After September 11th, most airlines cut flights back drastically. These cuts were heaviest in monopoly markets and as small as possible in more competitive markets. In each market considered for a cut, the least profitable flights were cut first. But, as flights are now being restored, the reverse formula is not being used. The major airlines are taking advantage of a prime opportunity to radically realign their flight networks. They are busy trying to grab market share from their competitors. They have reinstated some flights but the major plan has been to create new flights altogether. Southwest has ramped up its flights into the Las Vegas Market where America West all but pulled out entirely.
Discount carriers fared better than the major carriers during the downturn. Delta cut its domestic flights by 12.7%, but only 5% in Atlanta because of competition with AirTran. Continental cut back 14.9% but only 4.5% in Houston where discount rival Southwest did not cut back at all.
Firm Characteristics
Business Strategy and Goals
“Your Airline Has Arrived”… Airtran is one of the nation’s most successful new airlines. They are the second largest carrier at the Worlds Busiest Airport, Hartsfield Atlanta International Airport. Their commitment to providing low fare, regional, and ticket-less air travel to business and leisure passengers has yielded eight consecutive profitable quarters. The operate in 37 different cities, chosen as much for their location “as for the fact that they are served by few airlines or monopolized by the majors.” Airtran is a regional carrier, even though they fly into the Grand Bahamas.
Their cost of operation is significantly lower then those of the larger carriers (American, United, and Delta) who run a “hub and spoke” operation, and each serving with numerous international routes. The larger carriers operate at cost per available seat mile (ASM) of 12 cents, while Airtran operates at 6.87 cents per available seat mile. This is a significant difference in airline operation costs and with the reduced operations straining the larger carriers; Airtran is taking advantage of and exploiting their low cost air route network. Operating at a low cost enables the airline to offer discounted fares to both business and leisure travelers.
Their strategy is to create an “on-time” airline, which provides acceptable regional service – with one type of aircraft. Today, the airline is displaying continual growth in the industry as well as financially.
Investment Relations
As the 13th largest carrier, Airtran’s stock price is attractive to smaller investors. The last 3 months for Airtran have been quite successful, considering the events of September 11th. Today the stock closed at $5.80 per share.
Looking back on a three-year history, Airtran is proving that it is financially and operationally capable of competing in and growing in the airline industry.
Operating revenues for the past three years have increased on an average of 17% over the past three years, primarily due to passenger revenues. Before the September 11th, they had produced 10 consecutive profitable quarters. The chart below gives a 5-year history on operating revenue.
Operations
Airtran basis for operation consists of a significant cost reduction strategy. Its fleet consists of two different types of aircraft, the Boeing 717 and the DC-9, which is in itself a cost reduction due to the limited number of maintenance differences in the fleet.
Airtran currently operates a total of 61 regional jets and is in process of replacing the older DC-9 fleet with the newer, more fuel efficient Boeing 717’s. Training the mechanics is limited to two aircraft – which are very similar at that. Operating two types of aircraft also proves to be beneficial for pilot training and familiarization. Airtran serves 37 different destinations that are primarily located in the east and Midwest. They currently have 346 scheduled flights per day, 146 of which depart from their hub location in Atlanta.
Cost Reduction Methods
Maintenance and upkeep on Airtran aircraft is the same throughout it’s fleet – no need for additional training for mechanics, no need for any other types of auxiliary service equipment. This is a benefit to both the airline and the passenger. It minimizes operating expenses and therefore allows Airtran to continue to grow, without passing much additional cost onto the passenger.
A significant cost to all airlines is the fuel cost. Airtran took the initiative to set up several fuel-hedging agreements that covered nearly 35% of FY2001’s fuel needs and allowed the airline to facilitate ongoing cost control efforts. This proved to be a valuable decision looking back at skyrocketing fuel costs.
Their goal is to provide reliable service at low cost. One of Airtran’s many cost control methods is to do most of it’s ticket sales on-line, where they are leading the industry for rates of growth and percentage of sales. Airtran has effectively replaced the paper ticket with a computer generated confirmation number. The percentage of total ticket sales online has increased 30% in the past two years.
