Michelle Cumberbatch & Chelsea Bolter Professor Dubey 13 June 2019 ECON563-71 The Airline Industry: An Economic Analysis Air travel has existed for over a century. It is arguably one of the most timeefficient, safest, and cost-effective methods of transportation in existence and has evolved thoroughly since aviation’s invention more than one hundred years ago. The multi-trillion dollar industry serves almost every living person (and some animals) on our planet and employs millions of people world-wide. Many people associate first explorations of air travel to the inventors, the Wrights brothers. However, there are a few others who were traveling by air before the Wright brothers ever took flight. Samuel Langley flew a fixed-wing model airplane which used steam as its power method in 1896. That same year, a man named Octave Chute, an engineer from Chicago, tested several different gliders over sand dunes near Lake Michigan. A close friend of Chanute’s, Otto Lilienthal, also enjoyed testing gliders. In August of 1896, while Lilienthal was flying a glider in Germany, he lost control, crashed, and died. This fatal crash peaked the interest of the Wright brothers, who we famously credit with the invention of aviation. The Wright brothers were marveled by the research done by their predecessors and gave them credit throughout their experiments. Wilbur Wright said, “Of all the men who attacked the flying problem in the 19th century, Otto Lilienthal was easily the most important. ... It is true that attempts at gliding had been made hundreds of years before him, and that in the nineteenth century, Cayley, Spencer, Wenham, Mouillard, and many others were reported to have made feeble attempts to glide, but their failures were so complete that nothing of value resulted.” The Wright brothers began working on their official aerotechnical experiments in 1899 after much research and deliberation. They started their experiments with gliders similar to those of their predecessors. These gliders did not have engines. Their first model to contain an engine was built in 1903. The brothers flew their first successful flight on this model in December of that year. They flew separately and were never allowed to fly together. The brothers chose to focus on the control of the pilot rather than the force of the engine which was a unique approach. They learned through their experiments with bicycles that the pilot needed to be able to control stability and balance throughout the flight. They invented a special three-axis control for their plane which allowed the pilot to maintain balance while steering. The patent for their pilot control was awarded in 1906 and is still used in fixed-wing airplanes today. We’ve come a long way since the days of fixed-wing gliders. In 1917, Hugo Junker invented the all-metal airplane, made of lightweight aluminum. Metal was more durable than the previously used wood and would leave the aircraft less susceptible to fire and other damaging weather affects. The first jet engine planes were introduced in 1937, designed by Frank Whittle and Hans von Ohain. This jet engine significantly boosted the speed and efficiency of the previously used prop planes. They were also small and sleek in design. The first aircrafts were predominately used for racing and sport. Although, they quickly became a pivotal part of warfare and were used to achieve military advantage. It wasn’t until July 1949 that the first jet-powered commercial aircraft took flight from London to Johannesburg, South Africa, carrying 36 passengers. This aircraft, the British De Havilland Comet, was quickly pulled from service after several unfortunate crashes between 1953 and 1954. These failures and crashes within De Havilland Comet’s model were extremely impactful in two US companies’ development: Boeing and Douglas. BOAC, Great Britain’s first international airline even eventually switched to using Boeing 707’s for their international flights. The Boeing company is a dominant force in the aircraft production industry. When Boeing launched their first plane, Boeing 707, in the 1950’s, they controlled less than 1% of the airliner industry. In Sam Howe Verhovek’s book, “Jet Age”, he writes, “Boeing’s president, Bill Allen persuaded the firm's board to make an audacious gamble and develop the first American jetliner. As the industry giants Douglas and Lockheed held off on jets and instead competed with one another to build the most luxurious propeller-driven airliners, Bill Allen and Boeing jumped headlong into the future." Boeing dominated air transportation throughout the 1960’s and 1970’s, but not for long. One other airplane manufacturer quickly made its way into Boeing’s market: Airbus. Today, Boeing and Airbus dominate 99% of the commercial airline manufacturing industry, representing a duopoly. Complementary to the airline manufacturing industry is the airline industry. In 2018 there were 17 major commercial airlines in the United States. According to Airlines for America, “Annually, commercial aviation helps drive nearly $1.5 trillion in U.S. economic activity and more than 10 million U.S. jobs.” When booking a flight anywhere, one typically thinks of the top four US airlines: American Airlines, Delta Airlines, United Airlines and Southwest Airlines because, combined, they create 80% of the United States airline market. Although, a few other airlines are steadily creeping into the space of the big four and as fuel costs continue to affect each airline’s bottom line, they must take into account how they are most efficiently and safely handling customers who now have many options when choosing a preferred airline. American Airlines holds