Competitive Strategy: Techniques for Analyzing Industries and Competitors The model originated from Michael E. Porter’s 1980 book œCompetitive Strategy: Techniques for Analyzing Industries and Competitors. Since then, it has become a frequently used tool for analyzing a company’s industry structure and its corporate strategy 1.Threat of New Entrants “ The easier it is for new companies to enter the industry, the more cutthroat competition there will be. Factors that can limit the threat of new entrants are known as barriers to entry. Some examples include: ?Existing loyalty to major brands ?Incentives for using a particular buyer (such as frequent shopper programs) ?High fixed costs ?Scarcity of resources ?High costs of switching companies ?Government restrictions or legislation 2.Power of Suppliers “ This is how much pressure suppliers can place on a business. If one supplier has a large enough impact to affect a company’s margins and volumes, then it holds substantial power. Here are a few reasons that suppliers might have power: ?There are very few suppliers of a particular product ?There are no substitutes ?Switching to another (competitive) product is very costly ?The product is extremely important to buyers “ can’t do without it ?The supplying industry has a higher profitability than the buying industry 3.Power of Buyers “ This is how much pressure customers can place on a business. If one customer has a large enough impact to affect a company’s margins and volumes, then the customer hold substantial power. Here are a few reasons that customers might have power: ?Small number of buyers ?Purchases large volumes ?Switching to another (competitive) product is simple ?The product is not extremely important to buyers; they can do without the product for a period of time ?Customers are price sensitive 4.Availability of Substitutes “ What is the likelihood that someone will switch to a competitive product or service? If the cost of switching is low, then this poses a serious threat. Here are a few factors that can affect the threat of substitutes: ?The main issue is the similarity of substitutes. For example, if the price of coffee rises substantially, a coffee drinker may switch over to a beverage like tea. ?If substitutes are similar, it can be viewed in the same light as a new entrant. 5.Competitive Rivalry “ This describes the intensity of competition between existing firms in an industry. Highly competitive industries generally earn low returns because the cost of competition is high. A highly competitive market might result from: ?Many players of about the same size; there is no dominant firm ?Little differentiation between competitors products and services ?A mature industry with very little growth; companies can only grow by stealing customers away from competitors Few inventions have changed how people live and experience the world as much as the invention of the airplane. During both World Wars, government subsidies and demands for new airplanes vastly improved techniques for their design and construction. Following the World War II, the first commercial airplane routes were set up in Europe. Over time, air travel has become so commonplace that it would be hard to imagine life without it. The airline industry, therefore, certainly has progressed. It has also altered the way in which people live and conduct business by shortening travel time and altering our concept of distance, making it possible for us to visit and conduct business in places once considered remote. (For more on the airline industry, read Is That Airline Ready For Lift-Off?) The airline industry exists in an intensely competitive market. In recent years, there has been an industry-wide shakedown, which will have far-reaching effects on the industry’s trend towards expanding domestic and international services. In the past, the airline industry was at least partly government owned. This is still true in many countries, but in the U.S. all major airlines have come to be privately held. The airline industry can be separated into four categories by the U.S. Department of Transportation (DOT): ¢International “ 130+ seat planes that have the ability to take passengers just about anywhere in the world. Companies in this category typically have annual revenue of $1 billion or more. ¢National “ Usually these airlines seat 100-150 people and have revenues between $100 million and $1 billion. ¢Regional “ Companies with revenues less than $100 million that focus on short-haul flights. ¢Cargo “ These are airlines generally transport goods. Airport capacity, route structures, technology and costs to lease or buy the physical aircraft are significant in the airline industry. Other large issues are: ¢Weather “ Weather is variable and unpredictable. Extreme heat, cold, fog and snow can shut down airports and cancel flights, which costs an airline money. ¢Fuel Cost “ According to the Air Transportation Association (ATA), fuel is an airline’s second largest expense. Fuel makes up a significant portion of an airline’s total costs, although efficiency among different carriers can vary widely. Short haul airlines typically get lower fuel efficiency because take-offs and landings consume high amounts of jet fuel. ¢Labor “ According to the ATA, labor is the an airline’s No.1 cost; airlines must pay pilots, flight attendants, baggage handlers, dispatchers, customer service and others. Key Ratios/Terms Available Seat Mile = (total # of seats available for transporting passengers) X (# of miles flown during period) Revenue Passenger Mile = (# of revenue-paying passengers) X (# of mile flown during the period) Revenue Per Available Seat Mile = (Revenue) (# of seats available) Air Traffic Liability (ATL): An estimate of the amount of money already received for passenger ticket sales and cargo