The following report analyses the industry environment for the domestic airline industry operating out of the Coolangatta airport using Porters five force model. This report will conclude why the potential for returns is so low in this industry using Porters diamond. The report will incorporate appropriate and adequate discussion of key theoretical concepts and clear linkages between theory and practice demonstrating understanding of subject matter.
The focal airline which I have chosen to analyse in the following report is Virgin Blue, in which I will be comparing it to other domestic airlines operating from the Gold Coast: Qantas, Jetstar and Tiger Airways.
Air travel has changed the way people live and experience the world today. The airline industry is a strategic sector that plays a fundamental role in the globalization of other industries since it promotes tourism, world trade, foreign investment and, therefore, leads to economic growth (http://www.investopedia.com/features/industryhandbook/airline.asp, April 12, 2008). However, all airlines within the industry operate in a highly dynamic environment where various legal, social, technological and economic forces interact with each other, thus influencing their decisions and actions (http://www.investopedia.com/features/industryhandbook/airline.asp, April 12, 2008)
Currently in Australia and operating from the Coolangatta Airport, are three main domestic airlines, namely Qantas, Virgin Blue and Jetstar, and currently a fourth new airline, Tiger Airways has been recently added to the market. The airline that has consistently prevailed over several challenges and obstacles over the years and has emerged triumphant is Virgin Blue Airlines.
The first Virgin Blue flights began in May 2000. In 2001 Virgin Blue saw a market for domestic flights from the Gold Coast, and begun its service (http://www.virginblue.com.au/AboutUs/index.htm, April 12, 2008). The timing of Virgin Blue’s entry into the Australian domestic airline market was fortunate as it was able to fill the gap created by the failure of Ansett in September, 2001. It was at this time that Qantas dominated the market share and saw Virgin Blue as a threat. Ansett’s failure allowed Virgin Blue to grow rapidly to become Australia’s second domestic carrier, rather than just a cut-price alternative to the established players. It also gave them access to terminal space without which growth would have been significantly limited (http://www.virginblue.com.au/AboutUs/index.htm, April 12, 2008).
In the industry where airlines can face severe financial distress due to oil crisis, recessions and terrorist attacks, Virgin Blue continues to grow and prosper. The main attraction of Virgin Blue is their cheap tickets. This “budget” airline provides ‘no frills’ affordable travel. With Virgin Blue entering the airline market, families are able to travel the short distance by air rather than spending multiple hours on the road. By offering short, frequent, low-priced and convenient flights Virgin Blue has carved a niche for itself and has left its competitors behind. However, one of the drawbacks of having such a successful strategy is that it can be imitated by competitors, thus causing the company to lose its competitive advantage. Virgin Blue currently captures 30% of the domestic airline market flying inbound and out bound from the Coolangatta airport, and intends to lift its share from 30% to 50% over the next couple of years ( Sydney Morning Herlad, Aug 22, 2005). However with the introduction of Jetstar in 2004 and Tiger Airways in 2007, Virgin Blue faces the risk of limited market share, reduced profitability and the loss of competitive advantages it worked so hard at achieving. Minister of Tourism, Desley Boyle quotes that ‘In the past 12 month the domestic airline capacity at the Coolangatta Airport has soared, with an extra 9000 seats arriving and departing into the region’ (Tourism Queensland, 28/02/2008) However the result of rocketing seat numbers has not only been the cause of Virgin Blue increasing its number of flights arriving and departing from the Gold Coast, it has also been a subsequence of the introduction of Jetstar and most currently, Tiger Airways.
In regards to the rise of competition delivered to airlines operating from Coolangatta Airport, the survival of the fittest rule applies more, in every sense of the word, than it ever has. In order to survive, as well as succeed, the business needs to assess its competitive environment and identify key factors that may influence its actions (Porter, 1998, p.45).
The airline industry is very competitive and Michael Porter’s five-forces model can be used to analyse the intensity of the competition and the profitability of this industry. Porter’s five forces model is a business unit strategy tool which is used to make an analysis of the value of an industry structure (Hubbard, 2004, pg 35). The analysis is made by the identification of 5 fundamental competitive forces. These include:
• Entry of Competitors
• Threat of Substitutes
• Bargaining Power of Suppliers
• Bargaining Power of Buyers
• Rivalry among the existing players
(Hubbard, 2004, pg 35)
One of the forces identified by this model is the threat of new entrants which refers to the possibility of new competitors entering the industry and undermining the profits of the established businesses (Aarons, Waalewijn, 1999, pg4). The degree of threat en route for Virgin Blue in the future is determined by the existing barriers to entry. In the world today, the airline industry is so saturated that there is hardly space for a newcomer to enter the market. The biggest for this is the cost of entry. The airline industry is one of the most expensive industries, due to the cost of buying and leasing aircrafts, safety and security measures, customer service and manpower (http://www.investopedia.com/features/industryhandbook/airline.asp, April 12, 2008). Other barriers to entry which will recess new comers into the airline industry include Government restrictions and high capital costs to develop new airlines. However, the entry barriers for new airlines is lower today since the Australian domestic airline market was deregulated in 1990, which since its founding, Virgin Blue has seen more airlines start up and existing airlines expanding their market due to this deregulation (Queensland Tourism Industry Council, 05 April 2007). This has produced far greater competition than before deregulation in most markets. The deregulation has allowed Jetstar and Tiger Airways enter the market and reduce the market share for Virgin Blue and with the added competition, together with pricing freedom, means that there is a major constraint on profitability for the airline industry.
