Strategy Case on Delta Airlines and their positioning in the industry

1. London Business School
STRATEGY CASE: DELTA AIR LINES (A)
Name: Maria Medvedeva
Class: DLEMBA2010
Friday, July 17, 2009
WORD COUNT: 1,999 without EXHIBITS

2. London Business School
Solution Analysis (1): Why low ROI persists in the airline industry in 90s?
(Word Count without Exhibit: 504)
The airline industry transported 620 million passengers by 2001. Its profitability is driven by a yield factor or amount of paying
passenger per seat being closely linked to buyers’ price sensitivity, competition from rivals and limited suppliers with high
power starting from aircraft providers to unionized workforce in maintenance, groundhandling, pilots and crew.
Airlines traditionally operated with low profit margins due to high start up expenditures, unregulated airport fees and unpre-
dictable labor and fuel costs. While the threat of entry is low, new airlines with lower fuel and labor cost coupled with targeted
regional routes could become a destructive force. As labor is the highest expense, unions have extreme power in employment
contracts negotiation. Additionally, there are only two suppliers of aircrafts and limited leasing companies available in the
market, resulting in a wait time of 2 or 4 years for aircraft purchasing. Fuel is another component that increases costs and
requires careful monitoring of the aircraft fleet utilization. Regional jets consume less fuel with higher yield and load factors.
The supplier power represents a major cost driver in the airline industry. As the power is high, it reduces profitability but can
be viewed as a source for differentiation if preferential agreements are signed.
Airline profitability is also dependent on price sensitivity and demands of buyers. While leisure travelers are extremely price
sensitive, business travelers focus on airline schedules, frequent flier program and ontime departures. High buyers’ power
leads to the increased cost as all airlines strive to provide superior offering with extra amenities. There are few substitutes
for air travel. Business travelers are not likely to substitute air travel for train due to limited railroad infrastructure and car
due to low convenience and required focus on driving. Considering time, money and convenience, air travel is still considered
as preference for both leisure and business.
The airline industry is highly fragmented with a total of 10 airlines operating in 2002. Competitive rivalry exists between LCC
such as Southwest Airlines, JetBlue, legacy airlines such as Delta and American and LCS of the legacy carriers such as Delta
Express and Shuttle. While such rivalries impact ticket pricing in a downward trend, they drive establishment of alliances in a
network linkage, thus sharing the costs of facilities in hub airports and providing the customer with greater benefits.
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3. London Business School
EXHIBIT 1: FIVE FORCE ANALYSIS of the AIRLINE INDUSTRY
Buyers Power
Threat of Entry (HIGH/POSITIVE) (HIGH/NEGATIVE)
Slow Industry Growth Price sensitive leasure travellers
High Cost to Start Up Cuts in business budgets increases
sensitivity but the main focus in on airline
Low profit margins frequency schedule and timely departures
Unpredictable Labor and Fuel Costs Heavy discounting of fares in advance
Challenging Route Structure with High Convenience, safety, reliability and brand
Landing Fees at Key Airports name were secondary concerns
Competitive Rivalry Service Quality, amenities, frequent flier
(HIGH/NEGATIVE) and entertainment were tertiary concerns
Depending on city of network
competition ranged from LCC:
JetBlue, SW, Airtran
vs legacy airlines: Delta, Delta
American, United, US Airways
Suppliers Power vs LCS of legacy airlines: Delta Substitutes (LOW/POSITIVE)
(HIGH/NEGATIVE) Express, CALite, Shuttle
Only 2 Aircraft Manufacturers and limited Automobiles were common but lacked
Lessors in the market convinience and required focus on the road and
Labor Unions for Ground Handling, speed limits
Maintenance, Catering and Crew were very Limited railroad infrastructure in only certain
strong and required high pay packages and states eliminated this option for most business
strict employment rules travellers
Travel Agents required commissions for Bus system existed for leisure travellers but was
each booking targeting college students and low class
Airport rented facilities; charged landing population
fees
The industry changed drastically since deregulation of 1978 with the last being increased security costs and decreased air
travel demands after September 11 attacks. By analyzing Five Forces it is evident that high supplier power leads to high fixed
and labor costs, while high buyers’ power increases competition and fare discounting. To improve position in such environ-
ment, airlines need to focus on managing suppliers while targeting niche buyers and fitting the cabin as well as selecting stra-
tegic route schedule. The industry is changing toward low cost air transport with conveniences of legacy carriers. Airlines
having smaller fleet with distinctive routes coupled with utilization of comfort chairs and In-flight perks are redefining the in-
dustry by offering a new way of competing.