the majority market share in the United States, about 36%. Founded in April of 1926, the company is based out of Fort Worth, Texas and are currently worth about $7.6 billion dollars. According to a SWOT analysis done by Marketing91, the company boasts several strength including but not limited to their AAdvantage loyalty flyer program, which rewards customers for consistently choosing American for their air travel needs. They can use loyalty miles earned to receive free seat upgrades, free checked bags, and even free flights. The company also has several strong alliances with other airlines outside of their network including AirBerlin, Cathay Pacific, and British Airways. These alliances allow American to increase flight frequencies within their network of allies. A glaring weakness of American is the increase of low-cost competitors entering into their market space. Companies such as Spirit, Frontier, and Jetblue, dominate the LCC market offering a no-frills experience at a more affordable cost. A major competitor burgeoning into American’s market is Alaska Airlines. Alaska Airlines was awarded the Money Best in Travel Award for 2018 and voted America’s most popular airline. Money compared the nine largest US airlines and considered factors such as customer experience, price, flight performance and fees. Alaska Airlines, based out of Seattle, Washington, showed an average 85% on-time departure, an average price of $450 for a roundtrip ticket, and $.22 cost per average kilometer flown. Alaska Airlines acquired Virgin America towards the end of 2016 which increased its total network tremendously. The glaring issue with Alaska Airlines, is their network is limited to mostly the Northwest United States. Their acquisition of Virgin Airlines was a positive next step, however, Alaska Airlines must continue to expand flight destinations in order to gain more market share. Another significant player in air travel, and one of the US’s big four, is Southwest Airlines. Once considered a budget-friendly option, Southwest Airlines is now faced with necessary rate hikes in order to increase revenue as fuel prices continue to rise. Southwest is notably targeting a business-type of traveler for several reasons. Think practicality: How often to last minute interviews and meetings arise or change course? A business traveler is likely willing to pay a bit more for their ticket if they are able to change or cancel flights within the Southwest network at no cost penalty to the traveller. Southwest also offers a free “companion pass” as a loyalty reward for those who travel over 100 one-way Southwest flights within a calendar year. Your “companion pass” is good for one calendar year after you’ve reached your 100-flight milestone. Someone traveling constantly for work would be highly incentivized by this “companion pass” because it would grant a loved-one access to travel with them for free which is often the downside of working on the road. Another way, Southwest has shifted their culture to target a business traveler, is their reward for planning ahead. Southwest seats are unassigned. This is unique to the airline industry. For each Southwest flight, a window opens 24 hours prior to takeoff when customers are able to log online, check into their flight, and sign up for a boarding group. The customer is rewarded with a higher boarding group based on how early the check in. The higher your assigned boarding group, the better chance you will get your preferred seat choice. A business traveller who is planning their schedule ahead of time will note exactly when to log on and claim their early boarding group, thus the airline targets and creates a client network of efficient, planner travelers and operation efficiency organically improves throughout the day-to-day of Southwest’s business. It is also important to note how technology is impacting the airline industry overall. Longtime airline analyst and Co-founder of Atmosphere Research Group, Henry Harteveldt, said, “more travelers are willing to consider trading up to save time and reduce hassle for a customized travel experience. Travel technology can take customization even further, especially through mobile channels. As airlines embrace new innovations, technologies and strategies to attract consumers- the sky is the limit!” Most air travelers today expect perks like in-flight wifi and a user-friendly mobile app. Customers will often choose an airline based on ease of prior experience with the check-in and boarding processes. This means that airlines must invest in information technology and technological updates to boost efficiency both in-flight and on the ground. For example, JetBlue has a user-friendly smartphone app that easily converts dollars to reward miles and vice-versa. One can open the app, book a flight using either reward miles or credit card, check in to the flight, add luggage and pay all fees associated, buy preferable upgrades, scan the downloaded boarding pass at bag drop, and walk to security in one fluid motion, all without ever speaking to another human. These advances in artificial intelligence and technological efficiencies allow airlines to cut labor costs which helps to keep ticket prices relatively affordable. These technological advances not only cut costs, but they also save the customer time which would be previously wasted in lines waiting for service. Time is money and when the customer is able to save time and money, the airline earns customer loyalty and repeat business. Another way that airlines earn loyalty is by building airline hubs in major cities worldwide. Airline hubs are highly concentrated transfer points where airlines can easily