“Delta Air Lines (a): the Low Cost Carrier Threat” (Hbs 9-704-403)

Question 1

Several reasons have led to low rates of return for the five largest carriers in the US in the 1990s. As the rate of return depends on the revenue, cost and the equity for providing the earnings, we will show how mix of Porter’s Five Forces analysis, with additional insights specific to the air carrier market can explain it.

Policy impact of the Deregulation Act of 1978 on the air carrier industry: Deregulation of the industry led to the entry of 22 Low Costs Carriers (LCC) into the market (see page 2 ). These LCCs provided substitutions for Legacy Carriers and thus had a negative impact on the market share and the subsequent earnings of the legacy airlines. (Porter on threat of Substitutions and new entrants, Downes’ analysis of deregulation impact)

Costs: The five largest air carriers were facing high costs per available seat mile (CASM, we will use CASM as an indicator for costs in the industry, for calculation of CASM see exhibit 2, page 10) during the 1990s.

Key factors affecting these high costs (see exhibit 6, page 12) are listed bellow:

1. Labor costs: employees’ salaries (unionized and at times with different unions) and benefits were the largest expense for an airline in 2002 (see page 3). For example, cost of labor at Delta accounted for about 41% of total costs (4.31/10.41 cents of total CASM - data from exhibit 6, page 12, see calculation of cost for available seat mile in exhibit 2, page 10 and data in exhibit 6 page 12). Most of the airline labor was unionized which gave them leverage over the airline. Note: although the question is about 1990’s, we are using data from the case study exhibits some of which refer to 2001-02 and we therefore assume that the basic pattern of the 2002 was similar to that of 1990’s.

2. Fuel costs: fuel accounted for about 10-15% of total costs, costs per mile were lower in long flights as the take offs and landings consume a huge amount of fuel, though they also depended on type and age of aircraft,...