Alitalia: Industry Environment Analysis - Assignment Example

I. Alitalia - Industry environment analysis 0 Introduction: Business organizations do not operate in vacuum. They do so in an environment that comprises the needs, wants and expectations of consumers and the activities of competing firms. Therefore business organizations have to constantly tailor their activities to meet consumer expectations and circumvent competitor activities by pitting their own resources to maximum advantage. These actions comprise business strategy. Johnson et al. define strategy as: "strategy is the direction and scope of an organization over the long term which achieves advantage for the organization through its configuration of resources within a changing environment and to fulfill stakeholder expectations" (2004:10). In this definition, the scope and direction of the strategy and the configuration of resources are within the purview of the organization. External competitive forces determine the 'environment' in which the organization works. Michael Porter (2004) describes five such forces that have an effect on the competitiveness of an organization. These five forces comprise the 'outside-in' business strategy tool as diagrammatically depicted below: We shall examine how these five forces impact the competitiveness of Alitalia's market strategy. 1.1. About Alitalia: Alitalia is the smallest of Europe's full service airlines (after the merger of KLM with Air France and Swissair with Lufthansa) in terms of revenues generated, flights operated and passengers flown and other financial parameters. (See Table-1 below. Table-2 provides comparative statistics for low budget airlines) Table-1 Comparative physical statistics for full service airlines. 1. As far as possible the latest figures published by the airlines were used for comparison. 2. Figures for Alitalia, British Airways Swissair and SAS are for 2005. Figures for Air France-KLM and Lufthansa are for the year ending March 2006. 3. KLM merged with Air France during 2004-05. Swissair merged with Lufthansa in early 2006, making it the third largest European airline. Table-2 Comparative physical statistics for budget/low cost carriers against benchmark airlines. All figures are for 2003, except for Virgin Express, which are for 2002. Alitalia (Alitalia - Linee Aeree Italiane S.p.A) has been operating as a full service airline that flies passengers and cargo for sixty years. Alitalia is Italy's national airline with the government holding 49% equity (other shareholders including employees hold 49% and Air France holds 2%). The airline has a fleet of 177 aircraft and flies to 102 destinations in Italy, Europe, the middle and far East Asia, Africa and the Atlantic. Alitalia has modernized its fleet keeping in view the distances and load factors involved in various sectors. In fact the company boasts of operating one of the youngest and most efficient fleets in the world. During the year 2005, 24 million passengers flew Alitalia, which represented a growth rate of 7.8% year on year over 2004. In April 2004, the company acquired the bankrupt regional airline Gandalf Airlines to gain additional slots at several European airports, mainly Milan (Linate) and Paris (Charles De Gaulle). In September 2004 the company sought to lay off almost 5000 employees to avoid bankruptcy and possible liquidation. A vicious fight ensued with employees unions striking work which finally ended with government intervention and provision of a bridging loan. There was a proposal to merge the company with Air France-KLM but it petered out. During this period, to save costs, the company was, splicd into two holding companies. They are Alitalia Fly which controls Alitalia Express, Volare SpA, Volare Airlines and Air Europe. The company holds 51% equity in the new formation Alitalia Servizi which controls the following: Alitalia Airport which operates ground handling services in Rome Fiumicino, Palermo, Cagiliary and passenger handling services in Catania and Naples; Alitalia Mainatenance Systems 40% of which is owned by Lufthans Technik and Alitech which offers maintenance services in Naples. Alitalia Servizi also provides IT services to the group companies - a part of which is outsourced, ground handling services in London Heathrow and passenger handling services in Athens, Brussels and Frankfurt. The Fintecna (a government agency) owns 49% of Alitalia Servizi. The parent company can sell whole or part of Alitalia Servizi by 2008 and not before as per the agreement it reached with employees' unions. Again in 2005 Alitalia 'acquired' another bankrupt airline the Volare Group which operates Volare Airlines, Volareweb and Air Europe but the acquisition is mired in a legal battle with another bidder (Air One) which continues to bubble and boil till date. Earlier in 1995 Alitalia entered into an agreement with KLM Dutch Royal