Five Forces:

Analysis of US Airline Industry

Abstract:

The model of the Five Competitive Forces was developed by Michael E.

Porter and published in his book, Competitive Strategy: Techniques for

Analyzing Industries and Competitors, in 1980. Since that time, it has

become an important tool for analyzing competitive forces in the industry

environment. This model focuses on five forces that shape competition

within an industry: (1) the risk of entry by potential competitors, (2) the

intensity of rivalry among established companies within an industry, (3) the

bargaining power of buyers, (4) the bargaining power of suppliers, and (5)

the threat of substitutes to an industry’s products.

Porter’s model is based on the insight that a corporate strategy should

meet the opportunities and threats in the organization’s external

environment. Specifically, competitive strategy should be based on an

understanding of industry structures and the way they change. Porter’s five

forces determine the intensity of competition; and more specifically, the

profitability and attractiveness of an industry. The objective of corporate

strategy is to modify these competitive forces in a way that improves the

position of the organization.

Question:
Using available research tools conduct additional research on Porters Five

Forces Model and apply this model to the Airline Industry circa 2009.

Threat of New Entrants:

At first glance, you might think that the airline industry is too

expensive to attract many new entrants, but don't be fooled. In the United

States, deregulation of the airline industry in 1979 allowed twenty-nine new

airlines to enter the industry between 1979 and 1993 (Hill, 2008). If

borrowing is cheap, then the likelihood of more airliners entering the industry

is higher. New entrants must analyze whether there are substantial costs to

access bank loans and credit. This becomes the balancing point for a new

entrant’s decision to enter or not. One thing is certain, the more new airlines

that enter the market, the more saturated it becomes for everyone.

For example, new-comer Southwest Airlines has come to dominate

domestic air travel in the United States. The success of Southwest

encouraged other low-cost carriers, notably AirTran and JetBlue, to enter the

market. Their overall success led to a survival crisis for legacy airlines. Three

of these airlines (United, Delta, and Northwest) were forced to seek chapter

11 bankruptcy protections. (Hill, 2008)

Power of Suppliers:

The airline supply business is mainly dominated by Boeing and Airbus.

For this reason, competition is not strong among airplane/jet suppliers.

Moreover, the likelihood of Boeing or Airbus integrating vertically isn't very

likely. In other words, the suppliers will not add flight services to their

existing business structure.

However, fuel is a major strain for airlines. If supplier prices spike, it

causes a huge financial wave for the industry. For example, the industry

would have been profitable in both 2005 and 2006 were it not for surging jet

fuel prices after January 2004 (prices for jet fuel more than doubled between

2004 and 2006). Instead, in 2006 the industry lost $ 1.7 billion, an

incremental improvement over the $ 3.2 billion lost in 2005. The

International Air Travel Association estimates that the fuel bill for all airlines

in 2006 was around $ 115 billion. This represented over 25% of the

industry’s total operating costs in 2006, compared to less than 10% in 2001.

Oil has now fallen to around $43 a barrel, but not soon enough to prevent

American carriers from posting what the trade group predicts will be $3.9

billion in losses for 2008. This year, North American airlines should claw out a

$300 million profit, but the margin will be less than 1 percent, the report

said. (Brothers, 2008)

Other suppliers who work with the airlines such as the providers of

onboard snacks do not have the same bargaining power as fuel or airplane
suppliers. The airlines will purchase their onboard snacks from the supplier

which is the most economical. This helps to make a higher profit margin from

the goods when they are sold.

Power of Buyers:

Customers can place a great deal of pressure on a business, thus,

affecting its prices, volume, and profit potential. In the United States, most

airlines are competing for the same customer, which results in strengthening

their buyer power. Many choices are available when choosing an airline, but

price is usually the most important factor. Therefore, buyers search for the

best deals available. Before the internet, buyers relied on travel agents or

contacted the airline directly. There was no price comparison. Now, the

internet has allowed price sensitive customers to shop for bargains. Also, the

buyer can search for direct flights. This has put a strain on airlines that use

the “hub” model. (McCabe, 2006)

Buyer power is a major part of the success of budget airlines. Their

strategy gives them a 30 to 50% cost advantage over traditional airlines. The

budget airlines all follow the same basic script: They purchase just one type

of aircraft. They hire nonunion labor, and cross-train employees to perform

multiple jobs, like pilots help check tickets at the gate. (Hill, 2008)
Availability of Substitutes:

Substitutes for air travel include travelling by train, bus, or car to the

desired destination. The degree of this threat depends on various factors

such as money, convenience, time, and personal preference of the travelers.

The competition from substitutes is affected by the ease with which buyers

can change over to a substitute. A key consideration is usually the buyers

switching costs; however low fare, non-stop flights can lure both price

sensitive and convenience oriented travelers away from these substitutes.

Some airlines, like Southwest, have actually joined forces with its substitutes,

such as car rentals and hotel to offer tour packages. (Five Forces Driving the

U.S. Airlines Industr, 2008)

Still, regional airlines have a higher level of substitution threat than

international carriers. Some incentive programs, like frequent flier points,

have been added to curve substitutions. An airline with a strong brand name

and incentives can often lure a customer even if its prices are higher than

the substitute.

Competitive Rivalry:

The airline industry is usually characterized by the cut-throat

competition that exists among the rival airlines due to its low-cost nature.

Since the carriers are involved in a constant struggle to take away the
market share from each other, the rivalry is increased. Buyers often switch

between airline companies depending on price. Fixed costs also influence

rivalry.

Much of the cost of a flight is fixed; there is a great opportunity for

airlines to sell unsold seats cheaply. This results in pricing wars between the

airlines (Hubbard, 2004, pg 38). The airlines are continually competing

against each other in terms of prices, technology, in-flight entertainment,

customer services, and many more areas. The net result of this competition

between companies is an overall slow market growth rate. This explains why

the potential for returns is so low in this industry.

References

Brothers, C. (2008, December 9). Airline Losses Expected to Be Smaller in

’09. Retrieved from website:
http://www.nytimes.com/2008/12/10/business/10air.html?_r=1

Five Forces Driving the U.S. Airlines Industry. (2008, June 23). Retrieved
October 28, 2009, from website:
http://findarticles.com/p/articles/mi_m0EIN/is_2008_June_23/ai_n27504119/?
tag=content;col1

Hill, C. & Jones, G. (2008, October 13). Essentials of Strategic Management,

2nd Edition. South-Western, Cengage Learning

Hubbard, G. (2004). Strategic Management: Thinking, Analysis & Action.

Australia, Pearson

McCabe, R. (2006). Airline Industry Key Success Factors. Retrieved

October28, 2009, from website: http://gbr.pepperdine.edu/064/airlines.html