Porter's Five Forces Analysis on Aviation Industry

Table of Contents

Introduction.......................................................................................................................................3

Main Aspects of Porter’s Five Forces Analysis...................................................................................4

Force 1: The Degree of Rivalry...........................................................................................................4

Force 2: The Threat of Entry..............................................................................................................4

Force 3: The Threat of Substitutes.....................................................................................................5

Force 4: Buyer Power........................................................................................................................5

Force 5: Supplier Power.....................................................................................................................6

Limitations of Porter’s Five Force Model...........................................................................................6

The Airline Industry...............................................................................................................................8

Overview...........................................................................................................................................8

Sector structure/Market size.............................................................................................................8

Growth..............................................................................................................................................8

MICHAEL PORTER’S FIVE FORCES......................................................................................................9

THREAT OF NEW ENTRANTS..........................................................................................................9

POWER OF BUYERS........................................................................................................................9

POWER OF SUPPLIERS.................................................................................................................10

AVAILABILITY OF SUBSTITUTES....................................................................................................10

POWER OF COMPETITORS...........................................................................................................10

Road Ahead.....................................................................................................................................11

PORTER’S FIVE FORCES

Introduction

There is continuing interest in the study of the forces that impact on an organisation, particularly

those that can be harnessed to provide competitive advantage. The ideas and models which

emerged during the period from 1979 to the mid-1980s (Porter, 1998) were based on the idea

that competitive advantage came from the ability to earn a return on investment that was better

than the average for the industry sector (Thurl by, 1998).As Porter's 5 Forces analysis deals with

factors outside an industry that influence the nature of competition within it, the forces inside the

industry (microenvironment) that influence the way in which firms compete, and so the industry’s

likely profitability is conducted in Porter’s five forces model. A business has to understand the

dynamics of its industries and markets in order to compete effectively in the marketplace. Porter

defined the forces which drive competition, contending that the competitive environment is

created by the interaction of five different forces acting on a business. In addition to rivalry among

existing firms and the threat of new entrants into the market, there are also the forces

of supplier power, the power of the buyers, and the threat of substitute products or services.

Porter suggested that the intensity of competition is determined by the relative strengths of these

forces.

Main Aspects of Porter’s Five Forces Analysis

The original competitive forces model, as proposed by Porter, identified five forces which would

impact on an organization’s behaviour in a competitive market. These include the following:

The rivalry between existing sellers in the market.

The power exerted by the customers in the market.

The impact of the suppliers on the sellers.

The potential threat of new sellers entering the market.

The threat of substitute products becoming available in the market.

Understanding the nature of each of these forces gives organizations the necessary insights to

enable them to formulate the appropriate strategies to be successful in their market (Thurl by,

1998).

Force 1: The Degree of Rivalry

The intensity of rivalry, which is the most obvious of the five forces in an industry, helps determine

the extent to which the value created by an industry will be dissipated through head-to-head

competition. The most valuable contribution of Porter's “five forces” framework in this issue may

be its suggestion that rivalry, while important, is only one of several forces that determine industry

attractiveness.

This force is located at the centre of the diagram;

Is most likely to be high in those industries where there is a threat of substitute products;

and existing power of suppliers and buyers in the market.

Force 2: The Threat of Entry 

Both potential and existing competitors influence average industry profitability. The threat of new

entrants is usually based on the market entry barriers. They can take diverse forms and are used to

prevent an influx of firms into an industry whenever profits, adjusted for the cost of capital, rise

above zero. In contrast, entry barriers exist whenever it is difficult or not economically feasible for

an outsider to replicate the incumbents’ position (Porter, 1980b; Sanderson, 1998) The most

common forms of entry barriers, except intrinsic physical or legal obstacles, are as follows:

Economies of scale: for example, benefits associated with bulk purchasing;

Cost of entry: for example, investment into technology;

Distribution channels: for example, ease of access for competitors;

Cost advantages not related to the size of the company: for example, contacts and

expertise;

Government legislations: for example, introduction of new laws might weaken company’s

competitive position;

Differentiation: for example, a certain brand that cannot be copied .