Airlines, with a possible option for merger. The partnership was to develop the Malpensa Hub (Milan), Amsterdam and Rome Fiumicino. There are two airports in Milan: the Milan Linate, close to the city but small in size and Milan Malpensa far away but expandable. The Italian government planned to divert all traffic to Malpensa. Other EU Airlines moved courts as they contended that moving traffic to Malpensa would give Alitalia an unfair advantage. This was because while Alitalia could feed Malpensa from Fiumicino they could not do it. Malpensa is about 40 kilometers away from the city and did not have adequate infrastructure facilities. The Italian government promised to open a rail link to the hub within a year. After prolonged legal battles the other EU airlines agreed to the operation of 33% air traffic from Linate. However the story continued like a soap opera. Shortly before the opening of the rail link, the Italian transport minister changed. A day before the flights were to be originated from Malpensa (changing from Linate), he rescinded the earlier order and insisted that flights should continue to originate from Linate. This landed the airline in a soup with tickets sold for Malpensa (passengers arriving there for taking their flights) but flights originating from Linate. The incident led to KLM severing its link with Alitalia. In 2001, the company renewed its ground-handling contract with SEA instead of operating its own as in Rome Fiumicino, which meant that customers had to deal with SEA and not Alitalia staff. Even in 2006, the Malpensa hub and facilities in Rome were not developed fully and the company was forced to cut short some of its flight services such as the ones on the lucrative Los Angeles sector. 1.2. Action plan 2005-6: In order to rationalize and stream line operations the company has implemented the following major initiatives in 2005/2006, some of which are still in progress: 1. Increase the company's capital base by 1 billion by diluting the Italian government stake to 49.9%. 2. Maximize asset productivity without adding new fleet, which increased flight utilization by 7.9% in 2005 over the corresponding figure for 2004. 3. Concluding agreements with employees' unions to 'right-size' labor and improve efficiency. 4. Hiving off non-core activities like ground handling, maintenance, shared service and information technologies to be handled by a new service company called Alitalia Servizi, a joint venture between Alitalia and Fintecna. While Alitalia Servizi has a captive customer in Alitalia, specific contracts between the two ensure the quality of service delivered to customers. 5. Signing new contracts with suppliers to rationalize costs. These contracts were expected to yield cost savings of 3.6% in fleet, 16.1% in airports 19.2% in cargo area, 20.7% in on board services, 48% in marketing and 20.5% in general spending over the corresponding 2004 figures. The high figure of 48% saving in marketing costs is to be achieved by direct sales, e-ticketing, reducing commissions and new effective organization. 6. The company acquired Volare/Air Europe to strengthen its domestic operations by adding low cost services. Alitalia clinched an attractive deal in this acquisition as it excludes previous Volare group liabilities except severance fund for employees as in November 2004. However the deal is under litigation with Air One, another bidder for Volare. The acts of hiving off of non-essential services into a new joint venture company and staff rationalization have had adverse effects in the short term. Workers of Alitalia Servizi worried about possible further retrenchments and hiving off of single unit businesses to third parties struck work in January-February 2006. The company had to forego approximately 350,000 seats worth 80 million because of the strike, which had a cascading effect through March. Alitalia joined the SkyTeam international alliance that includes several leading Airlines in Europe, America and the Orient such as Air France-KLM, CSA, Czech Airlines, AeroMexico, Continental, Delta, Northwest and Korean Air. The alliance helps Alitalia extend its reach to 684 destinations in 130 countries. 