The ten major domestic carriers in the United States reported revenue of 145. 3 billion dollars in 2012, according to data gathered by Airlines for America (2012). The combine market capitalization of the twelve largest and publicly traded airlines stood at 48 billion dollars as of April 2012 just four billion greater than the value of Starbucks and way below other companies like Facebook and eBay ( Airlines for America, 2012). Our research will give a detail analysis of the two theories developed by Harvard Business School Professor Michael Porter.
Porter posited that in order for businesses to compete an in-depth analysis should be done not only of your direct competitors but also external forces that can help a business performance; Porter labelled this as the Five Forces of Competitive Strategy. Another concept developed by Porter was the Value Chain, the Value Chain breaks the business process into two groups, Porter argues that business should analyse the areas of the Value Chain to see where improvements can be made to enhance performance. Our report will show how Southwest Airlines uses Information system in Porters theories and concept to gain competitive advantage
Introduction to Southwest Airlines According to information received from Southwest. com (2013), Southwest Airline was incorporated in 1971 by co-founders Rollin King and Herb Kelleher as Air Southwest Company. The company is based in Dallas, Texas and has a staff capacity of over 46,000 persons. The carrier was formed has a low cost domestic carrier originally only flying in the state of Texas before branching out to other US states. From inception Southwest policy business strategy was to offer low fare and conveniently times flights on short haul routes (Ross & Beath, 2007).
Today Southwest Airlines flies domestic in the United States to 79 cities. Southwest Airlines is the largest airline in the world by passengers carried, in 2012 over 100 million persons was transported by the airline to different cities in the USA. The airline has being a pioneer in the industry and is credited for setting the foundation for the rise of other low cost carriers across the world like Ryan Air and Easyjet. In an industry where profit margins are very low and different carriers filing for bankruptcy ever so often Southwest has managed to stay above the fray.
In almost 40 years of service the airline has consistently turned a profit while other airlines have struggled and has remained one of the world’s most profitable airlines. The airline’s consistent profitability was due to its own ability of low cost on a set per mile basis due to its use of a single aircraft model the Boeing 737 and its fuel hedging program that protect the company from rising fuel prices (Ross & Beath, 2007). Southwest Airlines commands a market capitalization of over nine billion dollars making it one of the most valuable airlines in the world.
Southwest credited its success for building a philosophy of simplicity, the company offering of low cost fares kept attracting passengers while its high touch customer service kept them coming back (Ross & Beath, 2007). As the airline grew and its business processes became more complex and with other airlines investing heavily in technology in order to survive Southwest’s CEO at the time realised that a solid IT infrastructure would be essential for the company to achieve its strategic goals and could lower the airline cost without compromising on customer service (Ross & Beath, 2007). Porters Five Force Model for Competitive Strategy
Porter’s Five Force Model was developed by Michael Porter, Professor at the Harvard Business School in 1979. According to Porter (1979) the Five Forces is a holistic approach of looking and analysing any industry to understand the structural underlining drivers of profitability and competition. Porter believes that industry players take too much of a narrow look in assessing competition by believing that direct competitors in an industry are the only ones that are important. He uses the five forces model to show how business are engaged in a broader form of competition that can affect their profitability.
These broader forces of competition include customers and suppliers who can have certain bargaining powers, new entrants that can emerge in the industry and affect your market share, substitute products or services that can be used and can have a direct effect on your profitability or growth and direct industry rivalry and competition within the industry. According to Hills & Jones (2008) a business’s ability to earn great profits are dependent on the strength of Porters Five Forces, the reverse is also true that a weak competitive force allows for a greater opportunity to make profits.
For example, a company that controls a monopoly in a certain geographical area will see greater opportunities for profit, because being a monopoly will eliminate the threat of new entrants, no internal rivalry and low bargaining power of consumers. The greatest issue most businesses will have is to identify changes in the five forces and knowing how to formulate strategies from the opportunities and threats that may arise from the change (Hill & Jones, 2008). The image below illustrates Porter’s Five Force Model. Fig. 1 Source: (Porter, 1979) Threats of Entry in the Airline Industry
The domestic airline industry in the United States has intense rivalry between its competitors. Over ten airlines fight for market share with the rivalry completely driven on price. Southwest Airline faces some its greatest competition from fellow low cost airlines such as Spirit air and JetBlue all three compete against each other on direct routes trying to offer the lowest prices and the best service to passengers with very low profit margins. Passenger figures stand at approximately 450 million passengers travelling domestic annually in the United States (International Air Transport Association, 2012).
However, Southwest Airlines remained the dominant domestic carrier with a passenger load of over 100 million 2012 (Southwest Airlines, 2012). The competitive nature of the domestic market in the United States has led to the merger of some of its carriers in order to consolidate costs. The most recent merger being that of American Airlines and US Airways and before that it was Continental and United Airlines who joined forces. Barriers to Entry in the Airline Industry Prior to 1978 the airline industry in America was heavily regulated by the United States government and was driven by high prices and empty airlines.
