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Today's airlines should adopt a low-cost strategy: can this popular idea be supported by the facts?
Subject:
Airlines (Management)
Strategic planning (Business) (Management)
Author:
Cobb, Richard
Pub Date:
01/01/2005
Publication:
Name: Academy of Strategic Management Journal Publisher: The DreamCatchers Group, LLC Audience: Academic Format: Magazine/Journal Subject: Business, general Copyright: COPYRIGHT 2005 The DreamCatchers Group, LLC ISSN: 1544-1458
Issue:
Date: Annual, 2005 Source Volume: 4
Topic:
Event Code: 200 Management dynamics Computer Subject: Company business management
Product:
SIC Code: 4510 Air Transportation, Scheduled, And Air Courier Services
Geographic:
Geographic Scope: United States Geographic Code: 1USA United States

Accession Number:
166751812
Full Text:
ABSTRACT

Airline strategic planners have viewed growth as their overriding objective as they have considered changes in customer markets and operations since WWII. This growth has been largely accomplished through an industry focus on differentiation with the exception of a few noteworthy carriers that have used a low-cost focus to achieve market growth. This research questions whether a strategy designed to achieve growth based on low cost has moved beyond being considered an exception to now being considered the norm for the airline industry. The methodology for answering this question involved an analysis of the airline industry's modern era business cycles and included an analysis of changing market forces, opportunities, and threats. From this analysis, we have to qualify our conclusions by first noting that the answer to the research question was not as obvious as the popular literature would suggest. Documented support for a low-cost strategy is summarized, and conclusions are drawn as to the long-term attractiveness of this strategic option.

INTRODUCTION

The current airline industry financial cycle began in mid-2000 (Lorenzo, 2001) with the declining national economy and a sharp drop in airline revenues and has received wide coverage in the popular press, scholarly research, and business media. Though currently in decline, the glamour nature of the industry has always inspired optimism, even as investors have seen wide ranging swings in profits and losses over an extended period. When viewed in the context of financial performance, reported research finds that the profit margin for the industry averaged only 1.6% during the 1980s (Poling, 1990) and only 1.0% for the period between 1990 and 2000 (Samuelson, 2001) before recording industry-wide losses of $7 billion in 2001(Airline of the year, 2003), $7.5 billion in 2002, and $5.3 billion in 2003 (Velocci, 2004). In fact, the only member of the industry to have long-term profits has been Southwest Airlines, which has had thirty consecutive years of operating profits (Azoulai, 2000; Airline of the year, 2003). Low profitability is, then, a traditional industry theme and is discussed today by some business analysts who write about industry problems and solutions, business cycles and trends, or government regulations and controls in a manner similar to that of writers in previous periods. However, a review of the literature finds a recurring theme linking profitability to an industry-wide, low-cost strategic focus. For example, Costa, Harned, and Lundquist (2002) observed that while some airline analysts are optimists and assume that the industry has learned how to manage cyclic activity, others view the current industry climate and observe that dramatic long-term changes in both fleet composition and airline networks will require traditional carriers to adopt a service model based on an improved cost structure. Donoghue and Geoff (2003) offered additional evidence to support this conclusion based on both their analysis of recent statistics collected by the Air Transport Association (ATA) and on their review of current sentiments expressed by airline industry leaders. In their findings, they noted that the ATA predicted a reduction in air travel spending and that many of today's airline industry leaders strongly support a long-term planning model built around a cost structure that would yield better profitability. This view is consistent with other research findings that confirm the widely held consensus that restructuring, based on cost, must be at the heart of the industry's long-term survival strategy (Forsberg, 2001; Kangis & O'Reilly, 2003). The fact that the popular press is also aware of the airline cost issue can best be exemplified by an editorial in the Chicago Tribune, which addressed the airline financial landscape and noted that low fares and electronic shopping have "irrevocably shifted" (Airlines: Cut Cost, 2002, p. 28) the planning environment and created other options for today's business passenger. Recognizing this new environment, The Economist suggested that traditional network carriers are "not just grappling with a cyclical slump in the basic airline business model but will have to reinvent themselves or go out of business" (Silver linings, 2004, p. 68).

