Between the same two cities, a single airline may fly on one airport pair while several airlines compete intensely on another. Both connect the same cities, yet the market dynamics are completely different. In this lesson we examine, step by step, how airlines analyze these different competitive environments, the thinking of the Positioning School, how the five forces model is applied to airline markets, the strategies of cost leadership, differentiation and focus, and the airline business models that are the concrete reflection of these strategies.

What will you learn in this episode?

• Explain the thinking of the Positioning School and how it places competition at the center of strategy
• To list the three sources of extended competition
• To explain the five forces model and its application at the airport-pair level in the airline market
• Compare the strategies of cost leadership, differentiation and focus
• To explain how differentiation creates entry barriers through flight frequency and frequent flyer programs
• Explain the concept of being "stuck in the middle"
• Distinguish between the full-service, low-cost, regional, non-scheduled and airline-within-airline business models

Summary of this episode

1. The Positioning School

Definition: The Positioning School is the school of thought founded by strategic management thinker Michael Porter through his works Competitive Strategy, published in 1980, and Competitive Advantage, published in 1985. According to this approach, whether a firm succeeds or fails depends on the structure of the industry it is in and on the position it takes against its competitors in that industry.

Its basis: The approach is based on industrial organization, a branch of microeconomics. Because the environment has a great influence on firms, the starting point of strategic analysis is industry analysis.

What did it replace? The strategic planning approach, dominant from the 1960s to the mid-1970s, saw strategy as the product of a long-term formal planning process. The Positioning School instead put competition at the center of strategy .

Extended competition: Competition comes from three sources:

• From existing rivals: direct competition,
• From producers of substitute products: indirect competition,
• Created by new investors who may enter the market: potential competition.

2. The five forces model

Definition: According to the five forces model, competition in an industry comes not only from existing rivals but from five separate forces:

1. the intensity of rivalry among existing competitors,
2. the bargaining power of suppliers (sellers),
3. the bargaining power of buyers,
4. the threat of new entrants,
5. the threat of substitute products.

Why does it matter? The combined effect of these forces determines the profit potential of the industry. The model seeks answers to these questions: Which markets are profitable, where should business be done, which position best defends the firm against the five forces, and which generic competitive strategy should be followed?

3. Five forces in the airline market: why at the airport-pair level?

Explanation: In airline transport, the real competition takes place on the routes the airlines serve. Therefore five forces analysis should be carried out not only for the industry as a whole but separately for each airport-pair market .

Example: Let us consider two different airport pairs between Istanbul and Ankara. On one airport pair a single airline may serve as a monopoly, while on another airport pair between the same two cities more than two airlines may compete. Same city pair, same distance; but a completely different intensity of competition. This is because competition takes shape not only at the city-pair level but at the airport-pair level.

Consequence: An airline that carries out this analysis is expected to prefer markets with less competition and to use practices that make it harder for others to enter.

4. How the five forces look in the airline market

Threat of substitute products: This is especially pronounced on short-haul routes . Why? As distance shortens, the time advantage air transport offers over road and rail decreases. Example: When high-speed train services between two cities become faster and more widespread, air travel demand on that route may be negatively affected. An important reason why there is no air service between nearby cities is that surface transport is a strong substitute. An airline must analyze this threat before entering such a market.

Bargaining power of buyers: Thanks to the internet and information technologies, passengers can access fare information much more easily. On city pairs with intense competition, buyers' bargaining power grows as the number of options increases.

Bargaining power of suppliers: In areas such as fuel, catering and ground handling there are usually few suppliers, which increases their bargaining power. Example: If there is only one catering and ground handling company in a market, the airline may have to accept the price and service quality offered, or may even choose not to operate in that market.

Threat of new entrants: This threat is expected to grow as market entry regulations are liberalized. On the other hand, the high entry barriers that economic regulations sometimes create protect existing airlines from competition to some extent.

Rivalry among existing competitors: When several airlines schedule flights at similar times on the same airport pair, the intensity of rivalry increases.

Consequence: Positioning in markets that allow the firm to defend against or overcome the five forces, and creating entry and exit barriers, are expected to bring the firm above-average profit in the long term, that is, competitive advantage .

5. Generic competitive strategies

After the five forces analysis, airlines follow one of the three generic competitive strategies proposed by Porter: cost leadership, differentiation and focus.

Cost leadership — definition: The firm carries out its activities at a lower cost than its rivals and tries to earn above-average returns by selling its products at prices below the industry average.

How is it applied in airlines? Costs are reduced through high productivity, and these savings are passed on to fares to reach high load factors; all management functions and production processes are designed around reducing cost.

Its development: In aviation, this strategy spread worldwide especially from the 1990s onward and led to the emergence of low-cost airlines on many continents (details in Unit 8, Weeks 15–16).

Differentiation — definition: The firm differentiates its goods and services from similar ones and offers them at a higher price.

How is it applied in airlines? Differences are created in the comfort, schedule, convenience and image components of the product. Example: wider seat pitch, higher-quality catering, more cabin crew, advanced in-flight entertainment systems.

Its cost: Differentiation also increases costs.

