Competitive Advantage in the Airline Industry

Competitive advantage refers to the strategic advantage that a firm has over its competitors. Attaining a competitive advantage reinforces a firm placing it in a prime position within its business environment.

Competitive advantage is realized, when a firm gains an aspect or a collection of aspects permitting it to do better than its rivals. These aspects may comprise of right to use natural resources, for example, high quality ores or cheap power; or possession of highly skilled human resources. Recent advancements in information technology have also led to emergence of new types of competitive advantages. The internet, for instance, has enabled companies to develop unique information-related products that take the form of web content and software. It has also led to elimination of middlemen and their related costs by allowing business to transmit information directly to customers. Since time immemorial, the role of middlemen has been to bridge the information gap between consumers and firms a function which has now being seized by the internet. Because of this ability of the internet, it is now possible for a company to develop a competitive advantage by establishing an effective website.

The expression competitive advantage means the capability acquired through characteristics and resources to outperform competitors in the same sector or market (Porter 1980). There has been increased research interest regarding the sources of competitive advantage for firms, following sustained superior performance by various companies around the globe.

A firm is regarded as having a competitive advantage, if it is carrying out a value creating strategy that is not presently being executed by any other existing or potential players in the industry (Barney 1991). Successful execution of such strategies raises a company to exceptional performance by enabling the firm with a competitive advantage to do better than current or potential competitors. To acquire a competitive advantage, a company’s business strategy plays around with the mixture of resources, over which the firm has direct influence. Such resources must be capable of producing a competitive advantage (Coyne, 1996). Outperforming rivals as well as outstanding production resources indicate a competitive advantage (Wesley, 2008).

Competitive advantage, therefore, implies the ability to outperform current and potential rivals. Such a superior performance attained through possession of a competitive advantage helps a company to achieve and maintain market leadership. In addition, resources possessed by a company and its business strategy have a deep effect on the production of a competitive advantage. Porter (1980) sees business strategy as a mechanism that plays around with resources to produce competitive advantage. Thus, a feasible business strategy may not be sufficient to achieve a competitive advantage, if the firm does not possess exclusive resources that can generate a unique advantage. Competitive advantage promotes the survival of a firm by putting it in a superior position relative to other firms in the market.

Porter’s Five Forces Analysis

The five competitive forces model was introduced in 1980 by Michael Porter in his book of competitive strategy. The book discusses various techniques for analyzing industries and competitors. The model has been used regularly in the analysis of companies’ industry structure and business strategies.

In the book, Porter isolates five competitive forces, which structure any industry and market. The five forces assist us to examine the concentration of competition, profitability, and the attractiveness of an industry. The following figure depicts the relationship between the various competitive forces.

Threat of New Entrants

If it is easy for new firms to come into the industry, the chances of competition intensifying are very high. Dynamics that reduce the threat of new entrants are referred to as barriers to entry. These barriers include: profound consumer loyalty to key brands, incentives for buying from a specific firm e.g. customer loyalty program, excessive fixed costs, scarce resources, switching costs, and government laws and policies.

Power of Suppliers

Power of suppliers refers to the amount of pressure, where  suppliers are capable of applying on a firm. If a single supplier has a very huge influence as to control a firm’s margins and volumes, such a supplier possesses considerable power. Suppliers may gain substantial power from various sources including monopoly in the supply of a given product, unavailability of substitutes, high costs of switching to another supplier, the product being very significant to buyers, or the suppliers’ industry being more profitable than the buyers’ industry.

Power of Buyers

The power of buyers refers to the amount of pressure that buyers are capable of applying to a firm. If a customer has a very huge influence on the company’s margins and volumes, such a customer possesses substantial influence. There are various reasons why a customer may gain considerable power, such as existence of only a few buyers, a buyer buying in huge volumes, switching costs to a rival product being low, where the product is essential for buyers, and where customers are price-sensitive.

Availability of Substitutes

Availability of substitutes determines the probability that a consumer will switch to a competitor’s product or service. Low switching costs increase the threat posed by availability of substitutes. Another factor related to the threat of availability of substitutes is their similarity to the company’s product. For instance, tea and coffee are dissimilar substitutes. On the other hand, a new brand of coffee by a rival company can be viewed as a new entrant into the industry.

Intensity of Competition

Intensity of competition implies the degree of rivalry among competing firms in an industry. Normally, industries that exhibit intense competition generate low returns because of the costs incurred by firms in fighting the competition. Intense competition in an industry could arise from:  presence of many similar players, low product or service differentiation, and maturation of an industry thereby eliminating opportunities for growth.

Competitive Analysis of the Airline Industry

The airline industry subsists in a fiercely competitive market. Nowadays, significant changes have occurred, which have the potential of influencing the industry’s future trends. One of these changes is an increased divestiture from the industry by governments around the world, therefore, paving way for private investors.

According to the US Department of Transportation, the airline industry can be broken down into four classes: international, national, regional, and cargo. International airlines usually have planes with over 130 seats capacity and they transport passengers to numerous countries around the world. Normally, these firms register annual revenues of over 1 billion US dollars. National airlines, on the other hand, have planes with 100-150 seats capacity and post annual revenues of between $100 and $1 billion. Firms categorized as regional airlines have revenues of under $100 million annually and they operate short-haul flights. Finally, cargo airlines deal exclusively with the transport of goods.

Key Factors Affecting the Global Airline Industry

Major factors affecting the airline industry include airport capacity and an airline’s routes, technology, and costs of leasing or purchasing aircrafts. Other important factors are weather, fuel, and labor costs.