So, it is obvious from today's literature that airline managers are advised to see more than the usual suspects when considering industry problems. However, since most major airlines have successfully flown through past financial cycles without adopting low cost strategies, what facts today would support an industry-wide shift from a strategy emphasizing growth and differentiation to one emphasizing standardization and cost control? To answer this research question, this paper will review both the past and present operating environment of the U.S. airline industry and will contrast the current financial cycle with well-documented past cycles. Important factors considered in this review will include the environmental opportunities and threats offered by new technology as well as the impact on long-term strategy caused by the effects of industry life cycle and the threat of substitutes for airline business travel. Finally, in answering the research question, two overriding factors were considered: the redefined business travel climate since 9/11 and the continued refinement of e-commerce and technology tools. This research concludes that these factors have come together to influence airline strategy in ways not seen since the beginning of the modern era of the U.S. airline industry.

OPERATING ENVIRONMENT: ELEMENTS OF CHANGE

Operating Environment: The Modern Era

The foundation for the modern era of the U.S. airline industry began during WWII with the construction of airports and the development of modern transport aircraft. Following the war, hundreds of these modern transports were declared surplus, and personnel trained during the war stood ready to staff this equipment as airlines added new routes to their networks. With these resources in place, air travel was now possible to most U.S. and international destinations, and the industry evolved as both its technical capability and the scale and scope of its customer base grew. For the increasing number of business travelers, the airlines represented a value-added activity that could bring faraway customers or corporate subsidiaries within easy reach of each other. For leisure travelers, visiting distant points became a viable option, even those with limited travel time. During this growth period, early prop-driven aircraft were replaced by jet aircraft that were later augmented with higher capacity, wide-bodied jet aircraft as improvements to both speed and efficiency contributed to growth. A growth strategy built around differentiation seemed to be the only logical direction for airline managers during this early period as they witnessed a dramatic increase in passenger traffic. Banks (1993) referred to this period as the industry's "gravy days" (p. 40) and observed that as the airlines took advantage of technological improvements, they saw an average passenger growth rate of 13% per year while realizing a 50% drop in operating costs per seat mile for the period between 1950 and 1973. However, airline industry growth has not been consistent or uniform over time. In fact, Costa et al. (2002) observed that the industry has experienced major economic cycles with each cycle having its own complex set of environmental forces, lasting from three to five years during each decade beginning with the 1970s. These cycles, coupled with the current downturn and threat of future industry downturns, give greater emphasis to the need for better industry analysis and strategic planning. The following sections will review this cyclic activity and will note that in pursuing solutions to the operating problems of these periods, both marketing and operations decisions would receive greater emphasis. This review will aid in better understanding the unique role that cost control plays in the current industry cycle.

Operating Environment: Marketing Innovation

Kaynak and Kucukemiroglu (1993) reported that during the 1970s the airline industry considered marketing to be "a comparatively unimportant activity" (p. 32). However, events of the 70s would set the stage for dramatic changes in the operating structure of the industry. The stable growth pattern that developed after the introduction of new jet service was interrupted in 1973 by the Middle-East oil embargo. The ATA reported that this embargo triggered a rapid increase in fuel prices that helped increase the rate of inflation prior to a subsequent energy crisis and downturn in the national economy (The Airline Handbook, 2003). Gowrisankaran (2002) explained that as the industry entered the 1970s, route structures and ticket pricing policies were regulated by the Civil Aeronautics Board (CAB) and were controlled in a manner similar to that of a public utility with air travel treated as a public convenience or necessity. In a historical review of the 1970s, the ATA reported that in an attempt to maintain profit margins during the energy crisis years, the CAB responded by approving fare increases and limiting the introduction of new routes for a four-year period (The Airline Handbook, 2003). However, these efforts were unpopular and unproductive because, even with higher fares, the industry would continue to suffer from the combined effects of over capacity, a weak national economy, and poor earnings recorded for most of the 1970s. During this period, public pressure and dissatisfaction with air service continued to grow until the role of government in airline regulation was drastically changed in October of 1978 with the passage of the Airline Deregulation Act (Gowrisankaran, 2002). This act created a new control environment that allowed greater flexibility in ticket pricing and route planning as the industry now came under the control of the Department of Transportation (DOT). The DOT's regulatory authority would focus primarily on issues of safety and operating procedures in determining which airlines should operate. Kaynak and Kucukemiroglu (1993) reported that in this new marketing environment, airline service began to change "from a sellers' market to one of a buyers' market" (p. 33) as incentives to innovate brought new carriers and new marketing ideas into the industry. Gowrisankaran (2002) suggested that large fluctuations in the airline economy presented an environment that offered new opportunities for those carriers willing to innovate. Marketing innovations became an integral part of this new deregulated environment as the number of certified air carriers ranked by the CAB in one of the four main categories (e.g. major, national, large regional, or medium regional) increased from 37 in 1978 to 100 by 1984 (CAB, 1978 & 1984). Also, between 1978 and 1999 the number of carriers using large aircraft doubled while the number of flight segments with a choice of two or more carriers increased from 66% to 85% in the deregulated environment (The Airline Handbook, 2003). This period would usher in new marketing concepts and programs as carriers tried to fly successfully through each business cycle.

