Delta Air Lines Strategy, Competitive Forces & Financial Analysis

Introduction and Strategic Overview

Delta is a legacy carrier and the largest airline in the United States. It has faced difficult financial times in recent years, with two major write-downs that have crippled profitability and wiped out the company's equity. Delta has very little pricing power, and the industry itself is unfavorable. Firms compete under conditions of monopolistic competition, but most airlines find it difficult to foster sustainable competitive advantage through differentiation. They are also constrained by regulations that limit international expansion, although further domestic competition remains entirely possible.

It is recommended that Delta seek further domestic consolidation as a means of building sufficient size and scope to improve both market share and margins. It is also recommended that Delta focus on controlling fixed costs. The company can do little about most of its costs, so it must find efficiency wherever possible.

Delta competes as a mainstream air carrier. Using Porter's typology, the strategy on which Delta competes most closely resembles that of a differentiated player, implying that the company must develop points of differentiation and competitive advantage in order to succeed in the market. There are a few main points of differentiation in the airline industry, including the routes served, the service levels offered, pricing, and brand value. Delta has one of the largest fleets of any airline, which helps it offer a wide range of routes across multiple hubs.

The airline industry in the United States operates under monopolistic competition. This means that firms must differentiate themselves in some way in order to earn revenues above equilibrium — that is, to be able to earn a profit. The larger legacy airlines like Delta typically rely on a combination of route network, service quality, and name recognition. They employ strategies to win customer loyalty in order to boost their load factors. In addition, firms typically compete on price. The best profits are generally earned on routes with limited competition, so having a larger fleet allows Delta to operate more of those routes. High-traffic routes — such as those from Delta's Atlanta hub to LAX or New York — are subject to more competition and are therefore likely less profitable.

There are several key metrics used by airlines to measure the effectiveness of their strategies. Load factor is a capacity measure reflecting the finite nature of any seat offering — it is the percentage of seats sold for any given flight. Revenue per passenger is another key metric, reflecting the reality that airline pricing schemes are complex and that passengers on any given flight pay different prices for their tickets. The higher the average revenue per passenger, the more successful the airline is likely to be.

This strategy, however, is facing obsolescence. Delta's stock price fell to $7.43, and the company lost money in three of the past five years, including two years with very heavy losses. There are several reasons for this. Competition is intense, leading firms to compete on price while simultaneously pursuing a differentiated strategy. Fixed costs are high for legacy airlines, including the cost of aircraft, landing rights, and the contracts and pension obligations that most airlines carry with their unions. The broader economy is a major factor as well, as downturns reduce air travel generally, and business travel — the most lucrative segment — in particular. Additionally, the regulatory environment has imposed considerable burdens, discouraging air travel. The combination of these factors has made it especially difficult for legacy carriers with high fixed costs to remain profitable.

Competitive Forces within the Airline Industry

The Five Forces model can help explain the competitive forces within the industry and how those forces affect the ability of firms to earn a profit. For each firm, the forces operate somewhat differently; this analysis focuses on the impact of each force on Delta specifically.

Bargaining power of buyers is high. Consumers can readily access pricing information, especially through websites that aggregate travel data — such as Expedia. Other sites function as discounters (Hotwire, Priceline), further enhancing buyer bargaining power. There are even websites that seek to demystify airlines' pricing algorithms. As a result, airlines retain pricing power only over last-minute shoppers, who have lower price elasticity of demand than casual purchasers.

Bargaining power of suppliers is moderate. Some suppliers, such as unions, can exert pricing power over the key input of labor, but airlines are sufficiently large to maintain some leverage in these negotiations. Delta is the least unionized of major U.S. carriers and actively campaigns against unionization. Where airlines have little bargaining power is with the other key input — jet fuel. Airlines do not have significant bargaining power over the price of crude oil, the core ingredient in jet fuel. Delta has hedged its exposure to fuel prices since at least 1994 (Cobbs & Wolf, 2004). This strategy allows Delta some cost certainty over fuel prices, which in turn helps it manage both pricing and other costs. However, even sophisticated hedging strategies have limited impact when crude prices spike dramatically, as they did in early 2008. In 2011, the company shifted its hedging strategy from U.S. crude to Brent crude, which tracks more closely with jet fuel prices — an indication that no perfect hedge for jet fuel exists, and airlines must settle for imperfect crude oil proxies.

