Economic Analysis Forecast Macro Environment Airline Industry Delta Airlines 1996 Present

Overview In today’s global economy, firms rely on the analysis of macroeconomic and industry data to develop performance improving strategies and increase their profitability. With this in mind, the following report consists of an analysis of the U. ... macro environment, the airline industry, and Delta Air Lines. It covers both a historic period from 1996 to 2000 and a current period from 2001 to the present. ... Even though there has been current significant improvement in GDP, there are new concerns regarding deflation, the present jobless recovery, and the fact that production is increasing at a faster rate than demand. ... Subsequent analysis will focus on the changing factors that have lead to these results. When facing economic expansion or recession, the Federal Reserve Board (the Fed) relies on different measures to potentially influence the economic environment. ... The Fed’s current approach has been the opposite; it has expanded the money supply to lower the targeted federal funds rate in order to try to pull the economy out of the recession and generate sustainable amount of economic growth. Economic expansion (1996 2000) contributed to Delta’s and the overall airline industry’s positive performance. On average, the airline industry contributed 0. ... These macroeconomic events had direct effects over the airline industry. For example, increase in labor and fuel costs forced labor cuts in the industry and the grounding of a significant number of aircraft. ... The different factors affecting the industry’s performance also have direct effects over Delta Air Lines. This is evidenced by the generation of profits during the expansion period (totaling US$ 4,040 million) and losses during the period of economic downturn (totaling US$ 2,934 million). With loss still remaining on their income statements, major carriers, including Delta, are searching for different ways to face the new low-cost competition. ... By analyzing past and current trends in the macroeconomic environment, in the airline industry, and in Delta’s performance, respectively, we highlight existing links between each. It is important to mention that our analysis focuses solely on the commercial aviation sector in order to satisfy Delta’s informational needs. Based on this research and analysis, our report is intended to provide an objective macroeconomic and industry forecast for the coming year and provide recommendations to Delta. The Macroeconomic Environment We now analyze the U. ... macroeconomic environment during the historic and current periods. ... GDP Analysis To understand the changes in GDP behavior we look at its basic components (See Average Growth of Real GDP Components graph). ... These international economic problems caused the dollar to strengthen against foreign currencies, which in turn debilitated U. ... This deteriorating environment gave way to the current period, greeted by recession. ... • Worries related to the war with Iraq, as well as persistent concerns about the course of economic activity and corporate earnings, created a high degree of risk aversion among business executives that constrained capital spending and hiring. ... These factors will be discussed in more detail in subsequent analysis. ... Inflation Analysis The general trend for inflation during both the historic and current periods has been to remain low. ... For example, in the airline industry, Internet fare bookings have decreased overall commission expenses. ... However, profit margins were contracted as rising costs created higher prices in a competitive market environment. ... Capacity Utilization In our previous analysis we mentioned the effects of increased productivity and market competition on inflation. ... These factors were fueled by the overall favorable economic conditions. ... After analyzing the differences and trends in the macroeconomic environment between the historic and current periods, we now focus our attention on the Federal Reserve’s role in the economy. Fed’s Response To meet the goals of high growth, low inflation, and low unemployment, the Fed looks at the range of variables discussed in previous analysis. ... 5% in order to try to pull the economy out of the recession and generate sustainable amount of economic growth. ... The Federal Reserve also lowered the targeted federal funds rate in order to reduce the strain on the economy caused by international economic instability (Asia, Russia, and Latin America). ... As mentioned in the Inflation Analysis section, price increases have been low throughout this period due to: • Decrease in overall spending • Decrease in wealth due to poor stock market returns • High unemployment rates • Lower capacity utilization In the present, fiscal policy has provided additional support to consumer spending. ... At present, inflation, for the first time since the early 1960s, is as low as the Fed wants -- so low, in fact, that theres a remote risk of the economy tipping into a debilitating deflation. ... The macroeconomic environment has great impact over the strategies used by industries and firms. To illustrate this relationship, we presented in this section an analysis of the most influential factors in industry and firm decision making which are: real GDP growth and its components, inflation, and productivity. ... Our analysis also covered the inverse relationship that exists between the unemployment rate and both capacity utilization and consumer confidence. ... The next section focuses on the airline industry. ... macroeconomic environment to the overall industry performance during the historic and current periods. Our main focus will be centered on the industry’s contribution to GDP, its competitive environment, pricing and economies of scale strategies, and its major costs. ... The Airline Industry All the macroeconomic factors we have analyzed have direct influence over the behavior of the different industries in the economy. In this section, we discuss the airline industry’s performance during the historic and current periods by emphasizing the relationship it poses with the macro environment. Traditionally, there