Rising Fuel Cost in the Airline Industry
Running Head: Rising Fuel Costs and the Airline Industry Rising Fuel Costs and the Airline Industry Of all the changes that we have seen in the economy, fuel has to be at the top of the list as an item whose pricing affects more than just the price we see at the pump. In addition to increased prices at the gas pump, we have also seen products, services, and virtually every item sold increase due to the high cost of fuel.
Although fuel prices have dropped today versus what they were in the third and fourth quarter of 2008, businesses had to make quick decisions as to how they were going to handle the rising cost so that they could still return a profit. One of the industries that the increasing price of fuel has made a large impact on is the airline industry. Four of the top airlines: Southwest, American Airlines, Delta Airlines, and United Airlines have all had to institute changes within their organization to minimize the impact of rising fuel costs on their bottom line. Southwest Airlines
Last summer, when the price of crude oil increased at an astronomical rate, Southwest Airlines was praised as the airline that would make it through the crises. For years, Southwest used fuel hedging to keep their costs down (Reed, 2008).
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Fuel hedging consists of a future contract, and in this case, means that Southwest agrees today to pay a certain price per gallon for fuel in the future (Reed, 2008). When barrels of oil began increasing, Southwest was basically “locked-in” with their fuel pricing. That meant that they did not have the same sense of urgency that other airlines had at that moment in time.
Southwest could still charge the same low rates, and not have to plan on making any drastic changes. Southwest began fuel hedging over 14 years ago (Reed, 2008), and was profitable by doing so. The executives of the company at that time developed a strategy many years ago that had paid off for them for quite some time. However, by the end of 2008, when crude oil began dropping, Southwest was at the other end of the spectrum. They were now paying more for fuel than the current price of fuel. This caused Southwest, for the first time in 17 years, to post a loss for the quarter (Fuel contracts 2008).
However, Southwest still did not start charging customers for additional items as other airlines began doing. Currently, on their website, they still boast “Low Fares…no hidden fees” (Southwest, 2009). Instead, Southwest opted to make other changes to their organization. These changes went into effect before the oil prices starting dropping. Southwest decided to hedge only 10% of their fuel, in contrast to hedging approximately 75% of their fuel (Cochran, 2009). Although touted as some that Southwest knows what they are doing (Cochran, 2009), it must also be noted that Herb Keller, the former CEO of Southwest, retired last summer.
It is difficult to determine at this point if Southwest is as creative, and that is the reason they have dropped their fuel hedging, or if the new leadership is reluctant to take the risks that the former CEO was willing to take and institute into the corporation. It is also difficult to determine if the new CEO is possibly at the eighth stage of Kotter’s model, and trying to anchor new approaches to the Southwest culture (Kotter, 1996). Only time will tell if the CEO’s new approaches will be successful. American Airlines
When oil price increased sharply in the summer of 2008, American Airlines was the first major airline to start charging for the first piece of baggage (Johnsson, 2009). According to American Airlines CEO Gerard Arpey (2008), “Our company and industry simply cannot afford to sit by hoping for industry and market conditions to improve” (Maynard, 2008). Because American was the first to institute these fees, some saw the move as something that could backfire on American, and called the move “stupid” (Maynard 2008). However, within weeks after American started charging fees, many other airlines followed suit.
As of today, although fuel costs have dropped, the baggage fees are still in effect at both American and other major airlines. American Airlines, during this volatile time, took a risk and instituted a non-traditional idea (Kotter, 1996). This move increased their baggage revenue by $94. 1 million dollars in the quarter that they began charging fees. In addition to baggage fees, American also made additional changes in their business. From mid April to mid May in 2008, American Airlines raised their fare rates 14 times to offset the higher costs they were encountering Maynard, 2008). Announcements were also made that additional efforts to reduce losses, such as cutting approximately 300 flights, and retiring approximately 75 aircraft were also taking place (Maynard, 2008). However, despite all of these changes, and generating additional revenue, American Airlines still posted a loss of $341 Million in the last quarter of 2008, and lost another $375 Million in the first quarter of 2009 (Bigger Q1 loss, 2009). Although the loss was large, it was still better than analysts expected (Bigger Q1 loss, 2009).
However, no company can continue posting losses without a major overhaul of change occurring. Although American Airlines appears to be the airline that steps out of their comfort zone and makes changes, they still are not making money. Businesses simply cannot afford to stay in business if they do not make money; therefore, it is important the American Airlines move up their somewhat complacency level, move out of their comfort zone, and arrive at a plan that will boost their bottom line to a profit. Delta Airlines Last year, when oil prices jumped, Delta did not begin charging fees for the first bag.
However, they allowed a passenger’s first bag at no charge, but charged fifty (50) dollars each way for the second bag checked. This double in price (from the original $25), along with higher fees for the third, fourth, and up pieces of luggage was a move to help defray the fuel costs (Delta doubles, 2008). In addition, another move made by Delta to help defray the fuel costs was charging Sky Miles or World Perks fliers a $25 to $100 fuel surcharge (Delta doubles, 2008). With fuel costs still increasing, Delta felt that they still had to make additional changes to cover the rising costs.
