2018 Volume 21 Issue 1

Strategic Challenges of Today’s Businesses

Strategic Challenges of Today’s Businesses

The Example of the U.S. Airline Industry

Once among the most highly respected and envied sectors of the economy, the U.S. airline industry has seen its image tarnished and many of its most well-known companies disappear. Falling from the ranks of worldwide giants, companies like Pan American, TWA, Eastern Airlines, and Continental no longer exist—and Northwest Airlines was acquired by Delta.[1] The once highly successful industry’s challenges and problems typify the difficulties being faced by many other industries as well.[2]

Introduction

Although the airline industry was once considered elite and becoming an airline pilot or stewardess was once thought of as a “dream job,” the industry has struggled in the face of political, economic, and management factors and today is dominated by four companies.[3] Three of those companies continue to struggle to deliver quality customer service while inadequate legroom, the quality (or lack thereof) of airline food, and plummeting customer service have hurt the industry with rare notable exceptions. This brief article reviews the history of airline travel in the U.S. and identifies eight strategic factors about the industry that apply to many different businesses in today’s challenging global economy.

The Rise and Fall of the U.S. Airline Industry

The U.S. airline industry began in Florida in 1914 prior to World War I with fixed-wing seaplanes, or flying boats, which were adapted for military purposes.[4] After that war, the U.S. aircraft industry declined largely as a result of competition from foreign manufacturers who possessed more advanced technologies. In the mid-1920s, the U.S. government began subsidizing airlines to carry airmail after the Kelly Airmail Act of 1925. Carrying mail expanded to carrying people and commercial goods—although passenger travel did not significantly increase until after World War II.[5]

As the airline industry made technological advances during World War II, revenues greatly increased, reinforced by the creation of the Federal Aviation Administration (FAA) which oversaw aviation safety and positively affected consumer confidence. For more than three decades, the airline industry maintained a high profile and was viewed as primarily market oriented.[6] Through the mid-1980s, regional startup companies provided reliable, scheduled airline transportation, airmail, and small package services to smaller cities across America—filling gaps in service not met by the larger airlines.[7] These low-cost carriers provided direct flight access to smaller cities and increased their share of the U.S. domestic market from 22.6 percent in 1999 to 32.9 percent by 2006.[8]

One of those regional providers, Allegheny Airlines, eventually evolved into today’s US Airways,[9] and a small airline out of Texas, founded in 1966, grew quickly to become Southwest Airlines, providing service throughout Texas and then serving neighboring states. From humble beginnings, Southwest Airlines grew to provide passenger services to 100 million passengers annually and has been profitable for 44 straight years.[10]

Due to increasing financial pressures, large carriers transformed their point-to-point operations to efficient hub-and-spokes services—typically in partnership with regional airlines.[11] Differentiated pricing structures peaked in the late 1990s,[12] benefiting American, Delta, and United Airlines. However, all of the carriers failed to effectively manage wage and work rules, which resulted in high wages and benefits, making larger companies vulnerable to new carriers with lower cost structures.[13]

Deregulation changed the fare structure, and in the fifteen years after regulation, the industry’s earnings fluctuated wildly as new carriers entered the industry.[14] Channeling passengers through centralized hub airports allowed carriers to increase their passenger loads but required extra fuel for two extra landings.[15] Although the marginal cost for servicing a connecting passenger decreased by 12 percent compared to the cost of servicing a passenger on a direct route,[16] that advantage disappeared due to fuel price increases which eroded profits.

Because of severe pricing competition, a rise in fuel costs, and a multitude of political factors, the airline industry went through tremendous turmoil in the early 2000s, resulting in four major bankruptcies and two mergers. In 2002, US Airways filed for bankruptcy[17] and only a few months later, United Airlines followed suit. In September 2005, Delta Airlines and Northwest Airlines went bankrupt on the same day, and Eastern, Pan Am, and Midway were also later liquidated. Adjusted for inflation, airline pricing had fallen by over 20 percent between 1995 and 2004.[18]

The 9/11 terrorist attack in 2001 slammed the industry and resulted in a 25 percent drop in volume of U.S. airline travel resulting in increased unit costs and severe financial problems. The U.S. airline industry did not fully recover from 9/11 until 2004. Between 2004 and 2007, the industry’s operating revenue gradually increased at an annual growth rate of 7 percent, but, once again, the 2008 worldwide financial crisis resulted in dramatically decreased revenues from 2008 until 2011.[19]

As a result of the 2008 fiscal crisis, air traffic in the U.S. again declined with 1.2 million fewer scheduled domestic flights in 2013 than in 2007, resulting in decreases ranging between 9 and 24 percent at large and medium-sized airports.[20] At the same time, the industry experienced rapid consolidation with the nation’s largest carriers merging. The average domestic airline fare gradually increased beginning in 2009, and in 2014 it was higher than at any point since 2003.

