(1) Does Airborne have a competitive advantage or a competitive disadvantage? What explains the performance of Airborne? (20 points)
1 - The Express Mail Industry:
The express mail industry is one that began in the 1960s recent innovations have led it to increase in size and demand. 85% of its market share is held by three major players: Federal Express (or FedEx, around 45%), United Parcel Service (or UPS, around 25%) and Airborne Express (around 16%) (p. 3). The remaining 15% were held by 6 other companies whose main activities are specific to a certain market segment or activity, or outside of the United States. While the three major players have different strategies, they generally aim to cover most of the market. This analysis will focus on Airborne's differentiation.
In order to first determine the attractiveness of the overall industry, I looked at the weighted average return on sales and weighted average return on equity of 85% of it. I justify this choice of only 85% of it by the fact that most of the other major players in the industry did not operate mainly in the US and if they did, did not cover the mass market. Basing the calculations on Exhibits 2, 5 and 6 of the case, I compare the results showcased in 1-A with the average return on equity and return on sales of the US market. The return on equity and return on sales of the US market were steadily averaging around 14% and 6.5% respectively throughout the year 1996 (cf Stern University). As such, while the average return on equity for the express mail industry is the same as that of the US average, that is, 14%, which could indicate that the industry generates high returns for investors, however; the average return on sales is higher than that of the US average - 7.1% compared to 6.5%. This indicates the industry is very efficient in its generation of profit for the players themselves. These facts seem to indicate that the industry is profitable for investors as well as major players.
In order to further investigate that result and find the reasons behind it, I conducted a Porter's five forces analysis, and conclude:
Threat of new entrants - LOW
There is monopoly (p. 3): 85% of the market dominated by 3 companies, and the market is saturated by the total of 9 companies.
It requires large capital investments (p. 3): from hubs, whose production cost at the time could reach $250 million to $860 million, to planes, which could cost $90 million.
Little differentiation potential (p. 2): major services already covered most services and the remaining 15% differentiated geographically.
Threat of buyer power - HIGH
Price sensitive: to the cost of having no brand loyalty (p. 2) or setting price scheme trends like distance-based pricing (p.1,14).
Low switching costs: Most contracts are now on a one-time basis. More regular ones, such as Xerox (p. 2), demand high value from the company they were signing with.
Little differentiation among brands (p. 4)
Threat of substitutes/complements - HIGH
Substitutes: faster, in average $15 cheaper substitutes for letters are emails and facsimile. It is easier to use (at home service) and available to all (p. 4).
Intensity of competition - HIGH
High concentration (p. 4): While the 15% of the market that operates mostly in specific zones is shielded from it, the 85% remaining have most of the market share for the mass and offer very similar services to their customers.
Increasing importance of marketing campaign and price cuts (p. 4, 6, 9).
Threat of supplier power - LOW
Low bargaining power: high propensity to make advantageous deals with aircraft providers and other operational suppliers (p. 3, 6).
High dependency: many of these providers exercise exclusively for the industry and are therefore subject to cost constraints by their customers (p. 3: aircrafts or contractors on p. 13, for example).
As such, the industry is very capital intensive, short-term oriented and demanding in terms of services provided for the lowest price possible, making it a quite unattractive industry to a new entrant. It is nevertheless quite attractive for a mature firm like Airborne, whose performance has been the fastest growing in the past few years (1-Ba) (p. 10-11). Yet, Airborne's margins have been consistently lower than that of its competitors, as can be seen for FedEx in 1-Bb. How come?
II - The strategy of Airborne Express:
I will now analyse whether Airborne exercises a competitive advantage or disadvantage in this industry and how.
WHO: Airborne Express is a company targeting primarily price and time sensitive business customers that regularly shipped large urgent volumes of items and needed a flexible delivery service. While it is also open to other customers, the company is very selective about its accounts and, while willing to adapt their production mode and offering to valuable customers (p. 13), does not hesitate to let go of other customers if inconvenient, such as catalogue companies that had consequent seasonal deliveries (p.11).
