Professional Documents
Culture Documents
Advanced Diploma
INTERNATIONAL BUSINESS
CS1209
CASE STUDY
Delta-Northwest
afternoon 1 December 2009
This is an open-book examination and you may consult any previously prepared
written material or texts during the examination.
Only answers that are written during the examination in the answerbook supplied by
the examination centre will be marked.
As in real life, anomalies may be found in this Case Study. Please simply state
your assumptions where necessary when answering questions. The ABE is not in
a position to answer queries on Case data. Candidates are tested on their overall
understanding of the Case and its key issues, not on minor details. There are no catch
questions or hidden agendas.
After the publication of the Case Study subsequent developments may occur. The
examination is based on the published Case Study and students who do not mention
such developments will not be penalised. However, students may consider such
developments in their answers if they wish.
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Delta-Northwest
Delta predicted declines in international demand during the rst quarter of 2009 as its Northwest
Airlines subsidiary announced that passenger load factors* were down seven-to-nine points for
the February and March periods. The company explained that the data points are within [their]
expectations for this environment but expressed uncertainty in predicting further declines. We just
dont know where to predict the bottom of the recession is going to hit but were utilising all the levers
that we can. (Lori Ranson, 2009)1 (See references on page 9)
In 2008, Delta Air Lines was one of the four largest passenger airlines in the world. From the turn
of the new millennium the company faced nancial difculties due to increasing price competition
from discount airlines, and in September 2005 the company was forced into bankruptcy (see
APPENDIX 1 for the companys 2005 Operating Statistics). The signs of downturn became
increasingly evident in 2004, as can be seen from the following table.
From 2007, Delta followed a revised operating strategy involving a network shift towards more
protable international routings. However, despite operational improvements, the company continued
to face threats to its protability, the most prominent among these being the price of oil.
*Passenger load factor This term describes a comparative measure of an airlines performance in terms of being
able to ll the available capacity on its planes. The passenger load factor (PLF) of an airline, sometimes simply called
the load factor, is a measure of how much of an airlines passenger carrying capacity is used. It is passenger kilometres
own as a percentage of seat kilometres available. This is a measure of capacity utilisation. As airlines frequently have
heavy xed costs and are capital intensive, the efciency with which assets are used is crucially important. This is an
important efciency measure, but it does not consider the pricing and the protability at which the capacity is sold. Delta
has one of the highest PLFs of the airlines with operating bases in the USA.
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
17 10 17 25 23 25 25 25 35 55 75 100
In late 2008, Delta and Northwest Airlines formally merged to form a new joint airline (Delta) and at
the beginning of December of the same year, the company announced that it would cut an additional
6-8% of capacity in 2009. It was predicted that the merger could result in a reduction in domestic
capacity of up to 10%. Delta also said that it would eliminate an undetermined number of jobs. Delta
President Ed Bastian called the cuts dramatic and said that the total seat capacity, domestic and
international, over the two-year 2008-2009 period, will be reduced by 20%. This was considered a
required step, due to the downturn in both business and leisure travel. (The Wall Street Journal,
2 December 2008)
During this time, Delta shares had rallied to around $8.48, partly on the back of the market. However,
further decline was to set in shortly afterwards and into 2009 as shown in the following graph.
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Deltas Operations
Mission
According to the companys website, the mission of Delta is to build on its traditions and always
meet customers expectations while taking service to ever higher levels of excellence. Within this
aspiration, the company stands for safe and reliable air transportation, distinctive customer service,
and hospitality from the heart.
Deltas marketing alliances allowed its passengers to earn and redeem SkyMiles on nearly 16,409
ights offered by SkyTeam and other partners. Delta was a founding member of SkyTeam, a global
airline alliance that provided customers with one of the worlds most extensive networks of worldwide
destinations, ights and services (see APPENDIX 1 for membership composition). Including its
SkyTeam and worldwide codeshare* partners, Delta offered ights to 841 worldwide destinations in
162 countries.
Northwest Airlines operated hubs at Detroit, Minneapolis/St. Paul, Memphis, Tokyo and Amsterdam,
and carried out approximately 1,400 daily departures. Northwest was a member of SkyTeam.
Northwest and its travel partners served more than 1,000 cities and in excess of 160 countries on
six continents.
In late 2008, Delta and Northwest formally merged to form a new joint airline called Delta and
in 2009 it was the largest airline in the world, by both enterprise value and available seat miles. In
the previous April, the companies had announced an agreement in which the two carriers would
combine in an all-stock transaction with a combined enterprise value of $17.7 billion and a total of
786 aircraft.
