Report on Five Forces Analysis of Airline Industry: Present and Future

Posted on May 27, 2022 by Cheapest Assignment

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BIO0226 - Real World Business Issues Assignment

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Executive Summary

This report presents the current status of the airline industry and describes the scope of growth in the future. Various participants in the aviation industry are listed and their roles are described. The critical part of the report is the analysis of the industry using the five forces model. The future scenario of the airline industry is also touched upon briefly.

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The present state of the Aviation Industry

IATA (2011) has reported that travel by air has increased tenfold at a global level in just four decades. Looking at the past, air transport is bound to increase even further because untapped markets are coming into the aviation sector. Also, the economy is improving in many underdeveloped countries leading to growth in aviation operations.

The technology improvements in engine design, fuel efficiency, ground handling and passenger administration have helped the airlines to manage costs and profitability. Due to an improved management system, the airport asset utilization and aviation personnel productivity are increased which ultimately reduced the unit cost of air transport (Belobaba, Odoni, & Barnhart, 2015).

The airlines have invented new business models in customers’ favour and attracted more passengers and cargo to air travel in many countries. The government support with liberalized laws has enabled many airlines to represent untapped markets. Overall, the airline passengers and air cargo users have benefitted to a large extent.

Some interesting observations by the researchers and business analysts have unearthed the following facts about the aviation industry. Most of the investors in the airline industry have gained in the long run. Out of the number of players in the value chain, the service providers, suppliers, vendors and allied industries in the aviation value chain have generated enough profits. However, Airlines, especially the larger ones that own bigger fleet has earned the smallest profits and operated at higher risks (IATA, 2011).

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Despite rigorous efforts in containing costs and inventing new business models, most airlines have experienced lower returns even after a decade of being in the business (Belobaba, Odoni, & Barnhart, 2015). As mentioned earlier, this failure is not due to a lack of effort or application of best practices. For example, most airlines have contained operating costs through outsourcing non-core services, efficient use of assets, application of management principles, opening up innovative revenue streams, rolling out customer loyalty programs, allying with synergistic business partners, etc. (Clausen, et. al., 2010). Despite these efforts, the profitability of the aviation industry is pathetic.

The Proposed Analysis

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Whether the customers are going to prefer air travel or the airlines will make better profits in future depends on several factors in the environment. The question can be answered through a robust analysis based on Michael Porter’s Five forces analysis. The reasons for the low profitability of the airline operations also can be examined using the five forces analysis. The five forces are rivalry among competitors, the threat of new entrants, the bargaining power of customers and suppliers, and the threat of substitutes or alternative transport. There are only a few industries where all the five forces operate strongly in the aviation industry to pull down the profitability to low levels. The Five Forces analysis has the potential to reveal the deep underlying causes of low profitability.

Major Participants in Aviation Industry

The aviation industry is a complex system with many numbers of players in it. The success of airline operations depends on the contributions of other players and stakeholders (IATA, 2011). Based on Michael Porter’s model the participants of the industry are listed and a brief description is provided about them (Forbes and Lederman, 2009).

Power, Influence & Leadership Models

Support Channels

Travel agencies: they work as intermediaries between the airline and the end customer for a commission. The travel websites are pushing the traditional travel agents to lesser relevance, but corporate customers still prefer traditional travel agents.

Travel websites: these websites are emerging as the main sales channel of airlines, especially low fare tickets. The travel portals help the customers to compare the prices among airlines and enable easy booking facilities.

Direct sales through airline websites: Because of technological advancement, the airlines can attract customers to their websites and get connected with the customers easily. Many customized services such as seat selection, allowing check-in process, and generating boarding passes have made it simpler here.

End customers

Individual Customers: Those who travel for vacation, educational visits, social visits, job travel, etc. are the individual customers.  This customer segment is highly-priced sensitive and is prepared to be flexible with the duration and timing of flights (Bilotkach, Gaggero, & Piga, 2015). Their buying behaviour is changing due to the introduction of e-ticketing and mobile apps.

