Analysis of the United States Airline Industry
Abstract1
1. Introduction1
2. Impact of the Aviation industry on the American Economy..2
2.1 Economic Impact due to Airline Expenditure Categories.3
2.2 Airline Economic Impact due to Employment .5
2.3 Airline Industry Exports6
3. United States Airline Industry Market Structure 7
4. Strategies of Companies in American Airline Industry.10
4.1 Hub-and-spoke structure10
4.2 Pricing Strategies10
4.2.1 Price Discrimination.11
4.2.2 Advance Purchase Pricing11
4.2.3 Peak Loading11
4.2.4 Cumulative Volume Pricing11
4.2.5 Risk Sharing12
4.2.6 Bundled Pricing .12
4.3 Mergers12
4.4 Low-cost Carriers.12
5. Evaluation of Southwest Airlines..13 6. Conclusion.14
7. Bibliography..15
Abstract
The United States airline industry holds a vast share of the total global airline market. The enactment of deregulation saw dozens free entry and exit into the market. The industry grew and encouraged competition resulting in more affordable flight fares and also had a great impact on the economy. To get a better understanding of the effect on the economy, we break down the impacts, according to the industry expenditures, employment and exports in detail.
Although the deregulation of the company was meant to make the industry a perfect competition market, the industry through mergers and filing of bankruptcy by small airlines has grown into an oligopoly with instances of monopoly market structures being observed in certain environments. For companies to compete in the industry, they have to employ various strategies to attract consumers and get revenue. An analysis of one firm shows how the airline’s strategy aligns to the strategies employed generally in the industry.
1. Introduction
The international airline industry consists of over 2000 airlines, with over 23,000 aircrafts, providing transport services to over 37,000 airports all over the world. The global airline industry flew 28 million scheduled flights, carrying over two billion passengers to every corner of the world. This has made the industry be a major economic force in the global economy. The industry is growing rapidly with its revenue doubling over the past decade. According to International Air Transport Association, the industry’s revenue grew from $ 369 billion in 2005 to $ 746 billion in 2015 with a net profit of $ 29.3 billion observed.
The United States of America airline industry holds the largest share of the international airline industry. The country has over 100 certified airlines, operating over 11 million annual flights carrying approximately one-third of the total air traffic globally. This can largely be attributed to airline deregulation in the country that encouraged competition and an increase in service delivery leading to the growth of the industry. Five of the top fifteen airlines in the world come from the United States.
These factors have made the country’s industry generate $ 15.7 billion in profit last in 2015, that is over half of the global profit. The industry has contributed greatly to the economy of the country not only through its direct effects but also through indirect effects to other industries like tourism, airports and aircraft manufacturing industry.
2. Impact of the Airline Industry on the American Economy
In addition to providing transportation services and increasing accessibility between different parts of the world, airline industry also plays a vital role to the nation’s economic performance because it encourages economic output, attracts businesses, retains jobs and creates employment opportunities through direct and indirect expenditures known as primary impacts. The primary impacts associated with the industry include airline and airport operations, aircraft manufacturing and related operations, air couriers, visitor expenditures and travel arrangement costs. The impacts are entered in the Regional Input-Output Modeling System to produce estimates of induced impacts. Induced impacts also known as secondary impacts consist of spending by individuals and businesses who receive revenue related to the airline industry either directly or indirectly.
The airline industry contributed to 5.6% of the nation’s GDP. With the value of the contribution to a different state’s GDP varying from 17.9% in Hawaii to 0.4% in Delaware. The output related to the industry differs from one state to the other due to population and overall economic activity. The states that have the highest GDP contributions after Hawaii are Nevada at 12.1%, Arizona at 7.9%, Alaska at 7.5%, and Florida at 7.2%.
All these states are popular tourist destinations with most tourists travelling by air and spending on hotels and entertainment. Not all contributions to the economy are tourism related, for example Alaska apart from being a popular tourism destination has a unique size with logistical challenges making it necessary for residents to rely on air transport for travel, mail, medical services and other staple needs. The state of Washington has a large Boeing manufacturing company and Fedex Company has its headquarters in Tennessee. These two enterprises have generated 52% and 50% to each of the state’s overall aviation-related economic activity.
2.1Economic Impact due to Airline Expenditure Categories
Visitor expenditures by travelers using air have made the largest single portion contribution to the total economic impact due to the airline industry. The visitor spending accounted for $671 billion of the U.S economy. The states that contributed the most to this figure are California, Illinois, New York, Texas and Florida that generated $12.1 billion. These states have some of the busiest airports and are popular business and tourism destination.
Airline operations are the second largest contributors to aviation-related economic impacts. These are all expenditures relating to air transportation of passengers and cargo on commercial airlines. The airlines had a total output of $ 373.9 billion due to these expenditures. On the other hand, airports accounted for $ 73 billion of the country’s economy. General aviation had a total output of $ 39.3 billion with the state of California ranking first at $ 3.6 billion. Aviation related manufacturing output had a 15.5 % increase to $ 250.9 billion from 2009 to 2012.
