Chapter 2 Worksheet

Professor Edward Desmarais

Business Policy and Strategy

Fall 2004

Continental Airlines

Case Analysis

by: The Brain Busters

TABLE OF CONTENTS

I. Executive Summary

3

A. Mission

3

B. Vision

3

C. Objectives

3

D. SWOT Summary

7

E. Recommendations

8

II. Current Situation

9

A. Current Performance

9

B. Strategic Posture

10

IV. External Factors

34

V. Internal Factors

156

VI. Action Plan

231

Appendix A. Stakeholder Worksheet

245

I. Executive Summary

A. Mission

Continental is a major commercial airline that transports passengers traveling on business or leisure to destinations around the world while providing convenient, dependable, high quality service.

B. Vision

To continue looking for ways to improve performance, reduce costs, and increase revenues by listening to customers, responding to their needs, and continuing to improve the organization’s culture.

C. Objectives

Short-term strategic objectives

· To become the fourth largest commercial airline in 2 years.

· To expand Continental Express by 10% in the Southeast in 3 years in order to gain market share in that area without having to commit large planes with high break-even margins.

· To reduce the number of aircraft types to 4 in 3 years in order to continue to bring down maintenance expenses.

· Increase the amount spent on researching customer preferences by 5% in the next 3 years.

· Reduce operating cost per available seat mile by 2% in the next 3 years.

· Reduce on the job injuries by 5% in 2 years by providing better safety training.

· Increase hedging of fuel costs by 5% annually for the next three years.

· Decrease voluntary turnover rate to 4% in 3 years.

· Reduce absenteeism rate by 5% in 2 years.

· To add three new domestic destinations to Continental’s regular service each year for the next three years.

· To add 10 new cities to Continental Express within 3 years.

· To increase the percentage of total sales from e-ticketing by 10% in 2 years.

· To increase the number of independent websites that are allowed to book Continental flights by 5% in 3 years.

· On-time arrivals to 84% within 2 years.

· Remain in the top 3 companies in terms of on-time arrivals for 18 consecutive months.

· To be named the “Most Admired Airline” by Fortune magazine within 3 years.

· Reduce the number of passengers involuntarily denied boarding by 10% in 3 years.

· To reduce the percentage of mishandled baggage by 5% in 3 years.

· Increase the benefits of the frequent flyer program by 5% in 2 years.

· Continue international expansion. Add flights to fifteen new foreign cities within 2 years.

· To continue having more international flights than any other rival for the next three years.

· Spend 5% more on researching new information systems within 3 years.

· Send out 5% more surveys within the next 3 years.

· Increase the number of employees focused solely on innovation by 5% in 2 years.

· Increase the number of Continental and Continental Express flights by 10% within the next three years.

· Rank within the top three major commercial airlines in terms of the percentage of customer complaints as measured by the Department of Transportation within 2 years.

· Rank within the top three in terms of customer satisfaction within 2 years.

· Increase the monetary incentives for flight attendants to book passengers on Continental flights by 5% in 2 years.

Long-term strategic objectives

· To become the 1st or 2nd largest airline in 10 years.

· To dispose of all older aircraft within 10 years so that the maximum age of any aircraft in the fleet is 8 years old.

· Increase research expenditures by 10% in the next 10 years.

· To reduce interest costs by 15% in 10 years by paying down debt and financing new growth by issuing stock.

· To increase the number of first class seats by 10% in 10 years.

· Increase e-ticketing to 99% of their destinations in 8 years.

· On-time arrivals to 87% in 10 years.

· To receive the Air Transport World “Airline of the Year Award” for 7 out of the next 10 years.

· To increase customer service incentives for employees by 15% within 5 to 10 years.

· Rank number one in major commercial airlines for having the fewest number of baggage complaints within 5 to 10 years.

· Add three new hubs in International markets within 10 years.

· Reduce the amount of time it takes to produce financial results by 15% in 10 years.

· Increase the number of services offered to customers by 10% in 10 years.

· Increase the number of planes the company has to fly those flights by 7% within 10 years.

· Reduce the number of bumped passengers to 2% in the next 5 to 10 years.

Short-term financial objectives

· To increase the percentage of growth by 6% in 3 years.

· Increase earnings by 20% in 2 years.

· Raise the diluted earnings per share by 5% in 3 years.

· Raise profit margin to 5% within 3 years.

· Increase percentage of sales from code-sharing agreements by 5% within 2 years.

· Increase EVA by 5% within 3 years.

· Increase MVA by 5% within 3 years.

· Lower debt to equity ratio by 8% in 2 years.

· Receive the most-admired U.S. airline award from Fortune magazine within 3 years.

· Continue to have a 30% growth rate with Continental Express for the next 3 years.

· Reduce costs during times of recession by 5% within 1 year.

· Increase ROA to 4% within 2 years.

· Maintain an ROE of 30% for 2 years.

· To increase the amount of cash on hand by 10% in 3 years.

· Increase current ratio by 10% in 3 years.

· Improve net working capital ratio by 4% in 3 years.

Long-term financial objectives

· Achieve an average of 18% revenue growth over the next 10 years.

· Increase earnings by 50% in 8 years.

· Raise the diluted earnings per share by 15% in 10 years.

· Pay a 1% dividend within 5 to 10 years.

· Raise profit margin to 7% within 8 years.

· Increase load factors by 15% in 8 years.

· Reduce the number of flights with a profit margin less than 1% by 20% within 10 years.

· Increase EVA by 10% in 10 years.

· Increase MVA by 12% in 7 years.

· Have a 2-1 debt to equity ratio within 10 years.

· Receive the award for Tops in Customer Satisfaction by J.D. Power and Associates for 9 out of the next 10 years.

· Expand the number of Continental Express destinations by 25% in 10 years.

· Increase market share by 10% within 8 years.

· Increase the number of routes with a profit margin above 8% by 20% within 10 years.

· Increase ROA to 9% within 15 years.

· Improve ROE by 10% within 5 to 10 years.

· To increase current ratio by 20% within 10 years.

· Improve net working capital ratio by 8% in 10 years.

D. SWOT Summary

Strengths

· Information systems

· Advertising and promotion

· Product and service innovation

· Ability to continually improve quality

· Technological know-how

· Culture

· Brand name

· Alliances and cooperative ventures

· Attractive customer base

· Wide geographic coverage

· Image

· Location of operation facilities

· Regional service

· Recognized industry leader

· Reputation for customer service

· Intellectual capital

· Fixed asset utilization

· Age of aircraft

Opportunities

· Large quantity of buyers

· Extent of rivals vertical integration

· Population demographics (opportunities for growth)

· Changing societal values

· Feeder routes

· International routes

· Bargaining power with some suppliers

· Extent of rival’s horizontal integration

Weaknesses

· High overall operating cost

· Limited access to financial capital

· Cost disadvantages

· High debt to equity ratio

· Financial position – cash flow

Threats

· Economic recession

· Legislative, regulatory, and political environments

· Technology

· Mature market

· Exit barriers

· Volatile fuel costs

· Rivals using competitive weapons

· Extent to which rivals use economies of scale

· Large number of rivals similar in size

· Low buyer switching costs

· Increasing buyer knowledge level

· Degree of alliances

· Long term industry growth rate

· Industry profitability

E. Recommendations

· Develop a cost conscious culture.

· Hedge jet-fuel purchases.

· Share ground operations with other airlines.

· Renegotiate leases.

· Advertise service features on websites where plane tickets are sold (ex. Orbitz, Expedia).

· Have flight attendants hand out surveys encouraging passengers to identify what they would like the airline to offer in the future.

· Have top management work directly with flight attendants in finding innovative ways to improve services.

· Redesign the OnePass frequent flyer program to make it more attractive to leisure passengers.

· Increase advertising and double bonus miles when rivals use price cuts.

· Increase fares on routes with high passenger traffic when the planes are flying at or near capacity.

· Increase the number of profitable flights Continental and Continental Express are flying and remove flights with low profit margins from the schedule.

· Defer delivery of new aircraft on order.

· Enter into additional code-sharing agreements.

· Add additional international routes and destinations with high profit potential.

· Open a new hub in Europe.