Operating Environment: Deregulation

Both excess capacity and increased competition are blamed for the decline in the profitability of the airline industry in the 1980s as industry deregulation allowed new low-cost carriers to enter the market and begin to change the competitive landscape (Banks, 1993; Costa et al., 2002). In this competitive climate, most airline strategies continued to stress growth, with the established carriers focusing on market differentiation using new jet service and the newer start-up carriers generally entering the market using low-cost models. Common elements of these low-cost carriers generally included a simple, no-frills product positioned to attract the price-conscious passenger while following an operational plan designed to reduce unit costs (Impact of Low Cost, 2002). For example, PeopleExpress was started in 1981 and developed a growth strategy with low fares supported by a plan to maintain low operating costs. By 1986, it had successfully grown its market share to become the fifth largest carrier while maintaining a 75% aircraft load factor compared to an industry average of 55% (Smith, Gunther, Rao & Ratliff, 2001). In reacting to this new type of competitor, established carriers generally chose not to pursue low-cost strategies but chose instead to introduce new programs designed to differentiate their service, improve loyalty, increase load factors, and protect space for business travelers. Several innovative marketing and operational strategies were linked to enable the industry to succeed in these efforts. One of the earliest of these marketing strategies, the AAdvantage frequent flyer program, was introduced by American Airlines in 1981 and is credited by many as being the single most successful marketing program in airline history (Smith et al., 2001). This strategy was successful because it addressed the issue of customer loyalty in the new price competitive environment. Although tickets had been shown to be price elastic, American Airlines managers did not think that low prices alone would win and keep their best customers. Through their Sabre reservation system, they were able to track their best customers based on mileage. A scale was developed to offer free tickets to any destination or offer service upgrades to customers based on the number of miles flown. This bold move differentiated its service and was successful in retaining American's higher paying, frequent (i.e., business) travelers and in developing the largest frequent-flyer program in the industry (McDonald, 2001).

Efforts to protect the business travel market of the 1980s, while important, did not cause airline managers to embrace automatically a low-cost strategy or to forget about growth strategies in other market segments. Airline managers knew that in order to increase load factor and to improve yield, they would have to differentiate their service in ways that would attract more leisure travelers and compete directly with the low-cost carriers.

Operating Environment: Growth of the Leisure Market

During the 1980s, the number of leisure passengers grew as the proportion of passengers classified as business travelers declined (Banks, 1993). American Airlines, aware of the success of carriers like PeopleExpress, considered the leisure market trend and worked to improve further both yield and load factors through the introduction of its Ultimate Super Saver campaign in 1985 (Smith et al., 2001). The result was full service at discount prices for leisure travelers willing to accept certain purchase restrictions. This program was designed to grow market share while protecting seats for use by business travelers who might buy close to the flight date and be willing to pay more. By having access to historical flight demand and passenger booking data, company management science specialists were able to use operations research tools to predict seat availability and to alter seat price to reflect projected demand over time. This activity, known as yield management, helped to determine how many seats to save for late-booking, higher paying customers and how many seats to make available to those willing to accept certain restrictions for a lower fare (Belobaba, 1987).