The final category is the Air couriers’ category that contributed to 14% of the total airline industry output to the economy. The express air cargo has become an integral part of daily life for companies and individuals alike. Air couriers are involved with providing quick and reliable air delivery services of letters, packages and parcels mostly under 100 lbs to their customers to every corner of the United States. Tennessee and Kentucky have the largest economic outputs due to this expenditure since they are home to Fedex and UPS respectively.
2.2 Airline Industry Economic Impact due to Employment
The airline industry’s direct, indirect, induced and enabled impacts provided a total of 11 million part-time and full-time jobs amounting to $ 459 billion in labor income as wages, salaries and benefits. This generated $ 1.5 trillion and $ 807.1 billion to the output and GDP of the United States economy. The airline industry has a total of 376,000 employees working for the airlines; the tourism sector has 242,000 jobs arising from visitor expenditure and visitor travel arrangements, and the aircraft manufacturing sector having 102,000 jobs. The industry also has impacted other sectors of the economy through indirect and induced impacts as shown in the table below.
In 2014, the airline industry exported $ 43.7 billion in air travel that was a new all-time high that fueled an eighth consecutive yearly air travel trade surplus. The travel and tourism sector that includes air travel reached a record of $ 220.6 billion that was equal to 31% of service exports and 9% of all exports. This was greater than other sectors like agriculture and automotive industries.
3. United States Airline Industry Market Structure Analysis
Prior to the 1978 deregulation, the American airline industry was heavily regulated. The Civil Aeronautics Board (CAB) regulated travel routes and fares that are guaranteeing airlines a 12% return on flights that were more than half full (Morris, 2013). To ensure the return, the CAB had to limit competition by approving only 10% of all applications for new routes. After the deregulation act become law, CAB ceased to control the entry and exit of airlines in the market, transport fares and flight schedules. This led to dozens of new airlines entering the market, creating multiple choices for consumers, causing fares to plummet creating a perfect competition market structure. Between 1978 and now over 150 airlines joined the market as compared to only 10 airlines that were available during the regulation period. With most of the new entrants going out of business and some seeking bankruptcy for protection.
The airline industry in America currently comprises of network, regional and low cost airlines. Network airlines were in operation before the deregulation and have hundreds of aircrafts and thousands of employees, supporting complex hub-and-spoke operations. The network airlines serve both international and domestic routes at various fare levels with 40% of their revenue coming international service. Low-cost airlines gained entry into the market after deregulation and have fewer types of aircrafts serving cheaper point-to-point service. Low-cost airlines are just beginning to venture into the international market with flights to the Caribbean and Latin America. There are also airlines known as ultra-low-cost that provide transport services to leisure destinations at discounted prices, but with high optional fees for checked baggage and carry-on. Regional airlines operates small aircrafts of up to 100 seats and generally handle services to small communities under capacity purchase agreements with network airlines. The regional airlines operate 50% of domestic flights, carrying 22% of all passengers.
The U.S airline industry after deregulation has been characterized by extremely volatile revenue generation. Factors such as changes in fuel prices, the financial crisis and economic recession that occurred between 2000 and 2009 saw many companies file for bankruptcy or seek mergers. The mergers made four airlines that include; Southwest, American, Delta and United hold a 60 % share of total passenger traffic in the country’s airline industry. This results in the airline industry market being oligopolistic. There is just the general picture; further analysis into the market structure shows a more disturbing scenario.
The market structure analysis was performed using data the United States Department of Transport. The assessment consisted of 10% quarterly sample of all tickets sold in approximately 91,000 U.S markets with passenger traffic between 2007 and 2012 when most mergers were completed. To ensure statistical accuracy, data from small markets of less than 1,040 round trip passengers or 520 one-way passengers and also data from Hawaii and Alaska were excluded. Most of the data used came from the relevant city pair market that is metropolitan areas. Since certain routes carry more passengers than others; the routes are grouped into quintiles, with the first quintile being the largest markets and the fifth quintile being the smallest markets.
The study showed that the average number of effective competitors in the first quintile ranged from 4.3 to 4.5 each year, the second quintile showed an increase in the average number of competitors from 3.7 in 2007 to 3.9 in 2012. The fifth quintile that represents the smallest markets saw a decrease in the average number of competitors between 2007 and 2012 from 3.3 to 3.0. The research also showed there existed monopoly situations in 77 % of the total markets, especially in the least travelled-routes that is because the routes are much easier to control.
4. Strategies of Companies in American Airline Industry
All airlines must have a continuous strategy in place to enable them compete and remain relevant on today’s ever-changing and challenging environment. Deregulation had an enormous impact on the strategies employed by airlines because airlines gained the power to change fares in response to demand and competition, plan their schedules, develop networks and manage other relevant aspects associated with the business. To come up with effective strategies, companies must understand their customers. For example, business travelers are strict on flight times and expect high standards of service with long-haul business travelers being less sensitive to ticket prices than short-haul travelers. Leisure travelers care more about price than levels of service. Although there are various strategies used in the airline industry, the most important one is pricing.
