OIl Refinery...again....Vertical Integration

http://www.bloomberg.com/news/2012-04-19/delta-s-oil-refinery-plan-flies-against-economic-sense.html

Delta Airlines acquired a Philadelphia refinery in hopes of saving over $200 million a year in fuel costs but it could prove costly. This is a huge risk for the company. The article above also describes a scenario where Delta would have to choose between selling high priced fuel to their competitors and cancelling flights, vice using the high priced fuel for its self. 

The more I read about this vertical integration move, the more I become wary of this strategy. I feel that an airline has no business owning a refinery. It seems silly and I find it hard to believe that they will be able to refine oil better than an oil company.

I also feel that the hierarchal costs associated with owning a refinery will be astronomical. There is just so much more red tape and administration because the two different hierarchies really have nothing in common with each other; the efficiency factor is going to be extremely low.

However, I do see why Delta did this. Page 282 talks about vertically integrating into areas where the firm already posses a competitive advantage. Delta doesn’t really have a competitive advantage per-se, but they are currently making larger profits and conducting business more efficiently than the other guys. Buying a refinery will give Delta the competitive advantage to really pull away from their competitors.

Owning a refinery for yourself is also rare, valuable, and costly to imitate. Delta will have the competitive advantage for quit some time until another airlines decides to follow suit. I would image that other airlines are banking on Delta failing and will not follow their lead.

Overall, this doesn’t seem like a great idea. There seems to be more risk than reward. However, because there is so much risk, there is also more reward. If this works, it will payoff it in the end. 

Tacit Collusion

The link below is a great article about the recent merger between American Airlines and U.S. Airways and how there are just three major domestic and international airlines left in the US.

The Airlines argue that the recent merger is good for business but any business expert will tell you that it is now easier than ever to partake in tacit collusion.

Tacit Collusion: Circumstance where two companies agree upon a certain strategy without puttin it in writing or spelling out the strategy explicitly.

The article has a really good analogy about the competition and tacit collusion, “It’s not illegal. But it’s like having a few big people in a small boat. Anyone’s decisions tie you all together.” Tacit collusion is already happening the airline industry. It seems that as soon as one airline adopts a new fee for traveling, the other major airlines immediately follow suit. There really isn't any competitive advantage over one airline and the airlines know that. They are all cooperating with each other and sharing a piece of the pie rather than trying to destroy the competition. Waging war on each other would be too costly for the industry and they are in no position to wage war because they are finally starting to make a decent profit by working together. 

South West is really the only major airline that is attempting to operate on cost leadership and product differentiation, as they are normally cheaper than the their competitors and do not offer baggage fees. South West does not serve international routes though. 

Airline Consolidation: Tacit Collusion

Airline Product Differentiation

This is a really good article about Delta airlines trying to differentiate themselves from other airlines and partnering with other travel corporations like hotels and car rentals.

Delta Airlines wants to further their retail product by customized the travel experience to the traveler. Delta Airlines has a wealth of knowledge that could be useful in customize the travelers experience. Addresses, type of traveler, married/not married, etc... could be used to market partnership services to the traveler. The article talks about only giving hotel offers to that have overnight flights and offering deals to "day trippers."

Knowing information about a passenger and customizing deals that are tailored to that individual's needs will allow the customer to be better satisfied with the airline and the other company. This is a win win for both companies.

It wont be long before other companies copy this strategy and the differentiation will be eliminated. Excess profits will also disappear. The real question is whether or not this strategy will actually cause a differentiation enough for a passenger to chose Delta over cheaper substitutes.

Datalex and Delta AIr LInes Retail Strategy

Airline Identity Crisis

The 4 major airlines have a real problem on their hands when it comes to having an identity. No one can really tell one apart from the other based on how they interact with their customers. The average person will chose their flight based on who ever has the cheapest flight available. This is how the 4 major airlines are competing, low cost low quality.

These larger airlines don't have an identity and are riddled with massive amounts of bureaucracy and management which significantly already cut into their profits. These airlines are teetering on the edge of entering into the diseconomies of scale region.

The smaller airlines are getting the job done fast and better than the bigger guys. Southwest airlines allows its employees to be creative and to have fun with their job. They let them be funny. Southwest has a reputation to be fun, young, different, and low cost. If you had the choice to fly Delta or Southwest, what would you chose?

http://management.fortune.cnn.com/2012/02/17/the-real-threat-facing-the-airlines/
http://usatoday30.usatoday.com/travel/flights/2009-11-10-airshuffle10_CV_N.htm

Human Capital

I can relate almost everything in this chapter to Delta's oil refinery acquisition but I don't want to beat a dead dog.

