Domestic Airline Industry

Economics of AdvertisingAEM4550April 25th, 2011

Elle FennMargaret Loff

Stephanie Zimmerman

Agenda

Introduction

Industry Structure

Advertising Strategies

Advertising Mediums

Case Study 1: Southwest Airlines

Case Study 2: United/Continental Merger

Recommendations

Industry Structure

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

Hub and Spoke System

Governing Groups

• ATA: Air Transport Association of America, advocate of participating airlines for industry success

• FAA: Federal Aviation Administration, regulates airline industry

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

Products and Services

Market Segments

Leisure Travel

• Vacation, moving, or non-business activities• Dependent on:

– Disposable income– Discretionary spending

• Price elastic

Business Flying

• Companies cover expenses when business is strong

• Bankruptcies and bailouts• Dependent on:

– Economy– Employment– Business strength

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

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

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

Oil Price, Corporate Profits, Industry Revenues

Spike in 2008 in oil price > Decline in profits > Decline in industry revenue

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

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

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

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%

Current Trends

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

US Airline Industry

13.1

11.1

9.5

6.8

8.4

51.1

Concentration is mediumHHI = 501.87 (calculated using top 5 firms, ignoring ‘other’) HHI < 1000 – competitive marketsHHI > 1800 – proposed mergers challenged

4 firm concentration ratio: 42.1

This number has risen due to mergers• Delta/Northwest - 2008• United/Continental - 2010

Structure

• Price

• Frequency/capacity

• Route offerings

• Service quality

• Loyalty programs/promotions

Competition

• Internal

Competition

• External

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

Industry Organization

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

Food and Beverages

Breakfast served in Economy class, Continental Airlines

Food being delivered to an Boeing 767 American Airlines flight

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.

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

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.

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.

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.

Labor

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

Advertising Strategies

• Informative• Predatory• Persuasive• Combative• Restorative• Program type• Location

Ad to Sales Ratios

2001 2002 2003 2004 2005 2006 2007 2008 2009 20100

0.5

1

1.5

2

2.5

3

AMRDeltaSouthwestUS Airways

Ad to Sales Ratios

• High or low?

• Transportation/Travel industry =1.9

• Consumer Products, Books, PayTv, Communications, all > 5

• Downward Trend

Advertising Expenditure

2001 2002 2003 2004 2005 2006 2007 2008 2009 20100

50000000

100000000

150000000

200000000

250000000

DeltaSouthwestAMRUS Airways

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

Brand Equity

• Of the Major players, largest brand equities:– Southwest – 66.1– Delta - 58.2

• Southwest is also the largest spender on advertising

Informative

• Price focused• Sale fares

– The $10 ticket– Sell excess seats– Covers incremental variable costs– Loss leader

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

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

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

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’

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

Advertising and Location

• Southwest– Baltimore, Denver

• Delta– New York

• AMR– Chicago, Miami

• United/Continental– Paduca, Houston

**adjusted for population differences

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

Advertising Mediums

• Television• Print

– Magazines– Newspapers

• Radio• Internet

Popularity of mediums ($)

Television

Magazines

Internet

Outdoor

National Newspaper

Which firm dominates each medium? ($)

• Television: Southwest

• Print: American Airlines

• Radio: American Airlines

• Internet: Southwest

Total Advertising Expenditures (2010) (in thousands of dollars)

$95,443.30

$54,392.40

$392,993.70

$30,206.30 $9,059.40

AMR Corporation

Delta Airlines

Southwest Airlines

United Airlines

U.S. Airways

Total TV Expenditures (in thousands of dollars)

$31,708.40

$1,503.60

$307,405.10

$20,149.00 $37.10

AMR Corporation Delta Airlines

Southwest Airlines United Airlines

U.S. Airways

Total Print Advertising Spending(in thousands of dollars)

$51,412.60

$29,523.30

$12,756.60

$6,153.70 $2,090.50

AMR Corporation

Delta Airlines

Southwest Airlines

United Airlines

U.S. Airways

Print Advertising

Print Advertising

http://www.youtube.com/watch?v=HeZMOyqTf_E

Total Radio Advertising Spending(in thousands of dollars)