High-end business travellers: This segment has frequent travellers and prefers to have a direct connection with the travel agent to plan their travel schedules. Business travellers are less price-sensitive and expect special services from the airlines (Bilotkach, Gaggero, & Piga, 2015). This segment is amenable to loyalty programs

Air cargo customers: There are direct as well as intermediary customers for this service. The direct customers who ship large volumes negotiate with the airline directly for the space. While the intermediaries buy cargo space from the airlines and then sell the space to the individual customers for a higher charge (Porter, 2008).  This segment is highly-priced and sensitive.

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Suppliers of spares and aviation technology

Airframe manufacturers: They are Aircraft manufacturers who produce aircraft on order. Usually, I take months and years to fulfil an order. There are only a few manufacturers around the world; hence they have a tremendous influence on the airliners. Most manufacturers have different models depending on size, usage and capacity (IATA, 2011).

Aircraft engine manufacturers: These manufacturers produce only engines and spares for the aircraft, and do not have direct contact with the airliners. Their products go as components to the aircraft manufacturers. Engines occupy a large portion of an aircraft’s cost.

Maintenances, repair, and overhaul (MRO)

Maintenance and repair activity is mostly carried out by the third party on a contract basis. There are many contractors available on a global basis.

Financing Service providers

Because the airline business is highly capital intensive, external funding is required to maintain a sufficient fleet of aircraft. The banks and financial institutions develop special financing packages for the airliners depending on their needs.

Jet fuel

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A critical commodity for an airline operation is fuel, whose price depends on the global demand. The prices are highly volatile and take a significant portion of the total cost of operation commodity where prices follow global oil prices.

Labor

The airline industry is highly labour oriented and needs different levels of skills and competence to successfully run the business.  Each category of employees is invited for negotiating the wages and once it is fixed, the rate remains in effect for a long period (IATA, 2011).

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Ground handling services, catering

Ground handling services like baggage screening, and check-in service, are local businesses served by natives of a place. Similarly, in-flight catering services are provided by specialized food service companies that are locally based or have a global presence.

Airports

Airport administration collects fees from the airlines and other service providers for the usage of premises and facilities. Most airports are owned by the local or national governments. Very few private airports are used by major airlines.

Government-mandated services

Security services, air traffic control, Customs cell, etc. are government-sponsored institutions to enhance safety and prevent illegal activities.

Potential entrants

Corporations that have ambition and capital can enter the airline business. There are about 1500 airlines registered with the IATA.

Substitutes

There are many competing modes of transport such as ships, high-speed trains, private jets, etc. that compete with traditional airlines.

Airline rivals

Network airlines that operate in hubs and special routes have local and global competitors. The competition among airlines is stiff and ruthless.

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Future Scope and market segmentation

The aviation industry has further scope to expand in untapped geographical areas. Other competitive dimensions include specific customer needs, and service development to suit the needs of the market (Dana, Dana, Schmitt, & Schmitt, 2017). There is huge scope for segmented markets such as tourism, education, leisure, business travel etc.  Five Forces analysis is also meaningful for assessing relevant market segments than only for the complete industry. The observations about airline profitability are converging with the hypothesis that all segments have an equal effect on profitability. According to Michael Porter, profitability is a function of the aggregate effect of the Five Forces as well as the individual interaction among them. These forces influence the functioning of each component of the industry and determine the total value created in the industry.

Five Forces Analysis of the airline industry

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Intensity of rivalry

As it is observed earlier, the rivalry is ruthless in the airline industry. Airlines compete based on their capacity to serve the routes (IATA, 2011). The second is operating the routes and connecting various destinations. The third source of competition is the pricing pattern. All the three were put together to add to the rivalry among airlines.  The other factors include the following.

  • Airline service is highly perishable i.e. if the seats are vacant during a flight, the opportunity to monetize is lost (IATA, 2011).
  • The scope for differentiation is very limited in the aviation business.
  • The sunk cost is high per aircraft and returns are barely sufficient to meet the cost of capital.
  • Exit barriers are frustrating
  • There are direct and indirect rivals operating in the market

The threat of new entrants

About 1500 airlines are operating across the world indicating that entry barriers are low. At the same time if we look around there are only two large aircraft manufacturers i.e. Airbus and Boeing. Even though the airline industry has low profitability, the corporate is ambitious to enter the airline business. New entrants continue to enter the market and post failures soon.  Frequent new entries happen through the expansion of the new airlines to overly crowded routes or geographic locations. The only significant entry barrier is the high capital requirement. However, there are financial institutions to provide capital to the business owners who demonstrate the capability to repay the loan.