Commitment
With a new commitment to its employees, a new vision for it’s corporation, and new services for its passengers, Airtran is proving it is a force to be reckoned with in the airline industry. Airtran Airways is not only growing it’s own profitability, but it is also shaping the price of airfare in every market it serves. In keeping air travel affordable for the traveling public, Airtran is in itself stimulating air travel in the United States once again.
Current Industry Structure
Industry Description
History
The airlines are relatively new as a market driven industry. In 1938, the airlines faced steep competition that was vigorous and unstable. The industry asked the government for a regulatory body to control competition. The newly formed CAB "froze" the industry structure and blocking out new firms, which ended up creating monopolies. The industry continued in this state despite growth in traffic, increased profits, and changing conditions. The turning point for the airline industry began in the late 1970’s when the industry needed to break free from it’s regulated environment. New technology and ample profits made competition a viable option. The result was the passing of the Airline Deregulation Act in 1978.
Effects Of Deregulation
One of the large effects of deregulation was the increase in the number of carriers and increased competition. In 1978, there were 43 carriers certified for scheduled service with large aircraft. By 1983, there were over 60 new carriers since the act was passed. With the slew of new airlines, the airline industry was able to reach new markets and grow tremendously. Coupled with the price drops, air travel became a more favorable way to travel. Today there are no close substitutes for travel over 150 miles. However the trend of an influx of airlines eventually turned into many mergers, acquisitions, and bankruptcies in the late-1980s to early-1990s (see Figure 1).
Figure 1 – Family Tree of Airlines
Still seen today, another effect of deregulation is the development of the “hub-and-spoke” network. The major airlines developed this network to efficiently manage and serve more markets with the same fleet of planes. Another advantage of the “hub-and-spoke” network is that airlines will carry the traveler from departure city to arrival city and not have to hand over customers to competing carriers. Travelers enjoyed traveling with one airline though an extra stop was required.
A marketing innovation that airlines initiated after deregulation was the frequent flyer program. Repeat customers earned points toward free tickets or upgrades. This program generated loyalty beyond service and satisfaction with travelers. Recently, the frequent flyer program extends beyond receiving points for flying. The most popular is the use of credit cards (points per dollar) and using points to purchase things other than airline tickets.
A technological advance in the industry came with the introduction of computer-reservation systems (CRS). This allowed airlines to keep track of fare and service changes. The systems allow agents to process millions of reservations a day. Today these transactions have significantly increased and with the introduction of the Internet redefined how travelers shop, purchase, and receive tickets.
Safety
One constant that deregulation has not effected is the safety and certification of the industry. Since 1926, the government has been a regulatory body for every aspect of the industry from airports to airplanes and continues to do so through the Federal Aviation Administration (FAA). With the recent events on September 11th, 2001 the FAA will probably play a more important role in inspecting and creating policies for airlines and airports.
Airline Industry Economics
The airline industry is a service industry. The industry caters to its travelers to give them an affordable, pleasurable, and efficient method of travel. Airlines require a great deal of capital, probably the most of any service industry. The overhead of planes alone is a significant investment. Labor is intensive. Each airline employs a great number of people from maintenance to pilots. The labor in the airline industry is highly unionized. With the great deal of capital and employees involved in each flight, profit margins are thin and cash flow is high. Airlines have earned a net profit of 1%-2% compared to the 5% average of the US Industry.
Airlines derive most of their revenues from the fares they charge passengers. They also earn ancillary revenues from transporting mail, shipping freight, selling in -flight services, and from serving alcoholic beverages.
The airline industry faces two types of consumers: business and leisure. The airlines cater to the business traveler since companies pay their fares and usually are not flexible in their timetables.
The cost of industry is broken down as the following:
Size of Industry Relative to the Economy
The total revenue the airline industry makes is relatively small compared to the rest of the economy but significant in the transportation industry (see Figure 2,3). However the impact the industry has on the other industries is a different story. This effect was seen after the Sept 11th disaster as well as the fuel price hikes in the 80’s. In order to do business today traveling larger distances quickly is essential. When air travel is hampered by price increases or consumer tastes, businesses suffer.
Figure 2, 3 - Source: Bureau of Economic Analysis Web Site (www.bea.gov)
Current Market Structure
Close Substitutes
Car, Bus, and Train are the only close substitutes for travel over land, but when over 150 miles, airplanes are faster. Boat is another option, but too slow compared to an airliner. Small commuter craft are noisy, cramped, and unstable compared to the larger jets used by mainstream airlines.