WHAT: Airborne Express prioritizes fast delivery to business locations such as metropoles and business hubs. While not having any retail service centres and delivering typically up until 1h30 later than FedEx and UPS, their services were composed of an array of fast deliveries with fixed prices per weight and type of package (Exhibit 8). Concentrating on more afternoon and second deliveries, the price Airborne charges for these services is lower of in average $2.62 or 12%, with the highest difference being for the price of overnight, morning deliveries of 50 lb, for which Airborne charges an average of $7.82 less than its competitors (1-Ca). The costs for each package is also lower than that of its competitors, with an average cost of $7.44 per package compared to $8.96 for UPS and $9.44 for FedEx (1-Cb), or in average 9%. By achieving lower costs than prices, Airborne placed itself as a cost leader in the industry.
HOW: The production chain of Airborne resembles that of its competitors a lot (p. 3): it picks up packages using vans and drives them to their nearest hub, where they deliver it via airplane and/or van. However, Airborne differed from the rest thanks to a “no additional costs” strategy: The explanation for its low cost/package of $7.44 in average (1-Cb) can be found in the fact that Airborne owns its own airport and used 80%-full rehabilitated planes (compared to 65% with competitors) but also tried to cut on non-essential costs, such as labour, was 10% to 20% cheaper than FedEx', marketing and R&D (p. 11-13). Indeed, its delivery service passes through a single hub and is mostly handled by contractors (60% of the drivers' workforce), in average 10% less expensive than company-owned labour (p. 12). It also relies heavily on largely non-unionized part-timers. While having invested a bit in marketing in the last few years as well as updated its technology when necessary (such as its desire to invest in FOCUS but not a fully functional website - p. 12) it still relies very little on both, preferring to make use of the workforce.
From this analysis, it seems safe to say that Airborne holds a cost advantage compared to its competitors (1-Ca, 1-Cb). By reducing costs, Airborne should have been able to grab more of the market share. However, operational cost/revenue is larger of an average of 5% compared to that of its competitors' (1-D) (Exhibit 4,6,7) and its ROS and ROE are both under industry average (1-A) at 8% and 4%. Let us now analyse the internal and external consistency of the firm with its strategy:
Internal consistency: While the Who/What/How showed consistency, a few things should be said about…
Productivity: One explanation to Airborne's operations having a relatively low ROI (1-D) might have to do with productivity. By not having any training for its members and making use of many trucks (p. 12, 13), the company maximised the profits by increasing certain risk factors, as UPS had before (p. 8). This might be due to the fact that they don't own the same technology as other companies. On top of owning from half to a fifth of the competitors' air force (Exhibit 7), Airborne managers make it a company policy to follow the trend and use their competitors as “guinea pigs” (p. 12). While this policy might reduce costs, it can also contribute to loss in margins if the customer has high power, which it does in this industry.
Cost structure: Airborne's cost structure differs from that of its competitors in two ways: its station, maintenance and ground operation costs, as well as transportation purchased, account for a higher proportion of its operational expenses than those of FedEx and UPS (about 80% in 1996) (1-Ea). Indeed, the two latter focus more on Compensation and benefits for employees - from 47% to about 62% (1-Eb). While Airborne had managed to cut costs by not owning part of its delivery vans and cutting costs on labour, the differing cost structure indicates that in 1996, Airborne was still acquiring much of the capital it needed to be able to stay in the industry.
Economies of scale: Compared to competitors, who sent 3 to 12 million parcels a day, Airborne only sent 900,000. Similarly, Airborne was much less present on the territory, only targeting US business and metropolitan zones, whereas UPS and FedEx both covered the whole of the USA, as well as much a greater part of the international market and more assets, such as planes (Exhibit 7). This difference in scale explains the difference in revenue between the three competitors, especially the significant gap between the two “gorillas” (p.1) and Airborne (1-Eb).
Company culture: Airborne's company culture mirrored its brand. Professional and yet simple, it did not encourage loyalty and employed a great part of its workforce as contractors. Following a cost cutting strategy, the offices were modest and practical. This was topped by only half of its workforce being unionized (p. 13). Compared to its competitors, Airborne Express was not able to build a very strong company culture, with no use of internal communication, incentives or trainings, and it is therefore probable that productivity was lost in the workforce's lack of motivation or unity while performing the task (p. 13).