Government regulation not only prevented competition among industry players but also created an entry barrier for new airlines, as government regulated routes presented a monopoly for established carriers (Bloomberg Business Week, 2011). In the United States the state of Texas was the only state which never had government regulation in the industry. The deregulation in Texas gave Southwest Airlines an opportunity to enter the market offering its service in the major cities of Texas only (Southwest Airlines, 2012).
The deregulation effort that was led by democratic senator Ted Kennedy and signed into law by former President Jimmy Carter saw a dismantling of fare and route controls in 1978 (Bloomberg Business Week, 2011). This deregulation made it increasingly easy for new airlines to enter market and compete. With government control no longer a barrier airlines were able to enter the market once they were able to access the capital that was required and meet the safety standards that were required by the Federal Aviation Authority (FAA).
However, Michael Porter (2008) in an interview with Harvard Business School described the airline industry as one of the easiest enter with low barriers to entry he pointed out there is a constant stream of new airlines that enter the market regularly despite low profits. Bargaining Power of Suppliers and Customers in the Airline Industry According to Porter (2008) the limited number of suppliers in the airline industry gave a considerable amount of power to the ones that existed. Porter argues that airline suppliers made considerable more profits than airlines themselves.
Aircraft manufacturing is dominated by only two major players,’ American company Boeing and French company Airbus. In 2011 both manufactures controlled over 90 per cent of new air craft orders with Airbus dominating at 64 percent (The Guardian, 2012). An airline survival in the industry is also tied considerably to the price of oil which is core to operation. Southwest Airlines use a method of hedging to compete on the price of oil which allows the airline to lock in to contracts at cheaper prices in anticipation of future rises in the world market prices (CNBC, 2012).
Other supplier cost that affects performance includes security cost, airport gates and terminal fees and wages to staff. The greater the rivalry among industry players the more fickle customers will become. Customers in the airline industry have tremendous bargaining power and are very price sensitive. The fast pace nature of the industry can allow a customer to switch airlines at any time. Customers were the key beneficiaries from the deregulation of the industry, before the removal of price structure and other regulation, government policy ensured that airlines competed on service and not price (Bloomberg Business Week, 2011).
This shifted dramatically with deregulation has new entrants to the markets like Southwest and JetBlue built their business model on low prices which has caused older established companies to lower their own margins. Substitutes Products for Airlines There are a number of substitute services available in the domestic airline industry in America. Substitute products include rail service, water, coaches, private car transportation or refusing to travel. These substitutes provide customers with other alternatives other than flying and are strong competitive forces to the industry.
Airlines are therefore forced to show the economical convenience of air travel as oppose to using other means. For example a person travelling on business who places great value on time could find it more efficient to fly instead of using substitutes. Airfares offered by low cost airlines like Southwest are also competitive with other substitute products. The Value Chain Analysis Along with the Five Forces Michael Porter also developed the Generic Value Chain as a means of understanding competitiveness in the business industry.
The Value Chain is aimed at helping us understand how goods and services move through an organization and how value is added to them. According to Porter the Value Chain represents a business process that comes along with a product (Porter, 1985). The main aim has articulated by Porter (1985) is to find sources for a company’s competitive advantage by dividing the company into several activities in the business process which are all strategically relevant to the goods or services provided.
The business process is divided into primary and secondary areas. Primary activities include areas directly related to getting the product to the consumer. Inbound logistics is the acquisition of the raw materials that are necessary to provide the product or service. Southwest inbound logistics include areas such as route selection, flight and crew scheduling, fuelling, acquiring aircrafts and ticket management systems. Operation generally refers to the physical actions that are required to produce the service once all the raw materials are acquired.
Southwest Airlines operations include a variety of actions to provide its service. It covers the airlines customer care services, gate operations, air craft operations and maintenance and baggage handling. Outbound logistics involves moving goods into inventory and places where they can reach customers. Southwest Airlines outbound logistics includes website for booking tickets, connecting passengers on flights, offering, baggage collection systems and other gate services. Other areas Primary agents of the value chain include marketing and sales and services.
Marketing and sales involves the initiation of buying the product by utilizing advertising, promoting and monitoring sales (Porter, 1985). Therefore any advertising, promotional activity or deals and incentives offered by the airline will fall under marketing and sales activities. While service involves handling of customer relations once the product or service is in the hand of the consumer these include handling customer complaints, handling special request from customers such as disability requests or dealing with elements such as flight delays and cancellations.
The secondary activities are important in creating a product or service but are not directly involved in its creation. Procurement is responsible for buying the raw materials for the company it can include computers furnisher and other fix assets which are essential to the value chain, the act of procurement according to Porter is normally carried out by management or the sales department (Porter, 1985).
Technology support activity includes research and development that could lead to product development for the primary areas of the value chain, human resources role provides the company with essential staff to carry out functions while infrastructure involves the processes and procedures needed to execute the business process for example payroll and account (Porter, 1985). The purpose of this process is to analyse all the aspects of the Value Chain and determine if improvements can be made to increase the profitability and performance of the business.
For example, Southwest Airlines could look at a value chain and determine if they could reduce the speed at which it check in passengers to flights to reduce turnaround time or increasing the speed of operating procedures such as maintenance and refuelling. Value Chain is a structured way to look at improving the business process and information systems can play a key role in this effort.