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