II. Current Situation

A. Current performance

Continental’s performance has improved since Gordon Bethune became CEO in late 1994. The company’s revenues grew at a rate higher than industry average between 1995 and 2000. In 2000, Continental was the fifth largest commercial airline, in terms of market share, with 9.632% of the market. In the same year, Continental had more international flights than any of its rivals. By September 2001, Continental had 2,500 daily flights (Continental and Continental Express) and showed profits for 25 quarters in a row.

There is intense rivalry in the airline industry. Continental has a strong position relative to most competitors. They have improved the quality of their service and listened to customer’s needs to increase their revenues and reduce their costs.

B. Strategic Posture

Chapter 2 Worksheet

Mission

Criteria

Facts

What does this mean?

What is our business?

Continental is a commercial airline that operates in both foreign and domestic markets. Continental transports first class and coach passengers to cities around the world.

In 1994, it was the fifth largest commercial airline with revenues of nearly $6 billion.

Continental was in Chapter 11 bankruptcy in 1983 and a second time in 1990. It emerged from the second bankruptcy in 1993.

Continental had ten CEOs in ten years time.

By September 2001, Continental had 2500 daily flights (Continental and Continental Express) and showed profits for 25 quarters in a row.

Continental provides a means of travel in an Industry with a great deal of competition. Because of this competition, Continental must find ways to meet the needs of customers in ways superior to that of rivals. The company did not have a clear idea of how to do this until Bethune entered the organization.

Who are our customers (stakeholders)? What do we do for each of them?

How (technology used or functions performed) do we meet their needs and expectations?

“See stakeholder analysis worksheet”

“See stakeholder analysis worksheet”

How do we communicate the mission to our organization and our customers (stakeholders)?

Before 1994, Continental’s top management was cut off from employees. It was a top down organization with low morale, high turnover, high absenteeism, and low wages. The culture at Continental was very poor and employees resisted any changes passed down by management. Employees were used to fighting with each other over resources, worrying about layoffs, and pointing the finger of blame. Employees were not kept well informed by management.

When Bethune came aboard, he realized he needed to focus on the culture of the organization in order for employees to buy into the new mission. He apologized to stakeholders and ensured them that Continental was going to improve.

Bethune communicated the new mission by:

Propping the door open to his office (it used to be shut and guarded by security cameras)

Meeting directly with employees at all major locations and levels of the organization.

Sitting at the middle of the boardroom table during meetings and discussing each topic in the same order outlined in the “Go Forward Plan.”

Installing 600 bulletin boards and LED displays to keep employees posted.

Inviting top business customers to his home, apologizing for past mistakes and giving them a leather ticket case as a show of thanks.

Painting all planes to match as a symbolic way of showing Continental was under new leadership and changes were being made.

Burning manuals in the parking lot and empowering employees to use their own judgment when handling problems. Encouraging employees to make decisions and involve headquarters as a resource when they need to.

Having executives personally call old business customers to apologize and let them know about the new Continental.

Allowing employees to make suggestions to top management. Improve communication at all levels.

Providing a voice mail number to the CEO so that employees can contact him directly.

Created incentives for employees to work together and achieve the organizations objectives (ex. On-time bonuses, Absenteeism bonuses).

Gatherings sponsored by the company for employees to spend time with each other and network.

Monthly employee newsletter, Continental Times. This newsletter included information about how well the company was doing and reporting on any new changes.

Mailing quarterly newsletter, Continental Quarterly, to employee’s homes.

Bethune contacted travel agents and provided them with incentives for business passengers to try Continental. Bethune reinstated programs that helped travel agents to promote Continental.

Creating the slogan “Dignity and Respect” in 1996.

The mission is communicated in a variety of ways in order to reach all stakeholders. The goal is to get all stakeholders on the same page. Everyone must have a clear idea of what the company is doing.

By communicating the mission to everyone, it helps to create a team atmosphere that encourages synergy.

The missions of individual divisions can then be formed based on the company’s overall mission.

With a clearly defined mission stakeholders can make recommendations and give feedback.

The mission communicates to the stakeholders what the company is doing daily to differentiate their product from that of competitors.

Bethune went too great lengths to make sure stakeholders were kept well informed. This is very different from prior management. When stakeholders know what is going on they are more likely to want to participate and buy into changes.

Vision

Criteria

Facts

What does this mean?

What will our business be in 5, 10 years?

Continental plans to still be a commercial airline that operates in both foreign and domestic markets. It will continue to transport first class and coach passengers to cities around the world.

Continental plans to enter into more international markets and add features to its existing services if they add value to its product.

Continental will continue to look for ways to improve the quality and accuracy of the information they are able to receive from their internal financial systems.

The company plans to keep increasing its percentage of on-time arrivals and looking for ways to differentiate its product to attract customers with un-met needs.

Continental is planning to continue looking for ways to improve its performance, reduce costs, and increase revenues.

They plan to do this by listening to customers and responding to their needs and continuing to improve the organizations culture.

Continental has reward systems in place that will help motivate employees to help the organization achieve its future objectives.

Who are our future customers? What will we do for each of them? How (technology used or functions performed) will we meet their needs and expectations?

“See stakeholder analysis worksheet”

“See stakeholder analysis worksheet”

How will we communicate the vision to the organization and our customers?

The vision is communicated in many of the same ways the mission is communicated. Monthly newsletters, meetings, bulletin boards, reports, and word of mouth all help to keep stakeholders informed.

Continental makes sure that stakeholders are aware of what the company is planning to achieve in the future.

Continental wants stakeholders to be informed so that they will be motivated by past success and have a desire to contribute to the future of the company.

Top management is able to gain from sharing this information because employees can provide suggestions and knowledge that will help the company to reach its objectives.

ESTABLISHING OBJECTIVES

Strategic objectives

Criteria

Facts

What does it mean?

(How much of what kind of performance by when?)

Market share

In 1994, Continental was the fifth largest commercial airline.

Small market share in low-fare point-to-point routes.

Small market share in Southeast.

Short-term: To become the fourth largest commercial airline in 2 years.

Short-term: To expand Continental Express by 10% in the Southeast in 3 years in order to gain market share in that area without having to commit large planes with high break-even margins.

Long-term: To become the 1st or 2nd largest airline in 10 years.

Quicker design-to-market times

In 1994, Continental was using 10 different types of aircraft. The maintenance department was trained on how to repair and service each type of plane.

Continental disposed of older aircraft, such as the Airbus 300, because they were costly to operate and required specialized training, parts inventories, and special procedures. Older planes like this also required repairs more frequently.

By replacing older aircraft, Continental reduced the size of its maintenance department and was able to close its Los Angeles facility.

Continental reduced aircraft downtime by flying a smaller variety of newer planes.

Short-term: To reduce the number of aircraft types to 4 in 3 years in order to continue to bring down maintenance expenses.

Long-term: To dispose of all older aircraft within 10 years so that the maximum age of any aircraft in the fleet is 8 years old.

Higher product quality

In an effort to increase customer satisfaction and improve the quality of the product, superior on-time arrivals were focused on.

Continental also:

· Purchased newer planes

· Improved baggage handling

· Provided more room for passenger carry-on luggage

· Focused on improving its employee relationships in order to make employees feel better about where they work. Employees pass this positive attitude on to customers through courteous service.

· Uniform fleet (all planes painted identical)

· Convenient online ticketing

· Reduced wait times (more customers booking online)

· More international flights

· Better meals

· Flights to where people need or want to go (reducing the number of connecting flights needed)

Short-term: Increase the amount spent on researching customer preferences by 5% in the next 3 years.

Long-term: Increase research expenditures by 10% in the next 10 years.

Lower costs relative to rivals

Operating cost per available seat mile:

Year Cost Percent change

2000 9.76¢ 8.565%

1999 8.99¢ 1.125%

1998 8.89¢ -1.659%

1997 9.04¢ 3.314%

1996 8.75¢ 4.665%

1995 8.36¢ -4.566%

1994 8.76¢ 10.886%

1993 7.90¢

In the early years, operating cost increased as a result of management’s actions to increase the value of its product to attract and retain consumers.

Prior management had decreased costs to the point were the product was no longer attractive to potential customers.

The case does not include the operating cost per available seat mile of competitors, but does break it down by expense.