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Economies of scale on the demand side can be achieved through an established distribution network and a big network of operating routes. Established operations provide benefits by generating route density allowing bigger aircraft that lowers cost or run at a higher frequency than earns higher prices (IATA, 2011).

On the supply-side economics, the airline is likely to earn less profitability if it grows beyond fifty aircraft (IATA, 2011). This acts as a disadvantage to the new airlines but has little effect on the existing ones who explore new markets. Because capacity is the key asset in airline competition, airlines operating on adjacent routes have the least entry barriers. Established airlines can serve a new destination through available capacity on the existing routes.

Bargaining power of customers

The bargaining power of airline customers is high and is increasing due to the availability of alternative modes of transport. Sales channels have adopted aggressive steps to pursue the needs of corporate customers. This practice of agents automatically transfers the bargaining power onto the customers. Corporate customers are likely to seek price cuts for their frequent travel schedules (Bilotkach, Gaggero, & Piga, 2015).

The bargaining power of individual customers also is increasing. Internet websites are attempting new business models to attract more individuals to the site traffic. The price-sensitive market segment is not keen on the date and time of travel but is willing to wait for the prices to drop to decide the travel schedule.

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Bargaining power of suppliers

In the airline industry, the bargaining power of equipment suppliers and vendors is high. It is observed by the researchers that suppliers often earn higher returns than airlines. Airframe and engine manufacturers have the highest bargaining power in the airline industry due to the smaller number of aircraft manufacturers (IATA, 2011). However, the switching costs of airframes and engines are low. Only time lag to fix the new engine adds to the cost. Employees in the airline sector are critical in the operations; hence they have higher bargaining power, especially the pilots and the cabin crew. Airports have significant bargaining power because; alternate airports are not available in many cities. Due to this competitive position, airports tend to charge higher fees from the airlines.

The threat of substitutes

The market survey and business research have revealed that the greatest threat comes not from the alternate industry but the passenger’s decision not to travel (IATA, 2011). This is true in the case of leisure passengers that can change their decision in favour of other interesting activities. Business travellers also pose a similar threat. Many executives are not willing to travel because of the discomforts of travel and the availability of solutions such as videoconferencing, etc., to solve their travel problems.

Of course, the threat of other substitutes has a limited impact right now but is likely to intensify in the future newer modes of transport.

The airline industry in 2030

Economists and researchers are seeing the upcoming growth in air travel and cargo. It has been known that air travel is faster, safe and hassle-free when compared to other modes of transport (IATA, 2011). Second, many underdeveloped countries have attained economic progress and can afford to connect their cities with airline services. The agile ticket selling system, availability of mobile ticketing apps, affordable air travel prices and availability of flights to remote places will significantly affect air travel positively. The industry is growing and offering many business opportunities, and the stakeholders of the airline industry must develop models to increase operating profitability.

Hypothesis

References

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Belobaba, P., Odoni, A., & Barnhart, C. (2015). The global airline industry. John Wiley & Sons.

Bilotkach, V., Gaggero, A. A., & Piga, C. A. (2015). Airline pricing under different market conditions: Evidence from European Low-Cost CarriersTourism Management47, 152-163.

Clausen, J., Larsen, A., Larsen, J. and Rezanova, N.J., 2010. Disruption management in the airline industry—concepts, models and methods. Computers & Operations Research, 37(5), pp.809-821.

Dana, J. D., Dana, J. D., Schmitt, D. A., & Schmitt, D. A. (2017). The US airline industry in 1995. Kellogg School of Management Cases, 1-38.

Forbes, S.J. and Lederman, M., 2009. Adaptation and vertical integration in the airline industry. The American Economic Review, 99(5), pp.1831-1849.

International Air Transport Asociation (IATA). 2011. Vision 2050 report. Singapore, 12 February 2011.

Porter, M.E., 2008. The five competitive forces that shape strategy. Harvard business review, 86(1), pp.25-40.

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