According to the Airline Quality Rating study, airline service quality also declined in on-time performance, mishandling of luggage, involuntary denied boarding, and the frequency of customer complaints.[21] The size of seats, the amount of leg room, the elimination of amenities like beverage services and food, and additional fees for handling baggage and number of baggage items have all undermined the industry’s perceived service quality.[22] Ironically, complaints over the years have peaked during times of highest relative profitability.[23]

Part of the problem, of course, is that customers have grown to have inflated and unrealistic expectations. Many customers want something for nothing…or as close to nothing as possible. Air travel used to be relatively expensive, but with that high price came a fair degree of comfort and luxury. Today, even first class is not all that great. Only on international flights in business or first class does one experience anything like the “old days”—a time when travelers dressed up to travel, food was good, and crews were pleasant. Today’s airline travel experience is comparable to a Greyhound bus in the sky—but with much smaller seats.

Another problem facing the industry has been what appears to be a two-tiered employment system where new employees are substantially underpaid, and senior employees enjoy substantial compensation and benefits. As is the case with unions in many industries, this two-tier problem reflects the difficult reality of employers wanting to cut costs and senior members of unions fighting to retain compensation and benefits from bygone days when the economy was better.

Not all news about the airline industry has been bad. In 2016 profits increased, according to an International Air Transport Association report[24]. In the last two years, the airline industry has actually done better than “break even,” and, according to a CNBC projection, was expected to be profitable in 2018.[25]

Strategic Factors Affecting Business

Eight persistent strategic factors have affected the airline industry in its long history in the U.S. in determining the success of companies who have failed:

  • Evolving Technology. From the early days of WWI, technological advances profoundly impacted the airlines, and computerization reduced the time to perform many key tasks, including alerting pilots and other personnel if systems malfunction or other potential problems occurred. However, as with other industries, technological advances in the industry have been easy to duplicate,[26] leveled the playing field, and limited competitive advantages. Today, airline flying is, with rare exception, the safest way to travel, but companies struggle to create a competitive service advantage. Southwest Airlines is a notable exception with its simple online booking process.
  • Undercutting Each Other in Price Wars. The impact of price wars in the airline industry was a major contributor to the industry’s demise and has undercut the profitability of the entire industry.[27] Competing companies shaved prices to the point where they were unable to earn a profit and undermined their ability to address safety issues in order to cut costs.[28] As a result, the entire industry has “just broken even” financially[29] for many years—although the past two years have proven to suggest a slight industry recovery.
  • Delaying Partnering with Employees. Rather than thinking long term in identifying relationships with employees, industry leadership created lose-lose adversarial relationships leading to bitter disputes.[30] Instead of recognizing their interdependency with employees and seeking mutually beneficial options, the industry delayed acknowledging their need to cooperate with employees to achieve shared goals. Today’s two-tiered employment compensation system reflects the infighting occurring in unions and makes hiring excellent employees difficult because of the low entry-level wages provided. Once again, Southwest Airlines’s Herb Kelleher was the industry exception by creating a team culture that demonstrated it valued and empowered its employees. Southwest Airlines’ employee loyalty and enthusiasm are notable exceptions in an industry where service quality and employee courtesy seems to have seriously eroded.
  • Attempting to Be Everything. The larger airlines frequently overestimated their capabilities based upon best-case scenarios. They extended service lines without fully understanding the true costs associated with providing services and without accurately estimating the impacts of competitors on the markets. Rather than sticking with what they did well, airlines took on new tasks with disastrous financial results.[31] Although creating the hub-spoke model became a solution for larger companies,[32] companies like Pan American and Eastern Airlines simply lost their way and were unable to maintain profitability.
  • Unanticipated Political Factors. The assumptions of the industry were based upon operating within a stable political environment, but those assumptions changed during both world wars and the Korean War. The single most disruptive force on the airline industry that immediately reduced air passenger travel by 25 percent was the 9/11 terrorist attack,[33] but other political factors, including the 2008 fiscal crisis which affected the entire economy, also hurt the industry.
  • Economic Factors. Although the airline industry faced economic booms and busts, the biggest threat was the increased price of fuel. Oil price increases and conflicts in the Mideast have caused significant increases in the cost of fueling airplanes and have made estimating pricing and revenues difficult.[34] Coupled with the pressures to compete financially, companies like TWA and Continental misjudged their economic capabilities and went out of business as a result of their inability to take into account fluctuating costs.
  • Ineffective Branding. To most customers, the airline industry is an interchangeable service provider, and company branding for the industry is often indistinguishable for consumers.[35] Southwest Airlines has been the notable exception by providing easy online booking and check-in, a simple boarding process, free baggage service, and no loss of money if one has to cancel or change flights. Otherwise, the attempts of other carriers to generate loyalty by offering frequent business travelers mileage credit benefits, however occasional flyers actually resent the incentive plans as being virtually worthless in value.
  • Ineffective Corporate Leadership. Leaders, with the notable exception of Herb Kelleher of Southwest Airlines, seemed to lack a clear vision and a workable long-term strategy.[36] Despite the fact that Kelleher demonstrated that Southwest Airlines could not only enter the industry but be consistently successful for four decades,[37] the airline industry has seen many of its most famous icons fold up shop due to mediocre leadership and failing strategies.[38]