This week I am going to talk about the recent American Airways and U.S. Airways merger that was voted on last week. The $11 billion merger creates the world's largest airline. The U.S. now only has 4 major carriers. The biggest difference between Delta and the other three is that Delta made a billion dollars and the new merger would have lost $1.2 billion.

Delta is clearly doing something right is in their human capital department. This may be there greatest resource. Their employees and management are doing something right because they are one of the only airlines that made a decent profit last year. According to Yahoo Finance, Delta took in .5 billion less than United but somehow made $1.7 billion more in net income. The leadership at Delta is making the right decisions for the company.

The employees are even above the cut when it comes to the other 5 big airlines in 2011. Delta ranked the best when it came to customer satisfaction, baggage handling, on-time arrivals, and involuntary denied boardings.

Side Note: The refinery acquisition concerns me a little because refining oil is not their core competency.

Delta also has the largest market cap, operating margin, and earnings per share.



http://www.pbs.org/newshour/rundown/2013/02/american-airlines-us-airways-merger-by-the-numbers.html
http://finapps.forbes.com/finapps/jsp/finance/compinfo/IncomeStatement.jsp?tkr=DAL
http://travel.usnews.com/features/Americas_Meanest_Airlines_2012/

Previous Post May not be 100% Correct

According to the article below, airline mergers don't significantly affect flight prices and competition. It appears that having only 6 or 7 major airlines is enough to prevent the industry from price gouging and becoming an oligopoly.

http://www.usatoday.com/story/travel/flights/2012/12/13/airlines-merger-fares/1767647/

Delta: Airline Monopoly & Oligopoly

Delta Airlines recently acquired a 49% stake in Virgin Airlines which now allows Delta to delete & merge flights from NY to London. The deal in the merger was that Delta and Virgin Airlines would share costs and revenues on transatlantic routes. This works out well for both companies because the companies can legally share pricing strategies and slowly hike the fares up. Even though they are two entirely different companies, they are essentially the same company when it comes to pricing.

The US airline industry is an Oligopoly because there are only 6 major airlines in the US. (US Air, American, South West, Delta, Jet Blue and United. It is also extremely costly to enter and exit the industry. To add to the Oligopoly, most airports only service a couple of these airlines (Memphis). This creates a service and price monopoly on the airport location.

Essentially, the airline industry is a monopoly inside of an oligopoly. Unless you happen to live in Philadelphia, New York, Chicago, Atlanta, Dallas, Charlotte, LA, etc...


http://www.nbcnews.com/business/delta-air-lines-buys-49-stake-virgin-atlantic-1C7546210
http://www.bizjournals.com/memphis/blog/memphis-in-motion/2013/01/nate-silver-calls-out-memphis-airfares.html

Delta's Risk & Performancet: Can performance be predicted?

Can a firms performance be predicted two years out to earn a premium return? The following article points to an overwhelmingly "NO."...

"In calculating Delta's 2 year expected market return, we'll be utilizing the Capital Asset Pricing Model. We're utilizing the following assumptions: Beta of 0.7 (eTrade), risk-free rate of 0.62% (2-year note on June, 2010), and a 2-year market return of 33.1% (S&P 500). By the CAPM method Delta's expected rate of return should be:

1.24% + 0.7(33.1%-1.24%) = 23.54%

We can conclude that Delta's expected 2-year return since June, 2010, as calculated by the capital asset pricing model, should have been 23.54%.

Actual Returns

Historically, Delta hasn't issued dividends, making the only gain from the investment through capital gains. Had an investor invested 24 months ago, they would have lost 6.1%. These figures exclude devaluation from inflation, which represents an even steeper loss."

This article proves that methods of predicted performance are only as good as the data that is put into the CAPM equation, and that the CAPM has some fundamental flaws in the equation. The most basic flaw is the Beta. The Beta is already hard to determine and if it is not accurate the final number will be off. 

In the case of Delta airlines between 2007 and 2009, systematic risk was too large and unpredictable due to the recession. This caused a -6% loss for the stock. This just shows that you can not diversify systematic risk. 

http://seekingalpha.com/article/702221-airline-industry-focus-on-delta-part-2
http://www.investopedia.com/articles/06/capm.asp#axzz2JKRZULnd

Delta Airlines Vertical Integration Strategy

Delta Airlines is attempting to do something that no other airline has done before. Delta is attempting to vertically integrate the jet fuel industry with its airline company. Delta recently bought an idled oil refinery in Philadelphia for $150 million in early 2012 and has since spent $100 million in improvements necessary to make the jet fuel to fly its airplanes. This move is the first of its kind and is expected to save the company $300 million a year (2013) in fuel costs while supplying 80% of the company's jet fuel requirement. This equates to approximately 7 cents a gallon.