Previously, the management of airlines had largely resisted industry-changing deals, in part because
of concerns over integration problems and a generally poor record for airline mergers. However,
Deltas CEO, Richard Anderson, said that consolidation could make sense for Delta if its done
thoughtfully from a position of strength. Northwests CEO, Douglas M. Steenland, called further
industry consolidation inevitable. Other factors favouring consolidation were the high fuel prices
and the possible impact on demand of recession.2
*The term codesharing is an aviation business term which was rst coined in the 1970s and is an interline partnership
where one carrier markets the air-service and places its designator code on another carriers ights. This arrangement
allows carriers an opportunity to provide ights to destinations not in their basic route structure.
By 2009, Delta was the second largest airline in the USA and had a eet of mostly Boeing aircraft.
Cities it served stretched from limited markets in Japan and South Korea to several destinations in
South America and Europe and eastwards to the United Arab Emirates and India. Northwest had
hubs in Detroit, Minneapolis and Memphis and offered high capacity ights to many small cities
across the Great Plains as well as extensive long haul services to Asia and Europe. It had strong
codeshare relationships in several US West Coast focus cities. Recently, Northwest added hundreds
of Airbus aircraft to their eet which had consisted predominantly of Boeing and Douglas aircraft.
While US network carriers had shed more than 150,000 jobs and lost more than $29 billion since
2001, the combination of Delta and Northwest was considered to have created a company with a
more resilient business model, better able to withstand volatile fuel prices than either company could
on a stand-alone basis. Combining Delta and Northwest was the most effective way to offset higher
fuel prices and improve efciencies, increase international presence and fund long-term investment
in the business.
The merger was expected to generate more than $1 billion in annual revenue and cost synergies
due to more effective aircraft utilisation, a more comprehensive and diversied route system and cost
synergies from reduced overhead and improved operational efciency. It was anticipated that there
would be one-time cash costs not exceeding $1 billion to integrate the two airlines. The result would
be a stronger, more durable nancial base and one of the strongest balance sheets in the industry,
with expected liquidity of nearly $7 billion.
Under the terms of the transaction, Northwest shareholders received 1.25 Delta shares for each
Northwest share they owned. This exchange ratio represented a premium to Northwest shareholders
of 16.8% based on 14 April 2008 closing prices.
Richard Anderson, Deltas CEO, stated at the time: We said we would only enter into a consolidation
transaction if it was right for all of our constituencies; Delta and Northwest are a perfect t. Today,
were announcing a transaction that is about addition, not subtraction, and combines end-to-end
networks that open up a world of opportunities for our customers and employees. We believe that
by partnering with our employees, including providing equity to US-based employees of Delta and
Northwest, this combination is off to the right start. Together, we are creating Americas leading
airline an airline that is nancially secure, able to invest in our employees and our customers, and
built to thrive in an increasingly competitive marketplace.3
In response, Northwests CEO, stated: Todays announcement is exciting for Northwest and its
employees. The new carrier will offer superior route diversity across the USA, Latin America, Europe
and Asia, and will be better able to overcome the industrys boom-and-bust cycles. The airline
will also be better able to match the right planes with the right routes, making transportation more
efcient across our entire network. In short, combining the Northwest and Delta networks will allow
the strengthened airline to realise its full global potential and invest in its future.4
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The Delta-Northwest combination was considered to be pro-competitive. There was little overlap in
the non-stop routes served by the two airlines. There was only direct competitive service on 12 of
more than 1,000 non-stop city pair routes then own by both airlines. The merger was judged to have
created a stronger, more efcient global competitor. Discount carriers, which carried around one third
of domestic passengers, and other network airlines, remained competitors in the airlines markets.
Delta and Northwests complementary networks and common membership in the SkyTeam alliance
were anticipated to ease the integration risk that had complicated some airline mergers. The carriers
participated in a joint SkyTeam frequent-yer programme with common customer lounges and airline
partner networks. Furthermore, they shared a common IT platform, which was partially integrated
through the existing alliance between Delta and Northwest. The combination of Delta and Northwest
also enabled an accelerated joint venture integration with Air France/KLM, creating the industrys
leading alliance network.
Northwests Activities
Airline Alliances
Long-term alliance partnerships are an effective way for an airline to enter markets that it would
not be able to serve alone. Alliance relationships can include codesharing, reciprocal frequent-yer
programmes, through luggage check-in, reciprocal airport lounge access, joint marketing, sharing
of airport facilities and joint procurement of certain goods and services.
