The Domestic Airline Industry
Eric Huang
Chase Funderburk
Vincent Russomagno
Terry Wu
Why the domestic airline industry?
• Personal enthusiasm
• Purchasing experience and familiarity
• Geographic and temporal pricing differences
• Variety of pricing possibilities
Industry Overview
• Life Cycle Stage: Decline
• Revenue Volatility: High
– Rising fuel prices
Background
Background
• Demand determinants: leisure travel, business
travel, cargo transportation, sudden impacts
Background
• Capital intensity:
high
– Wages: 10.0% of
revenues (2013)
Background
Major Companies
• Delta Airlines
• United Continental Holdings
• AMR
Major Companies: Delta Airlines
• Market Share: 15.1%
• Headquartered in Atlanta, Georgia
–
–
–
–
80,000 employees
5,000 daily flights
Fleet size: 722 (mainline)
Destinations: 247 (mainline)
• Member of SkyTeam alliance
• Regional servicing: Delta Connection
• Volatile yearly revenue changes
Major Companies: United Continental Holdings
• Market share: 14.7%
– Brand names: United Airlines
• 2010 Merger: United Airlines Corporation and Continental Airlines
• Headquartered in Chicago, IL
–
–
–
–
88000 employees
5656 daily flights
Fleet size: 705 (mainline)
Destinations: 376 (mainline)
• Founding member of Star Alliance
• Plans to cut unprofitable routes (rising fuel prices)
• Expanded Wi-Fi servicing through LiveTV
Major Companies: AMR
• Market Share: 9.0%
– American Airlines, American Airlines Cargo, American Eagle
• 2011: AMR filed for bankruptcy
– 13,000 jobs elminated
• Headquartered in Fort Worth, TX
–
–
–
–
80,100 employees
3,400 daily flights
Fleet: 605 (451 on order)
Destinations: 250
• February 2013: AMR and US Airways Group merger
– Largest airline
– Close in Q3-2013 (72% AMR, 28% US Airways)
– New name: American Airlines Group Inc
Competition
• 6 Major Domestic Airlines/market shares:
– Delta Airlines, Inc: 15.1%
– United Continental Holdings Inc: 14.7%
– Southwest Airlines Co: 11.1%
– AMR Corporation: 9.0%
– US Airways Group: 6.4%
– JetBlue Airways Corp: 2.4%
Market Concentration
• Domestic Airline industry has a moderate level
of concentration
• Top 4 airlines in the industry account for
approximately 49.9% of the industry revenue
in 2013
• Market concentration has increased due to
merger and acquisition activity:
– Delta Airlines and Northwest Airlines (2008)
– United Airlines and Continental Airlines (2010)
Government Regulation
• October 24, 1978 – Airline Deregulation Act
•
Prior to 1978 government agency, the Civil Aeronautics Board (CAB)
determined the airline routes and the prices charged
• Post 1978
– Market-driven industry, customer demand determining price
– Hub and Spoke system (legacy carriers): funnel passengers from
different locations into central hubs at major airports where
passengers are sorted onto connecting flights to their final
destination
• E.g. American Airlines, United Airlines, Delta, United Continental
– Low-Cost Carriers (LCCs) – airlines formed post 1978
deregulation
• Eliminate many traditional passenger services offered on legacy
carriers
• E.g. SouthWest
Government Regulation (cont.)
