This was originally an article that I wrote for a business-oriented magazine at my high school in 2018. I was, and will always be, a travel/aviation geek — I take pride in documenting each and every one of my trips, with a huge focus on how I got to my destination. Understanding the nuances of the commercial aviation industry has always been fascinating for me — why is it so enjoyable to fly Singapore Airlines, but not Spirit? Most importantly though, the commercial aviation industry is one that follows the principles of theoretical economics VERY closely, and as such represents a great case study for those learning about finance, or are interested to become acquainted with the industry in general.
I noticed a lot in Venture Capital that, no matter for startups in their early, growth, or late stages, the focus on the customer’s needs is absolutely key. In my opinion, there’s few major airlines that do this as well as Delta Air Lines in the US — running a well-oiled operation as one of the world’s largest airlines while consistently achieving high customer satisfaction scores. Delta has shown that it is possible to do both — you just need to invest in your customer. While seemingly a no-brainer, most founders have tons of work to do on truly understanding the needs of their customers to figure out how to best invest in them. To invest in your customers is, in my opinion, one of the most admirable qualities of being a founder.
Ah, the glorious old days of air travel.
Large, recliner seats that are more than comfortable to take a nap in. Friendly and caring stewards and stewardesses doing their best to make your flight one you won’t ever forget. And let’s not forget about the champagne that flows freely.
In the second half of the 20th century, commonly regarded as the golden age of air travel, one might have dreamt that, by the turn of the century, airlines would be flying next-generation supersonic aircraft, capable of getting passengers from point A to point B much faster than anything else could. The passenger experience onboard the aircraft would be comparable to that of a luxury cruise ship. And flying, as a beginning of a new adventure, would become something that one would very much look forward to.
That vision still remains a dream today.
When one typically considers the American airline industry as a whole, the first comparison made might be to that of a Greyhound bus. Over the past several decades, although technology breakthroughs have made aircraft quieter, more fuel efficient, and capable of traveling long distances without the need to stop for fuel, the passenger experience has degraded quite significantly. Complementary meals have ceased to exist on all domestic flights, replaced with a snack and beverage service. More seats are being packed into aircraft, thanks to reductions in pitch (the distance from any point on one seat to the exact same point on the seat in front of it, or behind it) and seat padding. Flight attendants resemble security guards more closely than the stewards and stewardesses of the 1960s.
Take American Airlines, for example. It is currently refurbishing its aircraft to feature less legroom in both economy and first class, removing seatback entertainment from aircrafts that already have it installed, and installing more cramped lavatories and galleys, so not only are the passengers being squeezed, but the crew are as well. In fact, their new cabin configuration is so bad that Doug Parker, American Airlines’ CEO has long refused to fly on an aircraft that features the new seats.
Other airlines are also following this trend that was spurred by the introduction of Ultra Low- Cost Carriers (ULCCs) into the American airline industry. ULCCs, namely Spirit Airlines, Frontier Airlines, and Allegiant Air, have long-since offered low, unbundled base fares that seem way too good to be true. The trade-off was that these airlines offered terrible hard products, including seats with 28 inches of pitch (the standard for legacy U.S. airlines is 31 inches) in economy class, seats that do not recline, as well as ancillary fees for anything. For example, you could get charged for bringing anything larger than a small backpack onto the aircraft, ordering a drink (including water), and pre-reserving a seat. Even forgetting to print out boarding passes prior to arriving at the airport can incur a $5 charge. As such, unsuspecting travelers could face up to hundreds of dollars in fees if they don’t read the fine print carefully, which is why these airlines are able to generate large revenues despite offering base fares a fraction of those on legacy U.S. airlines (American Airlines, United Airlines, and Delta Air Lines). Most travelers end up paying more when they fly ULCCs, as a ticket ancillary fees added upon the base fare often becomes much more expensive than a comparable ticket on a legacy carrier.
As ULCCs drove down the cost of travel within the American market, the three legacy carriers realized that they needed to cut down their costs in order to better match the ULCCs on pricing. One of the main reasons why ULCCs succeeded in the short term was that they were under the assumption that customers mainly make their decisions on price and scheduling. At the time, there were two main business models used by airlines. One was the hub-and-spoke model, where the airline would funnel passengers through central “hub” airports spread throughout the country and allow them to connect to their final destination. This became the norm for U.S. airlines after the federal government deregulated the airline industry in 1978. Prior to this, airlines were forced to operate by the point-to-point model, which involved flying directly between smaller markets.