In September 2004, Northwest, together with KLM and Continental, joined the global SkyTeam
Alliance. The addition of Northwest, KLM and Continental made SkyTeam the worlds second largest
airline alliance. The eleven members of the SkyTeam Alliance: Northwest, KLM, Continental, Delta,
Air France, Alitalia, Aeromexico, China Southern, CSA Czech Airlines, Korean Air and Aeroot, and
three associate members: Air Europa, Copa Airlines, and Kenya Airways. The Alliance currently
serves over 427 million passengers annually, with more than 16,400 daily departures to 841
destinations in 162 countries.
Regional Partnerships
Northwest formed airline services agreements (ASAs) with three regional carriers: Pinnacle, Mesaba
and Compass. In accordance with the ASAs, these regional carriers are required to operate their
ights under the Northwest (NW) code and operate as Northwest Airlink.
The purpose of these ASAs is to provide a service to small cities and a more frequent service to
larger cities, increasing connecting trafc at Northwests domestic hubs. The business terms of
these agreements involve capacity purchase arrangements. Under these arrangements, Northwest
controls the scheduling, pricing, reservations, ticketing and seat inventories for Pinnacle, Mesaba
and Compass ights. Northwest is entitled to all ticket, cargo and mail revenues associated with
these ights. The regional carriers are paid for certain expenses based on operations and receive
reimbursement for other expenses.
In October 2005, Northwest Airlines Cargo joined SkyTeam Cargo, the largest global airline cargo
alliance. The eight members of SkyTeam Cargo, Northwest Airlines Cargo, Aeromexico Cargo, Air
France Cargo, Alitalia Cargo, CSA Czech Airlines Cargo, Delta Air Logistics, KLM Cargo, and Korean
Air Cargo, currently serve more than 728 destinations in more than 149 countries on six continents.
This alliance offers customers a consistent standard of performance, quality and detailed attention
to service.
Northwest is subject to the regulations of the US Department of Transport (DOT) and the Federal
Aviation Administration (FAA) because it holds certicates of public convenience and necessity,
air carrier operating certicates and other authority granted by those agencies. The FAA regulates
ight operations, including air space control and aircraft standards, maintenance, ground facilities,
transportation of hazardous materials and other technical matters.
Northwest operates its international routes under route certicates and other authorities issued by
the DOT. Many of Northwests international route certicates are permanent and do not require
renewal by the DOT. With respect to foreign air transportation, the DOT must approve agreements
between air carriers, including codesharing agreements, and may grant antitrust immunity for those
agreements in some situations.
Northwests right to operate to foreign countries, including Japan, China and other countries in
Asia and Europe, is governed by aviation agreements between the USA and the respective foreign
countries. Many aviation agreements permit an unlimited number of carriers to operate between the
USA and a specic foreign country, while others limit the number of carriers and ights on a given
international route.
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SkyTeam
Formed in 2000, SkyTeam is the second largest airline alliance in the world, partnering carriers from
four continents. SkyTeam also operates a cargo alliance called SkyTeam Cargo. Through the worlds
largest hub network, the Sky Team alliance provides its hundreds of thousands of passengers with
a global ight network which comprises several thousand annual ights to 728 destinations located
in more than 149 countries around the world.
In a joint statement following SkyTeams formation, the airlines CEOs stated that it would alter the
competitive landscape for airline alliances to provide more choices, better service and improved
benets. SkyTeams route system covered all the major destinations in the Northern Hemisphere,
where nearly 80% of the worlds trafc ies.
Frequent yers earn miles in their existing accounts when ying with any of the partner airlines. Miles
can be exchanged for a reward ticket on any SkyTeam airline. In addition, top-tier yers on each of
the alliance airlines automatically attain SkyTeam Elite and Elite Plus status with enhanced benets.
Elite and Elite Plus status are supplementary to the current frequent ier programme offerings of all
member airlines.
Cargo customers benet from the alliance partnership through reserved cargo space and marketing
agreements.
Operations to and from foreign countries are subject to the applicable laws and regulations of those
countries. Additionally, slots for international ights are subject to certain restrictions on use and
transfer.
On 30 March 2008, a new Air Transport Agreement between the USA and the EU Member States
came into effect and created new competitive opportunities and competition on routes between the
USA and Europe. For example, it enabled Northwest to commence services to London Heathrow
Airport, subject to the availability of slots.
In November 2007, the DOT issued a proposal to increase by 100% the minimum amount of
compensation that airlines must pay to consumers who have been denied boarding on oversold
ights.
Under the direction of the United Nations International Civil Aviation Organization (ICAO), world
governments, including the USA, continue to consider more stringent aircraft noise certication
standards. A new ICAO noise standard was adopted in 2001 that established more stringent noise
requirements for newly manufactured aircraft after 1 January 2006.
