Valujet Essay, Research Paper

The airline industry has been subject of intense price competition since it was deregulated, and the

result has been a number of new carriers which specialize in regional service and no-frills operations.

These carriers typically purchase older aircraft and often operate outside the industry-wide computerized

reservations system. In exchange for these inconveniences, passengers receive low fares relative to the

industry as a whole. This research examines two low fare air carriers, ValuJet and Southwest Airlines.

By investigating these air carriers, we can better understand the economic impacts of price versus

service in the airline industry as a whole, as well as, the impacts on passenger and investor confidence.

Until 1978, air transport rates were approved by the government, which meant that price was not a primary

competitive factor. Instead, airlines would compete on service and image. The airline industry was

dominated by giants (American, United, TWA) which offered nationwide and some international service, and

by regional carriers, such as Southwest, which offered short trips between airports not served by the

nationals.

Deregulation of the airline industry brought about in 1978 introduced a situation in which the

national and regional carriers were suddenly able to compete in an environment that resembled a free

market. Rate schedules were lifted, price fixing was eliminated and route management was removed. The

main factors that affected whether an airline could serve a particular city was whether or not that city

had enough gates for the new carrier, and whether the carrier was able to afford to purchase them.

Companies such as Southwest recognized potential for low fares, and began building a niche for themselves

by offering low fares with equivalent low levels of service. Southwest’s success gave rise to a new

generation of low fare airlines, with ValuJet entering the market in the early 1990’s. Unfortunately,

ValuJet suffered a string of accidents which brought the future of this air carrier into question.

ValuJet is a low-priced airline that offers inexpensive tickets for regional travel. Based in Atlanta,

the airline serves the Southeastern United States and competes with Continental Airlines as well as with

other small regional carriers. It serves 31 cities primarily in the southeastern United States. The

airline began its service with flights to Tampa and Orlando from Atlanta in 1993. The no-frills strategy

paid off for the fledgling airline, which posted half again as many revenue passenger miles in April 1996

as it did in April 1995. However, the company announced that it was slowing the expansion of its

services, voluntarily, at the same time that it posted this impressive revenue mark (Cole & Pasztor,

1996, p. A6).

Perhaps due to overexpansion or to poor luck, Valujet experienced a series of mishaps in its short

history. In January 1994, a DC-9 skidded off a runway in Washington which resulted in the entire airport

being shut down. In June 1995, a ValuJet flight went through an emergency evacuation after an engine

failed and shrapnel flew into the cabin. Additional incidents, including one where the landing gear

collapsed after a particularly forceful landing, led the FAA to begin an intense review of ValuJet in

February 1996. This review found that ValuJet was in compliance with FAA regulations, but cited concern

about pilot training and aircraft maintenance (Larson, 1996, p.30).

In May 1996, Valujet flight 592 crashed in the Everglades, killing all aboard and resulting in a shutdown

of the carrier for several months. When ValuJet began flying again, it did so with a reduced schedule,

and considerable speculation about whether the company will be able to continue operations long-term.

The company is also involved in litigation resulting from the crash, and the long-term prospects for the

company are questionable.

The following chart identifies key operating statistics for Southwest (seat miles are in millions, cost

factors are in cents)

(Shammas, 1996, p. 5541P):

199519941993

Revenue Passenger Miles (RPM)2,62494144

Available Seat Miles (ASM)3,8131,47163

Load Factor68.8 %64.0 %69.7 %

Revenue per RPM13.413.813.1

Cost per ASM6.86.89.8

Because Southwest’s flights are generally an hour or less in length, the airline saves money by not

having to serve meals. It has a liberal work rule arrangement with its unions, so productivity is high,

and overall costs are low. For example, Southwest gets 672 hours per year on average from pilots versus

371 for American Airlines pilots, and 60 percent more passenger miles per flight attendant (Levinson,

1993, p. 34). These figures enable the company to realize profits during years in which the industry as

a whole was suffering. The following chart identifies key operating statistics for Southwest (seat miles

are in billions, cost factors are in cents) (Klein, 1996, p. 2077):

199519941993

Revenue Passenger Miles (RPM)23.3321.6118.83

Available Seat Miles (ASM)36.1832.1227.51

Revenue per RPM11.8311.5611.77

Cost per ASM7.077.087.25

In addition, the company has a 70 percent average load factor in an industry that averages 63 percent,

and operating costs per passenger mile are 22 percent less than industry average. It has one of the

youngest fleets in the industry (6.9 years compared with an industry average of 12.9 in 1992), and the

best on-time and baggage handling records in 1992 (Gold, 1993, p. 29). Each of these factors

contributes to the company’s financial and marketing success.