and efficiently connect passengers from flight to flight within their network. Customers living near a hub are more likely to travel within that particular airline because it is cheaper and more convenient. And as previously mentioned, traveling consistently with the same airline results in favorable rewards such as upgrades, free flights, and much more. Most major airlines have several hubs. Delta Airlines main hub is HartsfieldJackson International Airport in Atlanta, Georgia, where their headquarters are based. They also have hubs in Salt Lake City International Airport and Boston Logan Airport, as well as hubs in the countries of Japan, France and The Netherlands. United Airlines has nine hubs total. Eight of United’s hubs are domestic including Newark Liberty International Airport in Newark, New Jersey, and their only international hub is based in Tokyo, Japan- Tokyo Narita International Airport. Hubs are extremely important in building customer loyalty and repeat business as customers are often looking for the fastest, cheapest flights. If given the choice to pay a bit of extra money for an easier connection or nonstop flight, travelers will often choose the upcharge. When analyzing the economics of the airline industry as a whole, it is necessary to link where it falls within Porter’s Five Forces. Below, we have chosen four of the Five Forces to analyze further: 1. Competition in the Industry Although, American Airlines has the largest fleet size, there are over 5000 total airlines worldwide. Between 2005 and 2010 there have been major mergers, specifically with U.S airlines, airline alliances, and code-sharing agreements. With new rules being implemented, a freedom to trade and open new markets and technological innovations which included faster and cheaper transactions on a global scale, widened the competition. United Airlines merged with Continental Airlines in a $3 billion dollar merger in May 2010. Jeff Smisek, United's new chief executive officer, said, “he is confident the enlarged carrier will be a potent competitive force among other global U.S. airlines and big foreign carriers. United has the world's best network, one of the strongest new-aircraft order books in the U.S. industry and the ability to win more corporate accounts and business travelers because of its breadth.” This confidence from Smisek came just before a series of unfortunate incidents splashed across US headlines over the years to follow. In April 2017, a Kentucky doctor named David Dao was violently removed from his seat after the airline overbooked the flight and asked him to give his seat to a United employee needing to travel to their next job. The airline desperately attempted to incentivize current passengers with high priced buyouts for their previously paid-for tickets. When no one took the offer, Dr. Dao was randomly selected to be removed from the flight against his will. Even though he paid for and booked his seat in advance, United employees ripped him from his seat and dragged him off of the plane unconscious, blood dripping from his face. A few months later, a healthy dog traveling in pet cargo on a United flight died due to the conditions of the pet cargo area. Most recently, a United flight sat stranded on a tarmac in Newfoundland, Canada in -20 degree weather for over 14 hours due to a medical emergency onboard the aircraft. The freezing and angry passengers sent tweets to United and others to save them from the ordeal. Needless to say, bad press can serve a magnitude of damage to a brand when in such a saturated industry as air travel. Customers have many options and these incidents and horror stories greatly impact their choices when deciding with whom they will fly. 2. Threat of Substitute Products As the airline industry expands over the next 20 years, this will also come with a pilot shortage due to the pilot retirement age of 65. This expansion will produce a demand of close to one million crew members. With so many crew members, there are constant labor demands and union negotiations. Airlines are concerned about the risk of their employees striking or abandoning their firms. From December 2018 to January 25, 2019, the partial United States government shutdown had a major impact on the global airline industry. “Federal staffing and other resource shortfalls brought on by this shutdown threaten existing and new air service to communities across the country, harming air travelers, businesses, and regional economies all over America,” Airports Council International (ACI). The shutdown didn’t just affect government workers such as TSA employees but airline employees and air travelers (customers) lost a sense of security in travel safety. The Federal Aviation Administration (FAA) halted hiring and training new employees due to the shutdown and there was a shortage of training certifications given to new pilots. Many airports were forced to shut down terminals because TSA employees were striking and not coming to work. Those TSA employees who continued working through the strike lost valuable screeners who were not working at this time. The volatility of the strike caused safety concerns, longer lines, delays in flights and many customers missed flights. Although the government shutdown was expected to last only one month, it is expected to occur again and would possibly cause another disruption in air travel. This will result in airlines providing discounts just to retain customers. Another threat to the airline industry is the rise of jet fuel costs. The price of fuel increased by 50% from 2017 to 2018. This dramatic hike cost American Airlines over $2 billion in total revenue. In 2018, fuel accounted for more than 20% of airlines’ operating costs. Airlines increase profit by charging customers additional fees for WIFI, luggage, flight-change, flight cancellation, and seat upgrades. Industry experts have predicted that international business and premium economy travelers will fly less competitive routes and will eventually have less flight options to choose from. Although experts have predicted healthy demand and increased revenue industry-wide in 2019, these predictions will largely depend on the stability of oil prices. 