This in turn would cause the airlines to lose money, because the flights would go out less than half full. The hub-and-spoke model allowed airlines to feed passengers from smaller markets into a larger hub airport, and then allow them to connect onwards to their final destinations. This resulted in flights that were more full, which in turn generated higher revenues for the airline. In recent years, however, ULCCs have started to operate point-to-point flights using smaller, more efficient aircraft, with allowed them to gain a schedule (less travel time) and pricing advantage over the legacy carriers. The belief in the airline industry during this time was that the only two things that customers cared about were scheduling and price. This sparked a “race to the bottom” during the early years of the 21st century, as the more premium legacy airlines started to have identity crises; attempting to become ULCCs and then failing to understand why customers became more and more frustrated. Gradually, the legacy carriers started to introduce “basic economy” fares, which set new, previously unheard of, restrictions on carry-on luggage, seat selection, and boarding order. United and American began to remove seatback screens from the majority of their domestic fleet. The ancillary fees also kept on rising. Over the next several years, a fierce battle broke out against the airlines, and the passengers. Customers wanted a better product but were also unwilling to pay a premium to gain access to more comfort in flight. United Airlines’ President, Scott Kirby, famously said, “If it’s (referring to legroom) worth it to you, you can do it. But if you just want the cheapest fare, it is what it is.”
When airline executives begin to make comments like this, it is impossible to deny that air travel is taking a turn for the better. Many passengers regard air travel as nightmares. Horror stories about passengers stranded in exotic destinations and people experiencing claustrophobia and panic attacks on airplanes are all over the internet. Air travel seems to have lost its glamour. Despite the depressing future of the American airline industry, one legacy U.S. carrier stands out amongst the others: as the world’s second largest airline by fleet size, Atlanta-based Delta Air Lines has recently made numerous headlines for investing heavily into providing a better experience for the consumer. Not only that, Delta has also raked in tremendous profits over the past year: it revealed during an earnings call that its revenue for the second quarter of 2018 was $11.78 billion, an increase of almost 10% compared to the previous year. Despite rising fuel and commodity causes, Delta has continued to surpass investors’ expectations, netting strong profits consistently while also delivering an industry-leading consumer experience. Among all U.S. based airlines, Delta consistently ranks in the top two, along with Seattle-based Alaska Airlines.
Originally established as Huff Daland Dusters, Inc. in 1924, Delta Air Lines grew to be the largest airline in the world by fleet size, until it was surpassed by American Airlines in 2013 after its merger with U.S. Airways. Ever since then, it has offered passengers regularly scheduled service both domestically and internationally from its hubs in Atlanta, New York, Los Angeles, Minneapolis, Detroit, and Seattle. Its global reach includes much of Continental Europe, East and Southeast Asia, the Caribbean, Australia, South America, and Africa.
The one most interesting part of the experience that Delta provides to its customers is that it always moves against trends in the airline industry. For example, as American Airlines and United removed seatback entertainment from their domestic aircraft (replacing it with a wireless system that allows one to stream content to mobile devices over the aircraft’s wireless network), Delta has committed to installing seatback screens on all of the aircraft in the mainline fleet, with its 600th installation performed in August 2018. Under current CEO Ed Bastian’s leadership, Delta has made numerous customer-friendly changes to its product, while at the same time ensuring that it remains profitable and competitive with the other legacy carriers, which are much more aggressive when it comes to cost-cutting.
When one walks onboard a Delta aircraft, he/she enters a soothing, relaxing atmosphere. Delta’s product, from check-in to landing, has been designed to relieve customers of the stresses typically associated with air travel. Here’s the breakdown of a typical travel experience on Delta: 24 hours before the flight is scheduled to depart, the “Fly Delta” mobile app automatically checks passengers in. Check-in is typically one of the aspects regarding air travel that customers neglect the most, but Delta’s automated check-in process resolves that process by sending out boarding passes a day before departure. Gone is the typical antiquated process of inputting information over and over again into an airline’s website, replaced by a few taps on a mobile phone.
As one walks through the doors of an airport, the Delta attitude of “Passengers First” begins to kick in. From the moment you interact with your first Delta-employed or Delta-contracted employee, you will be treated with courtesy and respect. That’s because Delta has invested heavily, compared to other U.S. based airlines, into customer service. Customer service is typically the most important aspect of the airline industry that affects a passenger’s view on an airline, and one single customer interaction can dictate whether or not a passenger will choose to move his/her business to the airline in the future. From the check-in staff to the gate agents, everyone has undergone extensive training in customer relations and how to handle all sorts of situations that could potentially arise during interactions with customers.