$16,599.00

$3,515.5

0

AMR Corporation

Delta Airlines

Southwest Air-lines

United Airlines

U.S. Airways

Total Online Advertising Spending(in thousands of dollars)

$10,666.20

$23,365.50

$15,316.50

$3,903.60

$6,931.80

AMR Corporation

Delta Airlines

Southwest Airlines

United Airlines

U.S. Airways

Online Advertising

• Search advertising• Interactive Ads• Banner and Pop-up ads• Facebook and social networking• Online giveaways• Promotional pricing- legal low fares• Airline websites, travel sites, booking sites

Targeting Consumers

• Ad Words• Ad Sense• Flight history: delays, cancellations, lost bags• Click responses• Geographic location, surfing patterns, airline

ad exposure

Interactive Ads

Southwest

“Ridiculous”

Banner Ads

Facebook

Websites

Websites

Websites

Most Successful Low Cost Carrier in Country

Top Competitors

Background

• Services 64 cities in 32 states• Originally an interstate airline linking Dallas,

Houston and San Antonio• Operated out of Love Field in Dallas • First with website and online sales in 1996

Why Southwest?

• Low-cost, No-frills, Open-seating• Operates solely Boeing 737s• Cuts costs:

– One type of aircraft to cut training and maintenance costs

– smaller, less congested airports• First online reservation system: 84% of online

booking

Recession Proof

• Southwest managed to record a net profit in the four years leading up to 2008

• 2008 was the lowest in profitability and 2009 recorded a 64% decline in net income

• Low operating costs• Steady demand due to low airfare• Strong fuel-hedging not employed by other

airlines

Fuel Hedging

• Large fuel consuming companies use call or swap options to fix or cap costs

• Mitigates exposure to future fuel prices that may be higher than current prices

• Establish a known fuel cost for budgeting purposes

South West Advertising

• Operated out of Love Field in Dallas and used love theme for original ad campaigns

• “Love Potions” and “Love Bites”• Logo changed in 2001 for 30th anniversary

Humor

1971Southwest Airlines Magazine

Emotion

Comparative

Sports Themed2000Sports Themed

1991

Sponsorship

Regional Ads1996

Demographics

Recruitment 1999

Recruitment

Love Campaign

http://www.youtube.com/watch?v=TR7JApjgIGw

Hot Pants

http://www.youtube.com/watch?v=oHnqnyzegfc

Television

Television

• “Ding! You are now free to move about the country.”

• http://www.youtube.com/watch?v=Bh3XDMzcdtU

• http://www.youtube.com/watch?v=PBjImZhcW5M&feature=related

• New ads against change fees, national tv during major sporting events

Spirit Magazine

• In-flight magazine• Lowest CPM in ad category• Greatest value in the sky• 32 million viewers per issue (second largest

audience)• Online issues at Spirit Magazine Website

United and Continental Become One

• On April 16, 2010, United began merger talks with Continental Airlines

• May 2, 2010, the board of directors of both Continental and United Airlines reached an agreement to combine operations to create the world's largest airline.

• On August 27, 2010, the U.S. Department of Justice approved the $3 billion merger.

• Share holders of both companies approved the deal on September 17, 2010.

• The transaction was completed on October 1, 2010

• The new company's corporate and operational headquarters are in Chicago, with a significant presence in Houston, the company's largest hub.

• The combination of United’s name and Continental’s globe logo symbolizes bringing together the best of each carrier to create the world’s leading airline.

http://www.continental.com/web/format/img/company/advertising/printads_firstclass_lg.png

Future Trends

• Increasing fuel costs• Continued cost cutting, route cutting• Additional fees• Stress on fuel-efficiency and green technology

Investment

• Industry in decline• Huge operating costs• High competition and barriers to entry

• Government requirements• Economies of scale• Fixed/variable costs

• Entry strategy: Follow Southwest• Low costs• No fees• Fuel-hedging, cost-cutting

• Recommendation: Do not invest, unless in a currently successful brand with appropriate business strategies

Investment- Delta

Investment- Southwest

Recommended Ad Strategies

• Stress no additional fees• Less focus on price advertising, more on service

and quality• Strong branding• Expand to different types of programs for

television advertising, use sample cities for testing• Increase advertising expenditure, Southwest

highest brand equity• Possible mergers, low HHI