Smith et al. (2001) reported that over a three-year period beginning in 1985, American Airlines used yield management to generate over $1.2 billion in additional revenues. In a review of the operating environment of the airline industry, Costa et al. (2003) credited yield-management techniques with improving revenues and helping to drive the industry recovery from the 1980s business cycle. By using yield-management techniques following deregulation, the major carriers were generally able to defend against the incoming tide of discount carriers. Low fares supported by low cost alone seemed to hold no assurance of success during this turbulent period. Records of the ATA show that 87 airlines filed for bankruptcy protection during the 1980s (The Airline Handbook, 2003). PeopleExpress, which had been so successful with its low-cost strategy, saw its aircraft load factor shrink to 25%, and the company was eventually sold to Continental Airlines in 1987 (Smith et al., 2001). Carriers classified in the "major" category survived this financial cycle without adopting low-cost strategies and actually increased in number from 10 in 1978 to 12 in 1984 (CAB, 1978 &1984). According to Bonne (2003), many of the discount carriers of this period failed because of flaws in their business models or because they were squeezed out by the marketing efforts of the major carriers. Dubin (1984), in reviewing the performance of new carriers for the period immediately following deregulation, attributed their high rate of failure to their "weak management, inept marketing, and under capitalization" (p. 75). As the industry entered the 1990s, the top ten airlines used similar pricing plans based on a differentiation strategy of full service with restrictions and were successful in controlling 90% of the market (Das & Reisel, 1997). The decade of the 1980s, known for the introduction of important marketing and operational innovations, would also mark the point in time when the measured growth of the industry would begin to stabilize and strategic planners would begin to consider life-cycle effects.

Operating Environment: Industry Life Cycle

For any industry, an analysis aimed at determining the stage of its product life cycle is a critical factor for strategic planners. Anderson and Zeithaml (1984) provided an example of this type of analysis with their in-depth historical summary of works linking life-cycle theory and strategy. They noted that the stage of a product's life cycle is a fundamental variable in selecting the appropriate business strategy. Das and Reisel (1997), in their analysis of life-cycle theory, discussed the characteristics of maturity and noted that as the product becomes standardized and there is an over-capacity condition, demand is mass-market driven and technological innovation is not concentrated. They found that when no airline has a technological advantage over other competitors, competitive advantage is achieved through "cost efficiencies" (p. 89) as assets become more industry specific and passengers tend to select carriers largely on the basis of price. Additionally, they found that in these market conditions, it is difficult to raise prices because the customer has "near perfect information about fare prices, marketing, and promotion" (p. 90) and one seat on one airline is a nearly perfect substitute for another seat on another airline. The importance of these signs of industry maturity was best summarized by Kluyver and Pearce (2003) when they observed that "while industries experiencing growth may mask certain errors in strategy, a mature industry is less forgiving of such mistakes" (p. 70).

Did the airline industry begin to mature in the 1980s? To answer this question, Poling (1993) used data from a Federal Aviation Administration (FAA) forecasting conference and compared industry revenue with Gross Domestic Product (GDP). He found that airline revenue grew from 0.65% of GDP in the 1960s to 1.00% of GDP by the 1980s and then remained steady. His conclusion was that stable revenue growth made the industry more susceptible to economic cycles. Other research efforts have measured percentage growth rates based on passenger-booking statistics and found a long-term decrease in those growth rates. As previously reported, Banks (1993) found that during the period from 1950 and 1973, passenger traffic grew at a rate of 13% per year. Later, Costa et al. (2002) reported that the passenger growth rate decreased to a 6% annual growth rate during the 1980s and further decreased to only a 4.7% annual growth rate during the period from 1990 to 2000. With the maturing airline market, the successful passenger growth strategies of the past became less effective as the rate of passenger growth tended to be equal to the rate of economic expansion (James, 1993). Additional evidence of this decline in passenger growth can be seen in the aircraft manufacturing industry where today only the Boeing Company and Airbus Industries divide a market in which each continues to battle for at least 50% of the market for large transport aircraft (Lunsford, 2004). In a related article, Lucas (2001) noted that the decrease in the rate of passenger traffic growth has resulted in strategic plans being changed for some in the aerospace industry. His report examined the Boeing Company and its efforts to diversify into support services based on company predictions of a maturing market for new aircraft. For the major airlines, these symptoms of a mature market led to a shift in emphasis from passenger growth to one of revenue growth as they began to use more aggressive yield-management techniques designed to increase revenue from business travelers. Das and Reisel (1997) conclude that this type of action by managers in a mature industry is to be expected as they "will see the future relative to the past and will be less likely to be proponents of discontinuous strategy options" (p. 88). Airline Business reviewed the competitive climate of the airline industry and found that "much of the US market would appear to be already mature" (Reflections, 2002, p. 70).