Force 3: The Threat of Substitutes 

The threat that substitute products pose to an industry's profitability depends on the relative price-

to-performance ratios of the different types of products or services to which customers can turn to

satisfy the same basic need. The threat of substitution is also affected by switching costs – that is,

the costs in areas such as retraining, retooling and redesigning that are incurred when a customer

switches to a different type of product or service. It also involves:

Product-for-product substitution (email for mail, fax); is based on the substitution of need;

Generic substitution (Video suppliers compete with travel companies);

Substitution that relates to something that people can do without (cigarettes, alcohol).

Force 4: Buyer Power 

Buyer power is one of the two horizontal forces that influence the appropriation of the value

created by an industry (refer to the diagram). The most important determinants of buyer power

are the size and the concentration of customers. Other factors are the extent to which the buyers

are informed and the concentration or differentiation of the competitors. Kippenberger (1998)

states that it is often useful to distinguish potential buyer power from the buyer's willingness or

incentive to use that power, willingness that derives mainly from the “risk of failure” associated

with a product's use.

This force is relatively high where there a few, large players in the market, as it is the case

with retailers an grocery stores;

Present where there is a large number of undifferentiated, small suppliers, such as small

farming businesses supplying large grocery companies;

Low cost of switching between suppliers, such as from one fleet supplier of trucks to

another.

Force 5: Supplier Power 

Supplier power is a mirror image of the buyer power. As a result, the analysis of supplier power

typically focuses first on the relative size and concentration of suppliers relative to industry

participants and second on the degree of differentiation in the inputs supplied. The ability to

charge customers different prices in line with differences in the value created for each of those

buyers usually indicates that the market is characterized by high supplier power and at the same

time by low buyer power (Porter, 1998). Bargaining power of suppliers exists in the following

situations:

Where the switching costs are high (switching from one Internet provider to another);

High power of brands (McDonalds, Jet Airways, Tesco);

Possibility of forward integration of suppliers (Brewers buying bars);

Fragmentation of customers (not in clusters) with a limited bargaining power

(Gas/Petrol stations in remote places).

The nature of competition in an industry is strongly affected by the suggested five forces. The

stronger the power of buyers and suppliers, and the stronger the threats of entry and substitution,

the more intense competition is likely to be within the industry. However, these five factors are not

the only ones that determine how firms in an industry will compete – the structure of the industry

itself may play an important role. Indeed, the whole five-forces framework is based on an

economic theory know as the “Structure-Conduct-Performance” (SCP) model: the structure of an

industry determines organizations’ competitive behaviour (conduct), which in turn determines

their profitability (performance). In concentrated industries, according to this model, organizations

would be expected to compete less fiercely, and make higher profits, than in fragmented ones.

However, as Haberberg and Rieple (2001) state, the histories and cultures of the firms in the

industry also play a very important role in shaping competitive behaviour, and the predictions of

the SCP model need to be modified accordingly.

Limitations of Porter’s Five Force Model

Porter’s model is a strategic tool used to identify whether new products, services or businesses

have the potential to be profitable. However it can also be very illuminating when used to

understand the balance of power in other situations.

Porter argues that five forces determine the profitability of an industry. At the heart of industry

are rivals and their competitive strategies linked to, for example, pricing oradvertising; but, he

contends, it is important to look beyond one’s immediate competitors as there are other

determinates of profitability. Specifically, there might be competition from substitute products or

services. These alternatives may be perceived as substitutes by buyers even though they are part

of a different industry. An example would be plastic bottles, glass bottles, and cans for

packaging soft drinks. There may also be the potential threat of new entrants, although some

competitors will see this as an opportunity to strengthen their position in the market by ensuring,

as far as they can, customer loyalty. Finally, it is important to appreciate that companies purchase

from suppliers and sell to buyers. If they are powerful they are in a position to bargain profits away

through reduced margins, by forcing either cost increases or price decreases. This relates to the

strategic option of vertical integration, when the company acquires, or merges with, a supplier or

customer and thereby gains greater control over the chain of activities which leads from basic

materials through to final consumption (Luffman and et al., 1996; Wheelen and Hunger, 1998).

