How Can British Airways Increase Profitability?
How Can British Airways Increase Profitability?
Introduction
This piece of coursework will consider how British Airways might seek to improve its profitability in the context of economic concepts and theories and the following operating environment: -
* Regulatory constraints, subsidies, exchange rates and barriers to entry applied by the UK and other foreign Governments on its operations and those of its competitors
* The elasticity, or otherwise, of demand and supply in a volatile market place
* The globalisation of markets, and the impact on BA's sources of customers and its competitors
* The impact of national economic performance on the Firm
* Issues of competition, monopoly and market structure on price, costs and market share
* Issues of efficiency and profitability as constrained by labour and employment issues
Background to British Airways
British Airways Plc is one of the world's leading international airlines, operating international and domestic scheduled and charter air services.
Its revenues are generated primarily from business and leisure passengers, cargo and mail.
On 25 August 1919, its forerunner company, Aircraft Transport and Travel Limited, launched the world's first daily international scheduled air service between London and Paris.
In 1935 several smaller airlines merged to form the original privately owned British Airways Limited, which became Imperial Airways' principal UK competitor on European routes. Imperial Airways and British Airways were nationalised in 1939 to form British Overseas Airways Corporation (BOAC). This company had a monopolistic position on international routes.
Following the formation of the Air Transport Licensing Board in 1960, the Government encouraged other British airlines to operate competing scheduled services. British Caledonian was formed in 1970, when the original Caledonian Airways took over British United Airways. Subsequently, the businesses of BOAC and BEA were combined to become British Airways in 1974.
This marked the initial change from a state owned and subsidised entity towards the privatisation of BA, and slowly changed the structure of the industry from being virtually monopolistic towards becoming a competitive oligopoly.
Currently British Airways is the world's biggest international airline as measured by the number of routes and destinations under its control. It carries more passengers from one country to another than any of its competitors.
Recent developments have seen it enter into alliances and agreements with other airlines, where costs and revenues have been shared in order to increase network coverage.
How has British Airways been affected by the UK and Global economy in the last ten years?
Increased Competition
Over the last two-and-a-half years, British Airways has made significant changes in its business strategy. The changes are a response to developments in the Global market environment and the impact of deregulation and competition.
The opening up of the European market has seen increased competition as established airlines have expanded their own networks and new low-cost competitors e.g. Ryanair, Buzz, Easyjet have arrived on the scene.
The UK has experienced a more rapid growth of low-cost operators than any other major European market and this has significantly affected the profitability of the airline on its short-haul European routes: -
OPERATING PROFIT
2000
999
998
997
996
Europe
(310)
(166)
(127)
6
26
Source: BA report and accounts
At the same time, the airline has faced increased competition as its competitors have gained entry to more capacity at Heathrow, supported by Government deregulation initiatives e.g. "Open Skies" agreements between a number of EU countries and the US.
BA's performance and profitability has been constrained by these regulatory actions, and the limitations of Heathrow's infrastructure and capacity, as competitors have absorbed this.
This can be illustrated by comparing British Airways' share price with that of some of its competitors'.
Key
Easyjet
Ryanair
British Airways
Source: http://www.uk.finance.yahoo.com
British Airways' share price has dropped by about 60% in the last year. Whereas it's short haul competitors' share price has steadily increased and also recovered much quicker from the economic downturn of September 11th. Both Easyjet and Ryanair have both quickly recovered at a similar rate, and now have a share price 20% higher than in March 2001. This contrasts heavily with British Airways whose share ...
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This can be illustrated by comparing British Airways' share price with that of some of its competitors'.
Key
Easyjet
Ryanair
British Airways
Source: http://www.uk.finance.yahoo.com
British Airways' share price has dropped by about 60% in the last year. Whereas it's short haul competitors' share price has steadily increased and also recovered much quicker from the economic downturn of September 11th. Both Easyjet and Ryanair have both quickly recovered at a similar rate, and now have a share price 20% higher than in March 2001. This contrasts heavily with British Airways whose share price has remained pretty static and not made a full recovery since September 11th. This has resulted in British Airways having to take lots of measures to cut costs. This has included making staff redundant, cutting back on running costs and reducing the number of routes being flown.
Due to the competition from cut-price airlines, BA is unable to sell all their seats on short-haul flights to destinations to which their competitors also operate. This has led to a situation of producer surplus.
Producer surplus is the difference between the price consumers are prepared to pay and the price at which firms are prepared to supply their goods.
Pricing Policies
British Airways operates a policy of differentiate prices between customers. E.g. destination, travel class, last minute deals, types and marketing channel used. This is done because the marginal cost of taking extra passengers on a plane is very low, due to most of the costs being fixed. Airlines would rather operate their planes at full capacity, some customers paying cheaper fares and still making a profit, than not filling them and making a loss. British Airways does this in order to in order to offset the impact of discounting by cut-price airlines. In the case of an airline it would not make sense to stop producing at a certain price. The reason for this is that fixed costs are always present for an airline whether they are running flights or not. Because of this it makes sense for them to run flights in order cover their fixed costs despite the prospect of very little or no profits. This is calculated according to the marginal cost, and also marginal revenues that can be made. As costs increase, for example the price of aircraft fuel increases, the profit maximising level of output will decrease. Inversely, an increase in revenues, for example a successful advertising campaign, will raise the profit maximising level of output.
