Strategic Report
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Strategic Report Ariana Schuster Linda Hahn Jason Hathaway April 20, 2005 United Airlines Table of Contents Executive Summary .......................................................................... 2 Company History .............................................................................. 3 Competitive Analysis ........................................................................ 5 Internal Rivalry........................................................................................5 Substitutes and Complements..................................................................6 Supplier and Buyer Power.......................................................................6 Entry and Exit ..........................................................................................8 Financial Analysis ............................................................................. 9 Key Issues and Solutions................................................................ 14 Conclusion ...................................................................................... 17 References ..................................................................................... 18 SageGroup, LLP 1 United Airlines Executive Summary United Airlines, one of the airline industry’s leading competitors, has suffered substantial financial damages over the past several years. The terrorist attacks of September 11, 2001 hit the airline industry hard, and while other top airlines were able to withstand the strain of this industry decline, United has had a particularly rough time. Immediately after September 11th, United began to experience significant financial losses, and by December of 2002, the airline had lost so much revenue that it was forced to declare Chapter 11 bankruptcy for government protection. Since 2002, United has engaged in a number of cost cutting strategies in order to become a more competitive player in the airline market and to acquire enough revenue to be able to emerge from its state of protected bankruptcy as soon as it can. Thus far, though, the Company has remained unsuccessful and has been forced to continue to apply for extensions to lengthen the amount of time that it can stay under government protection. At this time it has become evident that United must make some significant cuts in its costs of operation if it is to emerge from bankruptcy before the government terminates protection. In this report, SageGroup, LLP recommends that the Company continue its cost-cutting efforts by reducing the costs of labor (including employee pension plans and wages), eliminating unprofitable routes from its offered services, and reducing its sensitivity to the rapidly increasing prices of oil. If it is able to accomplish these tasks and cut costs by at least $2 billion, it should be in a position to healthily emerge from bankruptcy by fall of 2005. SageGroup, LLP 2 United Airlines Company History The 1920s was a booming era in United States history of significant development and prosperity. It was during this time that the field of aviation was launched, as it established the foundation for what has become one of the modern transportation industry’s major operations. Following the ingenuity of the Wright brothers around the turn of the century, aviation services for commercial transportation began to gain prominence. But it was when Walter Varney, the founder of the United Airlines predecessor company, established an air mail service in 1926 that the industry of commercial aviation began to take flight. With the introduction of stewardesses in 1930 and the merging of aircraft manufacturers and airport operators into large corporations, United materialized as an independent air transport corporation and began to set its own course in commercial aviation. By the 1940s, United was a well-established air transport corporation; however, with World War II at the forefront of international affairs, the Company shifted its focus to war aircraft production, crew training, and mail service to serve the U.S. military; ultimately, the Company flew thousands of flights during the course of the war. The post-war boom led to a significant rise in the demand for public air travel. With the establishment of Denver as its hub and the introduction of the jet aircraft, United began a momentous 29-year period of growth. After merging with Capital Airlines, the United States’ fifth largest air transport company, United quickly became the world’s largest commercial transportation airline. It was also during this period that UAL, Inc. formed, becoming the holding company of United Airlines, thereby allowing United to diversify and expand beyond the realm of air transportation. In 1970, however, United’s sunny past darkened. The company posted a loss of $46 million as a result of higher costs, lower fares, a flattened market, a failed bid for international routes, and the premature introduction of the jumbo Boeing 747. This downturn stimulated a sequence of six new Company presidents throughout the 1980s, a name change to the Allegis Corporation in 1986 and then to the UAL Corporation in 1988, and a revamped image. SageGroup, LLP 3 United Airlines By the beginning of the 1990s, United had become a major international carrier, but its story changed once again with the rise in fuel prices following the Persian Gulf crisis. By 1992, UAL posted a net loss of $957 million. United was forced to undertake cost-cutting strategies to remain competitive, such as the establishment of its ESOP, an Employee Stock Ownership Plan, in which 55,000 employees traded portions of their salaries for company stock. This move enabled United to become the largest employee majority-owned corporation in the world. In 1994, following the creation of ESOP, United stockholders made the uncommon move of adding representatives from the International Association of Machinists and the Air Line Pilots Association to its board of directors. In 1997 the Airline formed a partnership with Air Canada, Lufthansa, SAS and Thai Airways (and later that year, Varig) to create Star Alliance: the airline network for the earth. This move positioned the Company once again as a leader in the industry. Unfortunately, the economic recession that accompanied the turn of the century quickly shattered United’s regained hope for success. A decline in business forced the corporation into labor negotiations with its pilots and machinists, who were demanding higher wages, and when United proposed a merger with US Airways, complications with labor issues and air traffic congestion led to the cutting of 7,000 flights. Through 2001, United was able to make some technological enhancements to its services, but the severe drop in air travel resulting from the tragedy of September 11th forced the corporation to economize by releasing 20,000 employees. Fiscal year 2001 ended with a record loss of $2.1 billion, and 2002 was continued in a downward spiral towards the Company’s eventual declaration of bankruptcy in December of that year. Since 2002, United has been frantically scrounging for strategies to stay afloat and emerge from its state of protected Chapter 11 bankruptcy. It has restructured its cost and employee payment plans, and while analysts have varying opinions about the Company’s prospects for survival, United officials are optimistic and intend to emerge from bankruptcy within the year. SageGroup, LLP 4 United Airlines Competitive Analysis This section provides an analysis of United’s position within the airline industry, specifically in terms of how activity in the rest of the industry affects United’s mobility and power. This can be done most effectively by using Michael Porter’s Five Forces (Internal Rivalry, Substitutes and Complements, Supplier Power, Buyer Power, and Entry), which will identify the threats to profit that the firm faces within the industry. Overall, this analysis shows that United is in a position of high risk and should take action in areas such as internal rivalry and supplier power if it wishes to regain its status as a leader in the airline industry. Internal Rivalry The airline industry is highly competitive with many sellers in the market, most of which offering undifferentiated services. While the older, more traditional carriers are struggling to stay afloat with the old “hub-and-spoke” system, new low- cost “point-to-point” carriers are emerging and attracting customers by offering lower fares and more direct routes with fewer layovers. The hub-and-spoke system functions with each major carrier having a few central airports, through which most of their flights pass and then branch out to specialized destinations. United’s hub locations are Chicago, Denver, Los Angeles, San Francisco, and Washington, D.C. While the hub-and-spoke system has been effective for the major carriers over the past decades, a few newer airlines have been able to reduce their costs by introducing services only between certain high-profit destinations. Southwest and Jetblue, the industry’s leading domestic low-cost carriers, have engaged in this strategy further and even reduced costs by operating out of select secondary airports with lower airport fees, having a limited variety of aircraft, and offering limited services to passengers such as no on-board food service and, in Southwest’s case, no pre-assigned seating. These carriers have quick turn-around times in airports and are able to charge their customers lower fares than the more traditional airlines, thereby increasing their profits and