Porter's Five Forces Analysis on Aviation Industry

Table of Contents
Introduction ........................................................................................................................................ 3 Main Aspects of Porters 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 Porters Five Force Model ............................................................................................ 6 The Airline Industry ................................................................................................................................. 8 Overview ............................................................................................................................................. 8 Sector structure/Market size .............................................................................................................. 8 Growth ................................................................................................................................................ 8 MICHAEL PORTERS 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

PORTERS 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 industrys likely profitability is conducted in Porters 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 Porters Five Forces Analysis

The original competitive forces model, as proposed by Porter, identified five forces which would impact on an organizations 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 companys 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 priceto-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 Porters Five Force Model

Porters 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 ones 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 Porters 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

Overview
The 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 Indias 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 AirServices 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 size

The 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 PORTERS FIVE FORCES

Michael Porters 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.