Threat of new entrants is surprisingly high. Deregulation in the U.S. lowered barriers to entry, bringing in new players and enabling the rise of discount airlines seen elsewhere in the world. There are few true discounters in the U.S., but the regulatory environment permits such airlines to operate, making future entry likely. Despite the high fixed costs associated with starting an airline, new players continue to emerge, ranging from JetBlue to Ryanair to Emirates.

Threat of substitution is high on shorter-range flights and very low on intercontinental flights. The main substitutes are alternate modes of transportation — cars, trains, and so forth. For short routes (for example, Miami–Orlando or Washington–New York), this threat is very high. For longer routes (New York–Los Angeles), it is very low. The company's strategy for managing this threat will therefore differ by route. The substitution threat has grown more serious in recent years as TSA and Homeland Security measures have made flying more burdensome than it once was.

Intensity of rivalry within the industry is high. Each flight represents fixed, perishable capacity, which leads to intense competition to fill seats (load factor). This competition drives down prices and squeezes margins. Airlines are also compelled to maximize their route networks, since the route network itself is a point of competition. As a result, they must simultaneously build out expensive route networks while competing on price. The airline industry in the United States is generally an undesirable one in which to operate: firms have very little pricing power — even in the business segment — and very little control over the major external cost and demand drivers.

Drivers of Change in the Industry

In the airline industry, change is driven by three types of forces: technological, regulatory, and competitive. Technology drives change in many ways, and much of what we recognize in this industry today is rooted in new technology. Consider the way consumers purchase airline tickets — first through reservation systems like SABRE and now through the Internet after comparison shopping. When buying through a travel agent, consumers had no meaningful ability to compare prices. That shift fundamentally changed the dynamics of marketing. Another major change concerns the types of aircraft in use. Duopolistic competition exists in both large aircraft (Boeing, Airbus) and smaller aircraft (Bombardier, Embraer), driving innovation on both fronts. Manufacturers are developing planes that are more fuel-efficient, more comfortable, and safer. As a result, airlines operating fleets of older aircraft are at a competitive disadvantage relative to those with newer fleets.

Regulatory change can have numerous impacts. One of the most significant was deregulation in the 1970s, which ultimately set the industry on a path of consolidation. Today, security measures increase costs and make the flying experience less pleasant, affecting demand conditions across the industry. Other regulatory burdens include issues such as airport access (a challenge for Southwest at its main hub of Love Field). Many countries maintain closed air markets, which limits competition. For example, Delta cannot readily expand into Canada due to regulatory restrictions on foreign carriers.

Competition is also a key driver of change. Firms behave in a manner similar to oligopolists, responding to each other's moves. This forces firms to be creative in how they attract and retain customers. Innovations such as loyalty programs are easily replicated across the industry — a characteristic of monopolistic competition. Innovation therefore yields only short-term gains, and firms must constantly innovate and improve in order to sustain profitability.

Works Cited

Cobbs, R. & Wolf, A. (2004). Jet fuel hedging strategies: Options available for airlines and a survey of industry practices. Kellogg School of Management.

Jacobs, K. (2011). Delta says union rejection upheld. Reuters.

Meyer, G. (2011). Delta Airlines shifts fuel hedges out of U.S. benchmark. Financial Times.

MSN Moneycentral. (2011). Delta Airlines.

QuickMBA. (2010). Porter's generic strategies. QuickMBA.com.

QuickMBA. (2010). Porter's five forces. QuickMBA.com.