All eight of these factors have had a huge impact on the airline industry and reflect ineffective strategic leadership and inability to respond to conflicting internal and external pressures that have plagued the airlines.

Conclusion

Business leaders of all types are similarly affected by these same eight factors in their own industries. Although there are no simple solutions to facing these problems, successful companies like Southwest Airlines have demonstrated the ability to consistently be profitable despite an overall industry decline by adopting a leadership philosophy that has been based upon matching its strengths with industry opportunities. As the airline industry continues to evolve, the lessons that it has provided to other industries are worth considering in a world economy that has become increasingly competitive.

References

[1] A brief summary of the evaporation of each of these once well-regarded “icons of the air” is included in Maverick, J. B., (2017). “5 Iconic Airlines That No Longer Exist.” Investopedia, March 13, 2017 found online on February 26, 2018 at https://www.investopedia.com/articles/investing/102115/5-iconic-airlines-no-longer-exist.asp.

[2] Anderson, V., & Caldwell, C. (2018). “Strategy, Competitive Advantage, and Performance.” Competitive Advantage: Strategies, Management, and Performance, C. Caldwell & V. Anderson (eds.). Hauppage, NY: NOVA Publishing, 1-12.

[3] Caldwell, C., & Anderson, V. (2018). “The Rise, Fall, and Recovery of the US Airline Industry: Strategic Insights.” Competitive Advantage: Strategies, Management, and Performance. C. Caldwell & V. Anderson (eds.). Hauppage, NY: NOVA Publishing, 213-222.

[4] Davies, R. E. G. (1982). Airlines of the United States Since 1914. New York, NY: Smithsonian.

[5] Ibid.

[6] Edomswan, J. A., & Ben-Yosef, E. (2008). The Evolution of the US Airline Industry. New York, NY: Springer.

[7] Solomon, S. (2008). Airlines For the Rest of Us: The Rise and Fall of America’s Local Service Airlines. Bloomington, IN: iUniverse Publishing.

[8] Gorman, L. (2017). “What Happened to the Airline Industry.” National Bureau of Economic Research. Retrieved from http://www.nber.org/digest/mar09/w14503.html.

[9] Ibid.

[10] Ibid.

[11] Edomswan, J. A., & Ben-Yosef, E. (2008). op. cit.

[12] Ibid.

[13] Ibid.

[14] Morrison, S., & Winston, C. (1995). The Evolution of the Airline Industry. Washington, DC: Brookings Institution Press.

[15] Gorman, L. (2017). op.cit.

[16] Ibid.

[17] Berry, S., & Jia, P. (2010). “Tracing the Woes: An Empirical Analysis of the Airline Industry.” American Economic Journal: Microeconomics, 2, 1-43.

