Delta's New Song Case Analysis From Baidu 4m343f

Case Report: Delta’s New Song Background The entire US airline business is facing the challenge of operating within a low-margin, high-fixed-cost environment. Its profitability is particularly sensitive to decreases in volume, either from environmental factors or from competition. Moreover, the airline business is labor-intensive. Labor costs as a percentage of revenues ranges from a low of about 25 percent for the low-fare airlines to almost 50 percent for the large, full-service airlines such as United. Furthermore, for many airlines, labor unions are strong, presenting an additional challenge in the management of cost. Salaries are largely fixed in the short term for unionized employees. In recent years, some major airlines have won concessions from labor unions about reducing the staff and cutting down salaries. Delta Airline is the third largest U.S. airline in operating revenues and revenue enger miles flown. Traditionally, the competition came from the other full-service airlines such as United Airlines and American Airlines. However, in recent years, the major airlines have been forced to compete with lowcost, no-frill airlines pioneered by Southwest Airlines. Salaries are a significant component of Delta’s cost structure. Delta pilots are the highest paid in the industry. Meanwhile, it is the least unionized of the major airlines. Delta pilots are the only unionized employee group. Its flight attendant and ticket agents are not under union contract. Consequently, their salaries present flexibility and variability in nature. In November 2002, despite its previous failure in entry into the low-fare market, Delta decided to form a new low-cost carrier, Song, which is targeted to compete with successful newcomer JetBlue.

Main Issue How can Delta create a different cost structure and business model in order to succeed in the low-cost carrier market?

Problems Delta is in a position of evaluating entry into the low-cost carrier market. The success of Delta’s Song depends on the following issues:   

Can Delta create a very different cost structure and a new business model to compete with JetBlue? How to predict future salaries of Delta and JetBlue? How to deal with the strong work union?

Analysis 1. High-low method Firstly, we identify some possible cost drivers to estimate Delta’s salaries: available seat miles; available ton miles; number of departures; revenue enger miles; revenue ton miles. After

applying simple regression using each of the possible drivers and comparing R2 and residual errors of each driver, we choose two most reasonable cost drivers: revenue enger miles and available ton miles. The salaries consist of payments to pilots, flight attendants and ticket agents. They are determined not only by the number of engers and cargoes but also the miles or hours flown. In fact, miles and hours are correlated. So we choose revenue enger miles and available ton miles as cost drivers. Revenue enger miles is a major indicator in the airline industry, so it’s reasonable to be a driver. Available ton miles, however, seems not so good. But after calculation we find that R2 of the former is 0.1764, and R2 of the latter is 0.5577. For more obvious comparison, we draw the following scatter plots.

The scatter plot between revenue enger miles and salary

The scatter plot between available ton miles and salary

We can see that the latter scatter plot shows a more linear relationship between the two variables. From the perspective of either numerical analysis or visual judgment, available ton miles is more accurate for estimation. So we choose available ton miles as the cost driver. Low point (3132, 1145), high point (4029, 1514) Salary=0.4114×available ton miles-143.50 This technique has advantages: only two data is needed, so it’s quite convenient. It’s easy to apply and illustrate mathematically how a change in a cost driver can change total cost. However, not all the information is used, which is regarded as inefficient. Because it bases cost function on only two periods’ cost experience, regardless of how many relevant data points have been allocated. In a word, it’s less accurate. 2. Simple Regression We use simple regression to estimate the salary cost with available ton miles as the cost driver. Results are as follows:

Salary = 0.5517 × available ton miles - 682.64 R2 = 0.5577, and standard deviations are much smaller than coefficients, so it’s statistically valid and significant. Regression analysis measures cost behavior more reliably than other cost measurement methods, since this technique uses statistics to fit a cost function to all the historical data. Compared with the high-low method which only contains two groups of data, it’s an improvement. What’s more, regression analysis yields important statistical information about the reliability of the cost estimates, which allows analyst to assess confidence in the cost measures and select best cost driver. But we should notice that only one cost driver is considered, so it can’t explain the variation of salaries completely. 3. Multiple Regression Because of the reasons mentioned in Question 1, we choose revenue enger miles and available ton miles as cost drivers and use multiple regression to estimate the salary cost. Results are as follows:

Salary = -1144.55 + 1.05 × available ton miles - 72.30 × revenue enger miles R2 = 0.5577, and standard deviations are much smaller than coefficients, so it’s statistically valid and significant. This technique takes more cost drivers into consideration, and the results calculated are more close to the data given, so it’s an improvement over the model estimated in Question 2. The accuracy of estimation thus serves as its top advantage. However, it might be more costly, time-consuming and complicated to be implemented than other techniques. 4. The usefulness of analysis in Question 1-3 The cost functions estimated in Question 1-3 are based on the assumption that the wages per hour remain the same and there is no additional labor needed, so it’s useful only under certain conditions. Taking the background of the industry and the company’s circumstance into consideration, we think these are important: 

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The first one is that the present equilibrium between Delta and the labor unions is not interfered. That is, endeavors concerning lowering pilots’ salaries to industry level will not be obstructed by union forces, and employees other than pilots will not labor unions to require higher payments. If not, adjustments on cost structure will be futile and Song will only turn out to be another Delta Express. Secondly, no harsh regulations regarding reducing staffs or cutting salaries are to be formulated. Restrictions about layoffs will directly lead to weak control over budgets, and in turn creates similar problems as high salaries do. Nevertheless, regulations of this kind are almost inevitable. According to precedents, large scale furloughs have already been blocked once by ALPA, thus we have no reason to remain optimistic as long as the recession of the general economics stay as a fact. The last point we come up with is the new fixed cost caused by new security directives after the September 11 terrorist attacks. However, since security costs can be expected amid the whole industry, it shall not become a major concern for Song, although our prediction model may overall shift upwards.

If the conditions are not met, the cost functions will be less useful.

5. Estimate the salary cost for JetBlue According to Question 1, available ton miles should be used to estimate the salary cost. However, available ton miles of 2002Q3 is eccentrically low. So we draw a scatter plot:

In this situation, available ton miles and salaries are not linear. The scatter plot of revenue enger miles and salaries is as follows:

Revenue enger miles and salaries are quite linear. We use the high-low technique to estimate the salary cost with revenue enger miles as cost driver. Low point (599.4, 16000), high point (2016.2, 49000) Salary = 23.29 × revenue enger miles + 2038.83

6. Estimate the salaries cost for Song in its first year To estimate the salaries cost of Song is quite difficult because there is no historical data for reference. Because JetBlue is a successful example in the low-cost market, we use its historical salaries cost to predict Song’s salary. For simplicity, we make some assumptions:  

Song can achieve the same revenue enger miles as JetBlue in every quarter JetBlue’s salaries are linear with time series

Though the first assumption is very strong, the second one can be easily verified. We number each quarter in 2001 and 2002 from 1 to 8, and make simple regression between the time series and salary.

Simple regression between the time series and salary:

JetBlue’s salary = $ 4761.91 × number of time series + $ 9571.43 The scatter plot of number of time series and salary is as follows:

R2 = 0.9900 and standard deviations are much smaller than coefficients, so the estimation is statistically valid and significant. The scatter plot also s this predication. With the formula above, JetBlue’s salary of each quarter in 2003 can be calculated.

To determine Song’s salary, three deviations must be taken into consideration: 1) Song pilots’ per hour wage rates are $100 more than those of JetBlue on average. From the material, we know that a Boeing 757 captain is paid $254 per hour in Song, so a pilot is paid $154 per hour in JetBlue. Since Song is ed by a single-airliner fleet of 36 Boeing 757s, the additional salary to pilots can be calculated easily. But before that, we need to know how much is paid to pilots in JetBlue. As the material indicates, pilots are paid for hours flown. The question is how to predict revenue hours for JetBlue. As is done before, we number each quarter in 2001 and 2002 from 1 to 8, and make simple regression between the time series and revenue air hours.

Simple regression between the time series and revenue air hours:

Revenue air hours = 6.2821 × number of time series + 3.3095 The scatter plot of number of time series and salary is as follows:

R2 = 0.9936 and standard deviations are much smaller than coefficients, so the estimation is statistically valid and significant. The scatter plot also s this predication. With the formula above, revenue air hours and additional salary to pilots of each quarter in 2003 can be calculated.

