The Airline Industry
Economic rent is an important theory and concept in the airline industry as it identifies relevant factors of production and amount of resource that must be invested in production.
Airline industry has a number of production dynamics whose costs must be received in order to sustain the business. For instance, a firm should pay wages to employees in order to get services their service. According to Wessels, (2006), “Economic rent is any payment that does not affect the supply of the input. As a consequence, economic rent is a purely demanded-determined payment,” (p. 519).
Different factors of production earn economic rent because of their efficiency or relevance in line of service offer or output production. Private ownership and management in the airline industry is less affected by rent sharing between management and alliance partners. British Airline was less affected by rent sharing after privatisation of the firm and according to Neven and Roller, (1996), “This provides casual evidence in favour of the view that a private system of corporate control is more effective than a public one,” (p. 940). The airline industry is very dynamic and sources of economic rent are diversified.
Due to heavy investment needed in the airline industry, the industry operates either as government owned ventures or by a particular entity. However, global wave of privatization and private business entities entered the industry in the mid 1990s, revolutionising the sector. There are limited cases of merger of firms in the airline industry due to rigid international air agreements that domestic firms adhere to. Strategic alliances and alliances between carriers is now the norm in the industry. Alliances between big network carriers are common if compared with those between low cost carrier, (LLC) and charter airlines.
According to Forsyth et al., (2011), “These type of airline differ in that the first operate integrated route networks centred around one or multiple hubs offering passengers a dense network of flight connections, while low cost and charter airlines typically focus on point-to-point networks,” (p. 49). This paper discusses how various airline operations and activities affect economic rent of firms engaged in the industry at the global, regional, and domestic level. Analysis of the Airline Industry and Sources of Economic Rent Porter’s Model ‘Porter’s forces’ is a model that is relevant in analysing the nature of airline industry.
Entrant of a new carrier, customers and suppliers strength in bargaining, and emergence of a substitute service determine rivalry in the airline industry. New entrant into the market poses a threat to the industry when barrier to entry is weak. The airline industry is governed by strict international agreements between different governments and negotiations between airlines bear no weight if compared to liberal bilateral agreements signed by two governments. The geopolitics of bilateral agreements has serious consequences on routes’ preservation for state owned airlines, and this blocks new entrants. Moreover, “Incumbent airlines also erect barriers to protect their positions as well as being protected by natural barriers.
Some of the latter, for example, stem from the intrinsic economics of supplying network services,” (Ramon-Rodriguez et al., 2010, p. 110). Information passage between stakeholders in the airline industry has increased tremendously due to technological advances in information technology, (IT). As a result, interaction between carriers and passengers is stronger than before. Customers can book flights online and check from a list of travel options, available destinations.
The increased consumer awareness eliminates intermediaries and increases their authority over price determination. Customers bargaining power is high while the bargaining power of suppliers is reduced. Technology also allows employment of superior labour, which can be run from any place in the world. Superior services attract customers and according to transaction cost theory, it is a parameter for determination and an incentive to a sustained competitive advantage. Despite enjoying technology advances, Ramon-Rodriguez et al.
, (2010) observe that, “airlines need physical infrastructure to provide their service and barriers to entry can prevent an expansion in the delivery of aviation services, (p. 111). The degree of substitutability of airline products in the short run, affects the nature of competition in the industry. The industry is reaching maturity with its standardisation marks and price determinant mechanisms are in control of customers. In addition, low cost carriers have exhausted their expansion capacity by acquiring secondary airline facilities without the need to form network alliances. This competitive strategy has limited their ability to expand and own other critical international bases, a situation that creates market imperfections.
Hence, “That low cost airlines have enjoyed some financial success may thus not be because of the business model per se but rather the nature of the markets that they have entered,” (Button, 2011, p. 16). Network Integration Consolidation of the industry is a major source of economic rent as it presents rationales upon which networks integration would yield benefits. To begin with, working together brings in economies of scale for individual firms to improve technical efficiency. This is because firms in analliance can share codes, which increases passenger flight rates.
