EXECUTIVE SUMMARY
This report provides an examinaion of the current structure, performance, stragergy and management of Delta Airlines, along with an industry analysis of the airline industry. The report uses current and past financial and statistical data for the company along with other up to date material to determine Delta’s current market position and future potential. The report finds that Delta Airlines has successfully emerged from its bankruptcy in 2005 to report successful returns in both 2007 and 2008.
With its 2008 acquisition of Northwest Airlines Delta became the world’s largest airline, further improving its position in the airline industry. Despite this current positive position report also finds potential adversities faced by Delta in the future due to falling profit margins. This has been mainly attributed to through increasing overheads in particular huge increases in fuel prices and cost associated with the accusation of Northwest Airlines. The report concludes that Delta Airlines should hold its current market position into the future, and produce profitable margins.
It does however acknowledge the potential threat from new entrants to the market, current cut price competitors and increasing overheads as problems that must be overcome in order to achieve this profitability.
INTRODUCTION
Delta Airlines is a United States based airline carrier that has grown to become the world’s largest commercial airline. The airline that was established in 1928 has overcome many adversities to establish itself in the airline industry. Currently it is the only airline to service all six permanently inhabited continents in the world.
The company’s structure and management approach have constantly evolved in order to maintain competitive in the cutthroat airline industry. Despite filing for bankruptcy in 2005 Delta has managed to return to a profitable position and establish itself in a position to continue to be a major player in the commercial airline industry well into the future.
COMPANY STRUCTURE, CONDUCT & PERFORMANCE
Background The airline industry in the United States has experienced significant changes in the spatial configuration of networks since the Airline Deregulation Act of 1978 (Lee, Chen and Shaw, 1995).
Attempts have been made to study the structure of the market forces of the hub and spoke network in the airline industry. Due to competition from low-cost airlines, the negative effects of 9/11 on travel and skyrocketing fuel prices, the company held over $20 billion in debt as of September 2005 and declared bankruptcy. Delta was able to emerge from bankruptcy in 2007, achieving a profit in the same year. In April 2008, Delta announced its intention to purchase Northwest Airlines; the two companies combined would create the world’s largest airline (Gayle, 2008).
Market Structure Delta competes in the increasingly unattractive airline industry. While there are many variables in the airline industry, it is also a business where the end product is essentially the same regardless of which airline provides the services. It does not matter whether you fly on a Delta or United jet. This fact makes it imperative that each airline attempts to find those traits on which the other airlines may need improvements in and then trying to take advantage of the situation by setting itself apart from its competitors.
The market structure for airlines is an oligopoly. This means that there are only a handful of companies that compete in this industry. Oligopolies are more competitive than monopolies, industries for which there is only one seller of the product, but are less competitive than industries that experience near perfect competition. Oligopolies are industries where set-up costs are extremely high, so people can’t just enter the market even if there’s money to be made in the industry. Attempting to commence a new irline in competition with United or American would be extremely difficult.
On October 29, 2008, Delta acquired 100 percent ownership of Northwest Airlines and is in the process of fully integrating Northwest into the Delta family. The Northwest brand is gradually being phased out and being replaced by Delta’s name and brand. During the integration period, Delta and Northwest will continue to operate their own branded aircraft until the integration process is complete. This has given delta a combined market share of approximately 18% (Gayle, 2008)
Effects of Market Structure In the United States there are generally two types of airlines: “legacy carriers,” which are defined as airlines that specifically operated interstate routes prior to the Airline Deregulation Act of 1978, and “low cost” airlines that compete solely on the basis of offering the lowest price per ticket within the market in which they are operating Market conduct Market structure can be defined as patterns of behaviour by enterprises in an effort to adjust to the markets in which they operate (buy or sell).
Pricing strategies and collusive behaviour mergers are a few dimensions of market conduct. It is the industry norm for a legacy carrier to offer service to most popular destinations; Delta reducing routes to a similar schedule as the low-cost airlines is not an option in the multi-billion dollar industry. In order to gain market share from low-cost airlines, Delta must create a value proposition that differentiates itself from its competitors. Many customers will pay a premium if the level of service provided is higher than the low-cost, no-frills alternative.