2.0 Porter's Five forces: The five competitive forces (described by Michael Porter) that impact Alitalia's business strategy are described below: 2.1. Industry competitors (Rivalry among existing competitors): The structure of competition (leadership position, the number of competitors and their size), the structure of industry costs (the nature of fixed costs); the nature of switching costs, the nature of strategic objectives (aggressive growth strategies, 'cash cows' in mature markets etc.) and exit barriers determine the quality and intensity of competition. As we have seen Alitalia, is the smallest among the European airlines in terms of size and economic parameters but has incurred net losses of 843 m and 168 m during the years 2004 and 2005 respectively. All the four other European airlines (after the unification of Swissair with Lufthansa) have far larger fleets, which give them high maneuverability, and larger financial outlays, which give them, better 'staying' power. Even in the load factor, Air France-KLM, Swissair-Lufthansa and British Airways are ahead of Aliatalia. In addition to the other full service lines Aliatalia will have to willy-nilly compete with budget airlines and intercontinental airlines, which operate flights within its domain. Alitalia operates as a full service airline in three segments: domestic, international and intercontinental. The airline makes more revenues from its international and intercontinental operations in relation to the number of passengers carried. As we have seen, consolidation is becoming a key feature of industry. The merger of KLM Dutch with Air France and Swissair with Lufthansa gives these airlines larger fleets and infrastructures, larger financial outlays and therefore greater competing power. Alitalia itself toyed with the option of merger with various European airlines at different times but nothing came off these moves. 2.2. Potential Entrants (Threat of new entrants): One of the challenges full service airlines the world over face today comes from the 'low-fare no frills' airlines. (The challenge of low cost airlines) Their "meteoric growth" is sparked by "exploiting latent demand for cheap travel," especially in northern and central Europe where they have already saturated the demand. (Binggeli et al. 2005) This is not all. Attracted by the demand, charter airlines are foraying into the space. All this is resulting in full service airlines fighting back by cutting fares and sacrificing revenues. 2.3. Substitutes (Threat of new substitutes): High-speed rail networks and car travel have a potential to cut into airlines revenues. Rail networks are subsidized in countries like France and Germany. Similarly southern Europeans prefer car travel for longer holidays, as taking the car along gives them greater mobility. 2.4. Suppliers (Bargaining power of suppliers): Alitalia has hived off non-essential services to a joint venture company with Fintecna and signed contracts with specific guarantees for quality service. The company also signed new contracts with suppliers to reduce costs. However, as we have seen neither the hiving off nor the specific contract signed with Alitalia Servizi has helped it avert work disruption and it lost almost 80 million in revenues because of industrial strikes. In the end the hiving off to form Alitalia Servizi seems to be an exercise in some financial jugglery to rescue the bottom line from a deeper shade. The hiving off could have helped if the company retained the option to engage other service providers. 2.5. Buyers (Bargaining power of buyers): The variety within the full-service airline sector, the budget airline sector, charter flight services and of course surface transport options give the traveling public a plethora of choices and therefore enormous power over the service providers. Alitalia has followed other airlines and introduced the 'Mille Miglia' a membership card that allows members to save miles and trade off for free tickets. The company has seen the adverse effects of not providing efficient customer (described elsewhere in this report). 3. PEST-Analysis: Alitalia is owned by the Italian government and has to function as a quasi-government agency with the inherent weaknesses that go with it. As we have seen earlier, political compulsions seem to have forced it to paper over setbacks, enter into uneconomic business deals, acquire bankrupt companies and indulge in costly, time-consuming litigation to defend them. The company is given to looking for interim solutions; indulge in costly litigations with peers, competitors and even its own customers (as we shall see later). Its decision to hive off non-essential services into a separate company seems to be a fire-fighting exercise and merely transfers liabilities from 'one hand to another' without the stakeholders deriving much benefit. However the option to sell off the company in 2008, if exercised may help the company concentrate on customer service, increasing stakeholder value, and revenue generation. As a quasi-government agency it sought to derive some advantage in the Malpensa operation but failed to capitalize the opportunity, as firstly competitors in a fiercely competitive industry would not 'let go' an advantage that easily and secondly there were internal dissensions within the government - a new transport minister rescinded his predecessor's order leaving the airline 'holding the baby'. The company is abreast of competition in that it has deployed modern fleet and uses information technology tools for various functions including customer service. II. Alitalia - Resource