According to risk diversification theory, creating many routes manages adverse effects of depending on a single airline destination. Another reason to form network alliance is that it reduces transaction costs that are passed on to customers. Forsyth et al., (2011) pose that, “Airlines that offer connecting services to passengers and freight forwarders may increase profits by joint marketing of their services on the basis of one stop shopping.” Shopping at one point saves on transaction costs as passengers don’t need to connect flights but instead, buy products and services from a partner in an alliance.
In order to make this a reality, firms in an alliance should carry out joint branding and tender seamless travel plans to passengers. Network alliances is commonest practice in the world and as Ramon-Rodriguez et al., (2010) posit, “The success of this strategy has led to the creation of oneworld, Sky-Team and Star Alliance that are now responsible for about 75% of global passengers and 90% of long-haul flights,” (p. 111). Network alliances eliminate market imperfections, which majorly affect airline operations. Airlines do serve a particular route and when there is an alliance, interests of passengers who demand flight connection and complementary services will be served.
Individual carriers face market imperfection due to uncoordinated price-setting mechanism because of numerous price mark-ups set by individual carriers. This reduces marginal costs, (MC) leading to decrease in profit margins. Network alliance minimises price mark-ups due to coordination of a joint pricing model that offers complementary services to travellers. Customer also benefit from low prices set by network alliances. International flights are characterised by regulatory impediments, which prevent carriers from inflowing to a new destination. Barrier to entry into a new destination is an obstacle to expansion programmes of a carrier.
Network alliances open avenues for expansion and gives right to enter into a restricted territory. Network alliance also opens base for resource sharing. Limited runways for take offs and landings may be a challenge to individual carriers. Finally, network alliances eases competition pressures leading to a reduction in pricing and can earn supernormal profits. Alliance members should be weary of threat of new entrants and formulate stringent measures to counter the threats. One way of achieving this is through imposition of regulatory restrictions and initiating frequent flyer programmes.
Managing alliances need caution, especially when it involves a multiplexity organisation of multilateral restrictions. To mitigate this effect, alliance partners need a unified currency as a basis for sharing a wide range of resources that compliment their operations. However, Gudmundsson and Lechner, (2006) observe that, “Diverse complimentary resources are a facilitator for derived alliance benefits, since hard-to-replicate combinations of diverse resources can be a source of competitive advantage,” (p. 157). Moreover, burden of too much redundancy can be lessened by replacing such alliance partners with new partners with non-redundant carriers. Defying the Odds; Case of Emirates Airline Incumbency in the airline industry is a great barrier to entry into the industry.
However, disruptive technology is a threat to this barrier and an opportunity for a new entrant. Foster supported by Christensen as quoted by Vlaar et al., (2005) assert that, “disruptive technological change brings about new value propositions and strategic options that may have a devastating effect on established firms and industry structure,” (p. 155). Incumbents are unable to institute radical technological inventions due to protocol issues and conventional organisation structures that take long time to make critical decisions. Since new entrants face operation difficulties through service imitation and high investment costs in Research and development, (R), disruptive technology is a leeway towards market breakthrough.
Emirates Airline is a new entrant into the market that defied the odds to break into airline industry with great success after short period of time. Emirates Airline started in 1985 with just two borrowed planes, following Gulf Air reluctance to increase flights despite an overwhelming market to and out of Dubai. According to Sull et al. (2005, p. 36), “Sheikh Mohammed bin Rashid Al-Maktoum, chairman of the Emirates Group, established the Emirates airline with an investment of $10 million, a trifling sum by the standards of international airlines.” From the onset of Emirates Airline operations, the chairperson of the firm declined to take government subsidies to sustain its services unlike other national airlines.
The firm wanted to do everything differently, for instance, adopting a non-conventional structure of management. In addition, the firm carries open discussions with their stakeholders unlike the traditional secret office meetings popular in the west. These strategies expound on the effectiveness of Emirates Airline’s positioning strategy, one of the main reasons for their success. One of the marketing strategies in Emirates Airline is doing business differently. As mentioned, from the onset, the firm wanted to be different from other airlines. This is shown in the firm’s reluctance to impllement its auditors’ proposal to institute a non-executive board of directors: “Just because that government structure was common among other carriers, Emirates did not feel compelled to follow suit,” (Sull et al.