In 1994, Continental’s maintenance department had the lowest dispatch reliability and highest costs in the industry. In 2000, Continental was second highest in “Other Operating and Maintenance Expenses” compared to 10 major airlines.

Continentals move to dispose of some of the oldest and largest planes in its fleet and renegotiate maintenance contracts brought down maintenance costs.

In 1994, on the job injuries were also above the average for the industry. This meant higher workmen’s compensation costs.

The increases in the usage of e-ticketing brought down costs. Prior to e-commerce flight attendants handled 80% of all reservations. With more reservations being booked online, Continental lowered staffing costs.

Renegotiated leases on aircraft stretched out lease payments and lowered annual costs. Refinancing saved $25 million in annual interest payments.

Interest costs were reduced from $202 million in 1994 to $117 million in 1996.

Increases in the percentage of on-time arrivals lowered costs from $5 million a month down to roughly $2.5 million (the amount given to employees for on-time arrival bonuses).

Costs were reduced in 1996 as a result of the perfect attendance program. Employees with perfect attendance from Jan-June or July-Dec received a $50 bonus and a chance to win a Ford Explorer. Even though 83 cars were given out and the program cost the company $3.3 million it was estimated that reductions in the absenteeism rate saved the company $20 million. 14,980 eligible employees received bonuses.

Voluntary turnover rates decreased from 6.7% in 1998 to 6.1% in 1999 to 5.3% in 2000. Lower employee turnover reduces costs on recruiting, selecting, and training new employees.

Short-term: Reduce operating cost per available seat mile by 2% in the next 3 years.

Short-term: Reduce on the job injuries by 5% in 2 years by providing better safety training.

Short-term: Increase hedging of fuel costs by 5% annually for the next three years.

Short-term: Decrease voluntary turnover rate to 4% in 3 years.

Short-term: Reduce absenteeism rate by 5% in 2 years.

Long-term: To reduce interest costs by 15% in 10 years by paying down debt and financing new growth by issuing stock.

Broader or more attractive product line than rivals

In the early 1990s Continental was not known for having an attractive product line.

The company focused on lowering costs to try to show a profit. Lowering costs often brought down the quality of service and product customers received.

Continental Lite did not meet the needs of customers. The program was losing money because of relatively high costs and low revenues. People were willing to pay more for “frills.” Removing first class seats caused the company to lose a potentially profitable market segment.

Bethune made the company’s product line more attractive by flying to the places customers wanted to go. Surveys were conducted to determine customer preferences and changes were made accordingly. Large overhead bins attracted business customers. Frequent flyer programs and incentives were reinstated to attract Fortune 500 businesses.

Continental Express was created to broaden the services Continental offered. Customers that flew to large hubs through Continental Express were more likely to fly Continentals regular service.

Customers were able to fly Continental to more international locations than any other U.S. commercial airline.

Short-term: To add three new domestic destinations to Continental’s regular service each year for the next three years.

Short-term: To add 10 new cities to Continental Express within 3 years.

Long-term: To increase the number of first class seats by 10% in 10 years.

Better e-commerce and internet capabilities than rivals

Continental has recognized the importance of e-commerce in reducing travel agent fees and staffing costs.

They increased e ticketing to 95% of their destinations in 2000.

54% of their total sales in 2000 came from e-ticket sales, a total of $5.8 billion.

They also introduced www.orbitz.com in conjunction with American, United, Delta, and Northwest. The website offers consumers travel tips and helps them to book flights, rental cars, lodging etc.

Short-term: To increase the percentage of total sales from e-ticketing by 10% in 2 years.

Short-term: To increase the number of independent websites that are allowed to book Continental flights by 5% in 3 years.

Long-term: Increase e ticketing to 99% of their destinations in 8 years.

Superior on-time delivery

Continental was ranked last in 1993 and 1994 in on-time arrivals out of the 10 largest U.S. commercial airlines. The on-time arrival figure is the percentage of flights that arrive within the time they are scheduled.

Bethune recognized how important on-time arrival was to customer service and created a bonus program for all employees. The goal was to improve on-time performance and rank in the top three.

Instead of incurring the $5 million dollars in costs associated with customers missing their connecting flights, Bethune decided to give approximately half that amount to employees in the form of a one-time bonus. ($2.5m / 40,000 employees ( $65.00)

The results:

Ranking Month/year % on-time

Jan 1995 61%

10th Jan 1995 71%

4th Feb 1995 80%

1st Mar 1995 83%

1st Apr 1995

2nd Aug 1995

2nd Sep 1995

3rd Oct 1995

4th Nov 1995

1st Dec 1995

In January of 1996 the bonus amount was raised to $100 and Bethune paid employees the new amount for December 1995 because of high results for that month.

In 2000, bonus checks were paid for 11 out of the 12 months totaling $39 million. Between 1995-2000 a total of $157 million was given to employees in on-time bonuses.

For the first 8 months of 2000, the average was 77.7% for on-time arrivals.

For the first 8 months of 2001, the average was 80.9% for on-time arrivals.

Routes were revised in order to prevent delays on connecting flights. At airports like Newark where 15-30 min delays were common, planes flew to that airport and back rather than through to another destination. This way if one plane was delayed it did not affect other flights.

Short term: On-time arrivals to 84% within 2 years.

Short term: Remain in the top 3 companies in terms of on-time arrivals for 18 consecutive months.

Long-term: On-time arrivals to 87% in 10 years.

Stronger brand name than rivals

Continental had a poor brand name before Bethune.

Employees were ashamed of their place of employment and took off clothing with company logos on it before leaving work.

Continental had a bad record of poor performance, poor customer service, and high complaints. Rivals were much stronger in these areas.

When Bethune took over, the steps he took improved Continental’s image. He changed the climate of the organization and improved performance and service levels.

One of the earliest moves he made (repainting the planes by July 1995) was very symbolic. The uniform fleet of planes showed all stakeholders that Continental was on the path of change.

The awards and recognition that the company has received improve the Continental name.

Short-term: To be named the “Most Admired Airline” by Fortune magazine within 3 years.

Long-term: To receive the Air Transport World, “Airline of the Year Award” for 7 years out of the next 10.

Superior customer service

In 1994, Continental’s percentage of passengers involuntarily denied boarding because of problems, including overbooking, was one of the worst in the industry.

Continental had the highest number of mishandled baggage reports per 1,000 passengers.

Continental’s percentage of on-time arrivals gave it a last place ranking out of the 10 largest commercial airlines.

Employees were so ashamed of working at Continental that they took their patches off when not at work for fear irate customers might approach them.

Bethune introduced employee incentives for on-time arrivals, noting that on-time arrivals were crucial to improving customer service. He also monitored baggage handling to ensure that all parts of the system were working.

Bethune said that good service meant flying customers to where they want to go. He focused on removing destinations with low traffic and adding additional destinations and/or flight to high traffic destinations.

He redesigned routes to improve on-time performance.

He had surveys conducted of consumer preferences, catering to passenger’s specific needs.

Overhead bins were redesigned to accommodate business passenger’s carry-on luggage.

He put the OnePass frequent flyer program back into effect because customers enjoyed its features.

Around the year 1999, Continental received recognition for ranking in the top 3 airlines in fewest number of baggage complaints for 30 out of 31 months.

Short-term: Reduce the number of passengers involuntarily denied boarding by 10% in 3 years.

Short-term: To reduce the percentage of mishandled baggage by 5% in 3 years.

Short-term: Increase the benefits of the frequent flyer program by 5% in 2 years.

Long-term: To increase customer service incentives for employees by 15% within 5 to 10 years.

Long-term: Rank number one in major commercial airlines for having the fewest number of baggage complaints within 5 to 10 years.

Stronger global distribution than rivals

In 1994, Continental was operating on a global scale. However, many of its flights were unprofitable.

When Bethune took over, he began expanding into the international markets that looked promising and cutting flights to those that were causing losses.

Between 1995-2000, Continental added more destinations from hub locations and additional flights to destinations already served.

The expansion was done quickly.

Flights were added to South America, Mexico, Rome, Milan, Honk Kong, Tel Aviv, Tokyo, Guam, Caribbean, Central America, and many other European cities.

Continental served most of these countries through hubs located in the U.S.

In 2000, Continental was operating 2000 flights to 90 international destinations and 130 domestic.

In 2000, Continental had more international flights than any of its rivals.

