SmartGo Airlines Case Study: Analysis Essay.

Background of SmartGo Airlines

Read the separately enclosed scenario titled “The Rise and fall of SmartGo Airline”. The scenario is fictitious but represents what can possibly happen in an airline startup.

1. Analyse this scenario in terms of the Economics in Aviation principles to determine the strengths and  weaknesses of the startup using theories and material from the course.

Your report should include

1.The problems contributing to the weaknesses, how well these were addressed, how they contributed to the outcome, and what should have been done.

2. There are plenty of issues for analysis;

your task is to argue which are the most important using the course theories and principles. In your research and analysis, you should also compare SmartGo’s issues  to those experienced by three actual airlines in situations similar to SmartGo.

In addressing issues,

you should aim to apply material across the course up to and including Week 8. Focus should be on the highest priority issues and addressing the airline performance measures and economic theories most applicable to the SmartGo case study.

The origin of SmartGo had the simplest of beginnings. Ian Mansom, known to his many friends and business associates as “IM”, relaxed with his good friend Rob Smith after a tough session at the gym. Rob had made his money in commercial real estate and development, with a focus in rural areas. In contrast, IM had made his wealth in business information technology systems development, where he was the exclusive agent for an overseas business logistics system. Both were regarded by their business acquaintances as successful business people and “risk-takers”, going where others might fear to go and always looking for the next big business opportunity.

At the time, the nation’s economic cycle seemed to be on a continual expansion with a commodities “boom” and matching property development “boom” that seemed never-ending. IM and Rob had discussed the matching expansion of airlines and the problems they and their business acquaintances had experienced travelling by airline on business appointments which often took a considerable part of their time. The current airlines did not seem to providing the schedules, services or prices as part of normal business competition; they acted almost like a cartel both stayed within the regulations. Rob, who held a Commercial Pilot’s Licence and was an enthusiastic flyer, owned an old Piper Seneca which he used for commuting over large distances as part his commercial real estate opportunities but it had its limitations. “The trouble is there is not enough competition, especially to meet our particular needs” said Rob, as they packed their gym bags, jokingly adding “We could probably do better with by starting our own airline that addresses the needs of people like us and provides some real competition.” Such a simple statement was to start events that would change their whole attitudes to business.

Over the subsequent months, IM and Rob met to discuss the idea of an airline in further detail. They discussed the experiences and sought views from business acquaintances, including those who came in from overseas, plus canvassed the idea with travel agents. The answers always came to the same conclusion: the country was ripe for extra competition. Whenever they expressed reservations to their fellow business acquaintances about starting an airline, they were often told “Business is business whatever industry you’re in and getting into an airline is nowhere near as hard as in the past, plus there are plenty of new successful startups globally run by people with backgrounds in other businesses, even finance people, to prove that you don’t need to be an aviation expert.” The comment was further added “If you focus on a niche part of the airline market, such as business passengers or tourists, it becomes even easier” Thus the seed of a concept for an airline for business people was born and its name would reflect value by air; it would be named SmartGo.

Background of SmartGo Airlines

The global business scenario has changed considerably over time, much of which can be attributed to the changes in the economic activities and patterns in different countries as well as in the global framework. All these factors as well as the global integration of business environment has led to the increase in the number of demand side as well as supply players in almost all the industries in the world, with both domestic as well as international suppliers entering the markets for different industries across the globe (Wild, Wild & Han, 2014). This in turn has led to the increase in the level of competition in each of the industry, thereby making it challenging for the global businesses, especially the start-ups and new entrants in the markets to attain profitability, robust market share, market power, sustainability and competitive edge over their contenders (Wetherly, 2014).

In this context, like any other industry, the global airline industry has also been facing considerable dynamics and challenges, with the increase in the economic dynamics as well as increased competition from the local as well as global competitors from all parts of the world. This in turn makes it even more challenging for the new entrants in this market as starting up a commercial airline is a costly affair and the success or failure of the same depends on both its internal decision makings as well as the external economic and other factor and its responsiveness to the same (Cavusgil et al., 2014). Keeping this into consideration, the concerned report tries to address the concerned cast study of the actions, success and failure of a hypothetical airline named SmartGo in the airline market, by viewing the occurrences and troubles faced by the airline in the light of different economic and performance aspects.

The concerned case study reflects on how the airline named SmartGo came into existence, prospered eventually but started facing problems from different aspects and how several crucial faults in the decision-making aspects of the owners of the airline as well as several internal as well as external economic disadvantages led to the bankruptcy of the company as a whole.