4.1 Hub-and-Spoke Structure
Most of the airlines arranged their route maps using the hub-and-spoke network structure. In this structure, an airline concentrates most of its operations in one location known as the hub that is used to connect all other cities. This strategy enables airlines to utilize the economies of scale by sitting passengers heading to the hub in one big plane that is usually cheaper to fly on a per-seat basis, labor and maintenance costs also reduce.
4.2 Pricing Strategies
Competition in prices is inevitable in the airline industry and is the optimum goal of the competitive struggle between different airlines. For this reason, airlines have come up with creative and vigorous methods to try and outdo each other.
4.2.1 Price Discrimination
This strategy involves differing price elasticity of demand among distinct consumer groups segmented on the basis of their personal characteristics. This requires separating the passengers on the basis their price elasticities and adding restrictions on the purchases of their tickets. These restrictions include; maximum and minimum stays, advance purchase requirements, round trip-travel requirements, day and time of departure and return, indirect and one-stop direct routings.
4.2.2 Advance Purchase Pricing
This involves reducing the price of the ticket by a certain percentage when passengers are willing to commit their financial resources well in advance of service delivery. This allows airlines to efficiently predict the traffic volumes and plan for plane size and other variables.
4.2.3 Peak Load Pricing
Air travel demands have peak and trough periods with peak periods characterized by congestion in the airport and airline capacities fully utilized and sometimes even excess capacities are observed. To shift some off the demand to off-peak periods, the airlines offer discount on fares of flights flying at this time. This enables airlines to increase revenue during off-peak periods and reduce costs during peak-periods.
4.2.4 Cumulative Volume Pricing
This is a plan where frequent passengers are granted free flights or partially discounted fares on future flights on the basis of the accumulated travel mileage on that airline. This encourages customer loyalty and repeat business.
4.2.5 Risk Sharing Pricing
This strategy involves a policy of non-refund or partial refund on fares in the advent of changes in travel plans or an extra fee is charged on the changes. This makes the airlines averse any loss in revenue associated with changes in passengers’ travel plans because it is expected that most consumers will avoid any costs associated with changes in their travel plans.
4.2.6 Bundled Pricing
First class fares exceed coach fares by huge margins and has benefits such as wider seats, free beverages, better services and more leg room. For a passenger to purchase first class tickets, the passenger must have seen the benefits exceed the incremental fee. The airlines have noted this and have bundled additional services with the purchase of these tickets and charged a premium for it. The services may include holiday packages, car rental and hotel accommodation that are cheaper when bought with the airline tickets.
4.3 Mergers
Small airlines that cannot withstand the competition in the oligopoly market have been annexed by the major airlines. Even some major airlines have merged this past decade; an example is the merger between American Airlines and United Airways. The mergers have been successful and new airlines have enjoyed profits afterwards.
4.4 Low-Cost Carriers
Low-cost carriers’ emergence and rapid expansion seem to be an effective way to gain a share of the distorted power of well-established airlines. The airlines are affordable to most people and operate in most parts of the country.
Evaluation of South West Airlines
In 2005, South West Airlines signed a code sharing agreement with ATA that later filed for bankruptcy in 2008, with South West Airlines buying its assets and operating certificate. In 2010, South West airlines acquired AirTran Holdings at a cost of $ 1.4 billion. This acquisition was beneficial to the company’s earnings with AirTran having the potential to yield net synergies of $ 400 million every year.
South West airlines position itself as the only high frequency point-to-point, and short-haul airline in America that is fun to fly in. The airline has transformed the interior of their cabins with Evolve, free live Television and Wi-Fi connections. This has made the company have a strong customer base with up to 52,119 daily reservations.
The low-cost carriers of Southwest airlines also took 15% of the domestic market shares from the major airlines making it a major threat to these airlines. The airline had passenger revenue per available seat mile (PRASM) of 12.83 cents in 2013 from its low-cost carriers that are characteristics of these carriers to have low PRASM. This led to the company generating $16.7 billion in revenue.
Unlike other airlines, South West airlines does not rely on travel agents for the distribution of their products, rather bookings are done directly by phone or through their website. The website contains all fare structures, including low, unrestricted, daily coach fares and frequent flyer grants. Their pricing is relatively lower and is built for different demographics. The airline rewards customers on number of trips taken and not the mileage flown like other airlines. South West airline does not also assign seats in their flights making them turn planes quicker at the gate. Other advantages of using the airline are that they provide two free luggage items per customer and allow their passengers to fly from any airport. South West airline employs resources to both print and television to encourage people to visit their website and see their offers.
Conclusion
The airline industry in the United States of America has over 100 airlines. All these industries contribute to various sectors of the economy through primary and secondary effects. The industry has become quite competitive with all the companies trying to come up with strategies to make them have an edge over the others. This has led to some of the companies filing for bankruptcy or merging with others in a bid to realize profits or have a greater hold of the market. The remaining airlines have to plan continuously and vigorously to attract customers and remain relevant in the industry.
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