• Low entry barriers; high exit barriers
– Post deregulation: many new start-ups
• Good for consumers; bad for legacy carriers
• Start-ups offer lower fares than legacy carriers to
compete resulting in decreased legacy carrier revenue
• Results in many airline bankruptcies but credit card
companies and aircraft manufacturers would rather
keep bankrupt airlines alive rather than have them
liquidate
– Survival of bankrupt airlines makes it difficult for other airline
to raise fares to profitable levels
Government Regulation (cont)
• Maintenance Programs
– Federal Aviation Regulations (FAR) Part 121
• Industrial Regulations
– Standard industrial regulations
– Occupational Health and Safety Administration
(OSHA)
• Environmental Regulations
– 1990 Clean Air Act: National Emission Standards
for Hazardous Air Pollutants (NESHAP)
Industry Organization
• Aviation Suppliers Association (ASA)
– Represents more than 490 global member
companies that lead logistics programs,
purchasing efforts and distribution of aircraft parts
worldwide
– Focus on safety, international compliance and
ethical business practices that impact the aviation
parts supply industry
Industry Organization (cont)
• Horizontal Integration:
– Civil aircraft manufacturing: Boeing (60% of
market), Airbus (30% of market)
– Aircraft assembly and aircraft engine components:
Rolls Royce plc, General Electric (GE)
– Equipment and parts: Thales, Teledyne, Gables
Engineering, Timken
– Aircraft interior refurbishment and completion
companies
Industry Organization (cont)
• Numerous factors affect the aircraft
manufacturing industry:
– Industry must develop more efficient and
environmentally friendly aircraft parts to comply
with environmental standards aimed at reducing
negative aircraft externalities such as aircraft noise
and engine combustion emissions
Introduction
• Overview of stats on IBIS
• Trends and future
Pricing Strategies – Pre Booking
• Pre Booking:
– Short: 1 week
– Medium: 1 month
– Long: 3 months
Pricing Strategies – Trips
• Business Trips:
– Departure: Monday
– Arrival: Thursday
• Leisure Trips:
– Departure: Friday
– Arrival: Sunday
Raw Data Collection
• Using Yapta.com we collected prices for 9 selected routes over a
one week time frame
• Focused on 3 route lengths:
– >5 hrs
– 2.5-5 hrs
– <2.5 hrs
• Identified 3 major players:
– American Airlines
– Delta
– United
• Focused on 3 booking periods:
– 1 week prior
– 1 month prior
– 3 months prior
Raw Data Sample
Business Trips – 1 Week Booking
JFK-LAX (>5)
• The mid length flight was the
cheapest
• Closer to departure, the >5 hr
flight was clearly the most
expensive
• Prices were stable for the <2.5
hr flight and increasing steadily
for the other two
1200
1000
800
Delta
600
United
400
American
200
0
Mon. Tues. Wed. Thurs.
Fri.
Sat.
Sun.
ATL - IAH (<2.5)
LAX - SEA (2.5-5)
1200
800
700
1000
600
800
Delta
600
United
400
American
500
0
0
Wed.
Thurs.
Fri.
Sat.
Sun.
American
200
100
Tues.
United
300
200
Mon.
Delta
400
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
Business Trips – 1 Month Booking
JFK - LAX (>5)
700
• The longest flight (>5 hrs) was
the most expensive throughout
• The shortest flight was slightly
cheaper than the mid length
flight
• Prices were most volatile in the
<2.5 hr flight
600
500
400
Delta
300
United
American
200
100
0
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
LAX - SEA (2.5-5)
ATL - IAH (<2.5)
450
400
350
300
250
Delta
200
United
150
American
100
50
0
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
500
450
400
350
300
250
200
150
100
50
0
Delta
United
American
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
Business Trips – 3 Month Booking
JFK - LAX (>5)
520
• The longest flight was most
expensive
• Mid length flight was the
cheapest
• Low price volatility in the mid
length flight
500
480
460
Delta
440
United
American
420
400
380
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
ATL - IAH (<2.5)
LAX - SEA (2.5-5)
375
400
370
350
300
365
Delta
360
United
355
American
350
250
Delta
200
United
150
American
100
345
50
340
0
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
Business Trip Analysis
• When waiting till the last minute to book a
flight the distance has little impact
• On the 1 month and 3 month pre-booking
times, the distance has a more significant
impact on pricing
• Extemporaneous supply and demand factors
in regional markets cause additional price
fluctuation
LeisureTrips
vs Business
Analysis
Leisure
– 1 Week
Booking
looking at 1 Week Booking
Leisure vs Business
JFK - LAX
• These flights are similarly
priced over time
• There is a greater relative
spike in business than leisure
in the few days before
departure
JFK - LAX (Leisure)
1200
1000
800
Delta
600
United
400
American
JFK-LAX (Business)
200
1200
0
Mon.
Tues.
Wed. Thurs.
Fri.
Sat.
Sun.
1000
800
Delta
600
United
400
American
200
0
Mon. Tues. Wed. Thurs.
Fri.
Sat.
Sun.