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4. London Business School
Solution Analysis (2): How do Southwest Airlines and JetBlue are earning
valuable returns despite industry conditions?
(WORD COUNT without Exhibit: 744)
Airlines industry Five Forces model suggest that high supplier’s power and price sensitive buyers drive profitability down. To
become profitable, two carriers undertook a different approach to air travel by focusing on targeted niche audience, simplify-
ing fair rules and unifying fleet for faster plane turnaround, as well as working with employees to provide pay below industry
standards but with higher flexibility. Higher flexibility in work rules and shift sharing packages lead to increased employee mo-
rale and higher productivity.
Southwest Airlines (Exhibit 2) started as a low cost carrier for leisure and low key business executives as a substitute to auto
travel between regional remote airports in Southwest by utilizing:
a) All Boeing 737 fleet increased load factor and simplified turnaround process. Maintenance cost at low 0.19c.
b) Labor union workforce increased cost to 3.03c versus JB 2.16c. However, packages included profit sharing to give
sense of ownership but employees expected to assume any work positions during shifts.
It quickly grew to cover long distance flights to East and California, but not to exceed 515 miles on average. While SW load fac-
tor of 68% was below JetBlue 77%, it obtained lower CASM at 7.53c having lower landing fees, no food offers and low aircraft
rental expenditures. Business traveler demanded frequent flights leaving morning and returning at night at a budget price.
Leisure travelers looked for low cost fair accompanied with ontime departures and effective luggage handling. SW offered set
fair rules with no restrictions and schedules with hourly flights. In-flight crew was upbeat; and no seat assignments gave trav-
elers’ ability to network. Since SW was flying from remote airports, ontime departures, security procedures, and luggage han-
dling took far less rather than in a larger airport.
Unlike SW being a substitute for auto travel, JetBlue’s (Exhibit 2) audience was high level executives that travelled to key desti-
nations at a low air fare but in a high class social environment. JB flew Airbus 320 jets with coach only cabin fit out with leg
space, leather seats, individual 24 TV channel system and light snacks between key airports of New York, Florida and California.
These airports applied significant rental facility charges but they attracted high class crowd concerned with shopping and
lounge experience. Comparing to the industry JB load factor was 77% above the average of 70% and its CASM was at 6.7c vs
Delta 10.41c and Southwest 7.53c due to a combination of the following:
a) High technology usage with online pilot manuals, maintenance reports and electronic tickets
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5. London Business School
b) Owned all Airbus 320 fleet purchased at low cost and low maintenance requirement
c) Non-unionized workforce with and without industry experience; flexible work packages such as reservation agents
working from home and job sharing packages for college students and mothers.
EXHIBIT 2: “WHO< WHAT<HOW” SOUTHWEST AIRLINES VS JETBLUE
•JebBlue provided prestigious low- fair air service
•Southwest airlines is a provider of low cost
to bankers, brokers, fashion models and finance
air travel for leasure and business travellers
on budget WHO officers
WHO
•Point to point service between primary airports
•Frequest point to point service between in NY and Florida and California with ave
secondary airports in Southwest, California, distance 985 miles.
East (515 miles distances) •Booking on Internet; simple fair structures;
•Set fair rules ; no restrictions, set schedule electronic tickets
WHAT with frequest flights WHAT •Comfort of leather seats equipped with personal
•Absence of meals; no seat assignments; video monitor with Live TV 24 channels system
and no frills coach cabin •Absense of meals; but snacks available
•Utilizing all Boeing 737 fleet that burns low •Bought 23 Aurbus 320 jets
fuel and requires short turnaround time •Non-union labor force operating with few work
from maintenance and crew rules, flexible schedules and employment
HOW •Working closely with employee union to HOW packages (job sharing packages, college student 1
add profit sharing and flexible work rules; year package); working from home
•Hiring pocess focused on enterprenuers •Paperless approach through high technology
with enthusiasm for work. usage for pilots and maintenance crew
From the the value chain analysis (Exhibit 3) the key cost drivers are InBound/OutBound Logistics Management consisting of
plane turnaround time (refueling, maintenance, safety checks, landing fees and cleaning) and Infrastructure Management in-
cluding the organizational design and workforce management (salaries).