The bargaining power of buyers is another force that can affect the competitive position of a company (Porter, 1998, p.48). This refers to the amount of pressure customers can place on a business, thus, affecting its prices, volume and profit potential (Porter, 1998, p.45). The various airlines flying from the Gold Coast airport are competing for the same customer, which also results in strengthening the buyer power. Individuals wishing to travel to and from the Coolangatta airport are presented with various choices when selecting an airline but price is usually the most important factor, especially for students and families. Hence, the bargaining power of customers in the airline industry is very high since they are price sensitive and search for the best deals available. Virgin Blue attracts travellers that are price sensitive by offering them low fares and those that are convenience oriented by providing them with frequent flights. Qantas on the other hand has created a frequent flyer program to create switching costs which may be a significant factor to a traveller when choosing which airline to fly with.
In addition to buyers, suppliers can also exercise considerable pressure on a company by increasing prices or lowering the quality of products offered. The bargaining power of suppliers depends on supplier concentration, substitute supplies, switching costs, threat of forward integration and buyer information (http://www.unisanet.unisa.edu.au, 14 April 2008) Suppliers within the airline industry are concentrated since Boeing and Airbus are the main suppliers (http://www.unisanet.unisa.edu.au, 14 April 2008) As the supplier industry is dominated by Boeing and Airbus the concentration undermines the ability of airlines such as Virgin Blue to exercise control over suppliers and earn higher profits. Since Virgin Blue has a fleet of 53 Boeing 737 aircraft its supplier has a high bargaining power over Virgin Blue (http://www.virginblue.com.au/AboutUs/index.htm, April 12, 2008). However, other suppliers who work with the airline such as the providers of on board snacks do not have the same bargaining power as they are a larger industry which allows for Virgin Blue to have a choice over who they are purchasing from. Virgin Blue will purchase their on board snacks from the supplier which is the most economic so Virgin Blue can make a higher profit margin from the goods when they are sold.
The availability and threat of substitutes is another factor that can affect competition within the airline industry. It refers to the likelihood that customers may switch to another product or service that performs similar functions (Stahl, M, Grigsby D 1997, pg 145). Substitutes for air travel include travelling by train, bus or car to the desired destination. The degree of this threat depends on various factors such as money, convenience, time and personal preference of travellers. The competition from substitutes is affected by the ease of with which buyers can change over to a substitute. A key consideration is usually the buyers switching costs, however due to their low fare non-stop flights, Virgin Blue, Jetstar and Tiger airways can lure both price sensitive and convenience oriented travellers away from these substitutes. Virgin Blue has actually joined forces with its substitutes, such as car rentals and hotel and tour packages as they believe that these complement the Airline Industry by helping its growth and popularity. No other travel industry has such incentives and these really help the airline industry to a large extent.
The final force in Porter’s model is competitive rivalry that describes the intensity of competition between established firms in an industry (Stahl, M, Grigsby D 1997, pg 148). Industries that are very competitive generally earn low profits and returns since the cost of competition is high (Stahl, M, Grigsby D 1997, pg 148). The airline industry is usually characterized by the cut-throat competition that exists among the rival airlines due to its low cost nature. Since the carriers are involved in a constant struggle to take away the market share from each other, industry growth is average and as it is easy for buyers to switch between the airline companies, depending on price, the rivalry is increased. Rivalry is also high in the airline industry due to high fixed costs, as much of the cost of a flight is fixed, there is a great opportunity for airlines to sell unsold seats cheaply, which resolve in pricing wars between the airlines (Hubbard, 2004, pg 38). The airlines are continually competing against each other in terms of prices, technology, in-flight entertainment, customer services and many more areas. The net result of this competition between companies is an overall slow market growth rate.
In conclusion we can understand that the airline industry is very competitive and Michael Porters five-forces model can be used to explain why the potential for returns is so low in this industry. Firstly, the threat of new companies entering the industry is high and the entry barriers are low. Secondly, the bargaining power of customers is high since they are price sensitive and search for the best deals. The third force, bargaining position of suppliers, is strong since they are concentrated and this limits the control airlines have over suppliers to reduce prices and earn higher profits. The availability and threat of substitutes is another factor that can affect a company’s competitive position. However, the degree of this threat depends on various factors such as time, money, convenience and personal preferences of travellers. The final force in Porters model is competitive rivalry between the companies within an industry. Cut-throat competition exists among the airlines and since there is a constant struggle for market share, the over all profit potential of this industry is low.
The Industry Handbook:The Airline Industry, viewed 12 April 2008 (http://www.investopedia.com/features/industryhandbook/airline.asp)
Virgin Blue Corporate Information, viewed 12 April, 2008 (http://www.virginblue.com.au/AboutUs/index.htm, April 12, 2008)
Rochfort, P 2005, ‘Qantas plots no frills war with Virgin’, Sydney Morning Herald, Aug 22
Queensland Government 2002, ‘Gold Coast flying high on domestic airline seat increase’, Tourism, Regional Development and Industry, 28th February, p.1
Queensland Tourism Industry Council 2007, ‘Changes In The Sky’, Thursday, 5 April
Queensland Tourism Industry Council 2004, ‘Queensland ‘s tourism industry takes off with increased flights’, Wednesday 24 March
Porter, M 1998, Competitive Advantage: Creating and Sustaining Superior Performance, Free Press, Texas
Hubbard, G 2004, Strategic Management: Thinking, Analysis & Action, Pearson, Australia
Swaan Aarons, H. Waalewijn, Ph 1999, knowledge base representing Porters Five Forces Model, IOS Press, Netherlands
Strategic Management Accounting: Tools and Techniques of Strategy, Viewed 14th April 2008, http://www.unisanet.unisa.edu.au
Stahl, M, Grigsby D 1997, Strategic Management: Total Quality and Global Competition, Blackwell Publishing, New Jersey