THE BUSINESS TRAVELER

As the industry transitioned into maturity during the 1980s, the cost improvements associated with jet aircraft operations tended to stabilize as major airlines found that they could rely less on falling costs to maintain margins (Banks, 1994). It was in this operating environment that the business traveler became a critical component of airline revenue strategy (Banks, 1993). With the need to make unplanned trips on short notice, the business traveler became the prime candidate for the application of yield-management techniques. Yield management worked because customers placed high value and utility on timely air travel. During the 1990 to 1995 industry cycle, business travelers began to accept even higher fares for tickets purchased close to the flight date. This acceptance resulted in improved yields that enabled the industry to regain profitability by 1995 (Costa et al., 2003). However, the relative number of full-fare paying travelers had declined from a reported 52% of total passengers in 1982, to 37% by 1992 (Banks, 1993), and to 23 % of total passengers by 2001 (Costa et al., 2003). To offset this decline, major airlines placed less emphasis on cost control and greater emphasis on yield-management techniques. These techniques grew in sophistication and tended to keep revenue and margins up during the growing economy of the late 1990s as the airlines became more dependent on high paying, frequent business travelers. Their presence in the ticket pricing equation and their willingness to pay even higher prices allowed revenues to grow. For example, one survey reported that on any given flight, the ratio of the highest priced tickets compared to the lowest priced tickets could be as high as 20 to 1 for the major airlines (Webbed Wings, 2001). In a specific example, Carey (2002) reported that United Airlines estimated that business travelers generated 46% of its revenue while representing only 9% of its customers. By focusing on yield from the business travel market and achieving this documented level of revenue growth success, airline strategists have found it difficult to reflect on an uncertain future and change to a mature industry strategy where cost control and standardization would be important to success.

THE CURRENT INDUSTRY BUSINESS CYCLE

Using recent ATA statistics, Donoghue and Geoff (2003) reported that the U.S. airline industry is currently generating revenues of 0.9% of GDP. These revenues mirror the 1980s industry average rate of 1.0% of GDP reported by Poling (1993). At that time, Poling accurately concluded that future improvements in communications technology would decrease the volume of business travel while the standard of living, on the rise throughout the world, would tend to increase the volume of lower yielding leisure travel. Current data support his conclusions and also show that in the overcapacity condition of the current business cycle, even with marginal improvements in yield management, there is little hope that the combination of higher operating costs and declining business/leisure mix will lead to an industry recovery (Callahan, 2002; Loranzo, 2001; Tully, 2003). Lunsford (2004) concluded that the current overcapacity condition is expected to be a long-term industry problem because over 500 of the currently unused 2100 aircraft (now parked in western U.S. storage areas) are capable of being returned to service. At a time when businesses are considering more widespread use of travel substitutes, excess capacity is causing many carriers to offer lower fares and corporate travel discounts of 20 to 30 percent in an attempt to maintain market share (Costa et al., 2003).

The Threat of Substitutes

Reviewing the business travel market, Belden (2002) reported that airline executives have begun to accept that the current industry problems are caused by more than the economy and that the complex airfare structure has driven away some business travelers and is helping to support a wide range of travel substitutes. Mechan (2002) supported this conclusion in a summary of a recent air travel survey that found that substitutes for air travel have become commonplace in business travel budgets.

Porter (1980) concluded that substitutes pose a serious threat whenever the relative switching cost is low. Today, we see the dollar cost of some popular substitutes for air travel coming down just as we see the effects of added security and other time delays reducing the value of traditional air travel for the business passenger. For example, Caton (2004) found that new web-conferencing technology is available today for less than the cost of one business class ticket. Just as the value of air travel grew and made it a substitute for rail and ship travel during the growth period following WWII, today's airlines must determine which, if any, viable substitutes are ready to compete for the business traveler. In addition to the market threat posed by low-fare carriers, two categories of substitutes threaten the traditional airline business travel market. These substitutes--business jets and video/information technology--are today receiving widespread recognition and investment.