It is important to be aware that this model has further limitations in today's market environment;

as it assumes relatively static market structures. Based originally on the economic situation in the

eighties with its strong competition and relatively stable market structures, it is not able to take

into account new business models and the dynamism of the industries, such as

technological innovations and dynamic market entrants from start-ups that will completely change

business models within short times. For instance, the computer and software industry is often

considered as being highly competitive. The industry structure is constantly being revolutionized

by innovation that indicates Five Forces model being of limited value since it represents no more

than snapshots of a moving picture. Therefore, it is not advisable to develop a strategy solely on

the basis of Porter’s models (Kippenberger, 1998; Haberberg and Rieple, 2001), but to examine it

in addition to other strategic frameworks of SWOT and PEST analysis.

Nevertheless, that does not mean that Porters theories became invalid. What needs to be done is

to adopt the model with the knowledge of its limitations and to use it as part of a larger

framework of management tools, techniques and theories. This approach, however, is advisable

for the application of every business model .

The Airline Industry

OverviewThe birth of civil aviation in India began happened on Feb 18, 1911 when Henri Piquet flew a

Humber biplane. In 1932, JRD Tata, a visionary launches India’s first scheduled airline, Tata Airline

and also piloted its first inaugural fight. In early 1948, a joint sector company, Air India International

Ltd. was established by the Government of India and Air India (earlier Tata Airline)with a capital of Rs

2 crore and a fleet of three Lockheed constellation aircraft. The joint venture was headed by J.R.D.

Tata. After the Second World War as many as eleven private domestic airlines operated in India. The

supply-demand was not in balance as the Indian aviation market was still in a fledgling state. Many

of these airlines were making heavy losses as a result of which the government decided to

nationalize the airlines by forming one domestic carrier and one international flag carrier. In 1953

Air-India International (name truncated to Air-India in1962) became a public sector corporation

along with Indian Airlines Corporation(catering to domestic and regional routes). Eight erstwhile

private airlines were merged to form Indian Airlines Corp., namely Deccan Airways, Bharat Airways,

Air India, Himalayan Aviation, Kalinga Airlines, Indian National Airways, Air Services of India and Air-

Services India. The fleet was fairly big consisting of 73 DC-3 Dakotas, 12 Vikings, 3 DC-4s and some

other smaller aircraft.

Sector structure/Market sizeThe Indian aviation industry is one of the fastest growing aviation industries in the world. The

government's open sky policy has led to many overseas players entering the market and the industry

has been growing both in terms of players and number of aircrafts. Today, private airlines account

for around 75 per cent share of the domestic aviation market. India is the 9th largest aviation market

in the world. According to the Ministry of Civil Aviation, around 29.8 million passengers travelled

to/from India during 2008, an increase of 30 percent on previous year. It is predicted that

international passengers will grow up to 50 million by2015. Further, due to enhanced opportunities

and international connectivity, 69 foreign airlines from 49 countries are flying into India.

Growth The Indian Civil Aviation market grew at a compound annual growth rate (CAGR) of 18 per cent, and

was worth US$ 5.6 billion in 2008. Airlines recorded a double-digit growth in air traffic in August

2009, according to data released by the industry regulator Directorate General of Civil Aviation

(DGCA).Domestic airlines flew 3.67 million passengers in August 2009, as against 2.92 million in the

corresponding period last year i.e. an increase of 26 per cent. The Centre for Asia Pacific Aviation

(CAPA) forecasted that domestic traffic will increase by 25per cent to 30 per cent till 2010 and

international traffic growth by 15 per cent, taking the total market to more than 100 million

passengers by 2010.By 2020, Indian airports are expected to handle more than 100 million

passengers including 60million domestic passengers and around 3.4 million tonnes of cargo per

annum. Moreover, significant measures to propel growth in the civil aviation sector are on the anvil.