3. Power of Suppliers Airline manufacturers are the majority suppliers within the airline industry. Boeing and Airbus are the top manufacturers worldwide. The remainder of the industry’s employee force consists of travel agents, pilots, air navigation service providers (flight attendants) cargo agents, reservation systems agents, catering, maintenance, repair, and oil manufacturers. Airlines have a strong dependence on fuel and labor suppliers and high bargaining power because of the scarce number of manufactures. It is very difficult to switch suppliers therefore, airlines must make long term agreements with their suppliers. Cost and capability are the main reasons why there isn’t a large new entry threat. 4. Bargaining Power of Customers The bargaining power for buyers within the airline industry is considered high. There are several types of buyers: those who buy individual tickets, for business or leisure, and those purchasing for groups. There are also travel agencies and third-party booking sites such as Kayak.com, Cheapoair.com, Expedia.com and Cheaptickets.com, to name a few. The goal of most customers is to win the best deal. When contacting a third-party site to help purchase tickets, the customer is seeking the convenience of not having to search multiple sites and airlines individually. But in searching via third-party sites, the customer also expects to be awarded the best value for their money. Another reason individuals have majority buying power is because they have over 500 airlines to choose from, as well as other modes of transportation as viable options for domestic travel. Buses, trains or and automobiles are ways to travel throughout the country, but Airlines for America lists air travel as the safest mode of transportation nationwide. They also note that air travel is currently experiencing its safest period of flying to date. International travel easily eliminates buying power of customers within certain modes of transportation. One cannot drive a car from New York City to Shanghai. However, customers have complete control over which international airline they will choose for a long-haul flight. 5. Potential of New Entrants Into the Industry There were 78 new airlines to enter the industry worldwide in 2017. Of the 78 new airlines to enter the market, none carry any name recognition as of yet and only three are US based. It is extremely difficult for new airlines to enter the market because the major airlines control such vast market share and the product the majority holders are producing is relatively affordable and reliable. It is also important for air-travelers to feel safe and secure while flying. This security and confidence is earned through a reliable track record of safe flights. New airlines don’t have these track records thus, customers are less likely to gamble with their lives on an airline they’ve never heard of just to save a few extra dollars. A more interesting future development of focus will be the general public’s access to the private flying experience. Once reserved for celebrities and politicians, private flying is becoming increasingly more mainstream. Companies such as JetSmarter and Jettly offer subscription services to seats on private jets on the world’s most traveled flights. For example, one can become a member of the JetSmarter community and pay a $2500 annual fee. This fee awards you unlimited access to perks such as guaranteed flight availability with 24-hr notice, discounted flights, 24/7 concierge and private lounge access, among others. If you choose to opt out of the membership, flights themselves are as affordable as $700 for a ticket to Miami from New York City. Keep in mind that these are private jets with maximum 15 seats per plane. There is no security checkpoint, no crowds, and no delayed flights. Aside from private jet access, one can also take helicopters fairly easily between close cities. For example, Uber just launched helicopter services from lower Manhattan to JFK for $200. The ride is under eight minutes total. This will revolutionize city to city travel as it evolves. Imagine being able to avoid traffic and time wasted driving while instead taking a 10-30 minute helicopter ride depending on the destination. New airlines may not have much success attempting to enter the commercial airline market but private flight access for the general public will be especially interesting to watch over the next several years as it continues to develop. The airline industry has grown tremendously from its inception over one hundred years ago. Today, it is a multi-trillion dollar industry that serves almost every person on earth and employs millions of workers world-wide. It is exciting to anticipate the future developments in air travel. As the idea of ride-share begins to encroach into air space, the Uber of the skies via private jets and helicopters may seriously disrupt commercial air travel as we experience it today. For now, the airline industry continues to be a major contributor to the global economy and will continue to serve customers for many years to come. 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