The Airline Industry

Introduction

Airbus

Historically, air travel has survived largely through state support, whether in the form of equity or subsidies. The airline industry as a whole has made a cumulative loss during its strenuous history, the costs include subsidies for aircraft development and airport construction. Because of increasing fuel prices and new industry standards the airlines have raised ticket prices as a compensation for the high cost of operating. Going hand-in-hand with these increasing prices, the effects of 9/11 have added more strain to the already existing problem of debt the airline industry faces.

Airline Business Models

Traditional Model

The traditional operating model for large U.S. and European airlines has been the hub-and-spoke approach. This model enables airlines to virtually take anyone from any place to any desired destination. However, this model has been considered by many industry analysts as no longer competitvely substainable in its present form due to industry changes and exterior economic effects.

Boeing vs. Airbus

The airplane manufacturing industry is dominated by two companies: The Boeing Company and Airbus S.A.S. Boeing is the world's leading aerospace company and the largest manufacturer of commercial jetliners and military aircraft combined. Airbus began as a consortium between France and Germany which was later joined by Spain and Britain. Their fight for market share is the clearest example of global competition going on in the world today.

Airbus and Boeing is in tight competition with every year for aircraft orders. Airbus has managed to win over 50% of aircraft orders in recent years. However, once again Boeing surpassed Airbus in 2005 and 2006 as a result of their success in the market for wide body aircraft.

The impact of the weak dollar

Much controversy surrounds this international competition. The economic impact of the weak dollar has give Boeing a tremendous advantage in the global airplane markets. In, addition, both companies are accused of violating world-trade agreements relating to restricting government subsidies.

Both companies sell their airplanes in US Dollars; however Boeing’s manufacturing is primarily done in the United States while Airbus manufactures in Europe. This means that Airbus pays its cost in euros while Boeing spends dollars. The falling dollar means Airbus earns fewer euros causing a squeeze on profits. The weak dollar and the costly delays in the introduction of the jumbo A380 has cost the company billions of euros. Just two weeks ago Airbus’s chief executive, Tom Enders, proclaimed that the weak dollar is “life threatening” to the European airplane manufacturer. While there is much debate as to whether Airbus’s life is truly in danger, there are definitely indications of pain. Early this year Airbus devised a plan to turn things around; the plan calls for the closing of six factories and terminating 10,000 employees.

Boeing has been on the receiving end of the weak dollar situation. Revenue from their commercial airplane business is up 18% for the nine-months ended September 30, 2007 from the same period in 2006. The value of Boeing stock is almost double where it was at the end of 2004. The manufacturing delays at Airbus has also helped fuel orders of Boeing planes.

The Subsidy War

Boeing’s recent success not stopped the company from crying foul over Airbus’s receipt of unfair government subsidies. U.S. Trade Representatives decided to file a formal complaint with the World Trade Organization claiming that the European Union has provided Airbus with billions of dollars of unfair subsidies. The subsidies received by Airbus are referred to as “launch aid” and provides money for the development of new commercial airplanes. The Europeans claim that launch aid is no more than a loan to the company to be paid back from sales of the planes. However, launch aid transfers the risk of manufacturing from Airbus to the European governments because the loan does not need to be repaid if the aircraft program is unsuccessful. For example, if Airbus’s A380 fails to sell the company will not have to repay the $3 billion in loans it has already received. Boeing claims that these subsidies provide Airbus an unfair economic advantage that is strictly forbidden in the 1992 bilateral aircraft-development agreement.

Airbus and the European Union argue that launch aid is nothing more than repayable loans which are acceptable according to the agreement. They go on to accuse Boeing of receiving illegal subsidies for its midsize 7E7 “Dreamliner” program. However, the subsidies that the EU mostly refer to is the $3.2 in tax breaks Boeing secured from the stat of Washington for the 7E7 program. This benefit to Boeing comes over a twenty year period as reduced sales tax on airplane sales. The big difference is that Boeing only benefits if the plane is successful and only after they have made a substantial investment in the development of the aircraft. Airbus, on the other hand does not need to repay the $3 billion loan if the A380 fails to sell. Also, the tax break provided to Boeing is available to anyone in the aerospace industry including Airbus.

The subsidy war continues to wage on through mostly rhetoric. How it plays out in the international governing bodies such as the World Trade Organization is yet uncertain.

Ticket Sales

airline ticket

In attempts to fully maximize profits the airlines focus on the price of tickets. Since everything in the last couple of years, especially since 9/11, has changed, the price of tickets has become a very confusing aspect of the airline industry and has changed rapidly.

Most airlines use differentiated pricing, a form of price discrimination, in order to sell air services at different prices and in different time segments to coop with the losses that would normally occur. There are many factors that contribute to determining the price of tickets. These factors include the days remaining until departure, the current booked load factor, the projected public demand and variations by the day of the week the departure is and the time of day. This price distribution is obviously done mostly by seating classes.

The beginning of advanced computerized reservations systems in the late 1970s allowed competing airline industries to easily perform cost-benefit analyses on different pricing techniques, which lead to almost perfect price discrimination by filling each seat on an aircraft at the highest price possible without driving the consumer elsewhere. This crazy aspect of the industry has caused airlines to compete for lower prices on same routes and because of this competition aspect, most airlines experience major losses as a result.

These ticket prices end up having the greatest impact in the industry because due to operating costs, the income that is distributed amongst providers, even at its highest, is only a small portion of the overall income. Basically in the end, if the ticket prices are too low, the revenue won't cover the operating costs and competing airlines would see decreased profits and won't be able to keep up with the market. United Airlines, US Airways (twice), Delta Air Lines, and Northwest Airlines have all declared Chapter 11 bankruptcy, and American has barely avoided doing so, just proving the effects of ticket sales.

Van Wag

Group Members

Ted Sirvaitis (Sirvaitr)

Michael Outwin (Outwinm)

Alex Baranick (Baranica)

Kaitlin Van Wagner (Vanwagnk)