Capability & Financial Analysis In an industry environment where all the major players have been making profits, Alitalia has had a bad run for a second year in a row. The company not only has negative revenues reflecting in operating losses of 47 million but there are other factors which added up to a net loss of 168 million (See table). As against the negative revenue status of Alitalia, the largest airline, Air-France was able to generate a profit of 5.6% of revenues; British Airways and SAS are even better with 8.2 and 9.9 respectively and Lufthansa a modest 3.49% against its high revenue generation of 18065 million. The budget airlines too have been making reasonable profits commensurate with the size of their operations. Alitalia has fallen short in other parameters as well. The load factor, which is a prime economic indicator, was less than the largest airline Air France-KLM, even less than the smallest airline Swissair and also less than that of British Airways. Table-3 Comparative financial statistics for full service airlines. 1. As far as possible the latest figures published by the airlines were used for comparison. 2. Figures for Alitalia, British Airways Swissair and SAS are for 2005. 3. Figures for Air France-KLM and Lufthansa are for the year ending March 2006. 4. KLM merged with Air France during 2004-05. 5. Swissair merged with Lufthansa in early 2006, making it the third largest European airline. Table-4 Comparative financial statistics for budget/low cost carriers against benchmark airlines. All figures are for 2003, except for Virgin Express, which are for 2002. All financial figures are in m. The company has at this time increased its capital by infusing 1 billion, which will further lower profitability unless there is a steep increase in operational efficiency and profitability. Not only has this has not happened in 2006 the year for which results are still in the process of being made, there is a further erosion in revenues during the year to the extent of 80 million because of a strike in its subsidiary Alitalia Servizi (We are of course not aware at this stage as to how this is going to be accounted for in the company's financial data). This set back is to be viewed against the company's claim of an 18% decrease in internal costs than when Alitalia handled the operations now being handled by its subsidiary. The company has also invested a further 38 million in the purchase of Volare/Air Europe with the expectation that it will enhance operational efficiency, competitiveness and revenues. Again the outcome of this investment (which at the moment is under litigation) is to be seen in future. The company claims that it has maximised asset utilisation without further investment in fleet purchase and thereby overall aircraft utilisation has gone up by 7.9%. Similarly staff reduction has resulted in a reduction of 18% on the impact of sales. The company also claims that this rationalisation has resulted in increased productivity 12% for pilots and 6% for flight attendants. There is a reduction of 10% in the ex-fuel unit costs. (The company targets a figure of 24% in the reduction of ex-fuel unit costs by 2008.) The company has claimed that the new agreements signed with suppliers for reduction of costs have started generating results. These contracts were expected to yield cost savings of 3.6% in fleet, 16.1% in airports 19.2% in cargo area, 20.7% in on board services, 48% in marketing and 20.5% in general sending over the corresponding 2004 figures. The high figure of 48% saving in marketing costs is to be achieved by direct sales, e-ticketing, reducing commissions and new effective organization. How all these measures will translate into cold numbers in the financial statement is yet to be seen. Alitalia operates as a full service airline in three segments: domestic, international and intercontinental. The airline makes more revenues from its international and intercontinental operations in relation to the number of passengers carried. The following table describes the share of each segment for the years 2004 and 2005: The airline has seen an increase in its domestic traffic growth commensurate with its capacity increase. The actions it has taken include strengthening its position in high yield sectors and leveraging partnerships to face low-fare competition head on. Although its international passenger traffic is almost similar in terms of the share of passengers, the yield is higher. Therefore the company focused on key west European destinations, increased its capacities in the east European sectors and exploited its geographical position as a bridge between eastern and western Europe. Thus it could withstand low cost competitive pressure and maintain load factor in spite of increased capacities. In the intercontinental sector the company focused on emerging markets like China and India, while strengthening