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Airline industry and Porter’s five forces

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1.Use Porter’s five forces of competition’ framework to show how the structure of the airline industry has caused low profitability during the past twenty years.

Below are Porter’s five forces of competition. In them you will understand what has caused low profitability.

The bargaining power of suppliers: Labor is the airline industry’s largest single expense. Most airline workers belong to one of a dozen unions, which give the airline workers strong power in negotiations with the airlines.

Airline operations are also energy-intensive, and some carriers attempt to hedge their fuel costs by buying and selling futures. Jet fuel prices are currently high because oil refiners kept jet fuel production down in 1996 as they waited for crude oil prices to dive following the return of Iraq to the market.

The bargaining power of buyers: The customers can be broken down into two main segments: business and leisure. Because business travelers often book flights at the last minute and frequently have their organization pick up the tab, they tend to be relatively price-insensitive. Consequently, business travelers generate a larger portion of the industry’s revenues relative to their numbers.

The frequent flier programs were originally targeted toward the business segment. We have recently seen a trend toward expanding the frequent flier programs to let members earn miles by conducting business with a variety of other organizations. This makes the frequent flier programs a powerful tool in the leisure market as well. An attractive frequent flier program will increase the power of the airlines in the customer relationship.

Threat of entry: threat of new entrants presents new firms’ possibility to enter the industry and make its returns falling down through prices competition. Since the hub and spoke system has taken place, the barrier to entry are higher because new carriers find it difficult to obtain gates and landing slots at the major hubs.

In addition governmental and legal barriers are the most effective barriers to entry: in fact, there is new policy adopted by federal aviation administration, that put caps on the number of aircraft a new airline can operate based upon carrier’s financial and managerial resources. This because according to a governmental accounting office study made many years ago, startup airlines’ accident rate was higher than the major airlines’ rate.

Competition from substitutes: the airline industry faces competition from other transportation modes, such as cars, railroads and buses. The car is the airline industry’s main competitor: in fact, airline travel is neither practical nor economical for short trips. On the other hand, for long distances, buyers may be more inclined to choose air travel to reach their destination.

In the last five-year period, less obvious substitutes to airline travel in the business segment include teleconferencing, enabling virtual meeting rooms where participants can sit in different geographic locations.

Competition from established rival: the airline industry can be characterized as an imperfect oligopoly, in which a few carriers dominate in long distance flights, while several dozen small carriers compete for short-distance flights. The airline industry has become more concentrated over the last 10 years. Two main factors have contributed to this concentration: several mergers have taken place during the last decade. As traffic growth has slowed and carriers have exhausted means to boost profits through conventional cost-cutting measures, mergers provide opportunities for saving by consolidating administrative, distribution and maintenance operations. Bankruptcies have also contributed to the increased concentration, especially in the early 1990s.

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