Business Jets

The use of general aviation (GA) aircraft, the category of planes in which business jets are listed, expanded rapidly after WWII, beginning with single- and twin-engine prop aircraft and evolving into corporate jet aircraft by the 1960s (Olcott, 2004a). From modest beginnings, the fleet of corporate aircraft has grown to over 10,500 aircraft according to the General Aviation Manufacturers Association (GAMA) (General Aviation, 2003). Corporate aircraft come in all sizes and seating capacity and can serve over 5000 airports while U.S. scheduled airlines serve only 429 airports (Industry Facts, 2004; Olcott, 2004a). Corporate aircraft may be wholly owned, fractionally owned, leased, or chartered. Carey (2002) refers to the fractional jet option as the "ultimate upgrade" (p. A1) and concludes that the use of this type of aircraft represents a threat to today's larger airlines. The business jet, with its many advantages in convenience and savings of executive time, is a viable substitute for high-end business travel (Airlines Likely, 2001) and is expected to take 10 % of the business passenger market away from the airlines by 2005 (Costa et al., 2002).

Today's cost of business travel, measured in terms of dollars and travel time, has spawned a new type of aircraft and threat to traditional airline service. This substitute, known as the minijet or very light jet (VLJ), will soon be available to the budget-minded business traveler. Little is known about the degree of threat that this new design poses for the airlines. However, initial performance data indicate that these aircraft will offer point-to-point service and will cruise at over 400 miles per hour while operating for as little as $1.00 per mile (Olcott, 2004b). There are currently eight companies, ranging from the traditional Cessna Aircraft Company to the nontraditional Honda Motor Company, involved in the development of these 6- to 8-passenger designs (Lunsford, 2004). Stone (2003) refers to these manufacturers as a "new generation of aviation entrepreneurs seeking to change the air travel equation and to mint a new class of airplane and air travel" (p. 60). At present, over 2,500 orders have been placed for the various designs of the current manufacturers, with the first planes scheduled for delivery beginning in 2005 and having a potential demand estimated to be over 10,000 units by year 2020 (Olcott, 2004a). Supporters see the minijet option as an economical way to save time and avoid airport congestion for travelers who desire to connect quickly to all parts of the country. The development of these aircraft is but one more indication of the threat of potential changes ahead in the business travel market.

Video/Information Technology

Evidence that videoconferencing impacts airline business travelers has been a factor in airline strategic planning for many years. For example, as early as 1979, Boeing Computer Services used videoconferencing as a substitute for air travel in its efforts to save time for engineers (Nordwell, 1990). Saving time was also the focus for Hughes (1993) when he reported the results of a FAA funded study on the potential impact of videoconferencing on passenger demand at Boston Logan Airport. He found that using videoconferencing to save time, particularly the time needed for visits by employees to other company facilities, was predicted to impact business trips and could result in a 13% to 23% reduction in business travel by 2010. Because of the inconvenience of security delays and travel time, many companies today are turning to videoconferencing to replace airline travel. For example, Callahan (2002) reported on the results of a survey by the Business Travel Coalition and found that 61% of corporate travel executives say that they have urged their employees to increase their use of webcast and conference calls rather than travel. According to Adams (2001), most videoconferencing firms saw surges in customer demand of 30% to 50% in the days following 9/11.

DISCUSSION

This research questions whether a strategy designed to achieve growth based on low cost has moved beyond being considered an exception to now being considered the norm for the airline industry. The methodology for answering this question involved an analysis of the industry's modern era business cycles and changing market forces, opportunities, and threats. Based on this review, conclusions would have to be qualified by first noting that the answer to the research question was not as obvious as the popular literature would suggest.

No one expects business jets, videoconferencing, or web conferencing to replace completely airline business travel. However, this research finds that dependence on both the business traveler and on greatly inflated short-term ticket prices is at the center of the long-term strategic threat for most traditional carriers. Banks (1993), one of the first to observe this threat, reviewed the role of the business traveler in airline pricing strategy during the 1980s and found that most carriers of that time would have realized zero profitability if they had lost just one out of ten business passengers. Today, with the industry experiencing its third major business cycle in the last 25 years, there is an increased risk of loss because most traditional marketing and operational remedies are not available. This review of industry cyclic activity finds that dramatic changes have occurred in the competitive landscape. The number of certificated carriers, routes, and airports served by multiple carriers has increased as carriers following low-cost operating models entered the industry after deregulation and had considerable influence in shaping the strategy of major carriers. Even with this influence, major carriers increased in number during the 1980-1984 business cycle as they survived without adopting low-cost strategies. This paper has already documented that some new discount carriers failed because of flawed business models or because they were squeezed out by the marketing efforts of the major carriers (Boone, 2003; Dubin, 1984). During the 1980s, the strategic choices exercised by the major carriers generally allowed them to avoid adopting low-cost strategic models and still control 90% of the market at the end of the decade (Das & Reisel, 1997). Their creative marketing efforts resulted in the frequent-flyer and leisure- fare programs that successfully protected market share while the first use of yield- management techniques helped to recover more revenue from business travelers. Entering the 1990s, further evidence shows that the industry was maturing and that airline service was becoming more standardized with the competitive advantage shifting to those carriers who achieved cost efficiencies.