Delta can use its advantage in the amount of capital over the smaller, low-cost airlines by investing in more comfortable seats, better facilities, and an increase in customer service personnel. Mergers Market conduct, of which market power results, can also be viewed as a way in which the firms behave in order to increase market share. Three different types of mergers can be identified namely, horizontal mergers, vertical mergers and conglomerate mergers. Horizontal mergers occur when firms in the same industry combine.
Vertical mergers occur when firms combine at different stages of the production process. The merger between Delta and Northwest Airlines in 2008 resulted in a horizontal merger, allowing Delta to increase their market share (Journal of Commerce Online, 2008). Financial Summary Delta’s financial summary illustrated in Figure 1, indicates that the company has had a positive revenue growth increase by eight percent in 2007 and fifteen percent in 2008. However, their continual increase in operating expenses is eroding any possibility of a positive operating income.
Although these loses are not acceptable, there is a several contributing factors which have reduced their operating income. Firstly, due to their restructuring plan in 2006, initiated by filing for bankruptcy in 2005, they incurred costs of $6. 2 billion. This did have a flow on effect into 2007 in which they saw a gain of $1. 2billion. Similarly in 2008, Delta suffered a fuel price increase of 30%, which increased their overall operating expenses by seven percent from the previous year.
In addition to the fuel increase, extra costs associated with the Northwest merger in excess of $US1. 1billion were incurred (Delta Airlines, 2009). Key financial and industry metrics illustrated in figures 1 and 2 suggest Delta’s year on year performance is indicating marginal improvement. Their return on assets has operated negatively for two of the last three years and marginally positive for one, indicating they are under utilising their asset base.
Positive improvements in passenger mile yield and passenger load factor may indicate the decline in the asset ratio could be attributed to the acquisition of Northwest. In addition to Delta’s return on assets, the debt to operate in the airline industry is generally high compared to other market indexes (Delta Airlines, 2009). Boyes (2009) describe a firm with negative economic profit as using resources, that if used elsewhere, would generate more value.
Under normal operating conditions a company can sustain negative economic profits over short periods, however for sustained periods it can be detrimental to a company’s existence. In Delta’s case the decline can be contributed to the debt financing required to fund the acquisition of Northwest Airlines. Even though Delta’s economic profit has declined as indicated in Figure 3, their cumulative returns index is in line with the Amex airline index, demonstrating that there is support for the airline (Delta Airlines, 2009).
In summary, Delta’s performance recently has shown signs of improvements, although they have been plagued with increased fuel, merger and restructuring costs which is deflating their net accounting and economic profits. Further improvements could be made by reducing their operating costs and improving the return they are currently receiving on their assets.
STRATEGY & MANAGEMENT
Background
Delta Airlines is a United States based, global air carrier. Since the company was founded in 1928 under the name Delta Air Service, it has experienced considerable growth, with a history of several major mergers and acquisitions (Delta Airlines, 2009). Notable examples of these include the 1972 acquisition of Northeast Airlines, the 1987 acquisition of Western Airlines, the 1991 acquisition of Pan American World Airways’ trans-Atlantic network, and the 2008 merger with Northwest Airlines, which made Delta the world’s largest airline (Delta Airlines, 2009).
The Northwest merger in particular has given Delta Airlines unrivalled global capability, demonstrated by the fact that Delta became the only airline in the world to service six continents with the addition of its Los Angeles to Sydney flights in 2009 (Delta Airlines, 2009).
The Business of Delta Airlines
Delta Airlines is in the business of passenger transportation. This applies to both domestic transportation within the U. S. , and to international transportation.
Domestically, Delta views its competitors as other air carriers, as well as other land-based transportation providers. Internationally, competitors consist of other major global airlines. The airline’s main operating unit, Delta, focuses primarily on high-volume domestic flights, and now, particularly since the Northwest merger, on long-haul international flights. However the scope of these services is broadened due to Delta Airlines’ many subsidiaries, which also provide domestic short-haul, low-density, high frequency flights and regional services.