Continental was planning to take advantage of TWA's decision to discontinue flights from New York to the Middle East and Europe.

Because of TWA’s decision, Continental planned to expand to 30 more cities in Europe within 3-5 years, and look into expanding in the Middle East.

Short-term: Continue international expansion. Add flights to fifteen new foreign cities within 2 years.

Short-term: To continue having more international flights than any other rival for the next three years.

Long-term: Add three new hubs in International markets within 10 years.

Industry leader in technology

Before Bethune, there was no mention of technology.

Bethune looked for ways to use technology to make information more readily available in order to facilitate effective decision-making. He wanted information that was reliable and trustworthy.

Larry Kellner created a financial system that generated a daily report with updated profit figures for various flights, fuel costs, maintenance costs, etc. This report was circulated to all top executives.

The report was improved over time as technology increased. It helped Continental with its decision to expand more in Europe. The report showed that Continental’s flights to Europe were generating higher than normal profits.

Continental purchased new planes in an effort to bring down the average age of its fleet. The new planes with their updated systems required less maintenance and had less mechanical problems.

In 1997, LED boards were placed in high employee traffic locations and break rooms to provide employees with up to the minute information about the company’s stock, it’s competitors, weather reports and other news.

Continental also expanded its e-commerce operations and received $5.8 billion in sales through e ticketing.

Toll-free voice mail numbers were put in place so employees were able to communicate directly with the CEO, get answers to their technical problems or concerns and make changes to their benefit packages.

Short-term: Spend 5% more on researching new information systems within 3 years.

Long-term: Reduce the amount of time it takes to produce financial results by 15% in 10 years.

Industry leader in product or service innovation

Bethune stressed the importance of adding costs only when the costs added greater perceived value to the product in the eyes of customers.

In trying to meet the needs of its business customers, Continental installed larger overhead bins in 2000 to accommodate a greater amount of carry-on luggage. It cost the company $12 million dollars to install these new bins.

Continental’s rivals were using templates to restrict the size of carry-on luggage.

Continental also listened to customer’s requests for new services or changes to existing services. Surveys of customer preferences led to:

· Coke being served instead of Pepsi

· More beer variety

· First-class priority with baggage handling

· Improved meals (tested by Bethune)

· Music while customers boarded

· In flight phones

When travel agents told Bethune that business customers needed additional flights to certain locations, Bethune listened to their advice and added the flights.

Short-term: Send out 5% more surveys within the next 3 years.

Short-term: Increase the number of employees focused solely on innovation by 5% in 2 years.

Long-term: Increase the number of services offered to customers by 10% in 10 years.

Wider geographic coverage than rivals

In 2000, Continental had over 2000 flights with over 130 domestic locations and 90 international.

Continental served more international destinations than its rivals.

Continental has plans to take advantage of high profitability on flights to Europe by increasing the number of international destinations.

In 2000, Continental Express had over 1000 flights to 70 U.S cities, 10 Mexican cities, and 5 Canadian cities.

Continental Express is a subsidiary of Continental offering regional service. It provides frequent and economical service to small cities and transports passengers to Continental’s hubs where they can use Continental’s regular service to get to their destinations. Continental Express led to improved load factors on Continental’s normal flights.

Short-term: Increase the number of Continental and Continental Express flights by 10% within the next three years.

Long-term: Increase the number of planes the company has to fly those flights by 7% within 10 years.

Higher levels of customer satisfaction than rivals

In 1994, in operating performance and customer satisfaction, Continental ranked last compared to 10 major U.S. commercial airlines.

Customer complaints to the Department of Transportation regarding Continental were 30% greater than the 9th ranking airline and 3 times the industry average.

Highest number of complaints per 100,000 passengers.

Flight attendants avoided booking travelers on Continental because they did not want to lose their customers.

Bethune tackled these problems by apologizing to customers for past mistakes and promising to improve service.

He focused on fixing problems with employees first in order to get them to treat customers better.

In 2001, J.D. Power and Associates recognized the airline as being the “Top in Customer Satisfaction” for four out of five years.

In a study done by the Aviation Institute at the University of Nebraska at Omaha and Wichita State University titled “Air Quality Rating 2001,” Continental dropped from 2nd place the prior year to 7th place out of the top 10 ten U.S. airlines because of poor ratings on mishandling bags and bumping passengers.

Continental bumped an average of 18 passengers out of 100,000 (it was 3.4 the year before) and mishandled and average of 535 bags per 100,000 passengers (the number was 442 the prior year).

Short-term: Rank within the top three major commercial airlines in terms of the percentage of customer complaints as measured by the Department of Transportation.

Short-term: Rank within the top three in terms of customer satisfaction within 2 years.

Short-term: Increase the monetary incentives for flight attendants to book passengers on Continental flights by 5% in 2 years.

Long-term: Reduce the number of bumped passengers to 2% in the next 5 to 10 years.

Financial objectives

Criteria

Facts

What does it mean?

(How much of what kind of performance by when?)

Revenue growth

Operating revenues have steadily increased in every year except for 1994.

Year Revenues Change % Growth

2000 $9,899 $1260.00 14.585%

1999 $8,639 $712.00 8.982%

1998 $7,927 $733.00 10.189%

1997 $7,194 $847.00 13.345%

1996 $6,347 $522.00 8.961%

1995 $5,825 $155.00 2.734%

1994 $5,670 $-97.00 -1.682%

1993 $5,767

(in billions)

The greatest jump in revenues occurred between 1999 and 2000.

From 1993-2000, revenues increased by 71%.

Short-term: To increase the percentage of growth by 6% in 3 years.

Long-term: Achieve an average of 18% revenue growth over the next 10 years.

Earnings growth

Year Earnings Change % Growth

2000 $342 $-113 -24.835%

1999 $455 $72 18.799%

1998 $383 $-2 -.519%

1997 $385 $66 20.690%

1996 $319 $95 42.411%

1995 $224 $837 136.542%

1994 $-613 $-574 -1471.795%

1993 $-39

(in millions)

From 1985 to 1994, there were no earnings.

In 1995, the earnings became positive. They have stayed positive since then and have fluctuated yearly. The biggest positive increase occurred between 1994 and 1995.

Bethune’s leadership helped the company to increase each year. The biggest increases occurred after his initiatives were introduced.

In the first quarter of 2001, earnings were $9 million in the second quarter they were $42 million. In the prior year, these two quarters generated $149 million in earnings.

The fluctuations in earnings are due in part to downturns in the national and global economies.

Short-term: Increase earnings by 20% in 2 years.

Long-term: Increase earnings by 50% in 8 years.

Higher dividends

Between the years of 1993 and 2000 no dividends were paid.

The diluted earnings per share were as follows:

2000 $5.45

1999 $6.20

1998 $5.02

1997 $4.99

1996 $4.17

1995 $3.37

1994 $(11.88)

1993 $(1.17)

Some rivals in the industry pay dividends.

Short-term: Raise the diluted earnings per share by 5% in 3 years.

Long-term: Raise the diluted earnings per share by 15% in 10 years.

Long-term: Pay a 1% dividend within 5 to 10 years.

Wider profit margin

Year Revenue Costs Net Inc. Margin

2000 $9,899 $9,215 $342 3.455%

1999 $8,639 $8,039 $455 5.267%

1998 $7,927 $7,226 $383 4.832%

1997 $7,194 $6,478 $385 5.352%

1996 $6,347 $5,822 $319 5.026%

1995 $5,825 $5,440 $224 3.845%

1994 $5,670 $5,681 $-613 -10.811%

1993 $5,767 $5,786 $-39 -.676%

(in billions)

Net Earnings/Revenue = Profit Margin

Between the years of 1985 and 1994, Continental reported net losses. Despite years of costs cutting attempts by prior management the company did not operate profitably until 1995. Between 1994 and 1997 the profit margin rose every year. In September of 2001, Continental and Continental Express had 25 consecutive quarters of profitability.

Many of the other airlines were operating profitably between 1985-1994.

In 1994:

At least 18% of Continental’s routes were not profitable.

Continental Lite- A “low fare/no frills” program had very high costs and low revenues. One third of Continental Lite’s routes were generating 70% of Continental’s loses.

The maintenance department had the highest costs in the industry with the lowest dispatch reliability.