This review of the 1990 to 1995 industry cycle observed that the major carriers were successful in holding off most low-cost carriers even though the low-cost strategies of some competitors had become a permanent fixture in the industry landscape. For example, Southwest Airlines, a benchmark low-cost carrier, had become so successful in its low-fare promotion by the early 1990s that when it began to operate flights out of any airport, the resulting effect on all ticket prices undermined the ability of major carriers to charge the higher prices needed for them to recover their higher operating cost. The FAA called this phenomenon "the southwest effect" (Bennett & Craun 1993). Today, low-cost carriers control about 20% of the U. S. airline market, and analysts expect this market share to expand to 40-50% in the future (Velocci, 2004). Ott (2004), in his analysis of the perils faced by discount carriers, noted that this expansion will not be without risks as the industry faces the harsh tests of reorganization and reconstruction. However, Tretheway (2004) observed that today's low-cost carrier model "is not a fad, but rather a business model with a permanent role in the marketplace that undermines the price discriminating ability of the full cost carriers and is the most important pricing development in the industry in the past 25 years" (p. 13).

In a maturing market, industry planners should not depend on growth to attract new business customers, nor should they depend on management science specialists to find dramatic new opportunities to increase yield. This research concludes that a low-cost strategy should no longer be considered an exception but rather should become the norm for the airline industry. Most past options that have enabled the industry to avoid embracing a low-cost strategy are simply not available today. The major airlines need to change fundamentally their concept of the industry and understand that once benchmarked, today's low-ticket prices will be difficult to move up (Donoghue, 2003). Today's airline passenger, aided by better information technology and the internet, has gained the advantage over the airlines in ticket prices. Becoming profitable with a benchmark 2 to 1 spread from highest to lowest ticket price for a given flight should become a goal (Webbed Wings, 2001). Lower prices must be supported by lower operating costs while maintaining a service level needed to attract and keep business travelers.

LOW-COST SUPPORT AND APPLICATION

There is no magical formula for achieving a low-cost operating model. The literature offers many suggestions aimed at cost reduction, and the following section summarizes both the support for and examples of cost-cutting strategies found to be successful today. This summary is not offered in any ranked order because market and route structure will dictate application for each carrier.

Information Technology (IT)

Today, the leading low-cost carriers have embraced IT applications (Burns, 2001). For example, at JetBlue Airways all calls to its unique reservation unit are directed to a reservation specialist working out of his or her home (Ford, 2004). In this example, internet-based technology is a vehicle that has allowed a low-cost carrier to connect successfully e-commerce through strategy to its core business. Moon and Frei (2000) suggested that airlines adopt a co-production concept of e-commerce. They concluded that flight and ticket price information be revealed in an IT system designed for ticket shopping that helps remove the mystery and reduce the cost of making a flight reservation. In an example of this logic, Schwartrz and Zea (as cited in Smith et al., 2001) reported that America West Airline reduced its average per-ticket distribution costs from $23 for tickets sold in a traditional manner to $6 for direct internet sales. This example supports the overall IT goal of providing the online data and information needed by the customer while cutting cost and improving efficiency for the carrier (Azoulai, 2000). Other IT examples, such as the use of Kiosks technology for ticketing and check-ins, not only lower costs, but also give today's travelers some control over a process in which they sense a lack of control.

Homogeneous Fleet Type

A homogeneous fleet type will allow common flight crew training, crew certification, maintenance procedures, and supporting inventory. All carriers should adopt an aircraft purchase or replacement process that will limit their fleets to the minimum number of aircraft types necessary based on route distances and payload considerations (Airline of the year, 2003; Franke, 2004). For example, today's operation of each aircraft in each aircraft type typically requires five crews, and when these crew members change their route bid lines to fly different, higher paying type aircraft, there is a fleet-wide domino effect in training requirements as crewmembers bid to fill vacant positions (Dismal Demand, 2003). Today, the five largest U.S. carriers operate an average of eleven different aircraft types with eight different flight crew pay classifications ("Pilots Defending the Profession," 2004). On the other hand, Southwest Airlines and JetBlue Airways, current low-cost leaders, have successfully operated single fleet types.