High rivalry between the other companies, which can all match the services provided by Airborne and presented as premium services. In particular, one can think of the 2AM service provided on the hub, which allows urgent delivery to be performed as early as 8AM. This service, available to special accounts, is available to all customers in other companies (p.13), provided they pay a premium.
High entry barriers, which require a lot of capital expenditure. Indeed, while the fixed costs associated with the delivery are more important than variable costs associated with operations, as can be seen in FedEx' letter cost structure (Exhibit 3). As we can see, the biggest expense was related to operations and labour, which both accounted for about a third of costs. While Airborne had reduced costs of labour, increasingly popular substitutes still put pressure on firms' abilities to make a profit in this attractive and yet hard to navigate industry.
Red Ocean strategy due to the intense rivalry. While starting out with a Blue Ocean strategy and targeting only business customers needing large cargo deliveries fast (p. 11), it was now opening up to the mass market and was therefore put in direct comparison with its competitors. Nevertheless, it had not yet adapted its services to that offered by more advanced companies. This scale disadvantage due to its late technological advancement is reflected in its revenue difference (1-F), with Airborne's revenue ranging from a fifth to less than half of its competitors' in 1996 ($2,484mm compared to $5,708mm and 10,274mm).
International outreach: We have only concentrated on the US so far, however Airborne also has a few of its operations abroad. It does not use any of its own planes to operate these, however, and it covers only a small part of its operations - 6% of total assets. Comparably, UPS and FedEx have invested increasingly in the international market (12% and 19%, respectively) (p.13). While this does not bring much profit, it gives additional choices that might draw customers in.
Over time, Airborne has been following a cost advantage strategy whereby it offers lower price products for lower advantages and costs of production, but this has not led it to have a competitive advantage over FedEx and UPS. This is aligned with the industry's expected high capital expenditures involved in the production line. Recently, however, the wind seemed to have turned on the company. We shall discuss its opportunities for growth in the next question.
(2) What is your recommendation for Airborne to improve their performance? Specifically, with regards to distance pricing and strategies to survive and thrive in the industry.
I - The case of distance pricing:
First, this essay will summarize the coverage and position of Airborne within its own industry, in order to understand the rewards associated with as well as the risks stemming from such a policy.
Following a Red Ocean Strategy:
By adapting its prices to the trend of the current competitors, Airborne will continue with its current strategy of following competitive trends only when they are useful to follow (p. 12). As such, customers are making more and more use of substitutes and are less prone to loyalty. By not allowing them to be redirected towards competitors' distance-based deals, Airborne could be able to keep the accounts it currently has as well as capture a greater part of the increasingly growing metropolitan market.
Enjoying higher margins:
Using the current distribution of prices (Exhibit 8), I modelled a possible situation for 5 lb, 10 lb and 50 lb packages of distance-based pricing whereby the price would increase of 5% for every 200 miles. I capped the minimum and maximum prices and stuck to the US region for the purpose of this analysis. This model is not meant to be accurate but to see whether a distance-based pricing considering no additional costs would be profitable for the company. The results (2-A) show that by implementing such a technique on a mere 2,000 miles difference, Airborne could increase its margins by 2% in average. Putting the model through a sensitivity analysis reflects this result more clearly (2-B): as long as the original decrease is not too high (more than 20%), the policy could be profitable of up to 102%.
As a company targeting very price-sensitive customer that need adaptable services, Airborne is more prone to be the subject of criticism for going towards distance-based pricing than any of its two main competitors. Nevertheless, this effect could be countered by ensuring that the price presented to customers is still below that of its two competitors, such as was seen in 1-Cb. This would allow it to maintain its differentiating factor from the “two gorillas” (horizontal differentiation).
Airborne only has one hub and only operates around cities, owns its own airport and also makes more use of its ground force than its competitors. This means that on top of distance from the hub of the pick-up, it might have to include extra charges for long distances from the hub of delivery. While this would help cover the cost of the airport maintenance as well as increase the margin on the delivery themselves, this could become problematic for companies integrated to its airport hub and make use of its 2AM special delivery service for various locations, for example.
Knowing that it operates more afternoon and second-day deliveries for businesses who need services tailored to their needs, distance-based pricing might be a thing to consider but would have to be adapted the constraints of the company's current production chain.