Continental was spending $5 million a month because of it’s problems related to on-time arrivals. When passengers missed their connecting planes because of delays the company had to provide housing, food etc. Passengers were also occasionally booked on the flights of Continental’s rivals.

1994-2001:

When Bethune became CEO in late 1994, he applied the “Row 5 test.” Costs were only increased if they added value to customers.

He focused on making sure only profitable routes were served.

Older less efficient aircraft that required special training to service were replaced with new aircraft. This, combined with the reduction in the number of types of planes, helped to lower maintenance costs. Large planes flying at 50-60% capacity were no longer used. The smaller planes that replaced them meant less excess set capacity. Revenues were retained, costs were decreased, and profit margins swelled.

Larry Kellner created a program to hedge jet-fuel purchases that saved the company $3 million when the price of jet-fuel increased.

Code-sharing increased profit margins. Two companies listed the flight and one airline provided the plane and crew. This increased revenues, reduced costs led to higher load factors. The companies also worked together at certain destinations by providing the ground crew for each other’s flights when it did not make sense financially to have ground crews for both companies at every airport. Continental had code-sharing agreements with Northwest, Air Canada, America West, American Eagle, Horizon Airlines, Alitalia, Air France Virgin Airways, Air China, and KLM Royal Dutch Airlines.

Short-term: Raise profit margin to 5% within 3 years.

Short-term: Increase percentage of sales from code-sharing agreements by 5% within 2 years.

Long-term: Raise profit margin to 7% within 8 years.

Long-term: Increase load factors by 15% in 8 years.

Long-term: Reduce the number of flights with a profit margin less than 1% by 20% within 10 years.

EVA performance

EVA = Operating Profit – Income taxes – Cost of Debt – Equity Cost.

The cost of equity is not known from the case.

EVA is the amount by which shareholders wealth increased over what they would have received if they put their money into another investment at the same risk level.

Short-term: Increase EVA by 5% within 3 years.

Long-term: Increase EVA by 10% in 10 years.

MVA performance

MVA = Current Stock Price * Number of shares outstanding – Shareholders equity investment

The current stock price is not known from the case.

MVA is how much shareholder value has increased as a result of the company’s actions.

Short-term: Increase MVA by 5% within 3 years.

Long-term: Increase MVA by 12% in 7 years.

Strong bond and credit ratings

Continental emerged from Chapter 11 bankruptcy protection in 1993 and in 1994 it still had 2 billion in debt to pay off.

Continental was highly leveraged and did not have many unencumbered assets to use as collateral on future loans.

On September 30, 2001, it was determined that Continental had a little over $1 billion in unencumbered assets to use as collateral.

Because of liquidity problem in 2001 and its financial record, they are not the most attractive company to loan funds to.

Debt to equity ratios:

2001 2000

8564 = 6.840 8041 = 6.932

1252 1160

The higher the ratio the more a company has been financing its future with debt.

This can be a sign of trouble because Continental will have large interest payments in the future.

In 2001, they were able to take delivery of 14 new aircraft from Boeing.

Continental had roughly $1.3 billion in financing from Boeing for future aircraft on June 30, 2001.

Short-term: Lower debt to equity ratio by 8% in 2 years.

Long-term: Have a 2-1 debt to equity ratio within 10 years.

Recognition as a blue-chip company

Continental has won numerous awards but no mention is made of blue-chip recognition.

Awards include:

1996 and Jan 2001- Airline of the year, Air Transport World. First airline to receive award twice in five-year period.

2001- Best Trans-Atlantic Airline, Best Airline Based in North America, Best frequent Flyer Program, OAG Pocket Flight Guides

Tops in Customer Satisfaction four out of five years, by J.D. Power and Associates.

2000 and 2001- Second most-admired U.S. airline, Fortune.

June 2001- “Highest rating for outstanding management,” Aviation Week & Space Technology.

Short-term: Receive the most-admired U.S. airline award from Fortune magazine within 3 years.

Long-term: Receive the award for Tops in Customer Satisfaction by J.D. Power and Associates for 9 out of the next 10 years.

More diversified revenue base

Continental has diversified its revenue base both domestically and internationally.

New flights were added to existing destinations when it was profitable to do so and new destinations were added to Continental flights based on customer needs.

Continental Express was created as regional service. It grew by 30% annually and has led to increased revenue for Continental’s regular service by feeding Continental’s hubs with passengers.

Not all competitors operate internationally or offer service for short distances.

Short-term: Continue to have a 30% growth rate with Continental Express for the next 3 years.

Long-term: Expand the number of Continental Express destinations by 25% in 10 years.

Stable earnings during recessions

Bethune was able to maintain profit margins even though the economy was entering a recession in the late 1990s.

Earnings dipped between 1999 and 2000 but the company still showed a net income of 342 million. This is due in part to increases in the number of profitable routes that Continental was flying.

Continental focused on gaining market share by catering to the needs of its customers better than competitors.

In 2001, Continental and Southwest were the only two major commercial airlines to show a profit for the first two quarters of the year.

Short-term: Reduce costs during times of recession by 5% within 1 year.

Long-term: Increase market share by 10% within 8 years.

Long-term: Increase the number of routes with a profit margin above 8% by 20% within 10 years.

Higher ROA

Net Income/Total Assets

In 2000:

342 / 9,201 = 3.71%

In 2000, Continental was able to generate 342 million in earnings from its investment (assets).

We do not have balance sheets for rivals.

Short-term: Increase ROA to 4% within 2 years.

Long-term: Increase ROA to 9% within 15 years.

Higher ROE

Net Income/Shareholders Equity

In 2000:

342 / 1,160 = 29.48%

We do not have balance sheets or income statements for rivals to compare the profitability of firms in the industry.

Short-term: Maintain an ROE of 30% for 2 years.

Long-term: Improve ROE by 10% within 5 to 10 years.

Higher cash flow

Continental has had a history of cash flow problems. It emerged from its second bankruptcy in 1993 with $2 billion in debt and comparatively low revenues.

The company’s liquidity has come into question many times over the years. When revenues drop as demand periodically slackens, the company has had trouble paying its interest payments and accepting new aircraft orders. For example, in 2001, Continental was considering a third bankruptcy because of a drop in revenues and debt payments coming due. The government provided relief for the airlines, which helped Continental make it’s payments.

Although the industry has many firms with cash flow problems as a result of high debt, some firms have managed to keep large cash reserves.

Continental had $1,201 million in cash and cash equivalents on hand on September 30, 2001.

Continental had $1,371 million in cash and cash equivalents on hand on September 30, 2000.

Current Ratio:

Current Assets / Current Liabilities =

2001:

2,252 / 3,084 = .73022

2000:

2,459 / 2,980 = .82516

Short-term: To increase the amount of cash on hand by 10% in 3 years.

Short-term: Increase current ratio by 10% in 3 years.

Long-term: To increase current ratio by 20% within 10 years.

Financial ratios superior to rivals

Net working capital ratio:

Net working capital / total assets = net working capital ratio

2001:

2,252 – 3,084 / 9,816 = -.08476

2000:

2,459 – 2,980 / 9,201 = -.05662

Without balance sheets for competitors these numbers cannot be compared to other companies in the industry.

Short-term: Improve net working capital ratio by 4% in 3 years.

Long-term: Improve net working capital ratio by 8% in 10 years.

IV. External factors

Chapter 3 Worksheet

Macro-environment forces

Criteria

Facts

What does this mean?

The economy at large

The economy is changing throughout the time frame of the case. When the case began, the economy at large was picking up. However, it was still partly recovering from a recession that occurred in the early 90’s.

Between 1995 and 1998, the economy was in a period of rapid growth. New businesses were opening at an incredible rate and there was heavy investment in the stock market. Investors were profiting from high returns on most stocks.

In 1999, the economy was beginning to enter into a recession. The unemployment rate began to rise. Some investors were losing confidence in the stock market because of the burst of the dot-com bubble. People were spending less of their income on leisure.

The economy at large was an opportunity for the industry between 1995 and 1998. During this time period, the airline industry had the potential to increase revenues.

In 1999, the economy was entering a recession. A recession is a threat to the airline industry. In a recession, there is less demand for air travel. Competition increases and profits are decreased.