Customers
The wide-ranging services provided by Delta Airlines, as the world’s largest air carrier, mean that the airline’s current and potential customers are equally diverse. Examples that illustrate this point include the high number of business customers that utilise the airline’s Atlanta to New York, and Atlanta to Washington services, while customers travelling out of the New York hub are more commonly families and leisure-focused travellers (Arnoult, 2004). Again due to the scale of Delta Airlines’ operations, the company’s customer base also differs greatly in their level of price-sensitivity.
For example, business customers flying out of Atlanta may be seen as less price-sensitive, with convenience and accessibility of more importance, while domestic, leisure-based customers flying from the Cincinnati and New York hubs tend to be more price-aware in their search for value (Arnoult, 2004). Delta Airlines is overtly aware of the variety seen in their customer base, and has gone to extensive measures to ensure that they are all being effectively catered to.
This is evidenced by the recent training of 50 “Brand Ambassadors” that were sent to twenty-seven different locations, with the aim of communicating what the Delta Airlines brand is about, and gaining feedback from current and potential customers in this regard (Arnoult, 2004). Delta has also created a new website called Experience Change, where customers can make suggestions as to how the company’s services could be improved (Basulto, 2007). These measures indicate the intention of Delta to remain relevant with its broad customer base.
Costs Delta
Airlines operates their global route network out of 7 hub airports located on the North American continent and hub airports located in Amsterdam and Japan. International and domestic traffic is routed and distributed through these airports to the closest geographic markets. As noted by Bailey, Graham and Kaplan (1985), the hub and spoke network configuration may decrease costs of an airline by achieving economies of scale through the use of larger, more efficient aircraft.
Following the airline’s exit from Chapter 11 bankruptcy in the United States of America in May 2007 and prior to the airline’s merger with Northwest Airlines, several adjustments were made to reduce the airline’s costs. Most notably, Delta Airlines streamlined a consistent use of long range aircraft and more accurately matched aircraft capacity to the markets being serviced (Adams, 2007). As a result of reviewing the airline’s costs during the Chapter 11 period, Delta Airlines reduced the salary of most of its workforce (Adams, 2007). Both the strategies concerning aircraft utilisation and Delta Airline’s salaries were devised with the objective of reducing the airline’s costs.
Fit
The structure of Delta Airlines has been devised to compliment their business strategy. According to Delta Airlines (2009), their core strategies are based on ensuring long-term profitability and careful capital management to ensure a sustained presence for their customers and employees. The organisation’s strategies focus on providing a strong commitment to customer service and delivering a premium customer experience.
These strategies are echoed through the structure and operation of the airline. Contrary to the operations of low cost competitors, Delta Airlines focuses on providing a value focused service to the market. To maintain competitive pricing and protect the airline’s profits from external economic factors, diversification of revenue sources is employed. The airline diversifies its revenue streams through their cargo transportation operations, frequent flyer program and our aircraft maintenance, repair and overhaul business (Delta Airlines, 2009).
Barriers to Entry Delta
Airlines employ strategies to reduce the ease of entry of new competitors into the marketplace. The airline capitalises on economies of scale that exist in the organisation. The company’s maintenance, repair and overhaul operations enable the airline to efficiently service and maintain their aircraft fleet. As noted by Al-kaabi, Potter, Naim (2007), maintenance costs are a significant component of an airlines operating expenses. New entrants to the market would not experience the same economies of scale for the maintenance of their fleet.
The SkyMiles frequent flier program is an example of Delta Airlines using product differentiation to create a barrier to entry. Delta Airlines state that the SkyMiles program provides “incentives to increase travel on Delta” (Delta Airlines, 2009, p. 47). Although the cost of maintaining and delivering the SkyMiles program is considerable, customer loyalties are developed through consumers fearing loss of benefits for inactive loyalty accounts. This strategy results in consumers electing to continue transacting with Delta in order to build their mileage credit.
Cost advantages are experienced by Delta Airlines and contribute as a barrier to entry for new market entrants. The airline has established relationships with airports around the world and is able to collect data on the most profitable routes on their network for a significant period of time. As noted by Obeng (2008), Delta had been able to identify the profitability of a direct route between two US cities and therefore determine the elasticity of the market in order to maximise profit.