EXHIBIT 3: VALUE CHAIN of LCC
15% 20% 10% 15% 40%
Costs Costs Costs Costs
InBound
Operations Marketing Infrastructure
OutBound
Procurement and Sales
Logistics Management Management
Management
Management
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Purchase or lease Fueling/Refueling On-board Service Agents Promotion Labor Union and Non
aircraft from Boeing Aircraft Mainten- Catering and Advertising Union Workforce
or Airbus ance, Safety Checks Route Selection Ticket Counters Management
Fit out and custo- Parts Check Crew Scheduling Ticket Offices Org Structure De-
mized design Repairs Pilot Scheduling Online booking sign (Top to Bottom)
Facilities Rental Landing Fees Lost Baggage Han- Marketing Research Pilot Training
Parts Reorder Cleaning service dling New Product Design Crew Training
Baggage Tracking Reservation Schedul- and Launch Safety Training
and Handling ing System Communication Accounting, Legal
Gate Operations Complaint Handling Hotel and Rental Car Facilities Planning
Connections Yield Management
Online booking Sys-
tem
In-flight TV System
IT Systems
Both SW and JB strategic capability is ontime departure, achieved through fast turnaround time by utilizing efficient operation-
al procedures, flexible crew, newly purchased/leased and unified fleet of planes with minimum maintenance requirements (Ex-
hibit 4). JB achieves advantage through non-unionized workforce as a VRI resource. While hypothetically it is possible to im-
itate it, airlines traditionally have unpredictable labor union demands. Additional resources that built the capabilities in cost
advantage include:
a) Smaller planes to decrease landing fees linked to plane weight and standardized operational procedures to lower
maintenance costs.
b) Online booking systems to decrease travel agent commissions with JB being a leader with 1.16c vs 1.26c in SW.
EXHIBIT 4: RESOURCE and CAPABILITIES ANALYSIS
SOUTHWEST AIRLINES JETBLUE
All Boeing 737 fleet for low cost Owned all Airbus 320 fleet for cost con-
maintenance and faster turnaround trol of amortization and simplification in
on the ground, and low staff training maintenance, and low staff training
costs costs
Simplified internal operations and High technology utilizing computers for
maintenance procedures maintenance reporting and pilot ma-
RESOURCES Enthusiastic workforce on flexible nuals
profit sharing packages interested in Work from home reservation agents
the success of airline with online access
Finance: CASM of 7.53c per mile with Non unionized workforce from inside
key advantages in low landing fees, and outside the industry under flexible
low facility rentals, and low advertis- pay packages and shift sharing
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7. London Business School
ing expenditures Finance: CASM of 6.69c per mile with
Organizational structure from bot- differences in low salary and benefits,
tom up focused on cost control lower maintenance fees and low amor-
tization
Organizational structure from bottom
up focused on cost control
Regional point to point flights to low Long distance flights to key airports
cost remote airports that reduce with prestigious leather seat, individual
landing fees, and allows for faster entertainment system cabin to increase
security procedures, frequent flights passenger load and provide for a niche
and effective luggage handling target market accustomed to lounge,
CAPABILITIES Fast on the ground turnaround and food and shopping network access
timely departure Fast on the ground turnaround and
Maintaining low transparent pricing timely departures
to the customers with few fair Maintaining reasonably low fair with set
classes and few restrictions schedule and no restrictions
Online booking and check in
As a conclusion, LCC carriers were able to maintain low cost air fares through optimization in operational aspects of In-
Bound/OutBound Logistics and Infrastructure Management. Specifically, they minimized labor expenditures and reduced hours
spend on maintenance for faster plane turnaround leading to higher utilization of planes and passenger load factor. The other
core operational aspects for JB were advanced technology and comfort plane fitting which helped to maintain high class clien-
tele demands. While having higher labor costs, SA frequent flight schedule, timely departures and no seat assignments pro-
vided a good substitute for auto travel and a sense of community. Finally, these organizations were designed bottom up with a
mission of controlling costs and having a fun atmosphere. This allowed for all divisions to clearly communicate the same mes-
sage and operate with the same premise of cost savings being passed to customers.
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8. London Business School
Solution Analysis (3): Why do all low cost subsidiaries of legacy airlines
failed including Delta Express failed?
