Published in March 2016 issue

By Dr. Scott Ambrose

As anyone involved in it knows too well, the record profits of recent years do not make the US airline industry immune from a financial meltdown. And so the question looms: will it fare any better the next time the economy takes a turn for the worse? In fact, concern over global airline stability was the focus of the world travel conference held in Singapore in 2010. IATA, the conference sponsor, sought to develop future goals for the industry, calling the resulting report Vision 2050. Renowned strategist Michael Porter, of the Harvard Business School, used his popular five-force framework to provide a sweeping diagnosis of airline woes. This assessment tool, which can be applied to any industry, measures individual companies’ relative strengths vis-à-vis suppliers, customers, substitutes, potential for new entrants, and, most importantly, the intensity of the rivalry among existing competitors.

Of the five forces, the most telling aspect of the overall industry health is often the nature of the competition among existing rivals. According to Porter, industries typically suffer low returns when several actors of comparable size and capability coexist. Factor in the volatility of demand and an industry prone to excess capacity, and you get a recipe for cutthroat competition and disastrous prices wars. Sound familiar? One remedy in such cases is industry consolidation. And this is exactly what has occurred.

In 2005, there were nine major US carriers. Currently, there are four. The result has been capacity restraint to a degree never seen before in an upswing—drawing rare praise from Wall Street and the ire of regulators. Even the once maverick Southwest Airlines has recognized how fundamentally the industry has changed. The fourth-largest airline in terms of revenues, Southwest was recently chronicled in Fortune for changing its competition strategy to be more like that of the traditional carriers. It does not want to fall victim to one of Porter warnings—‘getting stuck in the middle’— by facing costs increasingly similar to those of the legacy carriers while lacking their ability to capture premium Business travelers.

At the time of the IATA report, consolidation was well underway, if far from certain. Since then, airlines have sought to gain more favorable positions with respect to all of Porter’s dimensions and in many other ways not anticipated by the Vision 2050 report. For instance, in 2012, Delta enacted a vertical integration strategy by purchasing the Trainer oil refinery in the hope of gaining more control over the industry’s most volatile input cost. Delta has also been innovative with its largest supplier—labor—by enacting a profit-sharing program that seeks to better align employee interests with company profitability.


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US carriers have made what perhaps is their biggest strategic push by regaining much-needed bargaining power with customers. The proliferation, in the early 2000s, of online travel sites, which enable side-by-side price comparisons, gave passengers considerable bargaining power. Several carriers countered with product unbundling: charging passengers à la carte fees for checked bags, assigned seating, and priority boarding, among other things, which were once part of the bundled price. These tactics have provoked strong criticism from many customers; yet, they have enabled airlines to more finely segment customer groups. Following a classic ‘benefits sought’ marketing strategy, airlines have increased their revenues while enabling passengers to vote with their wallets for additional amenities. Contrary to previous thinking, which viewed consumers as being only willing to pay for ticket flexibility, the airlines have captured billions in ancillary fees over recent years. To further entice additional spending, legacy carriers have begun to match loyalty rewards to dollars spent, as opposed to miles flown.

The decision on whether to bundle or unbundle has even created a meaningful source of differentiation among carriers. Southwest and Spirit have, in fact, incorporated opposing views in the bundling debate into their core branding strategies—decisions that would not easily be reversed. Consolidation has also specifically helped US airlines to regain some much-needed bargaining power over the highly concentrated global distribution systems (GDS).

On a more sobering note, legacy airlines remain highly vulnerable to discount ones, especially the new breed of ultralow cost carriers (ULCCs), which appear to be more than willing to exploit the vacuum created by consolidation. The adoption of online meeting software, improving as it is with technology, poses a credible threat as a substitute for travel. As the 2010 IATA report concluded, the long-term viability of the industry cannot be assured without significant changes in government regulation. Still, one can argue that the US airline industry has changed more during the current business cycle than at any point since deregulation. Will it be enough to weather the next economic downturn? Only time will tell.

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