Weather

Weather is an unpredictable variable. Weather elements, such as excess heat, cold, fog, and snow may lead to temporary closure of airports and cancellation of flights, which bring loses to the company.

Fuel Costs

As indicated by the Air Transportation Association (ATA), fuel cost comes second among airlines’ largest expenses. However, efficiency between different airlines varies extensively. Short-haul operators are less efficient in the use of fuel, because take-offs and landings consume a lot of fuel.

Labor Costs

According to ATA, labor costs form the largest expense for airlines. The high labor costs result from paying pilots, flight attendants, customer service staff, etc.

Economics of the Airline Industry

Although airlines earn revenues from transporting cargo, most of their revenues are generated from regular and business travelers. Therefore, it is essential for airlines to consider consumer and business confidence when formulating business strategies. Business travelers are more significant to airlines since they travel frequently in a year and they also buy premium tickets that bring higher margins to the airline. In contrast, leisure passengers mostly buy non-premium services and they are very price-sensitive. Economic uncertainty and low consumer confidence are some of the factors that may reduce the number of leisure travelers.

It is also vital for an airline to consider its target geographical areas. While a large market share in a given market may be important, diversification into various markets is equally significant. Therefore, it is crucial for each airline to determine the destination for the majority of its flights and try to diversify these flights to other potential destinations.

Another key aspect in airline`s operations is cost control. The industry is very sensitive to various input costs including fuel, labor, and borrowing costs. If, for instance, the firm expects fuel prices to rise in the future, the firm should take measures to guard itself from this rise. One way of protecting an airline from the adverse effects of soaring fuel prices is entering into forward contracts with fuel suppliers.

Porter’s Five Forces Analysis of the Airline Industry

Threat of New Entrants

As a result of high initial capital requirement, the airline industry seems to ward off new entrants. However, availability of substantial bank loans and credit may enable even small firms to enter the industry. The more new airlines come into the industry, the more competitive the industry becomes. The strength of an airline’s brand as well as loyalty programs is also important in establishing competitive advantage. For example, an airline with a strong brand and which rewards its frequent travelling customers can attract more travelers even when charging higher prices.

Power of Suppliers

The key suppliers of aircrafts in the airline industry are Boeing and Airbus. Therefore, there is no fierce competition among suppliers. The chances of a supplier integrating vertically with an airline are also very minimal.

Power of Buyers

In the airline industry, the bargaining power of buyers is very little. The costs of switching from one airline to another are also high and this tends to discourage customers from changing their favorite airlines.

Availability of Substitutes

The threat of substitutes in the airline industry is higher for national and regional carriers than for international airlines. Such substitutes include traveling by train, personal, or public vehicle. In choosing to travel by air, customers consider several factors including time, money, personal preferences, and convenience.

Intensity of Competition

The airline industry is characterized by intense competition deliver low returns since the cost of competition is very high. Competition in the airline industry has been increasing over the years leading to lower returns, especially during tough economic times.

Business Strategies in the Airline Industry

Increasing competition in the airline industry has created the need for airlines to formulate and implement effective business strategies in order to survive. Business strategy emerges from corporate strategy, which basically involves selecting the business sectors that a company will invest in. Business strategy can be thought as a plan of how specific business segments of a company will compete in the market. Virgin Atlantic, for instance, has implemented a corporate strategy of unrelated diversification investing in various business sectors, which include air and rail transport, music and entertainment, financial services, lifestyle services, etc. Within these business sectors, Virgin Atlantic has established a competitive advantage by differentiating and strengthening its brand.

Nowadays, airline passengers are going for those airlines with excellent customer service, on time arrivals, and low cost all together. Thus, it is becoming increasingly important for airlines to work out the right trade-off between low costs and differentiation instead of trying to pursue both strategies simultaneously.

According to Porter (1980), there are two kinds of competitive advantages, which can be integrated with either broad or narrow scope to form four types of business strategies: cost leadership, differentiation, focused low-cost and focused differentiation. Cost leadership is the common business strategy for firms in the electronic or compact vehicle industries. Firms that pursue low-cost business strategy rely heavily on the efficiency of their supply chains to deliver customer value. Differentiation strategy, on the other hand, is employed by those firms dealing in products or services viewed by customers as being different and, therefore, customers are willing to incur higher price to buy them.

In the airline industry, small airlines have tended to stick to cost leadership business strategy. For example, Southwest Airlines, which is the fourth largest carrier in the US, concentrates on maintaining low fares for its customers. To achieve this, the airline offers no frills to its customers for services like meals, seat assignments, luggage transfers, etc. Instead of full meals, the company offers snacks and drinks to its travelers. The company’s fleet of aircrafts consists of only one type of plane, Boeing 737, which is very fuel-efficient. Other global airlines that pursue low cost strategy include Ryannair of Ireland, Easyjet of the UK, and Air Berlin of Germany.

Large and more established airlines, on the other hand, tend to adopt service differentiation as their main business strategy. The basis of differentiation in the airline industry has been through pricing and particularly price discrimination. Thus, customers are charged fares based on the time of travel e.g. weekends, holidays, etc. and the level of customer service or frills offered, that is, First, Business, Economy Plus, or Economy. Airlines that have excelled in service differentiation include Delta Airlines, British Airways, and the Emirates.

Conclusion

All firms are required to establish a competitive advantage in order to survive in the market place. A competitive advantage arises from combining a firm’s unique resources with an effective business strategy. In the airline industry, firms have tended to follow to kinds of business strategies: cost leadership and service differentiation. Moreover, cost leadership is pursued by small firms while large firms tend to concentrate on differentiating their services. This differentiation takes the form of price discrimination on the basis of time and customer service.