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3 Business Strategies Reshaping the Airline Industry

By Alexander MacLennan – Feb 4, 2014 at 11:15AM

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Airlines are changing and these three strategies are moving the industry.

Even though the airline industry still relies on traveling passengers, much as it has done for the past several decades, airlines are adopting new strategies to make themselves more profitable. With billions in annual revenue at stake, investors should keep a close eye on these three industry practices.

Growing regional jets
U.S. travelers should expect to see fewer 50-seat regional jets in the skies over the coming years (although some are finding new homes with airlines in emerging markets). That's because U.S. carriers have been warming to the idea of using larger regional jets to operate short-range flights.

We can see examples of this strategy at the three remaining legacy airlines. Delta Air Lines (DAL -4.40%) leased larger Boeing 717 aircraft to replace many of its smaller regional jets. United Continental (UAL -4.05%) placed a regional jet order in April 2013 opting for the larger Embraer E-175 rather than the smaller models. And American Airlines Group (AAL -5.44%) decided on its regional jet order by choosing a selection of Bombardier CRJ900 aircraft and Embraer E-175 jets -- both larger than the 50-seat models they will be replacing.

As airlines are able to take greater control of their networks and fuel efficiency becomes a top concern, major airlines have been moving toward the larger end of the regional jet market. On a per-passenger basis, 50-seat jets are not as efficient making them among the first things to change as airlines begin to turn large enough profits to begin buying more new jets.

Top of the class
Airline seats are often referred to as a commodity but carriers are fighting hard to change this. Through the addition of new features, airlines are differentiating their products in a way that battles for consumers through price as well as product.

At the high end, Delta, United, and American all offer lie-flat seats to certain first and business class passengers. Some even go as far as to create personal suites around the seats. With business travelers making up a greatly disproportionate share of airline revenue, we should expect the product development battle for these highly valued passengers to continue.

Retail model
It used to be the only real shopping you could do during your flight was through the SkyMall catalog but airlines are getting on on this higher-margin market. While standard airfares typically make airlines a low-margin business, revenues obtained through fees and other products sold typically carry far greater margins.

With this in mind, it's no surprise the ancillary fee market and the offerings of extra goods and services are booming. Airlines have expanded well beyond checked bag fees and into sales of onboard snacks, entertainment, and legroom. Some airlines are even taking it a step further by offering such services as door-to-door baggage delivery.

The retail model is a place where I see airlines to have significant earnings potential. While the industry has traditionally operated on razor-thin margins, the retail model has the potential to bring in additional revenue while providing a boost to margins. It will be very interesting to see what the airlines launch in this field over the next several years.

Evolving industry
Airlines have long been thought of as an investment that balances out your capital gains. But today's airlines are reshaping the industry to be more profitable and more stable. Through the use of more efficient jets, the differentiation of products, and a developing retail model, I see the airline industry as having the potential to continue growing earnings and rewarding shareholders. Investors should keep an eye on this industry to see how it progresses as these strategies continue to be implemented.

Alexander MacLennan owns shares of American Airlines Group and Delta Air Lines and has the following options: long January 2015 $22 calls on Delta Air Lines, long January 2015 $25 calls on Delta Air Lines, long January 2015 $30 calls on Delta Air Lines, long May 2014 $31 calls on American Airlines Group and long January 2015 $17 calls on American Airlines Group. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Stocks Mentioned

Delta Air Lines Stock Quote
Delta Air Lines
$34.33 (-4.40%) $-1.58
United Airlines Holdings Stock Quote
United Airlines Holdings
$44.06 (-4.05%) $-1.86
American Airlines Group Stock Quote
American Airlines Group
$13.55 (-5.44%) $0.78

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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