Domestic Airline Industry

1. Domestic Airline Industry Economics of Advertising AEM4550 April 25th, 2011 Elle Fenn Margaret Loff Stephanie Zimmerman

2. Agenda • Introduction • Industry Structure • Advertising Strategies • Advertising Mediums • Case Study 1: Southwest Airlines • Case Study 2: United/Continental Merger • Recommendations

3. Industry Structure

4. Definition Companies that provide transport of passengers and cargo over regular routes and schedules within the United States. Primary roles: • Passenger air transport • Cargo/freight air transport • Mail air transport

5. Hub and Spoke System

6. Governing Groups • ATA: Air Transport Association of America, advocate of participating airlines for industry success • FAA: Federal Aviation Administration, regulates airline industry

7. Industry Life Cycle Decline • Low industry participation, mergers, less passengers • Less enterprises, less establishments and decreased employment • Stable and segmented services • Less technological advancements, new routes, but slow growth • Diminishing returns on investment

8. Products and Services

9. Market Segments

10. Leisure Travel • Vacation, moving, or non-business activities • Dependent on: • Disposable income • Discretionary spending • Price elastic

11. Business Flying • Companies cover expenses when business is strong • Bankruptcies and bailouts • Dependent on: • Economy • Employment • Business strength

12. Cargo Transportation • Impacted by level of high value time-sensitive imports and exports • More profitable to use air transportation with high value to weight proportion, time-sensitive products • When economy is poor, consumers desire less of these products, cargo decreases

13. Industry Costs • Profit: highly volatile, restructuring methods • Rent: aircraft rentals, facility rentals • Utilities: electric, gas, etc. • Depreciation: aircraft depreciation • Other: interest, tax, utilities, insurance, legal, SG&A • Wages: operating costs, labor costs • Purchases: FUEL, operations materials

14. Cost Drivers: Oil Prices • Increases in oil prices increase airline costs • Hard to keep profits up with quickly increasing costs • Airlines cannot pass full cost increase to consumers without losing sales • Forced to find other way to cut costs • Food charges • Internet charges • Baggage charges • ** ATA predicts, for every dollar increase in the price of jet fuel, the domestic airline industry incurs an additional $445 million in fuel expenses

15. Oil Price, Corporate Profits, Industry Revenues Spike in 2008 in oil price > Decline in profits > Decline in industry revenue

16. Technology • Dynamic changes, however no drastic changes in recent years • Advancements include: • Fuel-efficient engines • Larger aircrafts • Aerodynamic designs • Automated systems: kiosks, entertainment, website, reservations, operation, maintenance • E-commerce: paper ticket ban in 2008

17. Trends: 2001 • September 11th Terrorist Attacks • Fear of flying • Increased government regulations • Growth leading up to 2008 with weak U.S. dollar and solid income growth

18. Trends: 2008 • Oil prices reached a high of $147 per barrel • Passenger numbers fell by 5.1% • Decreased demand for business travel with bankruptcies and government bailouts • Recession forced airlines to file for Chapter 11 bankruptcy • Delta Airlines and Northwest Airlines merger

19. Trends: 2009 • Significant oil price decline • Passenger numbers continue to decrease by 7.8% • Low discretionary spending due to poor economy • Inbound visitor decline by 35% • Swine Flu Outbreak • Revenue down 17.1%

20. Current Trends • Oil price increase • Economy slowing improving • Passenger increase • Stress on fuel-efficiency • Additional fees and surcharges

21. US Airline Industry

22. Structure • Concentration is medium • HHI= 501.87 (calculated using top 5 firms, ignoring ‘other’) • HHI < 1000 – competitive markets • HHI > 1800 – proposed mergers challenged • 4 firm concentration ratio: 42.1 • This number has risen due to mergers • Delta/Northwest - 2008 • United/Continental - 2010

23. Competition • Price • Frequency/capacity • Route offerings • Service quality • Loyalty programs/promotions

24. Competition • Internal • External

25. Barriers to Entry • Barriers to entry are high • Fixed costs • Government requirements • Economies of scale • Entry strategy: No frills/low cost • Several of these now exist

26. Industry Organization

27. Airplanes • Airplanes can be leased to ease capital requirements, although some airlines prefer to own airplanes as assets. • Owns: • Delta Air Lines • Rent: • American Airlines • Southwest Airlines • United Airlines • U.S. Airways Delta Airlines Boeing 767

28. Food and Beverages Breakfast served in Economy class, Continental Airlines Food being delivered to an Boeing 767 American Airlines flight

29. LSG Sky Chefs • Brand name of LSG Lufthansa Service Holding AG, which is the world's largest provider of airline catering and in-flight services. • Its primary business function is to prepare and deliver meals, beverages and snacks to aircraft for domestic and international flights.

