Industry change and Porter’s Five Forces

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Method

Primarily chosen research area

Since the current crisis in the airline industry had resulted in a large number of bankrupt-cies and financial hardship for many other airlines, the initial idea with this thesis was to in-vestigate different airlines by using a statistical failure prediction model. This to see if fi-nancial distress and bankruptcy could be predicted beforehand. The thought was to analyze financially healthy companies, unhealthy ones and even already bankrupted companies with this type of model, which is based on historical data on a specified number of financial ra-tios.
A lot of time and effort was put into finding a suitable model of this type and one was fi-nally chosen. This was a failure prediction model based on logit analysis developed in Bel-gium and the persons who had developed it was even contacted to get a clear understand-ing for how to, as correctly as possible, calculate the financial ratios included in the model.
Sadly, it soon became evident, once gaining more understanding of the model, that the number of airlines with complete annual reports available (since detailed information was needed for the specified ratios) would be too few for a sample to conduct a statistically valid study on. At first, the thought was then to keep part of the idea with the failure pre-diction model. This by analyzing a smaller number of airlines using the financial ratios in-cluded in the failure prediction model initially chosen. Instead of a statistical study, a case study type of descriptive analysis would have been used, investigating how the specified ra-tios had developed within the company over time and then comparing the development of the ratios in airlines of different financial health with each other.
However, factors such as the complexity of the financial ratios included in the chosen model, in terms of finding all information in the annual reports, determining which items to include and missing data, hindered the execution and finalizing of this idea. Also the idea for the study was seemingly difficult to communicate successfully and left readers con-fused. Keeping some of the initial ideas, we formulated a research study more suitable to conduct.

Research approach

There are principally two ways of conducting a research study. These two approaches are the deductive approach and the inductive approach and they set the design of the research project.
A deductive approach involves testing a theory by research strategies that will lead to a conclusion that either supports the theory or not (Lewis, Saunders & Thornhill, 2007). The researcher uses the knowledge he/she has about the research area and theories to test theo-ries and draw conclusions (Bryman & Bell, 2007). On the other hand, an inductive ap-proach starts from the bottom with empirical data that is used to develop to a new theory (Lewis et al.). Here the researcher begins with an empirical study and then the results are evaluated against relevant theories and eventually a research problem is generated (Bryman & Bell, 2007).
This thesis takes a deductive approach since the purpose is to draw conclusions based on existing theories. Thus, numerical data has been used and analyzed and conclusions have been drawn based on these existing theories. This research approach is suitable mainly be-cause the topic of company- and industry analysis is well studied and many theories revolve around it. Also since the aim is to research the reality in the airline industry with help of different theoretical tools.

Qualitative and quantitative approach

All non-numeric data or data that have not been quantified is referred to as qualitative data while numerical data or data that have been quantified is referred to as quantitative data (Lewis et al., 2007).
To answer the research questions and the purpose of this thesis, the data gathering mostly dealt with numerical data and analysis of this data. Quantitative calculations for the finan-cial ratios; current ratio, quick ratio, debt-equity ratio, profit margin and return on equity (ROE) have been made A quantitative method, according to the definition above, has therefore been used for this thesis. But also qualitative data of short and long texts has been analyzed e.g. scientific articles and articles of current interest to get a deeper under-standing of the topic. To get more depth and detailed description of the topic, a qualitative approach has also been used in form of interviews (see chapter 3.5 Interview).

Primary and secondary data

Primary data is collected for the research project under study and secondary is data that were originally collected for some other purpose (Lewis et al., 2007). In this thesis the fo-cus is on secondary data since existing numerical data was extracted from companies‟ an-nual reports and interim reports. This was complemented with interviews (see chapter 3.5 Interview) that specifically was collected for this thesis, and therefore referred to as primary data.

Data collection and literature search

The numerical and financial data used in this report are extracted from the annual reports and interim reports of the six European airlines from year 2000 until the third quarter of 2008. The annual reports and interim reports were found through the companies‟ web pages. Additional company related information was also collected from the companies‟ web pages.
General airline industry specific information such as jet fuel and crude oil price, airline share price, trends on the European market, financial forecasts and industry outlooks was gathered from the industry organization IATA, the trade organization AEA and The Swed-ish Aviation Authority.
All books, scientific articles, articles on earlier studies in the same field, news articles and financial theories are available on the internet, and at Jönköping University‟s library as well as at the library‟s database.