Legislative, regulatory and political environments

The airline industry began deregulation in 1978. The goal was to increase competition in the industry to the point where passengers are able to benefit from lower fares and greater service.

Airlines frequently try to lower their own costs and raise their revenues by joining with other airlines in code-sharing agreements. These alliances occasionally involve the purchase of stock of one airline by a competing airline, thus giving voting control to the competing airline. When the U.S. Department of Justice believes that these actions reduce competition in the industry, it uses the Clayton Act and the Sherman Act to put an end to these alliances.

After September 11, 2001, many new security measures became mandatory. The FAA increased regulations concerning baggage handling, the screening of employees directly involved with the flight, passenger screening, cockpit security etc. The regulations not only increased costs but also increased the amount of time it takes for airlines to move passengers through the system.

The attacks of September 11 also had political ramifications.

The United States had to maintain relationships with the rest of the world while trying to find a way to prevent terrorist attacks.

Many countries have reduced some of the barriers to entry for firms operating outside of the country. Companies can now enter these countries more easily and compete with domestic companies for market share.

Deregulation is a threat to the industry. After deregulation, competition was fierce. The battle for market share drove profits down.

Anti-trust legislation is a threat to the industry. Airlines that are not able to earn enough revenues on their own cannot join with other companies when it reduces competition in the industry. Code-sharing agreements are allowed, but only to a certain extent.

New security measures are a threat to the industry. They add to the costs of the airlines and increase the time it takes for passengers to move through the system. The longer process is a hassle for customers and reduces the number of passengers willing to fly. While this was a strong factor immediately after September 11, it has become less of an issue as time passes.

The political environment is a threat to the industry. The attacks of September 11 caused many political disturbances throughout the world. U.S. citizens are now treated differently in many countries as a result of the attacks and the countries response to them.

Relationships with oil producing countries have been affected. This is a threat to the industry. The cost of jet-fuel increases when these relationships are damaged. The profit margins are so low in the industry already that a significant rise in the cost of jet-fuel sometimes causes airlines to file for bankruptcy.

Falling barriers are an opportunity for this industry. Markets that were once limited to domestic companies are now open to international firms.

Population demographics

The United States population has been changing in many ways over the last 15 to 20 years.

Although there continues to be a difference between the mean annual income of men and women, there is an increasing amount of women involved in all levels of organizations.

The education level has steadily increased. The percentages of people graduating from high schools, colleges, and graduate programs have all risen.

People have always been attracted to cities, but because of the high cost of living many have chosen to live further from cities and either commute or work from home.

The average life expectancy has risen.

Many baby-boomers are nearing retirement and some have already retired. This group is a relatively large portion of the U.S. population.

Household size is decreasing. The number of single-parent homes is going up. The number of families with both parents working is increasing.

Grandparents and other relatives raise more children than ever before.

Most people work in the service industry. The number of professionals has risen. The number of low paying manufacturing jobs has decreased.

More people are working longer before having children.

The U.S. population is much more diverse than it was 20 years ago. The number of African Americans, Hispanics, and Asians is increasing.

The airline industry is a global industry. The demographics in each country are very diverse and companies need to understand their differences in order to compete with other global and domestic companies.

Most professionals work in and around cities. They prefer greater comfort, convenience, and quality. Professionals also buy more products that convey a certain status position.

Most individuals and families in the average income range and up will pay for products that are safer and have fewer health consequences.

An increased number of women working at higher paying positions is an opportunity for the airline industry. This group will be more likely to use air transportation.

The rising education level of the population in general leads to increased income and a greater probability that flying will be used as a means of travel. This is an opportunity, as well.

Education also increases people’s curiosity. They will more likely to want to venture into the world and explore other countries and cultures.

People living far outside cities or videoconferencing still usually need to commute to work periodically. Low priced regional air service is one of their options. This is an opportunity.

The greater number of retired individuals is an opportunity. They often have the time and the money to travel.

The rise in single parent households is a threat to the airline industry. These families typically have less discretionary income and are less likely to use air transportation.

The rise in the number of professionals is an opportunity. This group is more willing to pay for greater comfort and service.

High unemployment rates are a threat. Not only do the unemployed have less income to spend on leisure, but they will also be less likely to travel on business.

The number of people working longer is an opportunity. This group tends to have a higher amount of discretionary income.

Societal values and lifestyles

Ethnographics and psychographics provide the following categories: personality, values, and lifestyle.

As a result of the education level rising and increases in technology, people have learned more about other cultures. Their curiosity has led to increases in global air transportation.

An increasing number of Americans are traveling overseas because the organizations they work for have international operations.

Exotic vacations and safaris are much more common.

After the attacks of September 11, many consumers were afraid to fly. As time passed, gradually the numbers of airline passengers began to rise.

The lifestyle of many U.S. citizens is very fast paced. People want to get where they are going quickly and with a limited amount of hassle. People often pay the additional cost of an airline ticket rather than waste valuable time on a long bus or train ride.

Immigrants now frequently travel back to their home country in order to maintain relationships with their relatives and stay reminded of where they are from.

Technology and education has increased the amount of information people have about other societies. Globalization is helping to merge world culture. This is an opportunity for the airline industry. People want to observe other parts of the world first hand and learn about differences.

With an increasing number of companies with overseas operations, the lifestyles of many people have changed. Employees spend a greater percentage of time working overseas and require transportation from their home country to their host country. This is an opportunity for the airline industry.

A fast paced lifestyle is an opportunity as well. People value their time and are willing to spend money to decrease the amount of time it takes to get to their destinations.

In general, people are now more likely to consider traveling by air for short and long distances and that is an opportunity for the industry.

Technology

Technology is changing the way passengers’ book flights. It is now much easier to book an entire trip from the comfort of your own home. The entire process takes a matter of minutes. E-ticketing and online travel agencies allow customers to completely customize much of their travel experience.

Technology has also improved scheduling systems allowing people to find out whether or not a flight is on time by phone or computer.

New technology installed at airports and on planes has improved security.

Technology improvements have been made in aircraft systems and maintenance equipment and procedures.

Computer systems have improved information processing and communication within organizations. For example, intranets have made it possible for all employees to receive up to the minute information.

Technology has also led to an explosion of portable devices designed to store and transmit information. It is no longer necessary to meet face to face for many business transactions. Telecommuting is very popular in some organizations.

Video conferencing has enabled people in countries around the world to see each other while they are speaking. This has reduced the need for travel. People can attend meetings in the comfort of their own home. They can instantly send documents via email or by fax almost as easily as passing it to the person next to them at a board meeting.

Technology is a double-edged sword. It has drastically improved the ticketing process. Now it is quick and easy to purchase tickets online without leaving your home. This has reduced costs for both consumers and airlines. This is an opportunity for the industry.

Technology that leads to reduction in other costs is also an opportunity for the industry.

On the other hand, e-commerce technology has also made it possible for consumers to instantly compare different flights and make an educated decision. This is a threat to the industry. Customers can base their decision on up to the minute information.

Much of the new technology that improves communication over long distances is also a threat to the industry. People no longer need to meet in person to exchange thoughts and ideas. It used to be that phones were impersonal because you were not able to see the person. Now technology has made it possible for a board meeting to be held in one country while a board member from around the globe can interact and view each others facial expressions. Having all the board members travel to one location is no longer always necessary.

1. What are the Industry's dominant economic features?

Criteria

Facts

What does this mean?

Market size

The total commercial airline revenue in 2000 was $98.1 billion.

The scheduled revenue passenger miles were $651.8 billion.

The industry had a total operating profit of $5.50 billion.

The market size was increased as a result of competitors reducing ticket prices to compete with each other. The lower ticket prices brought in a lower amount of revenue per ticket, but a much greater number of passengers that were willing and able to purchase tickets. This larger number of customers led to an increased market size.

After September 11, the market size was reduced. Many people chose other methods of transportation that were believed to be safer or simply did not travel. The market size has slowly rebounded.

The market in 2000 was very large. A large market is an opportunity for existing firms but it also increases the threat of new entry.

Large markets cause attention from companies that might want to enter the industry.

Scope of the competitive rivalry

(The competitive scope criteria addresses geographic scope (Global, National, Regional, Local), product scope, market scope and so on.)

Most of the large airlines in the industry operate globally while smaller airlines provide regional or national service.