The diagram above shows the profit maximising level of output for British airways. Between output 0 and output B it will make a loss, as total cost is higher than total revenue. At output B it breaks even. Between output B and D British Airways is making a profit because total revenue is higher than total cost. At an output of C, British Airways would be maximising its revenue. With an output of D it would start making a loss again, as total cost exceeds total revenue.
In order to make ensure BA sells enough of the right kind of seats to make a profit it has to assimilate all the information it can get from past and current performance to predict future trends in passenger demand. For example it must calculate the numbers of standard and premium fare customers likely to travel on certain routes, taking into account passenger cancellations. From this it is possible to calculate marginal revenues and so decide whether flying a route will be profitable or not.
At output A, marginal cost is the same as marginal revenue (MC=MR). This means that at this point the business has maximised its profit.
Exchange Rates
The strength of the pound against the other currencies has further undermined British Airways' profitability in "transfer markets" (i.e. attracting foreign passengers to use BA flights into Heathrow or Gatwick). Because of the relatively high cost
In addition the strength of the pound against the Euro has squeezed the finances of UK-based international trading businesses, which represent the core customer base, resulting in a downturn of business travel.
In 2000 the strengthening of sterling against European currencies contributed to a £9 million fall in revenue for British Airways.
Stability of the UK Economy and the Multiplier Effect
Currently the UK's marginal propensity to consume is 80%. This means that the economy has a multiplier of five, which in turn means the UK economy can be unstable, with high fluctuations between recessions and booms. This means that during times of recession people have less disposable income to spend on luxury goods and services, such as air travel.
However the UK economy is stable in relation to inflation, growth etc.
A recession will lead overall to a decrease in aggregate demand. In order to cope with this decrease in aggregate demand British Airways has to cut back on its costs, and therefore its output.
In a more stable economy such as Japan the marginal propensity to consume is 50%. This means that it has a multiplier of two. Which means their economy is more stable in turn attracting a higher level of foreign investment.
This multiplier effect affects British Airways because foreign investors may be less willing to buy shares that are based in the UK stock market. Over time this will lead to a shortage of money for BA to use for investment, and a shift of its operations from the UK to abroad in order to save costs.
Industry Structure
Because of the influences referred to above the nature of the airline industry has many of the features associated with being oligopolistic and others tending towards perfect competition in a contestable market.
For example in the airline industry barriers to entry remain high, and there are still relatively few firms competing with each other despite the emergence of new players such as Easyjet Ryanair etc. The main barriers to entry for an airline are factors such as:
o High capital costs
o Licensing restrictions
o Route capacity and Government agreements
o Ownership of landing slots
o Technical expertise
Increasingly the airline industry has become a contestable market with firms competing on price, and having perfect knowledge of the industry.
The perfect competition theory model appears to apply to certain segments of the market. E.g. short haul, no-frills leisure travel. This is because prices have reduced as a result of competition from new entrants and also a homogenous product E.g. seat only travel, with no differentiation on cabin service or class.
The oligopolistic model appears to be more applicable to that segment of the market, which focuses upon premium fare business travel where differentiation is not on price but on service and brand.
Airlines are becoming increasingly dependant upon each other and have entered into mutually beneficial alliances and networks in order to compete in a global market.
For instance BA has formed the Oneworld alliance comprising a number of previously competing airlines in order to share routes, customers, revenues and costs. BA also has ownership stakes in many of its franchise partners including Qantas, GB Airways and is attempting to take a major stake in American Airlines.
This consolidation and co-operation activity, and the formation of the competing Star Alliance have significantly changed the structure of the industry to enable its players to compete in a global economy and also helping to prevent new players to enter the market on long-haul routes.
Barriers to Entry
For a firm wishing to enter the airline industry there are several major barriers to entry.
* The initial capital cost of buying or leasing aircraft is high. The extent to which airlines are able to service debt on this capital is directly linked to national and international interest rates. Thus Monetary and Fiscal policy has a direct impact on the ability of the firm to invest in capital equipment and to pursue a strategy of entering new markets or attracting more customers.
* Airport capacity is a barrier to entry and is largely outside of the control of airlines such as BA who are merely customers of the airport operators. Usually all landing and take-off slots are already designated to existing airlines and new entrants can only obtain these where they are made available by existing operators.
* Flying internationally requires the co-operation of foreign governments who will usually only enter into reciprocal agreements. Eg. BA can only fly to New York if the UK government agree that a US carrier can fly to London. Governments are usually unwilling to allow foreign airlines to operate domestic routes within their country. E.g. BA is not allowed to fly from New York to Chicago.