INDUSTRY ANALYSIS
Industry Background
The structure of the airline industry has a strong influence on Delta Airlines’ performance. In recent years, the airline industry has seen its fair share of turbulence with rising jet fuel prices and increased competition. There are five driving forces of competition; Industry Competitors, Potential Entrants, Buyers, Suppliers and Substitutes (Porter, M. , 1980. p 3-29). This section will focus on Porter’s 5 generic forces and relate them to the operations of Delta.
Direct Industry Competitors
There are underlying factors that can influence competition, which include fuel, labour, costs, events, and seasons. By identifying these factors and its competitors, Delta can significantly reduce costs and increase its focus on identifying risks. Short of disruptive innovations, Delta must recognize its need to grow in order to conquer its competition. The international airline industry is extreme in its efforts to price cut, however the overall industry has very little motivation to tighten its return on sales.
Four airlines from the above table were specifically identified as comparable competitive substitutes to Delta; United Airlines, American Airlines, Continental Airlines, and Northwest Airlines (prior to the merger with Delta Airlines). These airlines displayed similar characteristics that drove them to operate domestic and international air travel services. Domestic high volume carriers often have lower operating costs, as they are not carrying the high cost of infrastructure and capital equipment associated with larger global operators, such as.
Airlines typically experience low marginal returns from low density, frequent flights, on both international and domestic routes. Delta alleviates this through the development of strategic alliances and code share arrangements, which enable greater returns for collaborating airlines. However, Delta’s uccess is threatened by competitors who also form strategic alliances that improve their operating costs and provide access to new routes, where barriers to entry previously existed (Porter, M . 1985).
To gain a greater competitive edge, Delta has also diversified its revenue stream. Since merging with Northwest, Delta has gained economies of scale through servicing approximately 800 aircraft within its own fleet and 125 aviation and airlines customers through its Maintenance Repair and Overhaul service.
Delta also competes in Domestic and International Cargo Carriage and is currently the largest US passenger airline cargo carrier (based on revenue). (Delta Airlines, 2009).
Potential Entrants
High barriers to entry exist within the airline industry. These barriers include high cost of capital equipment, leasing, information technology and the operation of loyalty programs. There is also necessary investment in “illiquid” assets such as aircraft, terminal facilities, lease negotiations and advertising, indicating exit high barriers due to large sunk costs.
Further barriers to entrants exist through Airline strategies like customer loyalty programs e. g Delta’s SkyMiles. These require significant start up, advertising and maintenance investment including accrual for the potential of customers to redeem points. The airline industry is also a low growth market crippled by global recession and fluctuating fuel prices. Price competition is also an issue, thus eliminating any opportunity to recoup increased costs through pricing. This creates a reliance on scale and efficiency to deliver profit.
Technological advancement in e-ticketing is just one example of how Delta has improved its efficiency in line with competitors. However, the development and implementation of innovative technology to reduce operating costs requires continual investment by the airline. Existing airlines may choose to enter the market by gaining access to new routes. This is made possible through changes in government legislation and the opening of “new slots”. Creating alliances through code sharing is another example of how Delta’s competitors may increase market share.
Entry is easier for existing airlines because they already have access to required routes, landing slots and airport infrastructure through contract and lease negotiations. With this in mind, there are a few airlines attempting to enter the American domestic air travel industry. One of these firms is Disney; with guidance from Disney’s already successful travel lines. Other airlines include Brazilian Airlines Azul and Germany’s Lufthansa. There have also been talks of Air France and British Airways making regular flights from domestic cities in America to other American cities.
New entrants are always a threat to Delta’s current market share. The more airlines there are the lower prices will be due to competitive forces that drive prices down. Buyer inclination to specific airlines will become more important to the overall strategic success of Delta.
Buyers Power
The overall bargaining power presented to airline passengers is weak to moderate. Many factors contribute to this including;
- Costs: Switching tickets from one airline to another are high.
- Ticket prices: Airlines set prices without allowing consumers to barter on price.
However, buyer power has increased through the introduction of innovative ticketing websites in recent years, like Travelocity and Kayak. Rather than searching by luxury amenities (such as fully reclining seat-backs), nearly all consumers search on price, thus increasing price competition. Contrary to this trend, Delta has introduced low fares that can only be found on its website requiring customers to buy tickets direct (Baer, 2008). Whilst this has not increased buyer behaviour, it has enabled a reduction in power of travel agents and wholesalers.