Model for observation

There are basically two types of observations; structured and unstructured. A structured observation is a type of observation where the behaviours and events that are to be studied are determined beforehand and an observational scheme is developed. This requires a well defined problem and purpose. An unstructured observation entails an explorative problem and purpose where no complete observational scheme is used (Paten & Davidson, 2003).
This thesis uses a structured observation to investigate and evaluate the development of the financial situation of the airlines over the chosen period. This requires a specified model for evaluation. The developed scheme for this thesis is a three-levelled process, which was used for the analysis of each individual airline and thereafter for a comparative analysis be-tween the chosen airlines of the study. In the comparative analysis the airlines were com-pared to each other within two groups; traditional airlines and LCCs separately.
The first level covers sudden shocks, change in macroeconomic factors, and general change in industry structure and trends. These all affected the overall change of the European in-dustry during the years of this study.
The second level, which is the first of a two -step analysis, is divided in two main groups; fi-nancial aspects and industry specific aspects of the airline(s). The information from the first level was used as the take-off point for the analysis of these aspects.
The third level constitutes the second step of the two-step analysis and focuses on the de-velopment of financial ratios that describe the capital structure and profitability of the air-line(s).
This three-levelled process, a two-step analysis preceded by an informational framework, led to grand conclusions.
Beyond the numerical data from annual reports that are the basis of these measurements, other relevant information about the airlines was obtained to complement the structured observational scheme.
Below follows a graphical conceptualization of the three-levelled process.

Interview

The intention with the interviews was to use them as a complement in the study to get ana-lysts‟ viewpoints of the current situation and their forecast for the future for the airline in-dustry.
Throughout the working process several names of analysts were noticed. Three well-cited persons who all work in different sectors and organizations were chosen. Anders Lidman (see appendix 2), an analyst, owner and CEO of Aeropol, represents the private sector. Helen Jakobsson (see Appendix 3), an analyst who works at the Swedish Civil Aviation Au-thority (Luftfartsstyrelsen), represents the public sector. Initially the interview was intended for Jacob Gramenius, an analyst at the Swedish Civil Aviation Authority (Luftfartsstyrel-sen), but who due to lack of time recommended Jakobsson. Even if not from an actual in-terview, statements by Chris Tarry (see Appendix 4), a well recognized airline industry ana-lyst (e.g. published on the IATA website) who established Aviation Industry Research and Analysis (CTAIRA), brings a general international viewpoint to the topic.
The interviews were conducted through quite broad open questions (see Appendix 1), to allow the respondents to elaborate and answer in their own terms. The questions concern the European airline industry in general, today‟s crisis and the future outlook for the airline industry. These questions, together with a description of the purpose of this thesis, were sent by e-mail to Lidman and Jakobsson, while a compilation of statements made by Tarry were put together based on the interview questions.
A compilation of the interviews can be found in chapter 4.7 Analysts viewpoints on the current crisis and the future outlook for the industry.

Reliability and validity

Reliability has to do with consistency and to what extent the data collection technique used will yield constant outcomes or same conclusions. In other words the repeatability of the measurement. Validity can be explained as the strength of the conclusions or propositions. It is the degree to which data collection methods precisely measure what they were pro-posed to measure and research findings are about what they acknowledge to be about (Lewis et al., 2007).
It is always important to strive for a as high reliability and validity as possible. Companies‟ annual reports and interim reports must be seen objectively from an external perspective. This means that the numerical data presented can only be interpreted in one way which in turn strengthens the reliability in this thesis. On the other hand there are some arguments that contradict this and these will be discussed further in chapter 3.4 on Source criticism.
Information from different organizations such as IATA, AEA and the Swedish Civil Avia-tion Authority (Luftfartsstyrelsen) must be seen as valid and reliable, since these are large and well-known organizations. Further, IATA and AEA base their statistical data on pri-mary data from their member airlines, which also makes it more reliable. Even though only the traditional airlines, out of the actors included in the study, are members of AEA and IATA, this does not decrease the validity or relevance of the information used in this thesis from these sources. When referring to increases or decreases in traffic for certain interna-tional routes this still just refers to the traditional airlines, since the LCC almost exclusively operate on the intra-European market. Statistics about macroeconomic factors such as price of crude oil and GDP growth the organizations refer to other well recognized organi-zations, e.g. IMF and EIA.
As for the interviewees, these are all well cited and respected analysts in the airline industry and must therefore be considered as trustworthy. Even though Gramenius at the Swedish Civil Aviation Authority (Luftfartsstyrelsen) was intended as an interviewee, his recom-mendation of Jakobsson ought to be reliable.