Their fare increase had not been successful because it prevented them from staying competitive (Airlines upping fees, 2008) in the market. Therefore, Delta decided instead to charge frequent fliers, in addition to the $25 phone reservation fee, another $25 fee if the flight included another airline partner (Airlines upping fees, 2008). At this time, Delta also increased their charges for pets, oversized baggage fees, and unaccompanied minor fees (Airlines upping fees, 2008). Delta also announced last year that in 2009 they would reduce capacity six to eight percent, and ask for voluntary job cuts (Trubey, 2008).
The interesting information concerning Delta was the fact that after they purchased Northwest Airlines, they lowered or dropped some of their fees. Reservations made over the phone fees was lowered, and curb side administrative fees were dropped (Delta to charge, 2008). Delta Airlines is optimistic that the merger of Delta and Northwest, along with decreased fuel costs, will allow them to post a profit in 2009. Although Delta did not jump on the bandwagon initially with baggage fees, they did change their business plan very quickly in March 2008 (Grantham, 2008).
They did not wait around to see what would happen, and quickly arrived at a plan as to how they were going to handle the increase in fuel costs. Delta raised their fares, and also cut unprofitable flights from their schedules. Early in 2008, when fuel prices began increasing, the CEO of Delta remarked that Delta needed “to ramp up changes to its operations to deal with rising costs (Grantham, 2008)”. The CEO seemed to understand the urgency of the situation, and also had the power, as the CEO, to make those changes.
The CEO also announced that they (Delta) would share with the employees the changes that the company was going to make, and how they would make them without the sacrifice of the employees (Grantham, 2008). This move, in my opinion, showed that the CEO had a process for change, and was communicating this to the employees. With the price of fuel increasing so rapidly, it is apparent that most likely employees were nervous about losing their jobs. By the CEO communicating the vision of the change to the employees, it most likely kept the rumor mill down, and got employees to focus on the change itself, instead of unfounded fears.
Another move made by Delta to decrease their fuel cost was slowing the flight speed of planes approximately twenty (20) miles per hour. On a flight from Los Angeles to Atlanta, this would add an additional 6 minutes to the flying time. This small difference would not be noticeable to the customer, but would save gallons of fuel, which in turn would save thousands of dollars. Delta also replaced seats and carts with lighter equipment, and was also studying the concept of replacing manuals by electronic means (Chapman, 2008). Over 1. million gallons of fuel per year has been estimated to be saved by making these changes (Chapman, 2008). Delta appears to be very proactive on all of their changes that need to take place within their organization in order to turn a profit. United Airlines When the price of fuel increased last year, United Airlines made their changes in another form. United decided to lay off employees in an effort to maximize the profits on their bottom line. In June 2008, United announced that it would lay off approximately 1500 employees, remove 100 airplanes from their fleet, and also eliminated one of their divisions (United Airlines, 2008). 00 of the 1500 employees were offered voluntary retirement packages, and certain contingencies must have been met for an employee to be eligible (United Airlines, 2008). This layoff was simply the “first” of layoffs, as by the end of 2008, United had laid off 2500, or approximately 30% of their employees (United Airlines posts, 2009). After posting a loss in the fourth quarter of 2008, United announced another layoff of approximately 1000 employees by the end of 2009 (United Airlines posts, 2009). This layoff was attributed to the corporation fuel-hedging in 2008 (United Airlines posts, 2009).
United made a gamble that fuel would continue to rise, and when fuel prices dropped, they were locked in at higher rates. (United Airlines posts, 2009). This fuel hedging strategy actually backfired on the company, as when fuel prices dropped, the company was paying higher prices. Fuel hedging almost appears to be a gamble that a corporation is taking, and with the price of oil jumping back and forth so rapidly, it is difficult to understand the company’s objective hedging. It is almost as if they copied Southwest’s process, yet it backfired on them.
United also jumped on the bandwagon and began charging for the first piece of luggage in September 2008 and also increased the price of the second piece of luggage from $25 to $50 (United Airlines raises fee, 2008). Although this scenario may not be accurate, it is almost as if United Airlines has a hard time going through their own processes and create any kind of plan or urgency levels, and relies on other companies changes to help them get through their own problems. Although United appeared to follow lead in 2008, they have just announced a new “fat fee” for overweight passengers (Passengers requiring, n. . ). Perhaps the most humorous part about this is that even on United’s website they have stated that this policy was implemented to “align themselves with other major airlines seating policies (Passengers requiring, n. d. )”. Conclusion When fuel made its dramatic jump in 2008, many of the airlines scrambled to come up with a plan to help offset the increase. It appears that all were not successful, as in 2009, many are still operating at a loss, and still trying to make changes to their operations. Southwest appears to lead the pack with making the most significant successful changes.
Although Southwest did lose money for the first time, they attributed their loss to the fuel hedging. As mentioned earlier, organizations can not continue to lose money, and if the airline industry does not devise a plan with significant changes, and successfully implement these changes, we may either see a bail out from the government, or see airline after airline file for bankruptcy. Perhaps the other major airlines should take a closer look at Southwest’s eagerness to make and implement changes into their company, and apply that to their own organization.
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