As per the assertions of the article taken into consideration, the SmartGo Airline came into operations in the market, as a brainchild of two persons, Ian Mansom and Rob Smith, who wanted to take advantage of the lack of proper scheduled services as well as lack of competition in the then situation in the airline industry in their region. The market appeared to be lucrative with the presence of 400 million people in the concerned city with two smaller habited regions in the West and the North of the city, located slightly away from the actual hub city. The presence of different mining communities and with 65% of the national commercial activities of the nation being carried out by national as well as international companies, the demand side for the airline market seemed to be lucrative for the entry of the new supply side player. On the other hand, in the supply side there exited one large legacy career, the National Airlines and another low cost and relatively new carrier EconAir, which was the subsidiary of an international conglomerate with operations in many markets.

Challenges and Dynamics of the Global Airline Industry

Thus, these factors led to the presence of a robust market, especially for the business people, which had the possibility of increasing even more with the businesses booming in the region over the years. This in turn, led to the entrance of SmartGo with the intension to capture a significant share of the market, as in the existing situation the business passengers were found to pay premiums for high grade service inclusive airline seats. However, though the company launched with high expectations, within 16 months of its beginning of operations the company had to shut down due to acute financial crisis and other issues. As per the case study, there occurred various financial as well as performance issues and wrong business decisions and speculations which led to the failure of the SmartGo Airline in the market of the concerned region. The following section of report tries to highlight the primary issues which led to the problem in the concerned airline and tries to analyse the same with the help of the economic and performance theoretical conceptual framework.

The failure and bankruptcy of the SmartGo Airlines, as discussed above, was a cumulative effect of the various financial as well performance issues and a host of wrong business decisions, the primary ones being discussed as follows:

The start-up decision being mainly an outcome of decisions taken in haste, the finances were unequally distributed with a major amount of $2 million being invested by IM and only $500,000 by Rob as his own business was in some trouble. The promise of the rest of the amount to be given by Rob never actually got fulfilled. In spite of the presence of these capitals and a promise of $150 million of equity capital, the amount was less than what it was required but still the entrepreneurs plunged into the business.

In terms of economics this shows the excessive “risk averse” behaviour of the entrepreneurs as can be seen from the over ambition and lack of far sightedness regarding the amount of capital that has to be kept in order to run the business smoothly (Holloway, 2017). This problem can also be explained with the help of the cost structure for of business as discussed in economics. In the conceptual framework of economics, there exist mainly two types of cost which are encountered by any business, which amount for the total cost of production or business operations.

Primary Issues and Analysis

Total cost = Total fixed cost + Total variable cost

The total fixed cost shows the expenses which the firms have to take irrespective of the number of commodities produced. On the other hand, the total variable cost shows the amount of expenses which vary with time. In case of the start ups in the airline industry, like that of SmartGo, the initial fixed cost being extremely high, the decision regarding the mobilizing of such capitals had to be taken to be more judiciously before plunging in the market (Lohmann & Koo, 2013).

As can be seen from the decisions of the entrepreneurs, they lacked in sight and experience about the products and their efficiencies in the airline industry. Based on the performance of Rob’s old aircraft and his assurance, eight Boeing 737-200 were bought as the primary assets for SmartGo Airlines which were considerably old models, from the 1970s and had less cost efficiencies in terms of fuel usage as they needed much more oil than the new and a bit costly new airline which had immense fuel efficiency (Doganis, 2013).

They bought these planes on the perception that the contemporary jet fuel prices being quite low, the additional cost of extra fuel usage will be compensated by the low prices of these old aircrafts. However, this particular decision of the SmartGo Airlines was not far sighted or economically efficient one as with the advent of the Global Financial Crisis, the price of fuel started rising globally, the impact of which was felt on the cost of operations of the Airlines (Tverberg, 2012). The airlines already having less fuel efficiency, led to the surge in the cost of production, which in turn led to the increase in the prices of their tickets by almost 10%. This in turn led to a fall in the demand for the services of SmartGo by almost 15%. The fall in demand can be explained with the help of the following figure:

 

Figure 1: Inverse relationship between price and demand for normal commodities

(Source: As created by the author)

As is evident from the above figure, with the increase in the price of the tickets, attributed to the fuel price increase and lesser fuel efficiency, the demand for the services of SmartGo Airlines fell considerably as by the law demand, with the increase in the price of normal commodities or services (airline services falling within the same) the demand for the same decreases and vice versa (Pindyck & Rubinfeld, 2014).

Entrepreneurial Decision-making and Capital Mobilization

As is evident from the above discussion, the increase in fare of SmartGo by 10%, owing to the fuel price hike during the period of Global Financial Crisis, led to a more than proportionate (almost 15%) decrease in the demand for their services. This is primarily due to the presence of other service providers in the airline market of the region, which primarily consisted of EconAir and National Airlines, both operating with comparatively more cost-efficient aircrafts. This can be explained with the help of the economic concept of price elasticity of demand in economics.

