35-Cost in Two Hostile Industries

Posted 7/14/08

Again, we will look at two domestic industries in overcapacity: the automobile and the airline industries. We call these industries Hostile markets, because returns for most of the players in the industry are low and price competition is intense.

Over the last twenty years, we have studied and worked in many of these Hostile markets. In about three-quarters of the cases, market hostility is caused by the expansion of industry competition, especially expansion by low-cost competitors. Hostility in both the airline and automobile industry is the result of expansion by competitors. In autos, the expansion of Asian competitors, in particular the Japanese, has gradually put a strangle-hold on the three domestic manufacturers, GM, Ford and Chrysler. In the airline industry, the expansion of low-cost carriers, including Southwest Airlines, Jet Blue and their ilk, have done the same thing with the legacy carriers.

Few of us would volunteer to be in a Hostile market. It’s painful on the best of days. But if you had the choice of working in and managing a company in one of these two industries, which would you choose? In which industry would you be more likely to succeed as an industry leader? Would you rather be a GM, Ford and Chrysler, or any of American, United, Delta and Northwest? The answer depends on your view of the relative strength of each set of companies against their expanding competition. In this and the preceding blog, we look at each industry’s domestic competitors compared to their expanding rivals on the basis of Value and Cost.

On the second dimension, that of Cost, both the domestic automobile manufacturers and the legacy airlines face a problem of age. But the legacy airlines can do more about it. Both the domestic auto manufacturers and the legacy airlines have well-seasoned work forces who have been with the companies far longer than most of their lower cost, expanding competitors. These experienced employees are at the top of their compensation ranges and are often protected by work rules that render them somewhat less productive than their younger, and less-protected, competitors.

Despite these disadvantages, both sets of industry leaders have proven to be more cost-effective competitors in the last few years. The domestic auto industry can now produce an automobile using total labor hours that are close to those of its Japanese competition. Bankruptcy and other means of cost reduction have enabled the legacy airlines to reduce their costs drastically over the last five years. They are still more costly than their low-cost competitors, but the difference has narrowed enough so that, in these strapped times, even the low-cost carriers feel the pressure of low prices.

The legacy airlines still face daunting cost challenges. They are still not as cost competitive as their low-cost, and low-priced, rivals, such as Southwest. The cost difference does not lie with the rate of pay for the workforce. Southwest pays its employees more on an annual basis than do the legacy airline competitors. Southwest continues to expand in the marketplace, even in the face of fully priced fuel on its marginal expansion. Southwest clearly can produce cash on routes that the legacy airlines cannot. The explanation for these differences in cost lies in the relative productivity of the employees of these lower cost airlines.

The relative performance of the two domestic industries clearly gives the legacy airlines more hope. The age issue, in the form of retiree benefits, hits both sets of industry leaders hard. But the cost for the auto industry is nearly unbearable because the domestic producers have shrunk. The domestic auto industry has lost so many jobs over the last twenty years that its dwindling domestic employee base must support an ever-growing set of retirees. The legacy airlines face much less of a problem here. They have expanded their capacity over time by opening up new markets, especially international markets. Their problem of handling retiree benefits is much less than that of the domestic automobile manufacturers.

Overall, the airline industry’s legacy carriers are in a much stronger position than are the domestic automobile manufacturers. The automobile manufacturers are weakest in the aspect of Performance where it is most critical to be strong in a Hostile marketplace, Reliability. They have a fixed cost problem in the form of retiree benefits that will continue to get worse until they are able to expand their presence in the marketplace, an unlikely outcome as long as Reliability issues remain. You can’t reduce costs without customers. (See “Achieving The Low Cost Position” in StrategyStreet.com/Tools/Perspectives.) Still, the legacy airlines have yet to prove they can continue their leadership in the marketplace. As they cut back on their capacity, their Function advantages inevitably ebb. As they cut costs in customer service, their Reliability performance is likely to fade. And, within five years, they have to have a cost structure that will enable them to confront, and price to a standstill, low-cost carriers such as Southwest, and probably others, who will be seeking to enter their lucrative international markets to carry their large numbers of domestic passengers further on their way. Both these sets of industry leaders face enormous problems, but the domestic automobile manufacturers face the worst. Neither one will have much fun.

 

Update 2021:

In 2021 the US domestic automobile manufacturers continued to struggle with their relative costs compared to their Asian competitors. The Japanese manufacturers continue to enjoy a cost and Performance advantage over their American competitors. The Japanese continue to make a higher profit per auto produced. These Japanese companies are focused on Reliability and quality. Objective reports find Japanese cars to be better engineered, safer, longer lasting and less expensive to maintain. Hence, their higher profit per automobile sold.  The Japanese then use their higher profits to maintain their quality advantage over their competition. Over time, customers see GM as “failing” in their implied promises to customers. Some of these customers then gradually migrate to the Japanese competition, Increasing their share and consequent economies of scale.  In 2020, traditional US domestic manufacturers GM, Ford and Chrysler controlled only 48% of the light vehicle market in the US.  (GM 18.35, Ford 18.16, FCA 11.9).

