Teaching Note: The United States Airline Industry
The U.S. airline industry has long struggled to make a profit. Analysts point to a number of factors that have made the industry a difficult place in which to do business. Over the years, larger carriers such as United, Delta, and American have been hurt by low-cost budget carriers entering the industry, including Southwest Airlines, Jet Blue, AirTran Airways, and Virgin America. These new entrants have used nonunion labor, often fly just one type of aircraft (which reduces maintenance costs), have focused on the most lucrative routes, typically fly point-to-point (unlike the incumbents, which have historically routed passengers through hubs), and compete by offering very low fares. New entrants have helped to create a situation of excess capacity in the industry, and have taken share from the incumbent air- lines, which often have a much higher cost structure (primarily due to higher labor costs). The incumbents have had little choice but to respond to fare cuts, and the result has been a protracted industry price war. To complicate matters, the rise of Internet travel sites such as Expedia, Travelocity, and Orbitz has made it much easier for consumers to comparison shop, and has helped to keep fares low.
Beginning in 2001, higher oil prices also complicated matters. Fuel costs accounted for 32% of total revenues in 2011 (labor costs accounted for 26%; together they are the two biggest variable expense items). Many airlines went bankrupt in the 2000s, including Delta, Northwest, United, and US Airways. The larger airlines continued to fly, however, as they reorganized under Chapter 11 bankruptcy laws, and excess capacity persisted in the industry.
The late 2000s and early 2010s were characterized by a wave of mergers in the industry. In 2008, Delta and Northwest merged. In 2010, United and Continental merged, and Southwest Airlines announced plans to acquire AirTran. In late 2012, American Airlines put itself under Chapter 11 bankruptcy protection. US Airways subsequently pushed for a merger agreement with American Airlines, which was under negotiation in early 2013.
This case introduces many of the themes of Chapter 2, including the impact that competitive forces have on industry behavior and profitability, concepts about market segmentation and strategic groups, and the changing nature of competition over an industry’s life cycle. One of the most important lessons of this chapter and this case, and one that may be somewhat surprising to students, is the very strong influence that external environments can have on firm performance. Much of what is discussed in the popular business literature focuses on the achievements or shortcomings of individual managers and other forces internal to the firm. But it is worthwhile to remind students that external forces can have just as much impact and can even cause the demise of industries with competent managers.
1. Conduct a competitive forces analysis of the U.S. airline industry. What does this analysis tell you about the causes of low profitability in this industry?
2. Do you think there are any strategic groups in the U.S. airline industry? If so, what might they be? How might the nature of competition vary from group to group?
3. The economic performance of the airline industry seems to be very cyclical. Why do you think this is the case?
4. Given your analysis, what strategies do you think an airline should adopt in order to improve its chances of being persistently profitable?