its operations in other key sectors like Japan and North America. This has resulted in revenue growth in sectors like far East and India resulting in very strong unit revenue performance and revenue increase. The company has retired a bridge loan of 400 million in December 2005, by raising new long/medium term loan of US$ 445 million. The company has a net debt of 754 million as in December 2005.The company has scheduled financial debt repayments of 190 million in 2006, 154 million in 2007 and 154 million in 2008 and is contemplating to reduce overall investment of 800 million between 2006 and 2008. All in all Alitalia's financial position vis--vis its competitors appears to be weak and is in urgent need of strategies to improve. 4. SWOT Analysis: 4.1. Strengths: The company was able to increase the number of passengers it flew in 2005 over the corresponding figure in 2004 by 7.8% in spite of financial set backs. Therefore the airline must have a core of loyal customers, which patronize Alitalia. If the company initiates measures to reassure this 'core' for winning their continued patronage it would definitely help it improve its market share. Deregulation of the industry spawned competition from domestic and foreign competitors. The company hopes that its acquisition of Volare/Air Europe would help it extend its reach both to the long haul (Mauritius, Sri Lanka Cuba, Mexico City and Cancun) and short haul (within Italy) destinations. The use of electronic/information technology tools has been revolutionizing services. Alitalia has been keeping pace with the industry; has already invested in technology up gradation and began reaping benefits. Thus the company was able to reduce its marketing expenses by almost 48%. 4.2. Weaknesses: Alitalia's larger competitors have greater operational and financial strength are a constant threat against which it must constantly guard itself. Even some of the 'low cost' airlines have been garnering increased passenger custom and retuning enviable financial results. However the company's greatest weakness seems to be within. As a quasi-government agency, it is not able to take decisions spot on and lacks the smooth efficiency that is essential for a modern corporate entity that can take on competition head-on. The effect of the crippling strike in its service provider Alitalia Servizi would only be seen when the results of 2006 are announced. The strike could have been the result of a conducive political environment within and outside the organization. And it needed government intervention to end the stalemate between the warring parties. Even the loyal 'core' customers will not have infinite patience and another strike might wean them away to competitors. 4.3. Opportunities: As the company has seen an opportunity in intercontinental travel it would make sound business sense to invest in it. China and India are emerging destinations for which everyone airline is vying and the early mover will have a competitive advantage. The company has an opportunity to sever the baggage of Alitalia Servizi in 2008, which it should seize to focus on customer service. 4.4. Threats: We have already discussed the environmental threats (from potential competitors, new entrants and substitutes) but again the company faces a major threat from its poor customer service and lack of internal cohesion. A passenger who was the victim of the company's inept baggage handling, a William Porta runs a website, http://www.alitaliasucks.com, whose specific objective is to air grievances against the airline. Alitalia sued Porta seeking closure of the website. The move boomeranged; US consumer action groups like 'Public Citizen' moved in to join the battle, with the result the company was forced to withdraw the case. Adverse customer reviews of the airline also appeared in other portals like http://www.mouthshut.com/review/Alitalia-114535-1.html. III. Alitalia - Strategic Fit Analysis The strategic fit of an organization is determined by an analysis of its Strengths, Weaknesses, Opportunities and Threats (SWOT), vis--vis competition (which we have discussed in II above). Alitalia has the opportunity to operate in two segments of the market, viz. full service and low budget when its acquisition of Volare/Air Europe is confirmed - hopefully when the current litigation ends in its favor. Before then the company has to consolidate its current operation as a full service airline in the three operational segments: domestic, intercontinental and international. The airlines industry is in a churn because of strong global competition. The big players are seeking mergers and acquisitions to become bigger. Everybody feels larger financial outlays are required to increase fleets, add routes, lower fares and improve amenities to attract customers. Consolidation is the name of the game. Airlines are resorting to three kinds of alliances to enhance