In the airline industry, Southwest Airlines continued to gain share at the expense of its higher cost legacy competitors. On the other hand, difficult times have tended to squeeze out low-cost airlines, not the legacy airlines.

By 2019, the top four domestic air carriers (American Airlines, Southwest Airlines, Delta and United Airlines) controlled 65% of the total domestic market. Their market power was greater than this percentage because these carriers held even higher shares of their key hubs and spokes. In recent years, these four major airlines removed unprofitable flights, filled a higher percentage of seats on planes, and slowed capacity growth to command higher airfares. Airline capacity has grown at a slower pace than ticket prices. In addition, since 2008, the airlines have charged ancillary fees for services that were formerly free.  These four major carriers finally achieved significant pricing power in their markets.

While these four major carriers have gained a great deal of pricing power, they are not all equally profitable. See HERE to portray and interpret differences in margins and costs among competitors.

 

Posted 7/30/25

US domestic automobile industry

US manufacturers, while reducing the gap, still struggle with higher costs than their Asian competitors. The best Asian competitors are better able to exploit their economies of scale by maintaining high capacity utilization rates with their attendant low unit costs.

The Asian manufacturers hold the edge in labor productivity per automobile, though the gap is narrowing somewhat, especially with Ford. In 2025, it takes GM about 30 labor hours per automobile. Ford comes in at 22 hours, Toyota at 15 to 22 hours and Hyundai at 24 hours.

To evaluate relative costs we compare operating profits per automobile, which reflect each company’s total costs. In 2024, Hyundai led in total operating profits, followed by Toyota and then the two US manufacturers. Both Toyota and Hyundai benefit from growing sales levels, enabling both companies to maintain high capacity utilization rates and improve economies of scale. Hyundai, with its exceptional sales growth over the last few years, also benefits from newer plants with newer technology and a relatively young labor force.  Despite its better labor productivity, Ford’s profits are inconsistent and highly variable compared to GM. Part of this is due to GM having a more favorable product mix with higher revenues per vehicle and average operating margins about twice those of Ford.

This unattractive cost position is likely to get worse. It appears likely that the domestic manufacturers will continue to lose share slowly. As their market shares decline, Ford and GM are losing their once superior economies of scale. The Ford company streamlined its operations and reduced the number of models it offered.  In 2007, Ford had 27 different vehicle platforms across the world. By 2021, it was down to 2: Ford and Lincoln. In the process, it sold off or eliminated many of its other brands, especially the high-end product lines. The General Motors continued to own and operate a number of automobile brands across the globe. However, it also discontinued several brands. Of longer-term concern, both domestic manufacturers continued to suffer from high pension costs, older infrastructure and lower capacity utilization rates.

 

US domestic airline industry

The US domestic airline industry is out of Overcapacity and Hostility in 2025. Its best competitors enjoy product mix and cost advantages that produce high returns on equity.

The leading legacy carriers used mergers and acquisitions to consolidate the industry, also in the hope of raising industry prices. While the mergers helped lead to the oligarchic structure of today’s domestic industry, they did not raise current prices nor did they stunt the growth of the Low Cost Carriers. The legacies frittered away much of their acquired market shares. Delta merged with Northwest Airlines but still lost about two percentage points in market share. American Airlines acquired US Airways and then lost about 5 percentage points of the combined airlines’ share. United merged with Continental and lost nine percentage points of the original airlines’ market shares. Both American Airlines , and United struggled to consolidate their acquired airlines. In the meantime, SWA gained five share points in this period, while the three legacy airlines lost a total of the combined companies’ 16 share points.

In 2008, Low Cost Carriers enjoyed a 3.8 cents per seat mile cost advantage over the legacy carriers. They used this cost advantage to reduce prices and invest in operational efficiencies. Most of that cost advantage has disappeared as the Low Cost Carriers faced ever increasing infrastructure costs and the challenge of offering attractive benefits to business customers.

Total cost levels reflected in comparative returns on equity indicate that the industry now has good control of pricing. While the four major carriers have gained a great deal of pricing power, they are not all equally profitable. See HERE to portray and interpret differences in margins and costs among competitors. Both Delta and United Airlines enjoy mid-20s returns on equity. American, even though it has gained share, has low and highly variable returns on equity. In a clear indication that the Low Cost Carrier business model has become problematic, Southwest has struggled with low returns over the last three years, again despite gaining share.  Southwest has begun to move away from part of that Low Cost Carrier business model by instituting its own fee structure for services like checked bags and seat assignments. Every day they look more like the three legacy airlines who have benefited from these fees and their premium priced international route structures (Performance Leader products).

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