However, a few large competitors have yet to expand internationally.

The product scope is in the middle of narrow and broad. Rivals are constantly looking for small changes to the product that customers will view as valuable.

Rivalry is very high in U.S. markets. There are fewer competitors in many international markets and U.S. companies are trying to gain market share in these countries to gain first-mover advantages.

The market for travel is international and the wealthiest nations have the largest markets. Because air travel is relatively expensive, in some countries only a small portion of the population can afford to fly.

The scope of the competitive rivalry is a threat to the industry. Rivals are operating in many of the same markets around the world. Intense rivalry limits the ability for companies to find profitable markets.

Rivals have made many attempts at differentiating their product but competitors can easily imitate these changes because many large airlines have similar capabilities.

Rivals will resort to price cuts and other competitive actions to keep competitors out of the markets they are serving.

The threat to competitors is building in international markets as well. Rivals monitor the moves of their competitors and quickly enter markets that other rivals have had a success operating in.

Market growth rate and position in the business cycle (development, growth, maturity, decline)

Commercial Airline Revenue Growth 1995-2000. (Revenue in billions)

Year Revenue Growth Rate

2000 $98.1 9.487%

1999 $89.6 5.910%

1998 $84.6 1.317%

1997 $83.5 6.369%

1996 $78.5 6.803%

1995 $73.5

The market is in the maturity position in the business cycle.

Airlines attempt to improve profits by cutting costs and maintaining or increasing market share.

Most companies try to differentiate the product as much as possible and some companies are focusing on improving processes.

The market is growing at an average rate of approximately 6% each year. In the months following September 11, this growth rate fell, but it has slowly recovered.

After September 11, demand fell and rivals competed for sales from a smaller number of buyers.

The market growth rate is a threat to the industry. With a slow rate of growth and a maturity position in the business cycle the airline industry is not attractive.

Competition among rivals is very intense in this industry.

Number of rivals and their relative size

(Relative size refers to each rival’s market share based on total sales for the overall market or, when applicable, individual market segments.)

Ten major rivals and their relative sizes based on operating revenues in 2000.

Airline Revenue % of market

United $19,331.3 19.705%

American $18,117.1 18.468%

Delta $15,320.9 15.618%

Northwest $10,956.6 11.169%

Continental $9,449.2 9.632%

US airways $9,181.2 9.359%

Southwest $5,649.6 5.759%

TWA $3,584.6 3.654%

America West $2,309.3 2.354%

Alaska $1,762.6 1.7968%

There are many other large competitors in the airline industry. Some operating in only their home countries and others internationally.

A large number of major rivals is a threat to competitors. Many competitors have similar capabilities and have to battle for market share. This market is close to pure competition. Market share is not held by a single rival or a select few.

With a large number of major rivals the threat of new entry is decreased. In order to compete with the major companies already in the industry, a significant investment is needed.

Number of buyers and their relative size

(Address the number of buyers in each market and market segment. Buyer size refers to the buyer’s volume of sales for the industry.)

There are over 554,000,000 buyers in the industry. Buyers are very small in size, usually individuals. Each buyer contributes an extremely small amount to total industry sales.

Businesses also buy tickets, but not in quantities large enough for them to have power in the industry.

There are a large number of both business travelers and flip-flop customers.

An industry with a large number of small buyers is an opportunity. Small buyers lack the power that large buyers have. The fact that there are many individual buyers makes losing a single buyer less of a concern.

Extent of rivals’ vertical integration (How far forward or backwards have the rivals extended their value chain?)

Rivals have done a small amount of vertical integration.

Some airlines have extended their value chain forward by partnering with other airlines in developing online services that offer customers discounted prices on airline tickets as well as car rentals, hotels, and tourist attractions. This reduces the need for travel agencies that erode profits.

Vertical integration is an opportunity for companies in this industry. While some areas are expensive to integrate into, such as airplane manufacturing or oil refinery, airlines can gain a cost savings by integrating backward into activities such as food preparation. Companies that are successful at vertical integration will develop a cost advantage over other rivals and increase the capital requirements needed to enter the market.

Offering other services to customers, in addition to air travel via the internet, is also an opportunity for this industry.

The extent of rivals’ vertical integration is not a threat in this industry.

Extent of rivals’ horizontal integration

(Horizontal integration applies to using the synergies in your value chain to produce different products or provide services for a different industry or market segment.)

Rivals have integrated horizontally by offering different services for different market segments.

Some major companies offering international and national service have regional services catering to passengers that need a quick flight from city to city. These flights are often scheduled frequently and have a short duration. Regional services often use smaller planes, keeping profits up. Not only are these regional divisions usually profitable, but they also feed passengers to hub locations where they can book flights on the companies regular service.

Some competitors agree to carry postal mail packages on their passenger jets to gain added revenue.

Horizontal integration is an opportunity for airlines to use the synergies in their value chains to cater to different market segments.

The extent of rivals’ horizontal integration is not a threat in this industry.

Types of distribution channels rivals use to access customers. (Do the channel types vary by customer segment?)

The airline industry receives its passengers through the gate system. All customers wait at the gate and are called to board when the plane is ready.

Rivals pay for the gates and have control over the amenities that are offered at them.

All major airlines use a gate system for boarding. This is neither an opportunity nor a threat for the airline industry.

Pace of technological innovation in production process innovation

Technological innovation is occurring at a fast pace.

The airline industry uses a large number of computers in its operations. Computers are used in the maintenance of aircraft, scheduling, information systems, automated phone systems, flight navigation, air traffic control, etc.

As the power of the computer increases and new programs are written and improved, the time and cost of many company operations can be decreased. New ways of accomplishing traditional tasks are frequently introduced. Improvements can lead to a higher quality product as perceived by consumers.

The pace of technological innovation in the production process is a threat to the industry. Technological changes increase the capital requirements for airlines to remain competitive.

There is a greater amount of risk for new entrants. Not only do they have to purchase the technology initially, but they will also need to make upgrades to keep up with the industry.

Pace of technological innovation in product introduction

Technological innovation in product introduction is not a factor.

Manufactures of aircraft are responsible for the improvements made to the aircraft.

Boeing and Airbus produce new types of planes with additional service features, increased safety, and greater comfort.

The pace of technological innovation in product introduction is neither a threat nor an opportunity in this industry.

Extent to which the rivals differentiate their products and/or services

Rivals have attempted to differentiate their services in a number of ways. Many companies are constantly adapting services to cater to the specific needs of the customers they are targeting.

Some of the ways competitors have tried to differentiae their product is by:

· Flying customers to exactly where they want to go (Providing a sufficient number of flights to the right destinations at the right times)

· Offering customers greater convenience when scheduling flights by providing online booking services

· Priority baggage handling

· First-class seating

· No frills flights at a reduced cost

· Higher quality service (Higher on-time arrival percentage, lower number of mishandled bags, courteous flight attendants and pilots, etc.)

· Increased carry-on luggage capacity

· One stop shopping services for all your travel needs

· A wide variety of incentives for business customers including frequent flyer miles and discounted flights

· Higher quality food and on-board entertainment

· More comfortable seating

· Gate amenities

· Price

· Improved information services for customers including automated flight information

· Improved parking facilities at a lower cost to customers

Rivals have an opportunity to differentiate their products to increase market share. Companies that have succeeded in this area are a threat to the rest of the industry.

Airlines are continuously making changes to their services to gain an advantage over rivals. Surveys are frequently conducted to identify what specific un-met needs customers have. When an airline meets the needs of customers in a way superior to the airlines rivals, they will likely increase their profit.

A differentiated product reduces a buyer’s power. A buyer will not always be able to fill the same number of needs with a competitor’s product.

Extent to which rivals use economies of scale in:

· Purchasing

· Manufacturing

· Services

· Transportation (logistics)

· Marketing

· Advertising

· General and Administration

· Other steps in the value chain

Rivals use economies of scale in purchasing by ordering large quantities of spare parts, food, maintenance equipment, fuel, and aircraft. Large companies can often negotiate lower costs on these items.

Rivals gain economies of scale by using hub locations to service their aircraft rather than having a large staff at all airports.

Large competitors can achieve economies of scale in advertising because any mention of the company’s name helps to advertise all of the company’s products. A simple advertisement for one destination helps to put the name of the company into the mind of consumers.