Comparability

As discussed in chapter 1.4 Selections and delimitations, the airlines included in the study was chosen with the aim to achieve a level of comparability as high as possible. Though, some issues for comparability still remain.
The fact that some of the airlines use different fiscal years is one of them. Three out of the traditional airlines; Finnair, Iberia and Lufthansa end their fiscal year 31st of December, while British Airways end their fiscal year 31st of March. The issue is even more apparent between the LCCs, EasyJet and Ryanair, which end their fiscal years half a year apart. Easy-Jet 30th of September and Ryanair 31st of March. The differences were kept in mind when conducting the analysis.
Another aspect in which the airlines chosen for the study differs is in which currency they operate and thus in which they present their annual reports. British Airways and EasyJet present their annual reports in GB Pounds while the rest present theirs in Euros. This will however not affect the analysis since the study focuses on the development of reported items and ratio.
Another, though minor, issue was that Ryanair report levels of Revenue Passenger Miles (RPM) and Available Seat Miles (ASM) where the other airlines report RPK and ASK. For the same reason as stated above about the difference in currencies, this issue does not affect the analysis.

Methodological problems

In this thesis the focus is on financial ratio analysis, based on financial statements, as a way of evaluating the development of company profitability and capital structure. This is a very good and vital method when analyzing a company. But there are other and more factors, apart from the information shown by financial ratios that affect a company‟s profitability and capital structure. It is therefore inappropriate to state that all relevant information to evaluate a company is reflected in its annual reports. One must not neglect factors such as; management experience, education, age, motivation, social skills, leadership quality, firm age and size may also be important factors to look at. Such reflections have been taken into consideration.
Other methodological problems are the issue of selecting more or less essential financial ra-tios. Even though we have studied many different ratios and know that numerous ratios exist, a selection has to be made. And the issue of essential ratios or not, will always exist.
Since decision-makers in companies partially can decide what to present and what not to present in a company‟s annual report, it have to be taken into consideration that a ratio with the same name in two different annual reports can contain different calculations de-pending on how decision-makers want to highlight the company. To get around this issue as much as possible, and to be able to compare the ratios more accurately, own calculations of the ratios were made.
One other issue that is important to take into consideration is that six European airlines are not representative for the whole European airline industry. Therefore, generalizabilty is not something that can be taken for granted from analysis of the empirical findings.

Source criticism

Annual reports are the major source used in this thesis. While annual reports are consid-ered to give a fair and true view of a company‟s financial situation, one must not neglect to also assume the opposite. Biased information and positive distortion of numbers is not un-usual. Companies‟ tend to manipulate their figures, this is especially true and common for unhealthy or failing firms. Earnings can be adjusted upwards to give a more positive view of the situation and companies own estimations of key ratios can also be misleading.
It is also important to take into consideration that annual reports of different companies can contain different information. Also other information in annual reports or on the companies‟ web pages can have a positive distortion.
All these issues have been kept in mind while conducting this study and in cases possible the issues have been minimized, e.g. own calculations of the financial ratios were carried out.

Table of Contents
Acknowledgements
Abstract
Definitions and abbreviations 
Table of Contents
1 Introduction 
1.1 Background
1.2 Problem and research questions
1.3 Purpose
1.4 Selections and delimitations
1.5 Perspective
2 Frame of reference
2.1 Industry overview
2.2 Industry change and Porter’s Five Forces
2.3 Ratio analysis
2.4 The ratios chosen for this thesis
3 Method 
3.1 Primarily chosen research area
3.2 Research approach
3.3 Qualitative and quantitative approach
3.4 Primary and secondary data
3.5 Data collection and literature search
3.6 Model for observation
3.7 Interview
3.8 Reliability and validity
3.9 Comparability
3.10 Methodological problems
3.11 Source criticism
4 Empirical findings and analysis 
4.1 The airlines
4.2 Comparative analysis of the different airlines
4.3 Analysts’ viewpoints on the current crisis and the future outlook for the industry
5 Conclusion 
5.1 Critique
5.2 Further research
References
GET THE COMPLETE PROJECT
How industry change has af – fected European airlines D e v e l o p m e n t o f p r o f i t a b i l i t y a n d c a p i t a l s t r u c t u r e y e a r 2 0 0 0 – 2 0 0 8

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