Use of the Regional Jet (RJ)

The RJ is designed to lower cost while offering passengers more convenient direct service over short to intermediate distances (Costa et al., 2003; Kluyver & Pearce, 2003). For instance, the Embraer RJ, a type of regional jet, can be configured with 70-118 seats, 85% common parts, and 100% common cockpit crew configurations (Shifrin, 2004). Southwest Airlines is now considering the RJ option, and JetBlue Airways is committed to buying the Embraer RJ for use over routes having low demand (Trottman, 2003). However, for many carriers their pilot labor contracts may contain a scope provision which sets pay based on aircraft seating capacity and may limit the use of the RJ designs (Feldman, 2001; Ott, 2002). Addressing the scope clause limitation on aircraft selection should be a priority in labor contract negotiations.

Work Rules and Pay

Low-cost does not necessarily mean low pay. During the 1990-1995 business cycle, Dooley (1994) addressed the issue of operating costs and noted that the average salary of employees at Southwest Airlines was about the same as the average employee salary at the largest carriers. In one job classification example, he found that in 1992 favorable work rules allowed Southwest pilots to fly an average of 63.7 hours/month compared to an average of 48.3 hours/month for the largest carriers. Measuring in terms of operating costs, he found that the additional duty hours spent operating a single-plane type gave Southwest a 38% productivity advantage, which resulted in a $1200 labor cost savings per average flight when compared to the largest carriers. A decade later, McCartney (2002) addressed this same issue and found that flight crews at Southwest had more favorable work rules that allow them to fly more duty hours/year compared to the other large carriers, yet flight captains with ten-years experience earned about the same, or $150,000 per year, at Southwest and the other large carriers.

Hub Operations

Traditionally, major carriers with hub operations have banked flights so that many flights would arrive during a short time interval. This banking could be repeated several times each day and provide passengers with the minimum time between connecting flights. In the new airline environment, an operating model involving "rolling hubs" is suggested in order to avoid arrival or departure congestion and to spread flights out more evenly throughout the day (Arndt & Zellner, 2003). The negative effect of this change is an average increase in passenger connection time between flights, but the positive effect is a reduction in block times. Block time begins when the aircraft leaves the parking blocks at the departure gate and ends when it stops at the parking blocks at the destination gate. A reduction in block time saves aircraft and crew time that can be used for flying rather than waiting on the ground. In one example, Ott (2003) reported on the benefits recorded by American Airlines with its introduction of rolling hub scheduling. In his report, he noted that American estimated savings of $100 million per year in facilities, personnel, and fuel costs at the expense of 10.7 minutes average increase in passenger connection time. The smoother traffic flow resulting from rolling hub scheduling improved efficiency at American and allowed it, for example, to complete its Chicago flight schedule with five fewer aircraft, four fewer gates hosting 8-9 departures/day, and a 5% manpower reduction.

Outsource Maintenance

Donoghue and Geoff (2003) concluded that a fundamental change is needed in the way that network carriers look at the industry and that they need to outsource activities such as maintenance. In-house maintenance activities have been a standard part of the business models of major carriers for decades with large airlines devoting 12% of their operating expenses to maintenance (Bacheldor, 2003). Arndt and Zellner (2003) noted that Southwest airlines and other successful low-cost carriers are outsourcing their engine and airframe maintenance. They suggested that those carriers with in-house maintenance units should consider selling the facilities to their employees, contingent on an initial maintenance contract. This action would be difficult to initiate and implement in any environment other than the current high-loss, high-risk climate. Dedicated aircraft maintenance firms and the maintenance divisions of the original equipment manufacturers (OEMs) offer the higher volume and spare parts inventory pooling needed to lower costs. McDonald (2002) stressed the importance of controlling costs for aircraft parts and noted that the tighter management of aircraft spare parts represents a potential for savings that is greater than any existing opportunity for improved revenue.

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Richard Cobb, Jacksonville State University
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