In the conceptual framework of economics, the price elasticity of demand of a commodity or service shows the degree of responsiveness of demand of the same to a unit change in the price of the product or service. If the demand for the product changes more than proportionately due to a unit change in the price of the same, then the demand for the good is said to be highly elastic and if it changes less than proportionately then the demand is considered to be inelastic (Granados, Gupta & Kauffman, 2012).

This can be shown with the help of the following figure:

 

Figure 2: Elastic and Inelastic demand

(Source: As created by the author)

As can be seen from the above figure, the same change in the price leads to a higher change in the demand of those with higher elasticity of demand than the demand of those with comparatively less elasticity of demand. Keeping this into consideration, it can be seen that in the concerned case, it can be seen that due to the presence of a number of efficient options, the demand for the services of SmartGo Airlines is found to be highly elastic (Hall & Lieberman, 2012). This can be seen to be negatively affecting the economic profitability of the airline, in terms of higher than proportional decrease in the demand due to the increase in the fares owing to the fuel price.

The primary intention behind the entry of SmartGo Airlines was to take advantage of the lack of competition in the industry, by bringing in new competitions in terms of products and services so as to give tough competition to the pricing and fare strategies of the existing competitors. However, in doing so the company entered into a strictly oligopolistic market structure with two already established firms already operating in the market, both with significant capital assets and market dominance (Anand & Venkataraman, 2016). These two companies, one being a large company and the other being a subsidiary of a large international multi-dimensional conglomerate, enjoyed large cost efficiencies in production and operations, which can be explained with the concept of “economies of scale”.

Aircraft Choice and Fuel Efficiency

Figure 3: Economies of scale

(Source: As created by the author)

As is evident from the above figure, with the increase in the operations and expanse of the clientele the cost of per unit production of service decreases for a company, thereby leading to the creation of economies of scale, which enables the company to produce and sell their service at a considerably low cost, as can be seen to be done by the other two airlines, which emerged in a price war with the concerned company (Polkinghorn, 2016).

 

Figure 4: Kinked demand curve in price war

(Source: As created by the author)

In case of price war in an oligopolistic market, the kinked demand curve arises, where the price cut by one firm is followed by a cut in the price by its competitors but not vice versa (Fudenberg & Tirole, 2013). In this context, the SmartGo Airlines failed to cope up with the price wars with the other two cost efficient airlines, as they were already enjoying economies of scale.

From the beginning wrong speculations and sub-optimal investments were seen to be done by the entrepreneurs. Instead of going for more efficient planes, they went for lavish decorations. They hired inferior crew with higher cost and took inappropriate maintenance measures, by taking the responsibility all by themselves instead of outsourcing the same to more cost efficient and specialised companies. The company also used Bizjet’s terminals, where the aircrafts of Bizjet got first preferences, thereby leading to higher waiting time and dissatisfactions among the customers. The schemes launched for leisure passengers also gave temporary benefits only in holiday seasons (Akamavi et al., 2015). The decision of purchasing old aircrafts backfired as technical glitches and issues became more frequent, the media coverage of which led to tremendous scepticism among the customers, which was even aggravated by the poor online booking portal and interface used by the company.

All these factors cumulatively led to the failure of the SmartGo Airlines in a very short span after its operations started.

The conditions faced by SmartGo Airlines can be found to be experienced by several real airlines, few of which are as follows:

1. Qantas-This Australian airline has been facing cost efficiency problems and has been losing out to the big Middle East carriers like Etihad and Emirates (Erotokritou, 2012).
2. Philippine Airlines- This, being one of the oldest Asian scheduled carrier had to stop its operations due to the Asian economic crisis which led to financial turmoil and investment scepticism in the company.
3. Island Air-This airline, primarily operating in the Hawaiian market also ceased operations in 2017 and filed bankruptcy as they lost in the price war and efficiency with the bigger players (Ciliberto & Schenone, 2012).

Conclusion 

As is evident from the above discussion, the SmartGo Airlines, in the concerned case study, soon after its beginning of operations faced problems in various aspects, ranging from financial to performance related issues, much of which arose due to the wrong decisions and lack of foresightedness of the entrepreneurs. The failure of the company indicates towards sheer lack of proper strategic planning and the trend of taking impulsive decisions without proper knowledge of the operational framework of the airline industry as a whole and about the market in which the company was venturing.

The lessons which can be learnt from the failure of the hypothetical company are primary that, while venturing in the airline markets, the airline companies, especially the new ones should take into account the market structure and level of competition which they are expected to face. The companies should also focus on the cost efficiencies of the operation of their services instead of emphasizing on short term attractions like decors and others. The existence of proper man power as well as robust supply chain and business linkages are also important as a lot of the profitability and sustainability of the company depends on the same.

References 

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