30. LSG Sky Chefs • Also provides extended services on all other aspects of in-flight service, including the design and sourcing of in-flight equipment, in-flight logistics, in-flight management, onboard retail management and the management of airport lounges • Services: • American Airlines • Delta Air Lines • United Airlines

31. Southwest • Some snacks that are found on board a typical Southwest flight include: • Peanuts • Pretzels • A variety of Nabisco brand selections • Southwest Airlines does not offer any full meals. This is another way Southwest is able to offer cheap flights to major cities.

32. Labor • Many domestic carriers utilize automated systems to operate their business. • These systems include computerized airline reservation system, flight operations system, telecommunications systems, website, maintenance systems, check-in kiosks and in-flight entertainment systems.

33. Labor • Labor requirements in this industry are also higher as labor input in flight safety, in-flight service and ground services are important factors in an airline's operation. • Many labor functions in the industry, such as piloting, safety requirements and customer service cannot be made less labor intensive.

34. Labor • Long or quick turn-around trips require extra crew members to adhere to federal safety requirements.

35. Advertising Strategies • Informative • Predatory • Persuasive • Combative • Restorative • Program type • Location

36. Ad to Sales Ratios

37. Ad to Sales Ratios • High or low? • Transportation/Travel industry =1.9 • Consumer Products, Books, PayTv, Communications, all > 5 • Downward Trend

38. Advertising Expenditure

39. Advertising Expenditure • Ratios appear low and declining • Value of the industry • In reality, the figures are in the hundreds of million $ for the major players, and increasing • Average ad expenditure across the industry - $94 million

40. Brand Equity • Of the Major players, largest brand equities: • Southwest – 66.1 • Delta - 58.2 • Southwest is also the largest spender on advertising

41. Informative • Price focused • Sale fares • The $10 ticket • Sell excess seats • Covers incremental variable costs • Loss leader

42. Predatory Pricing • Lower prices & add capacity • Force new players out • Not new airlines began service from 1995 until early 1999 • Legal solutions difficult; hard to prove • Price wars • 1996 Spirit v Northwest

43. Persuasive • Branding • Majors players differentiate from low cost carriers • Low cost carriers differentiating between themselves • Quality, service, ‘connection’ to America • Customer experience – providing value outside ticket price • Loyalty beyond price

44. Combative • Structure – 5 major players, largely homogenous product • Nominal ad expenditures increased, passenger traffic remains low • Demand shifting between carriers • Advertising wars • Major players’ debt – dangerous

45. Restorative • Injury (minor or serious) – no variation in advertising • Minimal media • Levels maintained; market share • Fatal accidents – advertising reduced • Media inaccuracies • Irrational to attempt to restore with ads • Non injury related – advertising adapted • Deltas bankruptcy – ‘change’

46. Advertisements by program type • Newscast #1 for all major players • Adults • Older viewers – less price sensitive • Quality, service • Strong viewership • Business • Sit coms & Talk shows- #2 • AMR documentary - #2 • Minimal sports spending - surprising

47. Advertising and Location • Southwest • Baltimore, Denver • Delta • New York • AMR • Chicago, Miami • United/Continental • Paduca, Houston **adjusted for population differences

48. Advertising and Location • Targeting major hubs • Southwest – Baltimore first east coast hub • United – Chicago • AMR – Chicago & Miami • Delta – NYC • Company branding + origins • Southwest – targets cities it started in  connection • Routes • United – recently launched service to Paduca from Chicago

49. Advertising Mediums • Television • Print • Magazines • Newspapers • Radio • Internet

50. Popularity of mediums ($) Television Magazines Internet Outdoor National Newspaper