A Note on the US Airline Industry
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Case Code: BSTR139 Case Length: 24 Pages Period: 2001 - 2004 Pub Date: 2004 Teaching Note: Not Available |
Price: Rs.500 Organization: Varied Industry: Airlines Countries: USA Themes: Corporate Restructuring |
Abstract Case Intro 1 Case Intro 2 Excerpts
Excerpts
Deregulation
In the 1970s, when the CAB regulated the industry, there were major barriers to entry and exit and severe restrictions on the operations of airlines. By the end of the 1970s, many airlines had begun to feel the negative impact of regulation – they were forced to operate on unprofitable routes just to keep certain areas connected, and were not allowed to expand into profitable routes or to set reasonable fares.
Keeping in view the shortcomings of regulation, the Congress passed the Airline Deregulation Act in 1978, which freed the industry from regulatory restrictions. The rationale behind deregulation was that the market would control the prices and determine the routes in the industry. It would also ensure that only the most efficient airlines would operate, thus offering passengers lower prices and better service.
By the end of 1978, the industry had made $5.45 billion in cumulative historical profits. The period immediately following deregulation was also very successful as airlines dropped fares and improved routes to attract passengers. In 1979, a record 317 million passengers traveled by US airlines. Another effect of deregulation was the setting up of several small regional airlines, which targeted less popular routes between small towns that were ignored by majors.
However, in 1981, the industry posted a net operating loss of $421 million, the reasons for this being rising fuel costs, economic recession, and over-expansion in the wake of deregulation. The number of passengers too fell to 286 million that year. To improve passenger numbers and create loyalty among passengers, airlines began to introduce Frequent Flier programs in 1981. American was the first to launch the program and other airlines soon followed suit...
September 11 and its Aftermath
On September 11, 2001, terrorists hijacked four passenger aircraft and crashed them into important buildings in the US, killing over 3000 people. (Two aircraft of American and two of United were hijacked for the attacks.) The event left the world in a state of shock, with the natural outcome being a sharp fall in air travel. Prompted by fear, people either cancelled their travel plans or chose other means of travel. Business travel also fell because of the hassles of stepped up security at airports after the attacks. After the attacks, the US airspace was closed for three days and the stock markets were shut down for four days. Most of the airlines were harmed by the sudden fall in traffic. The worst affected were those whose balance sheets showed high debts...
Profile of the Industry
A broad definition of the airline industry would include all airlines that provide passenger as well as cargo services commercially. However, in this note, we focus only on companies that provide passenger services.
In the US airline industry, airlines were classified under three heads:
• Major airlines: Airlines with over $1 billion in revenues were called major airlines or international airlines. Many of these airlines flew large planes with a seating capacity of over 130, and concentrated on long haul, coast to coast, or international routes. They were also the largest employers in the industry...
The Low Cost Revolution
There was a rapid growth of the LCCs in the US from the late 1990s. LCCs were set up on the premise that 'the customer considers one airline the same as another. The customer always chooses the lowest price'. While most of the LCCs offered only the most basic of services and passengers had to pay extra for normal services like in flight food or entertainment, analysts observed that an increasing number of people preferred the LCCs to the FSCs. In the early 2000s, it was estimated that low cost competition existed on at least 80 percent of the American routes and the market share of the LCCs had also increased dramatically since the 1990s...
Key Challenges
A number of issues contributed to the problems of the US airline industry. Some of the issues were internal, such as strong unions and overcapacity, while others like fuel prices and falling yields were determined by external factors.
Fuel, one of the critical components in the operation of an airline, comprised between 12 and 15 percent of operating expenses, making it the second highest cost after labor. The US airline industry was vulnerable to rises in fuel prices and analysts estimated that a one cent per gallon increase in the price of fuel drove costs up by $180 million for the industry...
Is Consolidation an Option?
There were no easy solutions to the problems of the airline industry. However, some analysts believed that making certain operational and strategic changes would go a long way towards dealing with some of the more pressing challenges. For instance, experts said that the hub and spoke system of airlines used by most FSCs was outdated as it cost more to operate than the point to point system favored by the LCCs. However, they also acknowledged that it would not be easy for all airlines to abruptly abandon their hubs in favor of point to point flights (Refer Exhibit XI for a figure of the two systems). Analysts also believed that airlines would be able to obtain considerable savings if they simplified their fleets and operated similar aircraft models...
The Outlook
Analysts said that the US airline industry was likely to begin its recovery in 2005-2006. They said that by then, some of the non-performing airlines like US Airways and United could be liquidated and with such unproductive capacity exiting the industry, better performers would have a chance to recover. It was also likely that some of the majors would relinquish their domestic routes, while focusing on overseas routes, which were relatively more profitable. They also expected the LCCs to dominate the market by 2005-2006. They saw the market share of the LCCs go up to 35 percent or more by around 2007-2008. While they did not think that the industry would go back into regulation, they believed that the government was likely to play a greater role in the industry in the future. Another important development they expected was the entry of foreign owned airlines. Richard Branson, founder of the UK-based Virgin Group, was considering setting up a domestic airline in the US in the early 2000s, and analysts expected that by 2005-2006, the government would lift the restrictions on foreign ownership in the industry, giving it a much needed boost...
Exhibits
Exhibit I: Layoffs by Major Airlines Immediately After September 11
Exhibit II: Categories of Airlines in 2003
Exhibit III: Market Share and Profit of Major Airlines in the US in 2003
Exhibit IV: Rising Market Share of LCCS
Exhibit V: Q2 2004 casm for U.S. Airlines
Exhibit VI: 2004 Airline Quality Ratings: 14th Annual National Study on Airline Quality Ratings
Exhibit VII: Fuel Prices Trend
Exhibit VIII: Hedging By Airlines in 2004
Exhibit IX: Breakup of Operating Cost in the Industry
Exhibit X: Labor Cost as a Percentage of Operational Cost in Q2 2004
Exhibit XI: Hub and Spoke System
Exhibit XII: Features Of Airline Alliances
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