Consumer
There are two types of consumers of air transportation: business and leisure. The business traveler travels as a representative of a company or firm and usually must travel on a timetable. The leisure traveler travels for vacations or visits.
The business traveler is a primary moneymaker for airline companies. Business travelers have a tendency to be price inelastic with regards to airfares, because their fairs are paid by companies and must travel to many locations. Airlines offer special deals to the business traveler such as priority check-in, expedited baggage handling, luxury lounges, in-flight amenities such as cellular phones, faxes, and outlets for laptop computer usage.
However, the leisure traveler is highly price conscious (elastic). The leisure traveler usually goes out of the way to save money by using the Internet, discounted airfares, and other methods to save money.
Classifications
The industry is broken in to four main categories: Majors, Nationals, Regionals, and Cargo. These classifications are determined by the FAA who gives a firm certification when the meet proper criteria. The Department of Transportation (DOT) gives similar certification to smaller commuter aircraft.
Major airlines generate over $1 billion annually. These airlines provide nationwide and international service. They usually operate with between 130 to 450 seats per aircraft. As of 2000, there were 12: Alaska, America West, American, American Eagle, American Trans Air, Continental, Delta, Northwest, Southwest, Trans World, United and US Airways. Three cargo airlines are considered major as well: DHL Airways, FedEx, and United Postal Service.
National airlines generate $100 million to $1 billion. These airlines primarily serve a region of the country, although they may extend to other regions and even international destinations. National airlines usually operate aircraft with a seat count from 100 to 150. Some of the airlines in this category include: Aloha, Atlas Air, Emery Worldwide, Evergreen, Hawaiian, Midwest Express and Polar Air Cargo.
Regional airlines generate under $100 million in revenue. This class is further subdivided to the subcategories: Large, Medium, and Small. These airlines operate almost exclusively in a certain region. These airlines serve majors in partnerships to get travelers to remote areas of the country.
Finally, cargo airlines do as the name suggests. Majors, nationals, and regionals can be cargo carriers and many of them are. To be cargo only, the FAA/DOT have different requirements for the airplanes that must be met before receiving such a certificate.
Geographic Area
The classification of airlines is one definition of markets in the industry, however it is more complicated than this. Each city-pair route is a clear and definite market that airlines compete. To add more complication, there are routes that include other city-pairs as well. For example: Atlanta to New York. The ATL-NYY is one direct city-pair market, however so is ATL-Memphis-NYY, and so on. Regions of the nation are another defining market as in Table 1.
Table 1 – Airline Market Share - Per Region
Airlines must compete on city-pairs, regions, and even services they offer.
Alliances
Along with hub-and-spoke strategies, the industry had firms, which form alliances. These alliances are join efforts to further expand their market. In these alliances, the airlines claim that they will operate more efficiently through the use of code-sharing. Code-sharing involves sharing flights, planning, and other resources. These types of alliances are most common between major airlines and regionals. In the 1980’s airlines used hub strategies to expand, and now global alliances “promise seamless service between hundreds of cities around the globe – all without investing in planes or hubs. The result: hundreds of millions of dollars of extra profits each year.
Macroeconomic Analysis
Introduction
Before we can begin a detailed analysis of Air Tran and the airline industry, it is important to understand the economic conditions in which Air Tran is operating. This section includes analysis of the U.S. economy from 1995 to the present. For a general overview of the economy, business journalists often refer to two indices, Leading Economic Indicators (LEI) and the National Association of Purchasing Managers Index (NAPM). The NAPM is an indicator of the current state of the manufacturing economy, whereas the LEI index is more general. Both are useful for short-term economic forecasts. The LEI rose steadily throughout the late 1990’s while the NAPM showed more fluctuation. Numerous other economic indices are cited, along with interpretations of their meanings. The analysis concludes with a forecast of economic conditions for the next twelve months.