Delta has also played with the idea of buying crude oil in North and South Dakota that is almost $20 cheaper per barrel than the current crude oil being shipped over from the North Sea and Norther Africa.  This is a big deal when you factor in their 12 billion dollar bill for jet fuel in 2011.

These two strategies will combined to save the company over $300 million a year and bring the company to the forefront of how aviation business is done. They are in unproven and uncharted territory but the $250 million isn't much when compared to their 2011 net income of $1 billion.

There is a lot of controversy with this strategy considering it is so new and unconventional for the airline industry. A lot of pundits are skeptical because Delta specializes in flight, not crude oil refining.

Personally, I think this is a radically new strategy for an airline and I think that this strategy will catch on if it works. It is obviously a big risk and the first person always gets hit in the face when they try something new. I think Delta can pull it off.

http://centreforaviation.com/analysis/deltas-unconventional-fuel-hedging-strategy-to-be-put-to-the-test-as-new-refinery-opens-82467

Delta Airlines: A Brief History

(from Wikipedia)


Delta Airlines was born as Huff Daland Dusters, Incorporated, an aerial crop dusting operation on May 30, 1924, in Macon, Georgia. Formed with a Huff-Daland Duster, the first true crop duster, the plane was deployed to combat the boll weevil in 1925 and was nicknamed "The Puffer" due to the clouds of white pesticides it emitted. Delta Air Corporation owned the plane (now in the Southern Museum of Flight). The company moved to Monroe in Ouachita Parish in northeastern Louisiana, in 1925, and began carrying passengers in late 1929. The single passengers sat in a chair placed in the bin where the pesticide was usually kept. The first routes were from one Southeastern state to another. Collett E. Woolman purchased the company on September 13, 1928, and renamed it Delta Air Service, with headquarters in Monroe.[12]


Delta grew through the addition of routes and the acquisition of other airlines; it replaced propeller planes with jets in the 1960s and entered international competition to Europe in the 1970s and across the Pacific in the 1980s. The company logo of Delta Air Lines, reminiscent of the swept-wing design of the DC-8 airplanes, consists of two 3D triangles.[13]




The current Delta Air Lines is the result of many airline mergers over the past 80+ years. The most recent merger was with Northwest Airlines on October 29, 2008 and at the time formed the world's largest airline. After approval of the merger, Northwest continued to operate as a wholly owned subsidiary of Delta until December 31, 2009 when both carriers' operating certificates were merged (the Delta certificate survived).[14] Delta completed the integration with Northwest on January 31, 2010 when their reservation systems and websites were combined, and the Northwest Airlines name and brand were officially retired.[15]


Predecessor carriers forming the current Delta Air Lines include:


• Chicago and Southern Air Lines (formed in 1933, merged into Delta in 1953).[12] Delta flew under the carrier name of Delta-C&S for the following two years.[16]


• Northeast Airlines (formed in 1931, merged into Delta in August 1972)[12][17]


• Northwest Airlines (formed in 1926, merged into Delta in 2010. Also known as Northwest Orient Airlines from 1950-1989)


◦ Republic Airlines (formed in 1979, merged into Northwest Airlines in 1986)


▪ Hughes Airwest (formed in 1968 as Air West, name change to Hughes Airwest in 1970, merged into Republic Airlines in 1980)


▪ Bonanza Air Lines (formed in 1945, merged into Hughes Airwest (Air West) in 1968)


▪ Pacific Air Lines (formed in 1941, merged into Hughes Airwest (Air West) in 1968)


▪ West Coast Airlines (formed in 1941, merged into Hughes Airwest (Air West) in 1968)


▪ North Central Airlines (formed in 1946, merged into Republic Airlines in 1979)


▪ Southern Airways (formed in 1944, merged into Republic Airlines in 1979)


• Pan American World Airways (formed in 1927, portions of which were merged into Delta in 1991)


◦ Atlantic, Gulf, and Caribbean Airways (formed in 1927, merged into Pan American World Airways in 1928)


◦ American Overseas Airlines (formed in 1937, merged into Pan American World Airways in 1950)


◦ Aviation Corporation of the Americas/American International Airways (formed in 1926, merged into Pan American World Airways in 1928)


◦ National Airlines (formed in 1934, merged into Pan American World Airways in 1980)


• Western Airlines (formed in 1925, merged into Delta in 1987)


◦ Standard Air Lines (formed in 1927, merged into Western Airlines in 1930)