The functionality of the “Fly Delta” app does not stop beyond check-in. As you complete the check-in process and drop off baggage, a page called “Today” is the go-to place for your travel needs. Described as a place that “gathers everything you need for your day of travel,” this page allows one to check in, change seats, track any checked baggage (yes, Delta even uses RFID technology to keep track the status of your checked baggage), etc. “Today” also displays boarding passes, as well as connecting flight information. Furthermore, as hub airports continue to expand, it is imperative that passengers know how to navigate these labyrinth-like structure. Thankfully, Delta has integrated high-resolution terminal maps with its mobile app, which gives passengers step-by-step instructions on how to arrive at their connecting flight’s gate, baggage claim, and the like, thus providing an extremely customer-friendly solution to the problem of potentially getting lost within an airport.
As the friendly and motivated gate agent bids you an enjoyable flight, you walk down the jetbridge towards your aircraft. Stepping onboard the aircraft, one is greeted by a relaxing and modern atmosphere, an effect mainly produced by LED lighting dispersed throughout the aircraft. The interiors are representative of Delta’s simple, yet symbolic, color palette of red, white, and blue. Its interior product is also designed to make flights pass by faster: all internationally-configured aircraft feature lie-flat seats in business class, and most feature seats that have direct aisle access. Furthermore, even in economy class, each seat features USB charging, AC power ports, and an entertainment screen stocked with over 200 movies, 300 TV shows, and over 1,000 hours of audio content. To make sure that the entertainment stays up-to- date, Delta enlists passengers to vote for movies to be shown in the future on its various social media channels.
Like Delta’s contracted ground staff, flight attendants undergo the same training to ensure that they are capable of handling any customer interaction. As previously mentioned, Delta has invested more into customer service training compared to any other U.S. airline, and this is reflected in the high service standards that Delta has set for its competition: Delta is consistently rated as one of the airlines with the friendliest, most knowledgeable, and most helpful personnel in the United States.
With a well-stocked entertainment system, flight attendants that are a pleasure to interact with, and a comfortable seat (that features memory foam cushioning and contouring to improve legroom without sacrificing seat pitch), flights will pass by in the blink of an eye. How does Delta manage to offer such a top-notch product, while simultaneously being one of the most profitable carriers within the American air travel market?
Because of the numerous passenger amenities that they provide compared to their competitors, Delta has long been thought of as one of the more premium airlines, at least within the United States market. It is in fact due to this perception that allows Delta to command a slightly higher revenue premium over its competitors. However, at the same time, Delta has found ways to cut its cost base, through devaluing its frequent flyer program, increasing its cost baggage fees by up to 20%, and the like. As offering a more premium product can significantly increase the cost base for Delta, it must find other sources of revenue to ensure that it remains profitable and competitive in the industry. To a certain extent, Delta has largely accomplished that goal.
It is necessary to examine the history of Delta, which closely details how it came to be regarded as one of the most premium carriers in the United States, as well as its rise to profitability. After the terrorist attacks of September 11, 2001, Delta, like most other U.S. carriers, were hit with heavy losses. This gradual downward trend of travel demand continued into the latter years of the decade. Delta ultimately entered Chapter 11 Bankruptcy on September 14, 2005, with $28.27 billion of total debt. After several series of restructuring and cost-cutting, Delta emerged from bankruptcy on April 30, 2007, and subsequently announced its merger with Northwest Airlines, which ironically entered bankruptcy on the same day as Delta. The merger was approved on October 29, 2008, where Northwest Airlines began to operate as a wholly owned subsidiary of Delta. On December 31, 2009, Northwest Airlines and Delta Air Lines were fully integrated, with Delta emerging as the surviving carrier.
One of the most important aspects regarding Delta’s rise to profitability is its fleet strategy. Prior to the merger with Northwest Airlines, Delta operated a fleet primarily manufactured by Boeing and McDonnell Douglas, while Northwest’s fleet was comprised of mostly Airbus SE aircraft. After the merger, all Northwest aircraft joined the Delta fleet. Delta’s fleet strategy differs from other U.S. carriers in that they often seek out to purchase used aircraft, instead of directly ordering newly built aircraft from the manufacturers. It is best known for operating the Douglas DC-9, a design more than half a century old, until the type’s eventual retirement in 2014. In order to better maintain these aircraft and ensure that they will be safe to fly for many years to come, Delta created a new MRO (Maintenance, Repair, and Overhaul) subsidiary known as Delta TechOps. TechOps does not solely maintain Delta’s own aircraft; as the 3rd largest MRO organization in the world, TechOps also provides MRO solutions to more than 150 third-party companies. As such, this is also a significant source of revenue for the airline.