[Insert Graph-LEI]
[Insert Graph-NAPM]
Gross Domestic Product and Inflation
In 1995, the economy was in a state of steady growth, as it had already climbed out of the mild recession of the very early 1990’s. From 1996 to 2000, the high-tech economy boomed, stocks skyrocketed, and production increased dramatically. All of this happened without the high inflation that one would expect in a period of strong growth. Triggered by lower-than-expected corporate profits, especially in the high-tech sector, the stock market tumbled in 2001. This contributed to the current mild recession, which was compounded by the terrorist attacks of September 11, 2001.
A simple economic index that is widely used to generalize the state of the economy is Growth in Real Gross Domestic Product (value of all goods and services produced in the U.S. over a period of time). A recession is generally defined as two or more quarters of negative GDP growth. In the current recession, the third quarter of 2001 was the only quarter of negative growth. However, a recession was declared by the National Bureau of Economic Research in November of 2001. The graph below shows annualized real GDP growth, along with growth in final sales.
[Insert Graph-REAL GDP Growth & Sales]
Growth in Gross Domestic Product is often broken into sectors of the economy, with the purpose of showing which sectors are booming and which are stagnating. As you can see from the graphs below, equipment, software, and durable goods had high rates of growth throughout the late 1990’s, mostly due to a strong high-tech economy. Since the economy needed no stimulus during this time period, federal government spending actually dropped. Government spending has since increased, in response to the current recession. As of the third quarter of 2001, growth in consumption is down and investment has shown negative growth. Growth in spending on structures has increased while growth in the strongest component during the late 1990’s, equipment and software, has nearly flat lined.
[Insert Graph-Component Growth of Real GDP]
[Insert Graph-Avg. Growth of Real GDP Components]
For our analysis of inflation, we will use core rates of consumer and wholesale inflation which do not consider price changes in food and oil. This results in smaller fluctuations in the rate of inflation since food and oil are more volatile than other components of our economy. As you can see, consumer inflation has hovered around 2% to 3% and wholesale inflation between 0 and 3%. These numbers are not indicative of the rapid economic expansion that was occurring at this time. We would expect higher rates of inflation under these conditions. One thing that has helped to keep inflation under control in the late 1990’s is the fact that capacity utilization has stayed below 85%, which is the level that is thought to lead to rising inflation. Reasonable rates of growth in the money supply have also helped to curb excessive inflation. A strong U.S. dollar during this period led to importation of cheap goods from other countries, which discouraged inflation.
[Insert Graph-Inflation Rates]
Productivity and Employment
Americans enjoyed some of the lowest unemployment rates in decades for the last half of the 1990’s. Consumer confidence also remained high during that period. The combination of low unemployment and high consumer confidence is a short-term indicator of a healthy economy. There is an inverse relationship between these two indices, as you can see from the chart below. During the recession of 2001, consumer confidence fell as unemployment rose. Unemployment is also related to capacity utilization, but inversely. During 2001, unemployment rose as capacity utilization fell.
With increasing productivity, labor cost per unit generally decreases, but this was offset by rising wages due to low unemployment in the late 1990’s. Growth in labor costs peaked in early 2000 and then fell during the period of rising unemployment.
[Insert Graph-Consumer Confidence & Unemployment]
[Insert Graph-Resource Utilization]
Productivity has also risen each year since 1995, although 2001 growth was slower than that of previous years. Production itself also increased during the same time period, peaking in 2000 and falling in 2001. Capacity utilization was steady until it fell 2001. This tells us that production capacity increased during the late 1990’s due to technological advances and investment. There is a positive relationship between increasing capacity and investment.
Spending and Interest Rates
In a high-tech economy, investment spending is essential to stay ahead of heavy competition, regardless of current earnings. There was strong growth in investment spending from 1995 to 2000, then a decrease in 2001. There is a negative correlation between interest rates and investment. The Fed raised the interest rate several times during 1999-2000 in an attempt to curb investment by companies who could not back up their investments with earnings. Ultimately, profit warnings by these companies led to a rapid decline in the stock market during 2000 and 2001. To combat the current recession, the Fed made several rate cuts in 2001. The rate cuts are intended to stimulate investment, which in turn stimulates the entire economy. Some factors that the Fed uses to judge the strength of our economy include trends in prices, wages, employment, production, consumer income and spending, construction, business investment, inventories, and interest rates. Below is a chart of the prime and discount interest rates.
