Delta Airlines Case Study

Introduction

Since the deregulation in 1978, the airline industry has had lower margins than other US industries. Delta Airlines is confronted with the competition of low-cost carriers. Nearly all major competitors have tried to come up with a low-cost subsidiary but failed to compete with the low-cost carriers. Delta Airlines now faces the challenge on how to battle with the low-cost carriers and decide which strategic choice to make.

The analysis of the case will be divided up into four major parts. First of all, the external environment of the airline industry will be assessed through the PESTEL framework (Macro) and Porter’s 5 forces (Micro) to figure out why there were such low rates of return in the airline industry. Secondly, the internal environment of Southwest Airlines and JetBlue will be evaluated with the Resource Based View and partly Porter’s value chain to discuss how they managed to earn enviable return compared to their competitors. Thirdly, an explanation will be given to why the low-cost subsidiaries of legacy airlines had failed. To conclude the report, several recommendations will be given to enhance Delta’s future strategy.

External environment

To introduce this case, the PESTEL framework (Exhibit 1) will be used to analyse the external environment of the airlines industry with a macro point of view. Based on the PESTEL framework, the following three points give a partial explanation for the poor financial results of the airline companies.

None of the five largest air carriers in the US earned its cost of capital in the 1990’s because of the deregulation of the airlines in 1978. The margin after the deregulation was below the average margin of other US industries. Before the deregulation, the Civil Aeronautics Board (CAB) was responsible for routes of each carrier and it covered the revenues and profitability of the airline companies. The deregulation also brought high fixed costs and more expensive labor.
Moreover, the legacy carriers had to face the rising competition of low-cost carriers that entered the market after the deregulation.

On top of these problems, the 9/11 terrorist attacks resulted in an immediate loss of over $650 million and a sharp decline in the demand for air travel. The security costs had risen for airline companies (i.e. insurance, airport tax, bulletproof cockpits, etc.).

The Porter’s 5 forces framework will illustrate the analysis of the external environment from a micro perspective.

According to Porter’s 5 forces, the competition is very intense in the airline industry. You have the major players : Alaska, America West, American, American Trans Air, Continental, Delta, Northwest, Southwest, United, and US Airways. But you also have the low-cost competition in recent years including Southwest, JetBlue, Airtran. Airline companies have to be extremely competitive on their prices if they want to survive in this industry. Therefore these companies have difficulties reaching profitability.

The buyer’s bargaining power is considered as high. Previously to the deregulation act, it used to be low. But now that low-cost carriers entered the market and the fares of flights tickets dropped to almost 45%, buyer’s bargaining power increased significantly. Another factor that raises the buyer’s bargaining power is Internet. Thanks to that, people are now able to compare prices of flights and by doing so, they have low switching costs. Low loyalty adds to the buyer’s bargaining power, since 1/3 of the passengers select a carrier on the basis of the ticket price.

The supplier’s bargaining power is medium to high. First of all there are the labor unions. The unions are extremely powerful because the employees’ salaries and benefits are the highest expense for the airline companies (40%). Secondly, you have the airplane suppliers (Boeing and Airbus) and the leasers. Aircraft and facility rental costs represent more or less 15% of the total cost. Since there are only two airplane suppliers and several lessors, their bargaining power is quite high. Last but not least the fuel suppliers. Fuel accounts for 10-15% of the total costs. Airline companies managed to hedge the fuel costs, which means it doesn’t affect the airlines as much as the unions and the aircraft suppliers.

The threat of substitutes can be described as medium. On long distances the threat is low. But on short distances it is high because of automobiles, buses and trains.

The threat of new entrants is low. The initial investment to enter this market is very heavy. Governmental and security regulations also make it very hard for new entrants. Additionally, the lack of experience and not being able to benefit from economies of scale creates a natural barrier to entry for new entrants.

After the analysis of the PESTEL framework and Porter’s 5 forces, the conclusion is that the external environment made it difficult to be profitable for airline companies.

Internal Environment of Southwest and JetBlue

To know why Southwest Airlines and JetBlue managed to earn enviable returns despite the challenging industry environment, it is important to analyse their internal environment. Therefore a brief description of their resources and capabilites will be given below based on the Resource Based View model (exhibit 2).

Southwest started off mainly in the Southwest states and California with point-to-point flights with an average of 515 miles. Afterwards they expanded to the East Coast. The airline limited itself to a 10%-15% growth rate to manage in good times and survive in bad ones. It opted for a differentiation strategy with a love theme. They focused on a simple operation with a full Boeing 737 fleet, no meals offered, no seat assignment, no frills, flexible work rules, enthusiastic workforce, high aircraft utilization. Southwest had a good relationship with employee unions, aimed attention at service, low price (to compete with the price of auto travel), a high load factor. Last but not least, they had a simple pricing structure (few classes of fares) that is transparent towards customers.

JetBlue provides low-cost flights of high standing to bankers, brokers, fashion models and finance officers that often travel and value their flight experience. JetBlue had bought a fleet of  new Airbus A320 that didn’t need a lot of maintenance. JetBlue had point-to-point from New York City to Florida but also in California with an average distance of 985 miles, which is consistently longer than Southwest. JetBlue concentrated on less traveled airports but not obscure. JetBlue wanted to focus on online sales, technology and in-flight entertainment. Indeed, their online strategy worked, because they had more than 60% of their seats booked online. The fare structure was simple just as Southwest and they only had electronic tickets (paperless operation). JetBlue operated with very few work rules, expecting flexibility among employees (non-union), and it offered corresponding flexibility in its employment packages. Their Cost per Available Seat Mile (CASM) was even lower than Southwest and the loadfactor was far above industry average. JetBlue had managed to create a strong brand with a “Cheap chic” image.