Economies of scale exist in a human resource department when the entire department operates as a cohesive unit and services a large company. Procedures can be standardized with forms drawn up in advance. Automated systems can speed up the process of benefit selection and inquiries.

The fixed costs of new technology, research and design, and general administration can be spread out over a wider number of ticket sales in larger companies.

Economies of scale are a threat to this industry. While rivals are able to gain economies of scale in some activities, they are not a significant force in all industry operations.

Rivals with economies of scale have an advantage over other rivals. They can lower ticket prices to levels lower than competitors and still remain profitable. These rivals require a lower number of passengers to break even.

Extent to which the key industry participants are clustered in one geographic location

Key industry participants have operations across the U.S. and in many major foreign cities.

Rivals often use a hub system where they can base their maintenance and administrative operations to serve a particular region or country. These hubs are often clustered in major urban centers.

The largest companies compete in every major city or travel destination.

The fact that industry participants are not located in one geographic location is a threat to the industry. With most major markets already being served there is limited room for expansion.

Customers have alternatives to chose from across the U.S. Rivalry is strong in almost all locations not just one region.

Extent to which certain industry activities result from learning and experience curve effects

The airline industry benefits from learning and experience curve effects in maintenance, flight scheduling, advertising, and daily operations.

Repairing aircraft and related equipment is a complicated process. When a new aircraft is introduced, it takes a while for the maintenance department to learn about the aircraft and diagnose problems. After a while the staff will become more familiar with common problems and the time it takes to fix these problems will be reduced.

Rivals that use a limited number of types of aircraft can benefit from learning effects. Mechanics working on the same types of aircraft frequently will become more familiar with each type of aircraft.

Companies schedule flights according to market data, past experience and competitors actions. In time, flight scheduling is improved as a company learns from its successes and failures.

Airlines also learn by trying different service modifications to see what works and what does not. This helps them to determine customer needs.

The learning and experience curve effects are a threat. The knowledge that is gained from past operations gives large competitors advantages when they redesign flight schedules and operations procedures.

Greater knowledge leads to lower costs and increased revenues. Experienced companies will have a better understanding of what flights to add to their schedule, how to efficiently handle maintenance problems, and how to effectively conduct daily operations.

Capacity surplus or shortage in the industry

(Capacity refers to the total manufacturing output capability for the industry. Capacity surplus would indicate that the industry has the capability to produce more products than the market demands.)

There is a capacity surplus in the airline industry as a whole. The industry is capable of carrying many more passengers than it is currently transporting.

The capacity varies from route to route. Some routes have very little capacity surplus while others have a shortage. Airlines adjust their flight schedules in response to changes in demand.

Major airlines usually have a capacity surplus because they have a limited number of planes with a set number of seats in each plane. These companies sometimes reduce their surplus by having smaller regional services feed their regular service. Smaller planes reduce capacity so that it matches the reduced demand.

The capacity surplus is a threat to the industry. In order to earn profits, companies need to cover the high costs of capital needed to operate in the industry. It is crucial for companies to fill as many empty seats as possible in order to earn enough revenues to show a profit on their flights.

Pressure on rivals to compete for passengers is very high. A capacity surplus reduces prices and profit margins.

Capital requirements and the ease of entry into or exit from the industry

Capital requirements make it very costly for a potential new entrant to enter into the airline industry.

The cost of purchasing the necessary equipment will run into the high millions. Leasing aircraft will still put a significant strain on the financial situation of the company.

Entering on even a regional level requires substantial cash outlays for planes, maintenance equipment, and advertising.

Exiting the industry is also very expensive. Liquidating the company’s assets is not easy. Aircraft become outdated as new technology is introduced. Finding buyers for old aircraft in this industry cannot be done quickly. Companies often continue to operate at a loss because of the high exiting costs.

Capital requirements are a threat to the industry. In most companies a large percentage of revenue goes to covering the lease payments on aircraft.

Capital requirements are also a threat because once a company purchases the necessary equipment it is not easy to liquidate it. An airplane is not a commodity; there are a limited number of potential buyers. Because companies tend to purchase new aircraft and the market is in the maturity stage, aircraft are often sold for far less than what was paid for them.

Industry profitability

(The annual net profit margin for the industry.)

The annual net profit margin for the industry is low. Competitors are always looking for ways to reduce costs or attract customers away from other airlines by offering travel incentives, improved service, more destinations or convenient flight times, greater comfort, etc.

The most profitable airlines are not making very large profits.

Competitors enter into code-sharing agreements to increase each other’s profitability.

The added cost of security measures after September 11, combined with the drop in revenues from fewer passengers has reduced profitability even further. However, the number of passengers has slowly increased since that time.

Low profit margins are a threat to this industry. When companies do not stay ahead of their rivals, their profit margin quickly begins to disappear.

In the airline industry, it is somewhat common for rivals to have liquidity problems from time to time and file for bankruptcy.

Companies in financial distress are often forced to reduce costs, which lowers the quality of service the airline provides. This helps to increase financial problems even more by reducing revenues.

Because of low industry profitability, rivalry is increased.

Degree of alliances

Alliances are becoming very common in the airline industry.

To increase profitability, airlines enter into code-sharing agreements. The agreements are usually designed so that one company provides the plane and staff, yet the flight is listed on both of the company’s flight listings. They also might share employee lounges and ground crew.

When one carrier does not provide a destination, it will negotiate an agreement with another carrier to transport its passengers the rest of the way.

When one airline does not have a ground crew in certain locations, it will team up with another airline and use their ground facilities.

Alliances are also made with online travel services that provide customers with easy ticketing and travel information.

Car rental companies, hotels, tourist attractions, and time-share properties form alliances with airlines to offer customers deals on packages.

The degree of alliances is a threat to this industry. The alliances are an opportunity for airlines to reduce their costs and increase revenues, but at the same time they increase rivalry.

Groups of competitors are formed by the alliances. These groups compete with each other for additional alliances. Airlines not involved in code-sharing agreements or other alliances are often less competitive.

2. What is competition like and how strong are each of the competitive forces?

Criteria

Facts

What does this mean?

(Does this make the force strong or weak for the industry?)

RIVALRY

How many competitors are there in this industry?

The case mentions 10 major competitors, American, Alaska, Continental, Delta, America West, Northwest, TWA, United, US Airways, and Southwest.

The case also mentions Air Canada, American Eagle, Horizon Airlines, Alitalia, Air France Virgin Airways, Air China, and KLM Royal Dutch Airlines.

There are a numerous number of other competitors in the industry, both domestically and internationally.

The large number of competitors in this industry is a very strong force, in terms of rivalry. Competition in this industry erodes profit margins and causes competitors to look for ways to steal market share away from rivals. The increased rivalry is a threat to the industry.

What is the relative size (market share based on their percentage of industry sales) of each competitor?

Ten major rivals and their relative sizes based on operating revenues in 2000.

Airline Revenue % of market

United $19,331.3 19.705%

American $18,117.1 18.468%

Delta $15,320.9 15.618%

Northwest $10,956.6 11.169%

Continental $9,449.2 9.632%

US airways $9,181.2 9.359%

Southwest $5,649.6 5.759%

TWA $3,584.6 3.654%

America West $2,309.3 2.354%

Alaska $1,762.6 1.7968%

Most of the major competitors are similar in size.

The relative size of each competitor is a strong force in increasing rivalry within the industry. A large number of competitors with similar capabilities and sizes mean that most companies are equally able to fight for greater market share.

Rivals are constantly monitoring other competitors and adjusting their strategies.

What is the industry concentration ratio (C4)?

( Top 4 company’s sales Industry sales

Industry concentration ratio:

Airline Revenue % of market

United $19,331.3 19.705%

American $18,117.1 18.468%

Delta $15,320.9 15.618%

Northwest $10,956.6 11.169%

63725.9 / 98.1 = 64.960%

The top four companies had roughly 65% of the market share. This industry concentration ratio is a threat to the airline industry. The industry is much closer to pure competition than it is to a monopoly. One company does not have the majority of market share. The top four companies each have a similar share of the market, causing rivalry to increase.

What is the product or service demand growth rate?

Industry Growth Rate:

1999-2000 9.487%