[Insert Graph-Interest Rates]
The decline in the U.S. stock market has decreased the wealth of U.S. consumers, prompting them to cut spending. Fortunately, the decline in growth of consumption has been slight compared to recent stock market declines. Consumers have also continued to increase their use of credit, despite the recession.
[Insert Graph-Borrowing]
World Economy
One way to compare the value of the U.S. dollar is to compare it individually with currencies of key trading partners. A more general approach is to use the trade-weighted value of the dollar. As you can see from the graph, the U.S. dollar has risen steadily in value for the last few years, even during the recession. The strong U.S. dollar is due in part to economic fluctuations in other countries and the devaluation of some foreign currencies during the 1990’s. The Mexican peso declined in value throughout the late 1990’s, while currencies of Thailand and Malaysia were devalued in 1997. In addition to these factors, a strong U.S. economy also contributed to a strong U.S. dollar. A downside to the high value of the U.S. dollar is that it makes U.S. exports less competitive on the world market.
[Insert Graph-Trade-Weighted]
[Insert Graph-XRateCrises]
Although the U.S. economy is currently in a mild recession, it is stronger than the faltering economies of some European and Asian countries. In the late 1990’s, many Asian countries experienced severe recessions. For example, in 1998, Indonesia experienced an economic downturn on the scale of the Great Depression. Poor economic performance in foreign countries often leads importation of goods by the U.S., since resulting exchange rates are favorable for this type of trade. As I mentioned earlier, cheap imports help to keep our inflation in check, but also create competition for U.S. manufacturers.
Forecast
Currently, a recovery from the current recession in the next year looks promising, as some economic indices are improving. General indices from the 4th quarter of 2001 are now being tabulated, and some show improvement over the past few quarters. However, corporate earnings are still not on target, investment is still low, and elevated unemployment persists. Improvement in unemployment rates tend to lag behind improvement of other indices when an economy is coming out of a recession.
Barring any unforeseen events, it appears that the U.S. economy is on the road to recovery. I would predict that production will substantially increase soon, since inventories are now very low. This will force companies to hire, and the new jobs will create more consumption. Low interest rates will also encourage companies to invest, which will also stimulate the economy.
Future of the Airline Industry
The Airline Industry is one of the many industries forever changed by the September 11 tragedies. As it attempts to make a come-back, there are numerous barriers, government regulations, and consumer tastes that will test this industry in the upcoming months. We believe that the sector will make a strong rebound due to the recession of consumer fears about terrorism, additional cost-cutting philosophies taken on by the airlines, and the overall increase in the economy as a whole.
The 4th quarter of 2001 was an extremely desperate period for the airline industry. With many of the airlines facing bankruptcy, the federal government assisted with over a $1 billion grant. The airlines were still forced to cut expenses through employee layoffs, decreasing flight numbers, and the grounding of numerous planes. These cost cutting strategies combined with revenues well better than the early estimate by congress give us a clearer explanation of where the industry is heading.
In the 4th quarter, early estimates were a decrease of 40% for revenues. Carriers monthly revenues were surprisingly higher. October was down 39.4% but rebounded in November and December, dropping only 33.3% and 27% respectively. As the economy strengthens and consumers’ fear of flying subsides, the airline industry is well positioned for the future barring another catastrophe.
Another component, capacity, is a revealing trend that bodes well for the airline industry. Fourth quarter capacity was estimated to be down 20%. Actual capacity for the airlines came in at a decline of 14.8%. With better than expected capacity, and the health of the economy increasing, we expect to see more planes in the air and expanding flights in the upcoming months. This will allow airlines to once again begin hiring back the laid-off workers, increase revenues and the bottom line, and strengthen the overall industry.
Two issues that need to be addressed and that could negatively affect the airline industry include security and insurance. Security was previously the responsibility of each airline. In November, the Department of Transportation’s Transportation Security Administration took control of airport security. The additional cost to the airlines for the maintenance of security is estimated to be 1.3% of sales. The estimate to purchase the new security equipment is roughly $6 billion. The current funding sources is said to be somewhere in the neighborhood of $2 billion leaving $4 billion needed from possible sources such as additional fees, grants, passenger facility charges, and/or appropriations. As the airlines struggle with the additional cost of this regulation and the ability to pass this cost along to passengers or take the hit individually will no doubt affect profitability.