* Environmental regulations regarding the number of flights may restrict the capacity available in the market.
* Operational costs can also be high and act as a barrier to entry because of the technical maintenance regulations and standards that apply. The availability of skilled and qualified staff is also a factor.
Recent initiatives at Government level appear to be aimed at reducing barriers to entry and increasing competition in the market.
The deregulation of the airline industry, particularly within markets such as the EU and within the US, and the introduction of "Open Skies" policies have resulted in a reduction of the barriers to entry.
This together with other economic factors such as falling interest rates, which have
reduced the cost of borrowing, have resulted in the market opening up to new entrants. This has meant that small, low-cost, short-distance carriers such as Easyjet, Buzz and Ryanair have been able to enter the market and become quickly successful.
The graph below illustrates how interest rates have rapidly decreased over the last 10 years:
Market
The past ten years has seen an increasing globalisation of industry and commerce. This has resulted in many more business people travelling internationally.
British Airways has responded to this by re-configuring its services for business travellers. For example, as a response to changing demand the proportion of seats given over for Business Class has greatly increased. By doing this British Airways has been able to significantly increase marginal revenues from business customers.
* Elasticity of Demand
Demand is the quantity of goods or services that will be bought at a given price. Thus demand and price are closely linked in that if the average price of a product falls demand will usually rise.
The level of consumer demand for air travel has significantly increased over the last 5 years. This has caused airlines to become more competitive on price. For example in the past there have been price wars on popular North Atlantic routes between BA and Virgin.
Elasticity of demand tends to vary according to the value of the product (I.e. class of travel.) For instance seats in First Class have a very high elasticity of demand in that price is not such an influential factor. In economy class seats have a very low elasticity of demand and customers will change their loyalties from one carrier to another for small differences in price. The number of short-term promotional offers which airlines make available in order to fill spare capacity evidences this. I.e. to increase the demand for seats which would otherwise remain unsold at the higher price.
A shift in the demand curve is correlated to the level of disposable income since consumers will tend to buy more goods and services as their income rises.
An increase to consumable incomes in the economy, and changing social trends has produced a situation where demand has increased for leisure travel. People now buy more foreign holidays, compared with the situation historically, where they would generally take their holidays in the UK. Recent trends indicate that people are tending to take several short holidays abroad in a year.
* Elasticity of Supply
Supply can be defined as the quantity of goods that sellers are prepared to sell at a given price over a period of time. Changes in the amount supplied can be caused by factors such as the supply of other similar goods, changes in costs, and increases in technology. British Airways' decisions to increase supply to different routes are closely linked to levels of consumer demand and predicted trends in the travel market. For example by expanding existing or entering new markets. Recently it has done this by flying more routes within Africa. In 2000 this has turned out to be one of BA's most profitable route outside of America, with profits of £62 million.
Quickly responding to changes in demand can be very problematic for a large firm in the airline industry such as British Airways. This is because responding to an increased demand for seats will require more airplanes, and these are not quickly, cheaply or easily available. Other factors that are difficult to change in such a short space of time are the number of landing slots available, numbers of ground staff in a particular location and the number of aircraft available.
How can British Airways increase its profits?
Over the last 5 years British Airways has lost a significant portion of the market to low-cost carriers with the growth of the no-frills, short-haul market. Because of the increased numbers of companies, competing on price has become commonplace. The events of September 11th have also very significantly affected the market for air travel and forced British Airways to take cost cutting procedures.
A major expense for BA, which it is possible to cut back on, is its staffing costs. This involves making some of its staff redundant. This has the advantage of being quick to implement and effective at saving significant money, but has several disadvantages also for BA. The first of these is that a knock-on effect is that as BA has less staff, they are unable to fly as many routes and so may lose out on potential profits. Secondly making staff redundant would make BA less responsive should there quickly be an upturn in the demand for British Airways flights. Lastly British Airways is seen as an excellent employer and making staff redundant could possibly tarnish its image.
Another way in which British Airways could cut costs is by utilising its aircraft more efficiently. E.g. It needs to fly fewer planes for longer hours. It could also transfer a greater proportion of its bookings to the internet, thereby saving on staff and administration costs.
History has shown that very few businesses have been able to operate successfully at both ends of a market. In order to be more efficient British Airways needs to streamline its business, so that it focuses closely on specific market segments, rather than trying to be all and everything to every type of customer.
It needs to cut back on its infrastructure. BA has offices and buildings all over the world. Currently this helps it to run and manage its international operations. However it could be argued that its operations could be run from fewer offices particularly if it were to shrink the scale of its international services.
A successful advertising campaign that manages to attract more customers to fly would help to stimulate demand for flights. Another way in which this could
A possible permanent solution for British Airways would be for it to consolidate with another large airline such as American Airlines. They are confident that they will be well placed in the restructured airline industry as it emerges when the upturn in global demand arises.