their competitiveness and consolidate growth. They are, marketing alliances, equity alliances and frequent flyer alliances. While the first two kinds of alliances take place between companies, the third kind of alliance is between the company and the customer. "here are tradeoffs inherent in these alliances. These are between airline revenues and consumer benefits, between non-stop and connecting markets, between service level and airline fares, and between different airports." (Glisson et al. 1996). For an organization like Alitalia, to compete with bigger airlines with larger fleets and financial outlays, the third kind of strategy would be ideal. As it continues to delight customers with its superior quality of service, it wins the esteem of its customers, enhances its reputation and attracts their repeated custom. The spin off benefit would be customer referrals and word of mouth publicity. The objectives of CRM programs are to "identify and retain valuable customers, encourage fickle ones to spend more, and to cut the cost of serving those who are less valuable." (Binggeli et al. 2002) Binggeli et al. further argue that that effective implementation of a properly designed CRM can increase profitability by 2.4% and for large carriers can increase the bottom line by between $ 100 million and $ 250 million. (2002) But given the history of the airline it is not going to be easy. There is an urgent need for the airline to refurbish its image. The following strategic steps may be recommended for a complete overhaul of the airline: 1. De-linking management control from the Italian finance ministry and empowering the board to take management decision without any interference. 2. Divest its subsidiary Alitalia Servizi at the earliest possible opportunity or renegotiate its status as a captive customer - with the company retaining the option to outsource services to others if it felt there was a deficiency in Alitalia Servizi's services. If there is competition Alitalia Servizi will be forced to improve its services. 3. Negotiate and settle its dispute with the other contender (Air One) for Volare/Air Europe rather than allowing the dispute to fester and drain valuable resources and management time. The two companies can even work out a via media solution such as floating a joint venture company for running Volare/Air Europe. 4. Focus on customer service. The company may have to take a re-look at its 2001 agreement with SEA for passenger handling services. This is because under the present arrangement, when there is a glitch, passengers have to deal with an outside agency that may not have the same commitment to them as Alitalia personnel. 5. Focus on customer service. It may not be possible to forcibly shut down the website that adversely publicizes Alitalia or silence others, which publish adverse reviews but they can be won over. 6. Focus on customer service: Merely offering 'Mille Miglia' to keep up with the Joneses is not adequate. There should be a genuine attempt to win over customers. Customer service is neither limited to ticketing agents or in-flight crews. Customer service as a corporate philosophy should emanate form the top and permeate all tiers of employees. It is a systemic application in which all employees from bottom to top should partake in. All personnel in the company should be trained for such an orientation. The airline should urgently consider these issues if it were to survive in the highly competitive industry. Increased competition, as in all other industries, drives the airline industry too and customers are likely to 'vote with their feet' if they are not satisfied with an airline's services. Bibliographic References: Alitalia website: http://alitalia.com Binggeli, Urs, Gupta, Sanjay and de Pommes, Carlos. (2002). CRM in the Air. McKinsey Quarterly. 2002 No.: 3 Binggeli, Urs and Pompeo, Lucio. (2005). The battle for Europe's low-fare flyers. McKinsey Quarterly. Web exclusive, August 2005. http://en.wikipedia.org/wiki/Alitalia Glisson, L. Milton,William A. Cunningham,James R. Harris,andJanet Di Lorenzo-Aiss."Airline industry strategic alliances: marketing and policy implications."International Journal of Physical Distribution & Logistics Management. 26. N3(March 1996):26(9).British Council Journals Database.Thomson.16-11-2006. http://find.galegroup.com/itx/infomark.do&contentSet=IAC-Documents&type=retrieve&tabID=T002&prodId=SPJ.SP00&docId=A18475549&source=gale&srcprod=SP00&userGroupName=bridelhi&version=1.0>. http://www.mouthshut.com/review/Alitalia-114535-1.html Porter, Michael E., (2004) Competitive Strategy Techniques for Analyzing Industries and Competitors. New York. Free Press A Division of Simon & Schuster, Inc. "The challenge of low-cost competition. (Managing Change in the Workplace)."Management Decision.34. N5(Sept 1996):59(2).British Council Journals Database.Thomson Gale.16-11-2006. Read More