Porter’s Five Forces and the Driving Force of Change

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Porter 5 forces and driving force of change Rivalry among competing sellers – High Airlines industry experiences intense competition. It looks like the industry is in the business cycle’s maturity stage where buyer demand grows slowly and number of competitors appears to maintain the same with equally distributed market shares. In the pre-post airline deregulation era, air routes and price were established by the federal government. After the Deregulation Act of 1978, as the government gave more control power to airline carriers, the industry turned into an aggressive price competition for many reasons. First, airline carriers have very high fixed cost and narrow profit margin. Majority of operation costs come from the cost of planes, gasoline, airport’s landing fees, high-technology monitoring systems and the needs to meet government safety requirements. Moreover, labor costs for pilots and flight attendants, which are the largest expense according to Air Transportation Association, do not depend much on how many passengers attending on the flights. On the other hand, variable costs for extra gasoline and food per passenger are insignificant. Under these high fix-costs and low variable-costs circumstances, flight carriers are motivated to undercut each others, for sales from every extra seat will go directly to their margin. Second, products of airline industry are weakly differentiated and buyer’s switching costs are low. Even though competitors try to build up their brand identities, consumers do not respond well with this differentiation strategy. While business travelers, who accounted for 30% of US total travel expenditure in 2013 may consider the total hours spent on flights and transitions, the rest 70% travel expenditure which come from leisure travelers tend to make their purchase choices heavily depended on price factor. Even though the airlines made effort to sustain customer loyalty by the introduction of frequent flier programs, this competitive advantage soon gets less relevant because of similar membership offers and low-cost strategies across the whole industry. Third, consumer demand in airline industry has not totally recovered since September 11 incident. After September 11, 2001, the world enter global recession because of low consumer confidence in spending. Airline industry suffered not only from economic recession but also from consumer’s safety concern on flights, which led to huge drop in air traveling. Lastly, significantly high capital investment and advanced technology enable price transparency and comparison also contribute to intensity of the market. Potential new entrants – low Airline industry faces low threats in new airline entrants because of large initial capital investment and high cost to meet government regulation. Even though airplanes and the right to use gates could be leased to reduce startup cost burden, the license process is very complicated and can take approximately one year. After that, they have to operate under frequent monitor by the Federal Aviation Administration and the Department of Transportation. As the competition is already intense and products offered are not well differentiated, existing incumbents are likely willing and able to contest new entry easily by lowering their price. Moreover, even though buyer’s switching costs are low, people hesitate to purchase from new brand. Because flight tickets are generally expensive and people give high concern for safety aspect, consumers tend to trust brands that have established for long period of time. It is also worth to pay some attention to the possible threat in the future from foreign competitors. The US government currently forbids foreign airlines to fly domestic routes to protect American jobs. If this restraint is lift off in the future, the competition will become much more intense when consumers are exposed to more options. Substitutes – low Consumers can choose other mode of transportation such as car, bus, train or boat to substitute airplane. Advanced technology has made these form of transportation more efficient in domestic travels, especially over short distance. There is switching cost, in which time is the most concern factor, and it varies depending on available routes, time, budget and purpose of travel. Ocean transportation is the least attractive in term of speed concern. Fuel-efficiency technology has recently created more cost-advantage opportunity for ground transportation firms. However, plane is still the fastest and most convenient form of transportation. Beside, advanced technology which enable online business meeting (e.g. Skype) can be counted as substitutes for business-purpose travels. Supplier – high The primary suppliers are airplane manufacturers and fuel. There are two dominant airplane manufacturers in the world: Boeing and Airbus, and they account for most of the market share in the world’s aircraft manufacture industry. Because of their monopoly power, they also hold strong supplier’s bargaining power to the airline industry. It is very hard for airline companies to switch suppliers. Because planes are very expensive, most companies build long term contracts and have long term loan agreements with their suppliers. It is also extremely difficult for airline companies to establish their own manufacturers dued to the complexity and high capital cost of the products. Airline companies can integrate horizontally with each other to make larger airplane order for larger discount. Aviation fuel suppliers do not pose threat to the industry as the product is a commodity. Aviation fuel price depends on market forces and geographic-political factors. Buyer – medium Even though airline services are quite standardized across the industry, which leads to low switching cost, buyers do not have much bargaining power over firms. Ticket websites such as Kayak or Travelocity enable consumers to browse and compare flight information and prices easily, still people do not have negotiating power on price. On the other hand, transparency in price and readily available information allows airlines companies to easier extract consumer surplus by engaging in price discrimination. Popular routes which are offered by multiple airline carriers and relevant substitutes usually have competitive price, while long-distance flights that have limitation in schedules, hubs and available carriers usually overcharge consumers. Work cited Kost, John M. “Effects of Airline Deregulation.” [Mackinac Center]. October 19, 1988. Accessed March 18, 2015. https://www.mackinac.org/6358. Cederholm, Teresa. “Lower Fuel Price, Merger Success Lift American Airlines in 2014.” Successful Merger and Integration Efforts Boost American in 2014. February 24, 2015. Accessed March 18, 2015. https://marketrealist.com/2015/02/successful-merger-integration-efforts-boost-american-2014/. Cederholm, Teresa. “The Airline Industry’s Growth and Impact on Economic Prosperity.” Share of Leisure and Business Travel. December 29, 2014. Accessed March 18, 2015. https://marketrealist.com/2014/12/leisure-business-travel-share-importance-us-travel-expenditure/. Davis, Marc. “The Impact Of 9/11 On Business.” Investopedia. September 6, 2011. Accessed March 18, 2015. https://www.investopedia.com/financial-edge/0911/the-impact-of-september-11-on-business.aspx “14 CFR Part 121 Air Carrier Certification.” 14 CFR Part 121 Air Carrier Certification. Accessed March 18, 2015. https://www.faa.gov/about/initiatives/atos/air_carrier/.

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