Southwest’s success has come about because it is providing a product that the market wants, no-frills

regional air travel, at a price that is attractive. Despite its no-frills orientation, the company

maintains strong customer service satisfaction and high levels of customer service, encouraging repeat

business. When the airline enters a new market, such as Baltimore, its fares are as much as 85 percent

less than those of its higher-priced competitors, attracting passengers quickly and forcing the

competition to either match the price or lose market share. In its target markets, Southwest has

positioned itself to even compete favorably with traveling by car (Thorpe, 1996, p. 262).

Southwest’s success has not been without problem, and the company has again demonstrated an ability to

find creative solutions to those problems. For example, the company has traditionally expanded its 737

fleet by adding older aircraft available at discounts (sometimes as much as 30 percent) (Kripanlani,

1992, p. 20). Since the company’s ability to enter new markets is determined in part by the size of its

fleet, and since the company is committed to staying with homogenous fleet of 737s, it runs the risk of

ending up with a large number of older aircraft that it no longer needed (depending on the market), or

that do not meet new environmental standards.

Southwest solved this problem by beginning a lease-back program in 1988. Under the program, Southwest

sells some of its older 737s, then leases them back for its own use. As of the beginning of 1992, the

company had done this with more than half of the Boeing 737-200 aircraft that it operated (Brown, 1992,

p.57). This program enables the company to release aircraft that it no longer needs or that no longer

meet the stringent new environmental standards. At the same time, the company can modify its remaining

737-200s in order to make them compatible with noise and pollution regulations if it needs the capacity.

The company’s stock has split three times since 1990, and its price-earnings ratio is a healthy 13.1

percent. Its load factor is well within the industry norm of 67 percent (Sanborn, 1996, p. 251), and the

company’s commitment low fares and its safety record should help it maintain good performance even in

light of the ValuJet crash (which brought increased attention to all low fare carriers).

The crash of Flight 592 has brought increased scrutiny to ValuJet (and to low-fare carriers in general),

and the long-term effect on ValuJet is not yet known. The stock, which had two, two-for-one splits in

1995 and which peaked at more than 30 dollars per share in late 1995, has plummeted to below 12 dollars

per share in late 1996. Investors with high tolerance of risk might consider the stock at this low

level, and the company might be a takeover target in the future as other carriers seek its routes.

However, the company’s aging aircraft fleet would not be an asset to most carriers, and it is unclear

whether stockholders would realize a reasonable profit, even at today’s low prices.

The outlook for Southwest is considerably brighter than for ValuJet. The company has one of the highest

safety records in the industry, and the company has also benefited from higher ticket prices and

increased passenger traffic. The recent reinstatement of the federal excise tax is not expected to have

a negative effect on Southwest demand since it has indicated it will increase fares in only 20 percent of

its markets, but this will affect profitability. The company’s strategy is to make up the difference of

lower revenue with increased demand through its lower fares (Thorpe, 1996, p. 262).

The airline industry has become one of the most competitive segments of our economy. The economic

realities of operation costs versus passenger demand for cost-effective travel has forever changed the

face of the travel industry. After deregulation in 1978, the airline industry was forced to abandon its

service-oriented philosophy and consider the competitive pressures since they affected the various

companies bottom line. Price had suddenly become the benchmark in the airline industry. Companies such

as Southwest and ValuJet recognized the potential for low fares with commensurably low levels of service.

With the changing paradigms in the airline industry comes risk, not only to the individual

airlines but also the public in general. At what point do the economic pressures of making a profit for

the airlines affect passenger safety? If the trend toward more airline disasters continues and those

accidents can be attributed to cost-cutting measures, surely Congress will intervene. The airline

industry must be disciplined in its approach to solving the economic pressures, while, at the same time

stay focused on safety issues. If the airline industry is to survive and give the consumer choices,

passenger confidence cannot be sacrificed for the sake of the bottom line!