The government plans to invest US$ 9 billion to modernize existing airports by 2010. The

government is also planning to develop around 300 unused airstrips. India ranks fourth after US,

China and Japan in terms of domestic passengers volume. The number of domestic flights grew by

69 per cent from 2005 to 2008. The domestic aviation sector is expected to grow at a rate of 9-10

per cent to reach a level of 150-180 million passengers by 2020.The industry witnessed an annual

growth of 12.8 per cent during the last 5 years in the international cargo handled at all Indian

airports. The airports handled a total of 1020.9thousand metric tonnes of international cargo in

2006-07.

MICHAEL PORTER’S FIVE FORCESMichael Porter’s five forces model has been used as a framework to analyze the Indian airline

industry and its attractiveness to new and existing players.

THREAT OF NEW ENTRANTS Huge capital requirement: Capitalization of minimum Rs.30Cr without which it is not allowed

to takeoff.

Expected retaliation: market is concentrated in the hands of a few players thus any new

player would to face stiff competition.

Legislation or government action: along with the equity restrictions for floating an airline

they also compel the airlines to operate on uneconomical routes.

Inadequate airport infrastructure: difficult for the existing airlines to function smoothly and

thus deters new ones Shortage of pilots and high fuel costs

Exit barriers

POWER OF BUYERS General Indian traveller is extremely value conscious.

Growing awareness has increased expectations for punctuality, safety and service.

Minimal switching cost and alternatives available.

No differentiation among the players in the same segment e.g. the differences between Air

Deccan and Spice Jet is minimal.

Transparent Web based comparisons in fare structures are available which increases the

power of the customer to choose the best deal.

POWER OF SUPPLIERS Two major critical suppliers:

I. High fuel costs-Fuel accounts for nearly 35% of the total cost and the cost of fuel is

increasing rapidly posing a threat to the company's profits.

II. Aircraft suppliers enjoy in a duopoly and fiercely control their market shares.

Acute shortage of pilots which makes the industry dependent on them.

Forward integration: airlines also face a threat of forward integration as the suppliers have

or know about most or the technical aspects of the industry .

Airbus and Boeing have two radically diverse views on the future needs of civil aviation and

this is reflected in their new product developments. Boeing has focused on medium capacity

long haul aircraft (expecting that demand will grow for smaller aircraft that can fly more

frequently offering a wide choice of departures in flight schedules). Airbus has made huge

investments in the A380 which is its new large capacity-long range super jumbo (expecting

that demand will grow for larger more fuel efficient and luxurious aircraft that can

accommodate more people per flight)

AVAILABILITY OF SUBSTITUTES Product for product substitution-Consumers have various options in terms of airlines to

choose from. They may also switch to other modes of transport such as road and rail.

Substitution for need-With the advent of technology options such as video conferencing and

conference calls reduces the need to travel thus the option of substitution of need in

present but it is marginal as it is not possible to totally do away with travelling.

POWER OF COMPETITORS Intense Competition amongst low cost airlines and the full service airlines. Apex fare sand

promotional schemes offered by all the full service carriers, offering prices at low error

similar to the low cost ticket fares are a tremendous competitive force.

Entry of additional players.

Mergers and acquisitions take place here too which increases competitive rivalry between

airlines.

Low level of differentiation between the services offered by the different airlines increases

the risk of switching.

High fixed costs and input constraints also add to the competitive pressures in the industry.

Road Ahead The Indian aviation sector is likely to see clear skies ahead in the years to come.

Passenger traffic is projected to grow at a CAGR of over 15 per cent in the next 5 years.

The Vision 2020 statement announced by the Ministry of Civil Aviation, envisages creating

infrastructure to handle 280 million passengers by 2020.

Investment opportunities of US$ 110 billion envisaged up to 2020 with US$ 80 billion in new

aircraft and US$ 30 billion in development of airport infrastructure.

Associated areas such as maintenance repair and overhaul (MRO) and training offer high

investment potential. A report by Ernst & Young says the MRO category in the aviation

sector can absorb up to US$ 120 billion worth of investments by 2020.

Aerospace major Boeing forecasts that the Indian market will require 1,000 commercial jets in the

next 20 years, which will represent over 3 per cent of Boeing Commercial Airplanes’ forecasted

market worldwide. This makes India a US$ 100 billion market in 20 years.