Monday, September 12, 2016

How to decrease industry rivalry

Apparently institutional investors are applying Michael Porter's five forces to the airlines industry and trying to figure out how to develop a sustainable competitive advantage.  Porter famously gave airlines as an example of an industry that does not make profit due to easy entry, strong suppliers and customers, many substitutes, and intense rivalry.

But institutional investors who own multiple airline stocks seem to be trying to convince airlines to soften competition, by raising prices or reducing capacity.  Southwest seems to be ignoring them:

The carrier won't join rivals in trimming capacity during the rest of this year, Chief Executive Officer Gary Kelly has said. Its unwillingness to take that step, which generally enables airlines to increase prices, is a disappointment to investors like Chris Terry.
"I'd like to see them boost their fares but also cut capacity," said Terry, a portfolio manager at Hodges Capital Management Inc. "That's what the market wants. That's what the market is telling everyone. Supply growth is exceeding demand growth, and I don't think that's healthy."


  1. Competition or rivalry amongst industries is a positive thing for consumers and benefits society overall. However, institutional investors look at competition negatively because they want to raise prices but would be a competitive disadvantage if other industries or companies are offering same service or product at a low cost. Airlines should not decrease their competition because by joining forces and increasing the price on flights/reducing capacity for consumers it will harm consumers. The Economic policy of the United States is competition and without it there would be monopolies and no protection for the public.
    Although Market competition harms some participants that do not develop competitive strategies or advantages it continues to benefit society. "I'd like to see them boost their fares but also cut capacity," said Terry, a portfolio manager at Hodges Capital Management Inc. "That's what the market wants. That's what the market is telling everyone. Supply growth is exceeding demand growth, and I don't think that's healthy."(Luke Froeb, blog dated Monday, September 12, 2016). Therefore, there is no need to decrease rivalry amongst the Airline industry and Southwest unwillingness to increase prices to avoid competition brings a positive outcome to the market. Investors will just need to learn how to adapt the competitive American market.

  2. It’s very interesting how investors are treating Southwest. The fact that Southwest has been a strong investment in the past should instill confidence as it goes through a market correction in relation to it’s long-term view with it’s upcoming new reservation system and airline capacity. I can’t help but to think that out of the 4 major airlines, which are being investigated for price correlation by the government, that perhaps Southwest is looking to prove itself as a leader and pull away from the pack in the future. Even though having a sustainable competitive advantage is good and healthy for the market, too little competition also could have triggered a government investigation for price correlation. While it may not be monopoly because it’s not one company dominating the market, not looking to be accused of price correlation may be another reason why Southwest is not bending to the calls to reduce capacity. Customers are also benefiting big time from the cheaper tickets that are being sold. So many times, especially when gas prices where high, flyers had to pay the extra high-ticket prices. But ticket prices also remained high when fuel prices dropped which was a big insult to customers. While the airline industry may be going through a hard time, customers are sure to reap the rewards of cheaper tickets.

  3. I find it interesting the way the investors are looking at Michael Porter’s five forces regarding the airline industry. It surprises me that investors are asking the airline companies to increase their tickets prices and reduce their capacity on flights. Consumers are shoppers when it comes to prices of flights and will use websites like or Expedia to try to find lower flight prices versus using the airline itself. The capacity is measured by the seats per mile and all air lines should be looking to have each flight at full capacity. Empty seats on the flights are loss revenue but increases expenses. Southwest makes sure they are at full capacity on each flight and have a very strict turnaround time at airport. They have the highest loyalty rate from customers because they do offer the lowest fare possible while still offering free bags and wifi on the flights. Southwest is holding on to the competitive advantage in the industry by not following suit with the other companies. Investors should be sitting down with the board at Southwest to see exactly what their strategic plan and how they are executing it to be continuously successful.

  4. As it is, airline tickets are very high and customer’s services is very poor. In now a day finding a reasonable ticket is nightmare especially for domestic flights. For instance, my friend booked a flight from Rochester, NY to Hawaii through Canada because it was cheaper to go to Hawaii from Canada than U.S. It is ironic but true. I can find a ticket from NY to Europe much cheaper than flight to California. Also, the security check points at the airport are not free, and the cost of them passed to passengers.
    In 2014, despite a decline in jet fuel prices of 24% and a drop in nonfuel operating costs of just under 3%, the average fare per mile increased 0.5%. Today, planes are already very packed and leave no room for airlines to reduce fares (capacity discipline). It’s ok to raise the price if customers have choice. Unfortunately, when it comes to airlines, customers have a very little choice. Raising the price or reducing the capacity is great for airline industry but not for consumers.
    Airlines may be successful in short run but not in a long run. Also, as mentioned in chapter 12 of the Froeb, if demand is hard to predict, pricing to fill capacity becomes much more difficult. With what confidence, airlines want to raise price of fare or reduce the capacity. For businesses, such as hotel and airline, adjusting the capacity is very challenging or undoable in the short run. Increasing the price, as mentioned in the case, will increase the substitutes, give more power to suppliers to raise their price, and make customers very reluctant and more price sensitive.

  5. Why does Southwest airlines succeed when the other airlines do not? Simple. Southwest airlines stays ahead of the competition by following a cost reduction strategy that his hard to emulate. Southwest airlines low cost is primarily attributed to having the fastest in the air times of any airline. The faster the plane is loaded, the faster it’s in the air earning money. Parked planes are a cost not being utilized. Southwest empowers their employees to work to improve processes and invest heavily in training. Southwest airlines generate superior economic performance and then passes it on to the consumer in the form of on time flights at low fares. Southwest does not fall into the same problems the other carriers do and therefore have a healthy supply of customers regardless of demand in the industry. The industry has changed and a oversupply of cheap seats has occurred affecting Southwest recent earning and creating stress among some of its investors.
    Investors seem to always be focused on short sighted goals. The new reservation system has a chance to create revenue growth that will only strengthen Southwest when matched with its historical cost reduction leadership. The government is in effect also aiding Southwest. By not colluding with the other four airlines, Southwest can potentially be a beneficiary of the government’s investigation. Southwest airlines has a sustainable competitive advantage and will weather the recent market shortfall.

  6. The textbook tells us that the when applying Michael Porter’s five forces the best industries “are characterized by having low threat of entry, low buyer & supplier powers, low threats of substitutes, and low levels of rivalry (Froeb et. al., page 128).” It seems that in the case of Southwest, as with other airlines if you similarly apply the five forces model you can see that this market is not always one of the most profitable as there are is steep rivalry in the marketplace. While it seems that the investors would like Southwest to reduce their capacity during certain times of the year to drive market price up during the year, Southwest seems to think remain they will be able to maintain their competitive advantage in other ways. According to Southwest, "our people are our single greatest strength and most enduring long-term competitive advantage (The Mission of Southwest Airlines)." Part of this includes the customers and the view Southwest has taken in terms of their competitive advantage resources, being careful to note that “imitation and substitution both erode firm profit (Froeb et. al., page 131).” Southwest has taken the strategic view of ensuring their people, their customers who they view as being the drivers of their competitive advantage are satisfied rather than that of the shareholders as noted.
    Froeb, L.M., McCann, B.T., Shor, M. and Ward, M.R. (2016). Managerial economics: A problem solving approach, 4th ed. Cengage Learning

    The Mission of Southwest Airlines