As according to their fleet strategy, the vast majority of Delta’s fleet consists of used aircraft acquired from other airlines. In the early 2010s, Delta was searching for a solution to fill in the 100-seat niche in the market. 100-seat aircraft have a seating capacity located between regional jets (up to 76 seats) and small mainline aircraft (at least 120 seats). Aircraft of this size are typically used to provide service from hubs to smaller cities that don’t have the demand needed to fill a larger mainline jet. At the time, there were no aircraft of this size in production.
However, Delta saw an opportunity in the fleet of former Atlanta-based carrier AirTran airways, which was acquired by Southwest Airlines in 2012. Since Southwest was planning to dispose of AirTran’s fleet, which consisted of 100-seat Boeing 717 aircraft, Delta struck a lease-buyback deal for all 88 of AirTran’s 717s, all of which are in service with Delta today, flying mainline routes that typically have less demand. Besides allowing Delta to efficiently serve smaller airports, 100-seat aircraft have other advantages as well. Per a “scope clause” in a contract between the airline and its contracted employees, with the new 717s, Delta is able to induct more regional jets, operated by third-party airlines, into its fleet, thus allowing it to operate commuter services between airports that do not have the demand of a mainline aircraft.
Thanks to its TechOps operation, Delta is able to keep many older-generation aircraft in service. TechOps-maintained aircraft have generally proven to be quite reliable, with less mechanical- related delays compared to other aircraft of the same age. At the time of this writing in 2018, Delta operated a 91-strong fleet of McDonnell Douglas MD-88 aircraft, with the oldest airframe being 32 years old. In addition, Delta is also the only remaining operator of the MD-88’s close cousin, the MD-90–30. In addition, Delta also operates the world’s largest Boeing 757–200 fleet, a design dating back to the 1980s, as well as a sizeable Boeing 767 fleet, dating back to the 1980s as well.
Granted, older aircraft tend to be less efficient than modern aircraft, but the initial cost of acquiring these aircraft is very low, which is enough to offset the higher fuel costs of these aircraft. In fact, Delta’s CEO, Ed Bastian, once claimed that they were able to acquire used Boeing 777–200ER aircraft for as little as $7.7 million. Before it went out of production, this specific aircraft model had a list price of $261.5 million.
In 2014, as oil production massively exceeded demand, the price of oil fell sharply. Suddenly, airlines realized that they could continue operating older, less efficient aircraft at lower costs than acquiring brand-new, more fuel-efficient aircraft. As such, even though United Airlines and American Airlines rushed to order brand-new aircraft during this period (thus adding up to heavy capital expenditures), Delta realized that there was no need to order new aircraft when they would cost more than continuing the maintenance and operation of older, existing aircraft. This greatly reduced their capital expenditures during this period, which allowed Delta to gain a more competitive edge as long as oil prices remained low. Of course, as oil prices began their eventual rise, it soon became more economical to order new, more fuel-efficient aircraft to replace older aircraft. Adapting to the changing industry environment, Delta placed several noteworthy orders in recent years to rejuvenate its fleet: It ordered Boeing 737–900ERs and Airbus A321s to replace its MD-88s and MD-90s, Airbus A321neo (New Engine Option) aircraft to replace the 757s, Airbus A330–900neo aircraft to replace the 767–300ERs, as well as Airbus A350–900XWB (eXtra Wide Body) aircraft to replace its Boeing 747–400s. As these aircraft enter Delta’s fleet, Delta will be able to operate a much more efficient fleet that not only will result in higher profits for the airline in the long run but will also provide a superior experience from a passenger’s standpoint.
With many major investments into its customer service, onboard hard product, and soft products, Delta certainly is able to command a higher revenue premium over its competitors. Remarkably, its cost base is also quite similar to those of American Airlines and United Airlines, because Delta has found ways to cut costs outside of the passenger experience, such as delaying the renewal of its fleet. This investment, in turn, has allowed Delta to effectively command a revenue premium over its competitors, putting it on the road to become one of the most profitable airlines in the industry.