(WORD COUNT without Exhibits: 364)
When launching Delta Express, Delta focused on key Florida regional market by introducing a low cost carrier achieved through
low labor cost and high aircraft utilization. Management negotiated 32% pay-cut with the union and simplified aircrafts to Boe-
ing 737 fleet for ease of maintenance. As infrastructure management and inbound/outbound logistics are the key to the airline
profitability (Exhibit 3), Delta Express achieved its target initially. After 4 years of operations the position was lost due to hikes
in salaries with union waging a “jihad” war with management. Another aspect leading to the failure was inability of Delta to
clearly separate this subsidiary into a functional organization. Since Delta shared its marketing, controlled pricing, routes, and
frequency of both airlines from centralized location, and shared the same maintenance, pilots and flight attendance, it created
a cognitive dissonance in the organization. Employee enthusiasm with high flexibility in their roles and responsibilities were
essential for low cost airlines to maintain cost advantage. Delta personnel lacked a clear vision of company differences and
required the same benefits.
The key competitor that entered Florida route and even further declined Delta Shuttle profitability was JetBlue. According to
the value curve below (Exhibit 5), Delta Express was known for its low cost fares but JetBlue differentiated itself by offering
higher cabin comfort and in-flight entertainment system. As price and schedule differential were low, buyers looked for added
convenience and extra perks. JetBlue clearly targeted high level executives with reasonable price sensitivity, while Delta Shut-
tle focused on leisure travelers.
EXHIBIT 5: VALUE CURVE of JETBLUE VS DELTA EXPRESS
12
10
8
6
4 JetBlue
2
0
Price Cabin Inflight Light Flight Timely
Comfort Perks Snacks Schedules Departures
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9. London Business School
By analyzing all of the LCS of legacy airlines, including Delta Express, CALite by Continental and Shuttle by United, it is apparent
that these subsidiaries did not operate as independent organizations but rather as business units of a large company under the
same cost structure applied as overhead to smaller operations. This centralized control and management complicated opera-
tions and logistics, confused passengers, created cognitive dissonance in the minds of personnel, confused overall organiza-
tional positioning and drove additional overhead for LCS. Another key point is that LCSs are not able to control labor unions,
and cost differentials were eliminated in a long run, thus decreasing the entire premise of LCS in the first place.
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10. London Business School
Solution Analysis (4): What are strategic options available to the cross
functional team? What course of action for the Delta Express business
would you have recommended?
(WORD COUNT without Exhibits: 387)
As Florida represents 30% of Delta revenues, it is important to continue operating there but considering reputation damage
and poor employee morale as related to Delta Shuttle, my recommendation would be to modify Delta Shuttle operations by
structuring it as a separate company under a new brand name with low fixed and labor costs, focused on the business profes-
sional audience and target markets where competitive LCC are not present by combining core capabilities of both SW and Jet-
Blue.
Creating a new structure would require high capital investment but allow for decreased labor costs under a non-union agree-
ment focused on providing high quality customer service to passengers and flexible work hours for employees. Paperless op-
erations, online booking and electronic tickets would also lead to cost reductions. Entering into an alliance agreement with
Delta would allow this LCC to outsource a significant portion of operations through sharing passenger terminal facilities, main-
tenance and administrative operations and information technologies used in flight scheduling and joint procurement as well as
sales/marketing organizations.
As the Delta Shuttle Old was only focused on providing low cost airfare for Florida holiday travelers, the target audience of the
Delta Shuttle New should be:
1) Senior executives in key regional business routes of Washington DC, Boston, Pennsylvania, New York
2) Leisure travelers between Washington DC and North Carolina, and Florida
EXHIBIT 6: GENERIC STRATEGIC OLD VS NEW DELTA SHUTTLE
Narrow
DELTA
SHUTTLE
NEW
Focus
DELTA
SHUTTLE
(OLD)
Broad
Low Cost Differentiation
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11. London Business School
By scheduling in strategic business routes, Delta Shuttle New differentiates itself by offering a service in the unserved loca-
tions by SA and JB. It also provides combined benefits of extra leg space and in-flight perks adopted from JB and no seat as-
signment, frequent departure timing and set fares adopted from SA. Inflight perks could include newspapers, soft drinks, alco-
holic beverages and branded cookies. Additional recommendation is to simplify aircrafts by offering 30/70 split of business vs
coach classes with preferential upgrades for Delta Skymiles members. Since major focus is on business travelers, it is impor-
tant to retain an alliance with Delta corporate for mile accumulation.
Analyzing the industry dynamics, my overall recommendation for Delta would be to focus on buying regional airlines in Califor-
nia and West Coast to continue its diversification of fleet to a lower regional grade that can consistently produce higher load
factors and lower CASM. Keeping these subsidiaries under their own management would allow for a common mission among
employees and decreased salary expenditures.
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