Network structure: These airlines usually operate a wide flight network on a global scale, on domestic and international routes, short and long haul; they carry cargo as well as passengers and try to create synergy by offering different products to different market segments. For a global and seamless network they use the hub-and-spoke (hub-and-spoke) network structure: passengers at spoke airports are first gathered at a hub airport and then distributed to the points they want to reach; in this way far more city pairs can be served. They also benefit from global distribution systems, frequent flyer programs and global strategic alliances.

Why does differentiation provide a defensible position? According to the Positioning School, the source of competitive advantage is market position, and the source of its sustainability is entry and exit barriers. Differentiation creates customer loyalty and reduces price sensitivity. In addition:

• operating high-frequency service at the hub airport an airline mainly uses makes it harder for rivals to enter, because flight frequency is one of the most important determinants of demand.
• Frequent flyer programsimpose an extra cost on passengers when they switch airlines (losing their accumulated points) and turn into an entry barrier for rivals.

Focus — definition: The firm consciously gives up the possible benefits of synergy and concentrates on a single activity or a narrow market segment.

Its two types:

• Focus on a value-adding activity: for example only integrated express cargo, only business passenger transport, or service to a particular tourism-oriented geography.
• Cost focus: for example charter airlines serving tour operators.

Entry barrier: For integrated cargo carriers, high investment requirements such as large fleets and advanced information systems create an entry barrier that is hard to overcome.

Comparing the three strategies: Cost leadership targets a broad market with low cost and low price; differentiation targets a broad market with high value and high price; focus targets a narrow area.

Stuck in the middle: According to Porter, firms that cannot clearly apply at least one of these three strategies become stuck in the middle and cannot gain competitive advantage. Example: Trying to pursue differentiation and cost leadership at the same time can lead to this situation.

6. Airline business models

Definition: A business model, in its simplest sense, is a firm's logic of doing business; it is also defined as the firm's realized strategy . An airline business model shows how an airline operates and how it creates value for its stakeholders.

Four basic models:

1. Full-service (traditional) model: uses global distribution systems, complex network structures, alliances and aircraft of different types and sizes to serve all passenger segments; because of its high cost structure it relies on revenue management and usually follows a differentiation strategy.
2. Low-cost model: the model of airlines that usually follow a cost leadership strategy.
3. Regional model: It is the model of airlines that, through a focus strategy, serve larger urban centers from small points.
4. Non-scheduled model: It is the model of airlines whose primary business is non-scheduled transport.

Another distinction: Some authors divide business models into three: the traditional model, the virtual model and the aviation business model. The word “virtual” here has nothing to do with information technology; it emphasizes the leanness of the business model and corresponds to the low-cost model. The aviation business model is a kind of aviation group that brings together aviation businesses operating in several different fields.

Airline within airline: low-cost airlines that large traditional airlines set up as their own subsidiaries in response to competition from low-cost airlines. Large airlines responded to this competition either by setting up such a subsidiary or by reviewing their operations and reducing their costs without fundamentally changing their business model.

Factors that make success harder: a mixed fleet, maintaining connecting service, a two-class cabin, inability to reduce labor costs.

Factors that support success: independence from the parent airline, a strong market position, determined leadership, a structure that does not deviate much from the low-cost model.

In short

According to the Positioning School, success depends on the structure of the industry and the position the company takes. Airlines decide where and how to position themselves by applying the five forces model to each airport pair; they then follow one of the strategies of cost leadership, differentiation or focus. These strategies take concrete form as the full-service, low-cost, regional, non-scheduled and airline-within-airline business models.

Key concepts

• Positioning School: The strategic management approach that links a firm's success to the structure of the industry and the position it takes against competitors.
• Strategic planning approach: The approach that sees strategy as the product of a long-term formal planning process.
• Extended competition: The sum of direct (existing rivals), indirect (substitute products) and potential (new entrants) competition.
• Five forces model: The model that analyzes competition in an industry through existing rivals, suppliers, buyers, new entrants and substitute products.
• Threat of substitute products: The likelihood that other modes of transport will attract airline demand; particularly evident over short distances.
• Cost leadership: The strategy based on operating at a lower cost than competitors and selling at below-average prices.
• Differentiation: The strategy based on distinguishing the product from similar ones and offering it at a higher price.
• Focus: The strategy based on concentrating on a single activity or a narrow market segment.
• Entry barrier: A factor that makes it harder for new firms to enter a market (such as high frequency, frequent flyer programs, high investment requirements).
• Stuck in the middle: The situation of a company that cannot clearly implement any of the generic strategies.
• Hub-and-spoke network structure: The network structure in which passengers are gathered at a hub airport and distributed from there to spoke points.
• Airline business model: The structure that shows how an airline operates and how it creates value for its stakeholders; the firm's realized strategy.
• Airline within airline: A low-cost airline established by a full-service airline as its subsidiary.

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Sources used:
Gerede, E. (2016). Havayolu işletmelerinin sınıflandırılması ve konumlanmaları [Classification and positioning of airlines]. In E. Gerede and A. E. Demirci (Eds.), Havayolu Yönetimi [Airline Management] (Unit 2). Eskişehir: Anadolu Üniversitesi Yayınları.

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