2) Song’s salaries paid to flight attendants, ticket agents and other workers might be higher, too. Considering Song’s poor performance in controlling the salaries, it’s reasonable to assume that Song’s salaries of other workers is also higher. However, there is no enough evidence in material, so we use a compromising method. Firstly, we assume the other workers’ salaries are the same and calculate a “floor”. Then we assume the other workers’ salaries are also higher and calculate a “ceiling”. A. Floor The additional salary cost of Song is just the additional salary paid to pilots.

B. Ceiling The additional salary coast of Song includes additional salary paid to pilots and other workers. To get the maxim, we assume that Song’s salary exceeds JetBlue’s by the same percentage. That is to say,

=

=

= 1.6494

3) Song began service on April 15, 2003 Salary cost before April 15, 2003 should be deducted, which includes salary of the first quarter and the first 14 days in the second quarter. Number of days in the second quarter=30+31+30+31=122. The adjusted salary is as follows. A. Floor

B. Ceiling

In conclusion, Song’s salary for 2003 lies between $191649 and $292636, taking the higher wage rates and the date of beginning service into consideration.

Solutions to problems & suggestions 1) Cutting Salaries The restructure of cost will primarily lie in the reduction of salaries. As implied in the background, its main competitor in low-cost market, JetBlue, enjoys the lowest labor fraction of 25.5%. Thus, Delta should no longer persist in its previous strategy on salaries. 

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Delta has the superiority of “being the least unionized one in the industry”, which makes a substantial competitive advantage. Since un-unionized employees are not restricted to fixed working hours, salaries cost can be largely eliminated through condensing working time, since all of the personnel are paid by hours. (1). Effective training programs are expected to enhance efficiency and accordingly reduce time needed per hourly personnel to get work finished. (2). Flexible working hours should be launched especially for the women personnel like flight attendants and ticket agents. As women are more inclined to family and personal life, an unpaid leave program should be launched for them to better achieve a balance between life and work. Furthermore, the humanistic vacation plan will nurture employee loyalty and thus enhance productivity in the long term. Delta provides the highest salary for pilots, combined with the block from furlough. Consequently, pilots’ salaries take up a majority of their cost. Since pilots are unionized with fixed working time, salary reduction will be the only way. As JetBlue’s cost function might be impractical for Delta, Southwest Airline’s figures might be an appropriate goal. (1). Attain concession from the labor union as other companies. (2) Since Delta’s salary level is currently above the industry average and, moreover, contracted maintenance work creates additional flexibility in salaries cost, there is no need to worry about brain drain.

2) Omit traditional service frills Apart from lowering salaries, Song needs to omit traditional service frills so as to adjust to the lowcost business mode. Concrete measures can be simplifying aircraft services, cancelling flight meals for short-term flights, refusing to return airfares for late engers and so on. To compensate for the relatively inferior service, it becomes an essence for Song flights to enhance in-flight entertainment. Approaches such as introducing satellite televisions, which has become a favorite for JetBlue’s customers, ought to be on the agenda of Song’s operation. 3) About its business model Delta plans to base its new business model on the low-cost model of Southwest Airlines. 

Southwest Airlines retain a leading role in the low-cost airline industry by innovation in business model. The condensed flight schedule and a good reputation of punctuation allow it to generate revenue from business men. More importantly, its planes are all Boeing 737s, which enormously decreases the maintenance cost. Southwest Airlines choose the landing airport in secondary cities to further cut the operating expenses, meanwhile enables the business customers to reach

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the destination by expressway in time. All the features can be copied by Song to reach its cost controlling goals. Since Song is facing the challenge of insufficient investment, the strategy of Southwest Airlines simply meets its current need. In addition, Southwest Airlines’ key to success is its highly-centripetal culture. The financing policy provides dividends to every employee, creating an efficient team with a high sense of company loyalty. The dividend institution acts as an effective incentive which motivates the personnel to contribute more efforts to the company especially in difficult times after the 911 incident. Nevertheless, company culture cannot be nurtured in one day. Delta might need to develop its own culture which better matches its own history and enterprise background.

Reference: http://wenku.baidu.com/view/885cb61ea300a6c30c229f32.html