[18] Borenstein, S. (2005). “U.S. Domestic Airline Pricing, 1995–2004.” Berkeley, CA: University of California, Berkeley Competition Policy Center Working Paper CPC05-48.

[19] This information is provided by the Bureau of Transportation Statistics. (2014). “National Transportation Statistics.” Retrieved from https://www.rita.dot.gov/bts/sites/rita.dot.gov.bts/files/publications/national_transportation_statistics/index.html.

[20] Dillingham, G. L. (2014). “Testimony Before the Subcommittee on Aviation, Committee on Transportation and Infrastructure, AIRPORT FUNDING Aviation Industry Changes Affect Airport Development Costs and Financing.” U.S. House of Representatives Report. Retrieved from http://transportation.house.gov/uploadedfiles/2014-06-18-dillingham.pdf.

[21] This overall decline in quality was reported in Kennedy, B. (2015). “It’s Not in Your Head: Airline Performance is Declining.” Moneywatch. Retrieved from http://www.cbsnews.com/news/its-not-in-your-head-airline-performance-is-declining.

[22] Brueckner, J. K., Lee, D. N., Picard, M., & Singer, E. (2015). “Product Unbundling in the Travel Industry: The Economics of Airline Bag Fees. Journal of Economics & Management Strategy, 24(3), 457-484.

[23] Birim, S., Anitsal, M. M., & Anitsal, I. (2016). “A Model of Business Performance in the US Airline Industry: How Customer Complaints Predict the Performance.” Business Studies Journal, 8(2), 96-111.

[24] IATA, (2016). “Another Strong Year for Airline Profits” found online on July 16, 2018 at https://www.iata.org/pressroom/pr/Pages/2016-12-08-01.aspx.

[25] Reid, D., (2017). “US Airlines to Scoop Almost Half of Global  Profit in 2018.” Dec. 5, 2017 CNBC News found online on July 16 2018 at https://www.cnbc.com/2017/12/05/us-airlines-to-scoop-almost-half-of-global-profit-in-2018.html.

[26] Christensen, C. M. (2016). The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail. Boston, MA: Harvard Business School Publishing.

[27] Among many reports of this problem, see Blair, R. D., & Harrison, J. L. (1999). “Airline Price Wars: Competition or Predation.” Antitrust Bulletin, 44(2), 489-518.

[28] McCartney, S. (2004). “Airlines Retreat as Price Wars Take Their Toll.” Wall Street Journal: Eastern Edition, 244(11), D4.

[29] Tyler, T. (2014).  “Remarks of Tony Tyler at the World Knowledge Forum, Seoul”  October 14, 2014 found online on July 16, 2018 at https://www.iata.org/pressroom/speeches/Pages/2014-10-14-01.aspx.

[30] Cross, D., Burrus, S. W. M., & Shaw, M. (2014). “Evaluating Conflict between Employees: Exploring the Costs to an Organization.” International Journal of Aviation, Aeronautics, and Aerospace, 1(1), Article 4.

[31] In Collins, J. (2001). Good to Great: Why Some Companies Make the Leap…And Others Don’t. New York, NY: HarperCollins. The importance of doing that which one does at a world-class level is emphasized. Unfortunately, that strategy was often not adhered to by the industry.

[32] Gorman, L. (2017). op.cit.

[33] Bureau of Transportation Statistics, (2014) op. cit.

[34] Berry, S., & Jia, P. (2010). op. cit.

[35] DuBuois, S. (2012). “Branding: The Real Threat Facing the Airlines.” Fortune. Retrieved from http://fortune.com/2012/02/17/the-real-threat-facing-the-airlines.

[36] The importance of visionary leadership is a major factor identified in Kouzes, J. M., Posner, B. Z. (2012). The Leadership Challenge: How to Make Extraordinary Things Happen in Organizations (5th ed.). San Francisco, CA: Jossey-Bass.

[37] Gittell, J. H. (2005). The Southwest Airlines Way: Using the Power of Relationships to Achieve High Performance. New York, NY: McGraw-Hill.

[38] Berry, S., & Jia, P. (2010). op. cit.

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Author of the article
Cam Caldwell, PhD
Cam Caldwell, PhD

Cam Caldwell, obtained his PhD degree from Washington State University in 2004 where he was a Thomas S. Foley graduate fellow. He has co-authored over 100 publications about leadership, trust, and ethics and is currently writing his eighth book about management and leadership.

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