Question

1. What would be the effect of a sharp decline on passengers for a firm with a microeconomic structure such as the one Delta had in place during 2001? Is Delta’s operating leverage high or low? 2. Analyze the proposal to launch Song as a response to the situation the firm is facing. Do you agree with this solution? Why? What would be some possible alternatives or alternative?

Answer 1

1. What would be the effect of a sharp decline on passengers for a firm with a microeconomic structure such as the one Delta had in place during 2001? Is Delta’s operating leverage high or low?

According to the article, “Airlines must operate within a low-margin, high-fixed cost environment making profitability particularly sensitive to decreases in volume due to environmental factors or competition.” The focus of microeconomics includes what may or may not happen when key players make certain choices that inevitably affect the bottom line. After the 911 attacks in 2001, Delta, as well as the whole airline industry, experienced a significant decrease in passenger traffic, which meant lower revenues. The direct effect of declining revenue and passengers in Delta’s high-fixed cost structure would be to Delta’s net income. Delta’s microeconomic structure made it easy for investors to see the relationship between low passenger sales and a drop in stock prices.

Operating leverage identifies the effects of both variable and fixed costs in a company’s cost structure towards understanding how much more they need to pay in order to continue providing more service. Airlines have typically operated with high fixed costs, including Delta. The company has a high operating leverage because high fixed costs, such as flight crew salaries, and low variable costs, such as the flight scheduling crew.

2. Analyze the proposal to launch Song as a response to the situation the firm is facing. Do you agree with this solution? Why? What would be some possible alternatives or alternative?

I agree with Delta making a second attempt to compete in the low-fare market to increase revenue; however, I do not entirely agree with the proposed cost structure that includes pilot’s hourly wage. Delta has decided to pay Song pilots the exact same pay as their Delta pilots and those wages are already considerably higher than the pilot wages at Southwest and Jet Blue. In order for Delta to create higher profit stability when sales fluctuate, the will need to change their operating leverage to higher variable costs and lower fixed costs, which will also enable them to incur lower losses when sales are down.

I would suggest the following alternatives to the proposal:

• Reduce the pilots wages to reflect the competitive landscape
  • Delta is the lease unionized of all major airline, with only the pilots being under union contracts, which creates a huge fixed cost in salaries
  • Seize the opportunity to hire outside pilots versus using current personnel whom are under union contracts.
  • Song pilots can receive a much lower wage to compete with the wages of Southwest and Jet Blue.