, 2005, p. 37). The fluid strategy process is effective as it saves time involved in making critical operation decisions. The positioning strategy that is so simple yet vital for Emirates Airline is their focus and detailed analysis of small issues. Most companies adopt the classical business school of thought that concentrates on the bigger picture envisaged by senior managers. Another positioning strategy at Emirates Airline is the employment of a multi-cultural workforce and according to Sull et al.
, (2005, p. 37), “Emirates Group has more than 90% different nationalities among its 22,500 employees, with expatriates accounting for nearly 80% of all employees.” This cultural diversity is a critical positioning tool that sustains consumer loyalty and oils economic mantle. Wages paid to employees are in line with the Dubai wage rates that are lower than wage rates in European nations. According to Kotler et al.
, there are myriad ways to identify competitive advantages, one of which is personnel differentiation. “Companies can gain a strong competitive advantage by hiring and training better employees than their competitors” (2010, p. 286). This process requires careful selection of customer-contact followed by effective training of the staff. Employees ought to perform their duty to the best of their knowledge, paying attention to accuracy, efficiency and quick response to matters arising from operational activities.
At Emirates Airline, sharing of information is open, as illustrated by Sir Richard Branson’s visit. Branson wanted the firms to share initiatives for improving their respective company services. Emirates Airline emulated Virgin’s successful cabin crew philosophy. In addition, following the company’s expansion to Europe, there were many cross-cultural challenges that prompted the company to recall staff for retraining. “Support services include anything that a firm can provide in addition to the main product that adds value to that product for the customer,” (Ferrell and Hartline, 2008, p.
205). Sull et al. (2005, p. 38) quote training vice president, Mr. Reed: “We brought people to Dubai, trained them and sent then back to their stations.
” Positioning strategy ought to reflect the image of a firm that consumers’ minds identify with at the onset. In developing a communication strategy, one has to identify the target group, why they value a given product or service, and competitors within a given industry. According to Shikoh (2005), research by Skytrax in 2005, Emirates was third behind Cathay Pacific and Qantas Airways but ahead of global brands like British Airways and Singapore Airlines. As mentioned, Emirates instilled a sense of ‘business unusual’ in the industry with more operation strategies that appealed to a diverse culture.Emirates Airline bases its operations on point of difference and disregards point of parity in nearly all its operation strategies.
Sull et al. (2005, p. 36) quote the company’s vice chairperson Mr. Flanagan saying, “We don’t have to do what other airlines do. We offer what seems right for us.
” The firm demonstrates Mr. Flanagan’s sentiments in their management structure (open agenda) and multi-cultural culture in recruitment of staffs. The aforementioned positioning strategies conquers global appeal of consumers, a feat that not only builds on consumer loyalty but also make them enjoy business with a difference (Sengupta, 2005, p. 152). Positioning strategy also requires proper selection and implementation where a firm identifies its competitive edges, adopts one, and eventually communicates and delivers that given position.
Perpetual mapping analysis is a recommended tool in the identification of brands’ popularity. A brand that is most recognized by consumers has a higher probability of purchase. Betting on the growth of Dubai, Emirates Airline expects advancement in spite of any economic downfall that may affect the industry. With an expected growth in the tourism sector of Dubai, “They want to capture 70% of the flights through Dubai airport by 2010 – up from the 60% they were responsible for in 2003” (Sull et al.,2005, p. 39).
By virtue of association, Emirates Airline has become a Dubai brand and holds the distinction as the most successful airline in the region. Conclusion The airline industry is a multi billion investment venture that is mainly funded by national governments. Due this, there is expansion rigidity brought about by legal restriction on routes usage. Network alliances therefore involve both liberal bilateral agreements between two government and agreement between partners. The geopolitics of airline industry is main source of barrier to entry by a new firm and the cause of incumbency by national carriers. This paper has established that other than privatisation, network alliance is one of the ways through which industry players can expand their operations to new destination.
However, the case of Emirates Airline is unique as the firm defied the barriers to enter into the industry and become a global brand. Disruptive technologies and organisational rigidity are a challenge to the incumbent but give rare opportunities to new entrants. Structural rigidity can also be eliminated by privatisation.