transportation that is yet to be provided. It is important to find out this figure so you can remove it from quoted revenue figures (unless they specifically state that ATL was excluded). Load Factor: This indicator, compiled monthly by the Air Transport Association (ATA), measures the percentage of available seating capacity that is filled with passengers. Analysts state that once the airline load factor exceeds its break-even point, then more and more revenue will trickle down to the bottom line. Keep in mind that during holidays and summer vacations load factor can be significantly higher, therefore, it is important to compare the figures against the same period from the previous year. Analyst Insight Airlines also earn revenue from transporting cargo, selling frequent flier miles to other companies and up-selling in flight services. But the largest proportion of revenue is derived from regular and business passengers. For this reason, it is important that you take consumer and business confidence into account on top of the regular factors that one should consider like earnings growth and debt load. (For more about the consumer confidence survey, see Economic Indicators: Consumer Confidence Index.) Business travelers are important to airlines because they are more likely to travel several times throughout the year and they tend to purchase the upgraded services that have higher margins for the airline. On the other hand, leisure travelers are less likely to purchase these premium services and are typically very price sensitive. In times of economic uncertainty or sharp decline in consumer confidence, you can expect the number of leisure travelers to decline. It is also important to look at the geographic areas that an airline targets. Obviously, more market share is better for a particular market, but it is also important to stay diversified. Try to find out the destination to which the majority of an airline’s flights are traveling. For example, an airline that sends a high number of flights to the Caribbean might see a dramatic drop in profits if the outlook for leisure travelers looks poor. A final key area to keep a close eye on is costs. The airline industry is extremely sensitive to costs such as fuel, labor and borrowing costs. If you notice a trend of rising fuel costs, you should factor that into your analysis of a company. Fuel prices tend to fluctuate on a monthly basis, so paying close attention to these costs is crucial. Porter’s 5 Forces Analysis 1.Threat of New Entrants. At first glance, you might think that the airline industry is pretty tough to break into, but don’t be fooled. You’ll need to look at whether there are substantial costs to access bank loans and credit. If borrowing is cheap, then the likelihood of more airliners entering the industry is higher. The more new airlines that enter the market, the more saturated it becomes for everyone. Brand name recognition and frequent fliers point also play a role in the airline industry. An airline with a strong brand name and incentives can often lure a customer even if its prices are higher. 2.Power of Suppliers. The airline supply business is mainly dominated by Boeing and Airbus. For this reason, there isn’t a lot of cutthroat competition among suppliers. Also, the likelihood of a supplier integrating vertically isn’t very likely. In other words, you probably won’t see suppliers starting to offer flight service on top of building airlines. 3.Power of Buyers. The bargaining power of buyers in the airline industry is quite low. Obviously, there are high costs involved with switching airplanes, but also take a look at the ability to compete on service. Is the seat in one airline more comfortable than another? Probably not unless you are analyzing a luxury liner like the Concord Jet. 4.Availability of Substitutes. What is the likelihood that someone will drive or take a train to his or her destination? For regional airlines, the threat might be a little higher than international carriers. When determining this you should consider time, money, personal preference and convenience in the air travel industry. 5.Competitive Rivalry. Highly competitive industries generally earn low returns because the cost of competition is high. This can spell disaster when times get tough in the economy. Few inventions have changed how people live and experience the world as much as the invention of the airplane. During both World Wars, government subsidies and demands for new airplanes vastly improved techniques for their design and construction. Following the World War II, the first commercial airplane routes were set up in Europe. Over time, air travel has become so commonplace that it would be hard to imagine life without it. The airline industry, therefore, certainly has progressed. It has also altered the way in which people live and conduct business by shortening travel time and altering our concept of distance, making it possible for us to visit and conduct business in places once considered remote. (For more on the airline industry, read Is That Airline Ready For Lift-Off?) The airline industry exists in an intensely competitive market. In recent years, there has been an industry-wide shakedown, which will have far-reaching effects on the industry’s trend towards expanding domestic and international services. In the past, the airline industry was at least partly government owned. This is still true in many countries, but in the U.S. all major airlines have come to be privately held. The airline industry can be separated into four categories by the U.S. Department of Transportation (DOT): ¢International “ 130+ seat planes that have the ability to take passengers just about anywhere in the world. Companies in this category typically have annual revenue of $1 billion or more. ¢National “ Usually these airlines seat 100-150 people and have revenues between $100 million and $1 billion. ¢Regional “ Companies with revenues less than $100 million that focus on short-haul flights. ¢Cargo “ These are airlines generally transport goods. Airport capacity, route structures, technology and costs to lease or buy the physical aircraft are significant in the airline industry. Other large issues are: ¢Weather “ Weather is variable and unpredictable. Extreme heat, cold, fog and snow can shut down airports and cancel flights, which costs an airline money. ¢Fuel Cost “ According to the Air Transportation Association (ATA), fuel is an airline’s second largest expense. Fuel makes up a significant portion of an airline’s total costs, although efficiency among different carriers can vary widely. Short haul airlines typically get lower fuel efficiency because take-offs and landings consume high amounts of jet fuel. ¢Labor “ According to the ATA, labor is the an airline’s No.1 cost; airlines must pay pilots, flight attendants, baggage handlers, dispatchers, customer service and others. Key Ratios/Terms Available Seat Mile = (total # of seats available for transporting passengers) X (# of miles flown during period) Revenue Passenger Mile = (# of revenue-paying passengers) X (# of mile flown during the period) Revenue Per Available Seat Mile = (Revenue) (# of seats available) Air Traffic Liability (ATL): An estimate of the amount of money already received for passenger ticket sales and cargo transportation that is yet to be provided. It is important to find out this figure so you can remove it from quoted revenue figures (unless they specifically state that ATL was excluded). Load Factor: This indicator, compiled monthly by the Air Transport Association (ATA), measures the percentage of available seating capacity that is filled with passengers. Analysts state that once the airline load factor exceeds its break-even point, then more and more revenue will trickle down to the bottom line. Keep in mind that during holidays and summer vacations load factor can be significantly higher, therefore, it is important to compare the figures against the same period from the previous year. Analyst Insight Airlines also earn revenue from transporting cargo, selling frequent flier miles to other companies and up-selling in flight services. But the largest proportion of revenue is derived from regular and business passengers. For this reason, it is important that you take consumer and business confidence into account on top of the regular factors that one should consider like earnings growth and debt load. (For more about the consumer confidence survey, see Economic Indicators: Consumer Confidence Index.) Business travelers are important to airlines because they are more likely to travel several times throughout the year and they tend to purchase the upgraded services that have higher margins for the airline. On the other hand, leisure travelers are less likely to purchase these premium services and are typically very price sensitive. In times of economic uncertainty or sharp decline in consumer confidence, you can expect the number of leisure travelers to decline. It is also important to look at the geographic areas that an airline targets. Obviously, more market share is better for a particular market, but it is also important to stay diversified. Try to find out the destination to which the majority of an airline’s flights are traveling. For example, an airline that sends a high number of flights to the Caribbean might see a dramatic drop in profits if the outlook for leisure travelers looks poor. A final key area to keep a close eye on is costs. The airline industry is extremely sensitive to costs such as fuel, labor and borrowing costs. If you notice a trend of rising fuel costs, you should factor that into your analysis of a company. Fuel prices tend to fluctuate on a monthly basis, so paying close attention to these costs is crucial. Porter’s 5 Forces Analysis 1.Threat of New Entrants. At first glance, you might think that the airline industry is pretty tough to break into, but don’t be fooled. You’ll need to look at whether there are substantial costs to access bank loans and credit. If borrowing is cheap, then the likelihood of more airliners entering the industry is higher. The more new airlines that enter the market, the more saturated it becomes for everyone. Brand name recognition and frequent fliers point also play a role in the airline industry. An airline with a strong brand name and incentives can often lure a customer even if its prices are higher. 2.Power of Suppliers. The airline supply business is mainly dominated by Boeing and Airbus. For this reason, there isn’t a lot of cutthroat competition among suppliers. Also, the likelihood of a supplier integrating vertically isn’t very likely. In other words, you probably won’t see suppliers starting to offer flight service on top of building airlines. 3.Power of Buyers. The bargaining power of buyers in the airline industry is quite low. Obviously, there are high costs involved with switching airplanes, but also take a look at the ability to compete on service. Is the seat in one airline more comfortable than another? Probably not unless you are analyzing a luxury liner like the Concord Jet. 4.Availability of Substitutes. What is the likelihood that someone will drive or take a train to his or her destination? For regional airlines, the threat might be a little higher than international carriers. When determining this you should consider time, money, personal preference and convenience in the air travel industry. 5.Competitive Rivalry. Highly competitive industries generally earn low returns because the cost of competition is high. This can spell disaster when times get tough in the economy.