OVERVIEW OF THE CASE
In 2002 Delta airlines faced the unfortunate realization that the competition from low cost carriers like Southwest and JetBlue was becoming a serious problem. Even though Delta had been looking at this problem for a long period of time, the business model of Delta Airlines was organized by function and their solutions generally focused on individual aspects of the firm. For example, the marketing department provided marketing ideas, the customer service department offered customer related solutions etc. Delta realized that they did not have a comprehensive solution to dealing with the low cost carriers in the market. One of the simplest solutions proposed by Delta management was the idea that Delta could launch its own low cost subsidiary, however, looking at the rest of the airline industry, low cost subsidiaries seemed to be ideas that were either immediate failures or unsustainable over time. According to experts, they had “never seen a high-cost carrier transform itself into a low cost carrier”. With or without this option, Delta would have to find a solution to this problem. The airline industry in the United States is immense, with more than 620 million passengers and over $81 billion in fares in 2001 alone. Unfortunately, while immense in size, in terms of profit, the airline industry continued to perform below the average for other industries. Many investments made by the larger carriers were not profitable and the tragedy of 9/11 put more pressure on this already struggling industry. For nearly 40 years, the US airline industry had operated within strict and specific operating rules under the Civil Aeronautics Board (CAB). The CAB determined and assigned routes for each carrier, which were typically a mixture of lucrative and moderately profitable routes. CAB also controlled fares, and dealt with airline labor unions. Salaries and benefits were fair, and income within the airline industry was supplemented by strict work rules that reduced labor flexibility. The airline industry was encouraged to improve service offerings – such as meals and inflight movies, greater capacity and more flexible flight times. As a result of these regulations, the major carriers faced high operating costs and excess capacity. Consequently, they started to charge prices that were approximately twice as high as their unregulated counterparts (i.e. the low cost carriers) for similar flights. When it was realized that the regulations were inefficient and putting pressure on the industry, the Airline Deregulation Act of 1978 was signed, and by 1980, the low cost airlines had become a major threat to the major carriers. Following deregulation, the average airline companies profits depended on the fraction of its flown seats that were occupied by its paying customers (also known as the “load factor”). Costs were generally measured by the cost per available seat mile (CASM) – which reflected the cost to fly one seat, occupied or empty, for one mile. The returns or yield calculated by dividing total passenger revenues by the number of revenue passenger miles (RPMs). Daily utilization, depended on how quickly an airline could turn its aircraft and prepare them for takeoff and Southeast airlines was the leader in that area with a 27 minute turn time. Also, since most cost items did not generally depend on the flight’s length, cost per available seat mile were low for airlines that flew long distances. As a consequence of these factors, most major airline companies developed a system to ensure high load factors. They shifter operations to hub-and-spoke models, where flights on small planes from lightly traveled cities (called “spokes”) would feed passengers into “hubs” in major cities and eventually take them to the desired destinations. This system enabled major airlines to achieve high load factors, and therefore, higher profits. By the year 2002, most of the major airlines had shifted to this business model. As far as...
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