Leisure vs Business
LAX - SEA
• There is a premium charged
to business passengers
• The extreme leisure rate hike
seen by American is an
outlier
• Could be a result of too
much pre-booking
LAX - SEA (Leisure)
1400
1200
1000
800
Delta
600
United
American
400
200
LAX - SEA (Business)
0
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
800
700
600
500
Delta
400
United
300
American
200
100
0
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
Leisure vs Business
ATL - IAH
ATL - IAH (Leisure)
• There is a premium charged
to business passengers
• Delta attempts to take
advantage of extreme last
minute bookings with steep
rate hikes
800
700
600
500
Delta
400
United
300
American
200
100
ATL - IAH (Business)
0
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
1200
1000
800
Delta
600
United
400
American
200
0
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
Leisure vs Business Analysis
• Airline appear to be effectively price
discriminating against business customers
– Charge them a premium for late booking
tendencies
• Example of 3rd degree price discrimination
Leisure Trips – 1 Week Booking
JFK - LAX (>5)
1200
• Interesting that the shortest
flight started as the most
expensive
• Ultimately the longest flight
matched the shortest’s price
1000
800
Delta
600
United
400
American
200
0
Mon.
Tues.
Wed. Thurs.
Fri.
Sat.
Sun.
ATL - IAH (<2.5)
LAX - SEA (2.5-5)
800
1400
700
1200
600
1000
500
400
300
Delta
800
Delta
United
600
United
American
200
100
200
0
0
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
American
400
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
Leisure Trips – 1 Month Booking
JFK - LAX (>5)
600
• The longest flight is the most
expensive
• Shortest and mid length flights
are comparable
• Shortest flight has the greatest
price volatility
500
400
Delta
300
United
200
American
100
0
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
ATL - IAH (<2.5)
LAX - SEA (2.5-5)
400
400
350
350
300
300
250
Delta
200
United
150
American
250
100
50
50
0
0
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
United
150
100
Mon.
Delta
200
American
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
Leisure Trips – 3 Month Booking
JFK - LAX (>5)
800
700
600
500
400
Delta
300
United
200
American
100
0
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
• The longest is the most
expensive
• Delta is pricing higher than the
competition for the mid length
flight
• They may have less
regional capabilities
Sun.
ATL - IAH (<2.5)
LAX - SEA (2.5-5)
375
500
450
400
350
300
Delta
250
United
200
American 150
100
50
0
370
365
360
355
350
345
340
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
Delta
United
American
Mon.
Tues.
Wed.
Thurs.
Fri.
Sat.
Sun.
Leisure Trip Analysis
• Similar findings to Business Trips
• Again we saw when waiting till the last minute
to book a flight the distance has little impact
• On the 1 month and 3 month pre-booking
times, the distance has a more significant
impact on pricing
• Outside factors like regional supply and
demand are difficult to nail down
Analysis
Leisure Pre-Booking
Trips – 3 Month
Booking
Average Observed Prices by Weekdays
• Book on Monday or Wednesday to save the most
money on flights
400
390
380
370
Business
Leisure
360
Combined
350
340
330
Monday
Tuesday
Wednesday
Thursday
Friday
Saturday
Sunday
Analysis – Business vs Leisure
• Leisure travelers pay a $20 premium over business travelers
for flights booked 3 months in advance
• Again this is successful 3rd degree price discrimination
Analysis and Recommendation
• Industry is heavily reliant on:
– Fuel Prices
– Seasonality of Travel
– Government Regulation
• Security
• Funding
Financial Analysis
• Industry P/E ratio is 10.4X on average
– This is extremely low compared to an S&P 500 average of 14.3X
• LTG forecasts are surprisingly high at an average of 28.8%
– This is likely explained by the airline industry weathering a few very tough
years of high fuel costs and consumer uncertainty
– When the economy improves  people travel more
• American Airlines has undergone significant restructuring through a Chapter 11
bankruptcy filing
• Other major players have cut costs and are now lean and ready to grow so long as
government regulation does not interfere
• Fuel prices are volatile and directly effect the costs of flying
• Airlines hedge their exposure to fuel prices but this is more of an
art than a science
– Low fuel prices will typically result in better industry performance
• With the emergence of alternative energy sources the airline
industry may face less competition for fuel
Crude Oil Futures
Final Recommendation
• The airline industry trades at a relative value
to the market
• There are many risks involved but if you
believe in management then “stock-picking”
may be a successful strategy within the
industry
• Suggest avoiding this sector as a long term
play