Economic conditions can affect a consumers buying power, as evident in 2008. Due to the global economic environment, consumer demand decreased, negatively affecting Delta’s profitability. To compensate, Delta reduced capacity by 5% to improve forecasted profit. This involved the reduction of the aircraft fleet by 31 aircraft and an 8% reduction of pre merger workforce (Delta Airlines, 2009). The reduction in capacity was a strategy to reduce costs and to alleviate pressure on price through the demand shift that had resulted from the reduction in average household income and lowered levels of consumer confidence.
Supplier Power
There are five main supply lines that influence Delta. These include, fuel costs, aircraft supply, insurance companies, credit providers, and the Government. Delta has limited power to control fuel prices; fuel is bought and sold in the “spot market”. Fuel prices accounted for 38% of operating expense in 2008 for Delta airlines, increasing from 31% in 2007 and 30% in 2006; partly due to adverse fuel hedging (Delta Airlines, 2009). There are two main aircraft suppliers, Boeing and Airbus.
Together they control almost 92% of the aircraft design and construction market. This situation creates little rivalry and a lack of industry intensification, so the supply side of the aircraft is quite rigid. The ability for an airline to switch suppliers is limited. In Europe the aircraft supply market is more attractive; but unfortunately Delta is restrained from gaining suppliers across borders (due to current instability of the U. S. dollar). Delta manages its limited supply market by engaging in maintenance, repairs and overhaul.
This enables the company to achieve lower costs and greater economies by providing services beyond its own fleet. Vertical integration with Boeing or Airbus is another way to manage the supply market. Although Airbus and Boeing openly state that their core competencies have no infusion with actually flying (News Blaze, 2008). Delta still needs to consider all options for any type of integration, whether vertically through suppliers or horizontally through consolidation. Provision of insurance is an additional example of supplier power, post September 11 insurance premiums escalated significantly.
Delta Airlines has been insulated from the increased cost of insurance through US government provided subsidies, however the subsidies are due to expire in 2009, potentially exposing the airline to greater costs. Suppliers of credit to the airline industry have power to restrict the provision of credit, which has the ability to impact Delta’s cash flow, threatening its operations. Government and local aviation authorities and airports also operate as suppliers in the airline industry, controlling and negotiating access to routes, landing slots and the pricing of landing fees.
The providers of airport infrastructure for cargo facilities, ground facilities, maintenance sites, offices, terminal space, and ticket counter negotiate contracts and leases, subject to normal laws of supply and demand. When hubs and routes are competitive, airlines are subject to potential increased costs through renegotiation as leases and contracts are expired or renewed.
Availability of substitutes
When the price of air transportation increases to an extent that it represents too large a portion of a consumer’s income, it is likely the consumer will substitute a different transport mode to meet their needs.
Additionally with technological advancement and increased efficiencies in modes of transportation, greater threats to the airline industry present themselves. Possible substitutes are railway, ocean vessels, and motor vehicles. With price-performance tradeoffs in mind, ocean transportation is limited in its appeal, as it lacks the advantage of speed in transatlantic crossings. This leaves railways and motorized transportation. These two modes have always been substitute options for air travel.
With oil prices increasing at a regular rate and even more so jet fuel costs increasing, both airlines and road transportation seem increasingly unattractive for business or pleasure travel (Evans and Kessides, 1994).
Conclusion
Delta Airlines is the world’s largest passenger carrier. For the past three decades Delta has experienced great change within the airline industry. The company has weathered deregulation, heightened fuel costs, increased competition, crippling debt lines, and the aftermath of September 11. Despite such adversity, Delta has emerged stronger and continues to plan for success in the future.
This is evident by the increase in revenue growth seen in 2007 and 2008. To stimulate this growth Delta has implemented a variety of strategies including, better services and facilities on board flights, increased aircraft capacity following the merger with Northwest, improved alliances, code-share agreements, the SkyMiles program, and finally diversification of revenue streams like cargo. Delta Airlines is on track to hold its market share, but management should also consider the threat of new entrants to the market, the availability of substitutes, and supplier power to ensure success in the future.
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