After September 11, the insurance industry reinstated war risk liability coverage at extremely increased premiums. The insurance industry was willing to provide $50 million in war risk coverage but many lessors are requiring $1 billion. The federal government has been paying the premiums to date but it is expected to end May 19th. With the government exit, airlines have reached an agreement to become self-insured. Although this will significantly lower premiums it is still expected to cost the industry upwards of $400 million annually.
To combat the increase in many of the costs above, Delta has announced the cutting of base commissions to travel agents. Other carriers are expected to follow suit in the upcoming months. Assuming a 50% savings in base commissions correlates to approximately a $1 billion pretax savings. Many of the details of agreements with travel agents have not been decided and could have a major impact on profitability but cost cutting strategies such as this are desperately needed for airlines to maintain profitability.
What’s Next For AirTran?
For the Future
As mentioned above, discontinuing use of all older Boeing 737-200 and upgrading to the newer B717 is a smart all-around move. They will be a boon to business as customer’s enjoy their ergonomic design and low noise output. The new planes will keep costs down by requiring less maintenance and less fuel. Lower fuel costs will help AirTran to continue to add additional routes and destinations to their roster for less. This will be especially important as their current plans include 50-100 new planes in the near future.
Airtran was also named Airline of the Year 2001 for the 3rd year in a row by the Southeast chapter of the American Society of Travel Agents. With the recent drought in airline commissions from Delta and other major carriers, AirTran’s good standing with travel agencies should stand them in good stead for more bookings if they can keep up the good relationship. Travel agents are a very valuable resource to AirTran. AirTran’s ticket sales via travel agencies have increased by five times in the last four years.
In December of 2001, AirTran purchased a license to CALEB™ Technologies Corporations’s PairingSolver™ software. This new system will optimize the schedules of AirTran’s 1,400 pilots and flight attendants. The PairingSolver™ software increases crew efficiency as less of the crew’s time is spent waiting around to fly and therefore it decreases expenses on hotels and meals. AirTran expects the program to save $1.1 million annually. The introduction of this CALEB™ Technologies program will bring AirTran up to Mid-tier airline market status as the same program is already being employed at the major airlines.
AirTran is marketing toward the younger generation. They recently revived their “X-fares” promotion. 18-22 year-olds can travel standby to any of AirTran’s destinations (except Grand Bahama Island) for only $52 one way.
The Future in General
Losses are expected to be big at most major carriers in the 1st Quarter of 2002. The general lack of demand for business travel as well as an industry push to restore pre-September 11th flight levels are currently driving prices down. The FAA expects to see commercial airfares continue to decline in 2002 and spike back up again in 2003 as traffic increases to pre-September 11th levels (barring future terrorist attacks). However, the FAA’s increasing airfare forecast does not take into account the prospect of a Federally mandated “ticket tax” to cover the cost of increased airport security. This might put a damper on increased demand, but at a maximum of $10 additional per ticket it is doubtful. Certainly by 2004, the FAA expects to see a normal level of growth taking place in the airline industry.
Another damper on recovery has been increased security. The long lines and lengthy check-in procedures (combined with fewer scheduled flights) are rendering business travel less productive than pre-September 11th. Airlines will have to find creative ways to maintain high safety standards but improve speed to re-attract these high-dollar customers.
The FAA has recently mandated that fortress hub airports where one carrier has upwards of 50% of the traffic find new and ingenious ways to foster competition. The Maryland Aviation Administration paid $4.3 million for US Airways to give up 29 gates at the Baltimore-Washington Airport. In North Carolina, the Raleigh-Durham Airport Authority is paying an undisclosed sum to American Airlines to acquire one of its terminals. The airports are buying out the airlines’ long-term leases with reimbursements for moving expenses and improvements. The ultimate goal for the airports is to attract greater competition. In the past, hub-and-spoke squatting by major airlines easily squashed competition as other airlines simply had no place to board passengers. This bull-by-the-horns strategy by local airports may signal a new era in airline competition and subsequently lower ticket prices to the public. Many other airports are swapping out their exclusive-use gate leases with preferential-use leases that require specific and frequent use. This will hopefully reduce gate idle time and leave more room for competition. AirTran and Southwest already have plans to utilize some of the gates left vacant in Baltimore.