has been a direct relationship between the growth of the economy and the growth of the industry. For instance, during the historic period, the industry and the economy were both characterized by decreasing unemployment, and as the GDP improved, the industry sustained profits. In the current period, the industry was badly affected by the existing recession, and even with the recent improvement in the economic environment, the industry has not been able to recover at the same rate as the economy. ... The changes in the macroeconomic environment have great influence over the industry mainly due to its principle characteristics: The current market structure of the airline industry is characterized by a high degree of market concentration with a small number of dominant, large firms although other producers are present. ... In the airline industry, the top airlines historically were American, Continental, Delta, Northwest, US Airways, and United, better known as the “Big Six”. Traditionally, entry of smaller firms into this market was moderately difficult due to strategies used by the Big Six such as: Cutting ticket prices below actual cost (“predatory pricing”) Holding gates and slots at airports so they can conveniently fly in and out blocking smaller firms Holding long-term leases on gates and retaining gates currently not in use to prevent their use by others Holding veto rights over airport expansion projects that might let in new competitors Controlling critical ground-handling baggage services at dominant hubs; usually charging smaller airlines prohibitively high prices for using them The Industry Evolves Even with the long-standing structure of the airline industry, changes are inevitable. The most important challenge faced is the change in the industry’s competitive environment. ... As the airline industry entered the current period, it faced problems related to the general economic recession. ... The 9/11 terrorist attacks and the war with Iraq have led to further dampening effects on the industry. A new breed of carriers is gaining strength in this environment: low-cost airlines. ... Industry’s Performance and Contribution to GDP Historically, there has been a very strict correlation between how the airline industry performs financially and how the nation’s economy performs, measured by GDP. ... This indicates that the airline industry was a major contributor to the nation’s economy. During this period, airlines reported high net profits linked to the period of economic expansion discussed in the macroeconomic section of this report. Historical period’s profits enabled airline carriers to rebuild their balance sheets from the Gulf War years. ... Unfortunately, from 2001 to the present, the industry has accumulated net losses. ... Although GDP figures had already been declining prior to 9/11, as the above graph indicates, the slowing economy and the bursting dot-com bubble also negatively impacted the industry. This deteriorating behavior is once again consistent with the performance of the overall macroeconomic environment. ... At the present, the low-cost carriers are capitalizing on the debt of the major carriers. This capitalization, coupled with huge investments made by big firms during the historical period (See Aircraft Orders & Options graph) to face increased demand, forced big airlines to improve efficiency through cost-cutting measures described in further analysis. The precipitous drop in traffic following the 9/11 attacks were mirrored by the industry’s sharp reduction in capacity - fleets shrunk by 298 aircraft. ... Industry Costs Bleed Profits During the historic period, the effects of decreased demand and increased competitive pressures from low-cost carriers have made major airlines focus on cost management to improve their income statements, which have been yielding negative numbers since 2001. The largest expenses for the airline industry in both the historical and current periods include flying operations (29%), aircraft and traffic servicing (16%), maintenance (12%), and promotion and sales (11%). ... We begin by analyzing the industry’s largest expense: labor. ... More than 1/3 of the revenue generated each day is used to pay the workforce, causing airline labor costs per employee to be among the highest of any industry in the US. The graph to the left illustrates this relationship by comparing the average annual employee compensation in the airline industry to that in the US private industry. ... The industry presented a steady increase in the number of employees from 1996 to 2000. This behavior is consistent with a moderate industry expansion and contributed to low unemployment rates. Following 2000, airline companies began to look for ways to improve cost management; they began cutting labor costs. ... When aviation experiences economic difficulties, those difficulties reverberate across the economy. For every job in the airline industry, an estimated 15 jobs are produced in the broader economy. Nearly 100,000 airline employees along with roughly 400,000 others in the U. ... Fuel constitutes the industry’s second largest operational expense. During times of relatively moderate fuel prices, these costs averaged 10 to 12% of industry expenses. ... The industry is exposed to severe price escalation - every one-cent increase in the cost of a gallon of jet fuel costs the industry $180 million per year. ... Past fuel increases and recessions have had negative effects on the airline industry, and profitability has suffered as a direct consequence of the weakening economy. ... Within these costs, the main expense is commissions, which constituted 13% of the industry’s operating expenses in the historical period. ... Unfortunately for airlines, they are unable to raise their prices in response to these escalated costs due to the highly competitive environment characterizing the industry. ... This term relates to the fact that once an airline operates in a network of city-pair routes, the marginal costs of adding new routes are low. ... Demand for Airline Service While the partnerships mentioned before have improved supply issues by limiting domestic competition, carriers must still deal with other factors affecting demand.