II - Recommendation for a future strategy:
As previously mentioned, Airborne was the fastest growing company in the past several years, with growth averaging at 13% in the past few years (1-Ba). An explanation for this could be found in several factors: its recent collaboration with RPS (p. 13), which allows Airborne to have access to the best information on the market in exchange for its capacities; the UPS strike (in 1997), which led to a temporary increase in the use of other providers' services; and its consistent cost advantage strategy that has allowed it to sustain the heavy capital costs of the industry while having a smaller reach than both of its competitors and not being able to compensate its activity like UPS with another market. One could also think of the leasing of its hub to businesses, which has brought in additional revenue as well as allowed for closer relationships with its customers, such as Xerox or IBM (p. 11) and its unique private foreign trade zone (p. 11), as drivers of diversification and therefore, growth.
This growth is nevertheless threatened by several potential risk factors that could develop in the next few years. First, UPS' strike interrupted their operations for 16 days (p. 10), a loss of about $700 million in revenue and 5% lower shipping activity after the strike. Nevertheless, although they have agreed to very rigid labour terms for their full-time workforce, including having to hire more full-time workers (an increase of 3% of the share of the workforce), they are still relying more on part-time workers (and are expected to retaliate to regain their market share the following year. Secondly, the market seems to be moving in the direction of high price-sensitivity and low loyalty (p. 14), which means that new competitors or renewed ones (such as the Postal Service) might enter the market. Entering into a price or benefits war without having a secondary activity might be fatal for the company. Thirdly, these market movements impact negatively the trend for contract-based orders, Airborne's main source of revenue (p. 11). As such, while continuing with its current cost advantage strategy, I recommend Airborne should also…
> Invest in its labour force and basic benefits: The threat of a UPS-like strike is one that Airborne must consider. Augmenting older employees' salaries of 35% in the next five years (p. 10), as is the case in, would incur higher costs and therefore lower margin on the already low margin company. By investing in labour force training and basic employee benefits more than it currently does (see 2-C), Airborne should be able to decrease the costs of labour while increasing productivity, therefore recouping the investment while decreasing the risk of a strike. As such, Airborne could aim to reach the 99% on-time delivery by 1999, instead of the current 96% (p. 12).
> Invest in awareness for its product offering: Airborne Express is the owner of two unique assets compared to its competitors that it could take advantage of: an airport and a private foreign trade zone. While operating a consumer airport might require too many additional charges, leasing the airport and the warehouse space to other companies (in the industry or not) should be able to cover the costs of new capital investments that are needed, such as $14 million newly acquired Boeing 767 (p. 11). As for its unique private foreign trade zone, we highly recommend investing in marketing directed at the target segment (international companies) to make it an even more attractive asset. This could be done by increasing the marketing budget and could replace an internationalization strategy for the company.
> Collaborate more closely with RPS and develop its technology: RPS is a company that does not cannibalise Airborne's market but holds information on delivery routes that might allow the latter to gain a strategic advantage over FedEx and UPS. By collaborating closely to create an integrated information exchange system for pick-ups and deliveries, Airborne could be gaining in productivity and reach - like FedEx's system, which is being used by 60% of its volume. In order to do that, Airborne would need to invest in technology more than it currently does (1-Ea, 2-C). Fast growing substitutes related to internet also suggest that the importance of technology might be increasing rapidly, and that investing in it might slowly close the gap while ensuring that Airborne won't lose part of its market share to tech-savviness.
As soon as higher growth is achieved, we recommend Airborne invest in extending its geographical area and install a new hub. This would allow it to make use of the distance-based pricing strategy like its competitors. One could finally consider internationalisation. In order for a firm's globalization to make sense, one of the following condition needs to be fulfilled: there needs to be a cost synergy available, it should be about differentiating oneself from competitors, diversifying risk, achieving growth when the home country market is saturated or advantages in the host country. As in the facts previously presented, none of these apply to Airborne Express. What is more, on top of not owning the physical capital to do so (Exhibit 7), when looking at results shown in FedEx statements, we see that the operating margin was negative for the first 7 years - with the lowest at -26% (Exhibit 4). In light of these results as well as Airborne's financial situation, we would therefore recommend against globalization.
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