence 4. Reservations 5. Qualifiers Claim Turnaround the ailing U.S. Airline industry by applying and further refining the Continental Airlines Model. Reason The reasons for supporting the claim are: • Continental Airlines was able to turnaround its airline by using this model. • Other airlines such as Hawaiian Airlines, Delta Airlines, etc are using part of this model to restructure their airlines. • Currently, the problems faced by major U.S. Airlines are similar to what Continental Airlines faced years ago. • The enormity of the problems currently faced by major U.S. Airlines is similar to that of Continental Airlines. • The industry is located in the U.S.; hence the Continental Model is appropriate for this case. 11
12. 12. What Ails US Airline Industry? Pritam Dey pritam.dey@gmail.com • The symptoms and underlying issues are similar. • The market conditions are similar. • The external conditions such as the governmental deregulation, terrorism fears, oil prices, etc are similar. Evidence The evidences supporting the reasons and claims are: • Continental Airlines went through a bankruptcy process to turnaround itself. Similarly, most of the major U.S. Airlines are undergoing Chapter 11 bankruptcy reorganization. Northwest is expected to come out of the bankruptcy reorganization sometime in 2007. • Even today, labor and fuel costs account for the bulk of the expenses. • Northwest Airlines is going through a restructuring plan similar to what Continental Airlines went through. Reservations The reservations of the solution are: • The time period, U.S. and global economy, and the business environment are very different as compared to the Continental Airlines’ turnaround period. Hence, the model might not be applicable now. • The oil prices have skyrocketed in recent times, driving up the operating costs of running an airline. Therefore, it is much more difficult to turnaround ailing airlines now. • Weather is variable and unpredictable. Extreme heat, cold, fog, and snow can shut down airports and cancel flights (which costs money). • The socio-political and economic conditions can delay the process of turnaround. Qualifiers In order for the solution to work, we have assumed that: • There will be no significant drop in future level of air travel. • There will be no significant drop in future passenger traffic and yields. 12
13. 13. What Ails US Airline Industry? Pritam Dey pritam.dey@gmail.com • Unpredictable pricing environment is minimized. • There will be stable cost of security. • Cost and availability of aviation insurance coverage and war risk coverage will remain stable. • General economic conditions of the United States and other regions of the world will not hamper the airlines’ recovery. • The price and availability of jet fuel will be stable. • The possibility of additional terrorist attacks or the fear of such attacks, concerns about SARS, Avian Flu, or other influenza or contagious illnesses is less. • Labor strikes, work disruptions, labor negotiations both at other carriers and the company will not delay the turnaround process. • Low cost carrier expansion, capacity decisions of other carriers will not be as rapid as so make the turnaround much harder. • Actions of the U.S. and foreign governments, foreign currency exchange rate fluctuations, inflation and other factors will remain predictable and stable. • The weather conditions will remain predictable and manageable. Disasters such as Hurricane Katrina could make the turnaround slower and harder. • The airlines have the capability to go through the change. Conclusion Assuming that the struggling airlines implement the steps mentioned above, there is ample opportunity to turnaround and recover from the current situation. Continental Airlines had done it. Hawaiian Airlines had done it. Airlines in other countries have done it too. With proper action plan, governmental support, industry alliance and support (in terms of price-cutting, code sharing, etc), there is no reason why the airlines cannot turn around. The outlook for the travel industry is one of strong growth. Forecasts suggest that the number of passengers will double by 2010. Successful airlines will be those that continue to tackle their costs and improve their products, thereby securing a strong presence in the key world aviation markets. 13
14. 14. What Ails US Airline Industry? Pritam Dey pritam.dey@gmail.com Sources: 1) PBS, ‘Continental Airlines’ Turnaround’, March 19, 1998 2) U.S. Government Accountability Office, ‘State of the U.S. Commercial Airline Industry and Possible Issues for Congressional Consideration’, November 28. 2001 3) Peter R. Costa, Doug S. Harned, Jerrold T. Lundquist, The McKinsey Quarterly, ‘Rethinking the aviation industry’ 4) Stephen S. Doig, Adam Howard, Ronald C. Ritter, The McKinsey Quarterly, ‘The Hidden Value in Airline Operations’ 5) Air Transport Corporation, 2006 Economic Report 6) The Industry Handbook, The Airline Industry 7) Andrew B. Steinberg, U.S. Department of Transportation, U.S. Airline Industry 8) Richard M. McCabe, Graziadio Business Report, ‘Airline Industry Key Success Factors’ 9) Northwest Airlines, ‘Northwest Airlines Files Its Plan Of Reorganization’ 14