Airlines are subject to regulation under various environmental laws and regulations, including the
Clean Air Act, the Clean Water Act and Comprehensive Environmental Response, Compensation
and Liability Act of 1980. In addition, many state and local governments have adopted environmental
laws and regulations to which airlines operations are subject. Environmental laws and regulations
are administered by numerous federal and state agencies.
Most, if not all, airlines depend on automated systems to operate their business, including internal
airline reservation systems, ight operations systems, telecommunication systems and commercial
websites. These websites and reservation systems must be able to accommodate a high volume
of trafc and deliver important ight information, as well as process critical nancial transactions.
Substantial or repeated failures in website reservation systems or telecommunication systems could
reduce the attractiveness of an airlines services versus its competitors and materially impair its
ability to market its services and operate its ights.
Airlines rely extensively on third-party providers to perform a large number of functions that are
integral to their business, such as the operation of certain regional carriers, provision of information
technology infrastructure and services, provision of maintenance and repairs and performance of
aircraft fuelling operations, among other vital functions and services. Failure of these parties to
perform as expected, or unexpected interruptions in the airlines relationships with these providers
or their provision of services, could have an adverse effect on nances and operations.
Because fuel costs are a signicant portion of operating costs, substantial changes in fuel costs
materially affect operating results. Fuel prices continue to be susceptible to: political unrest in
various parts of the world; Organization of Petroleum Exporting Countries (OPEC) policy; the rapid
growth of economies in China and India; the levels of inventory carried by industries; the amounts
of reserves built by governments; disruptions to production and rening facilities; and the weather,
among other factors.
In 2005, Hurricane Katrina and Hurricane Rita caused widespread disruption to oil production, renery
operations, and pipeline capacity in parts of the US Gulf Coast. As a result of these disruptions, the
price of jet fuel increased signicantly and the availability of jet fuel supplies diminished during the
fall (autumn) of 2005. These, and other factors that impact the global supply and demand for aircraft
fuel, may affect nancial performance due to its high sensitivity to fuel prices. For example, a one-
cent change in the cost of each gallon of fuel would impact operating expenses by approximately
$1.4 million per month (based on 2007 mainline and regional aircraft fuel consumption).
The airline industry is intensely competitive. Competitors include major domestic airlines as well
as foreign, regional, and new entrant airlines, which have varying nancial resources and cost
structures. Revenues are sensitive to numerous factors, and the actions of carriers in the areas of
pricing, scheduling and promotions can have a substantial adverse impact on revenues.
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Industry revenues are also impacted by the growth of low cost airlines and the use of internet travel
websites. Taking advantage of low unit costs, driven in large part by lower labour costs, low cost
carriers, and carriers who have achieved lower labour costs, are able to operate protably while
offering substantially lower fares. Internet travel websites have driven signicant distribution cost
savings for airlines, but have also allowed consumers to become more efcient at nding lower fare
alternatives than in the past, by providing them with more powerful pricing information. Such factors
become even more signicant in periods when the industry experiences large losses, as airlines
under nancial stress, or in bankruptcy, may institute pricing structures intended to protect market
share, or raise cash quickly, irrespective of the impact on long-term protability.
A signicant portion of operations may well be conducted in foreign locations. As a result, operating
revenues and, to a lesser extent, operating expenses, in addition to assets and liabilities, will be
denominated in foreign currencies. Thus, uctuations in foreign currencies can signicantly affect
operating performance and the value of assets and liabilities located outside of the host country.
The industry is exposed to changes in interest rates. An increase in interest rates would likely have an
overall negative impact on earnings, as increased interest expense would only be partially offset by
increased interest income. From time to time, nancial instruments may be used to hedge exposure
to interest rate uctuations. However, these hedging strategies may not always be effective.
The airline industry is seasonal in nature. Due to seasonal uctuations, operating results for any
interim period are not necessarily indicative of those for the entire year.
The airline industry is labour-intensive, and collective bargaining agreements (CBAs) provide
standards for wages, hours of work, working conditions, settlement of disputes and other matters.
The Airline Deregulation Act of 1978, as amended, eliminated domestic economic regulation of
passenger and freight air transportation in many respects. Nevertheless, the industry remains
regulated in a number of areas. The DOT has jurisdiction over international route authorities and
various consumer protection matters, such as advertising, denied boarding compensation, baggage
liability and access for persons with disabilities.
In April 2007, the US and the European Union (EU) approved an open skies air services agreement
that provides airlines from the USA and EU Member States open access to each others markets,
with freedom of pricing and unlimited rights to y beyond the USA and beyond each EU Member
State.
Under the open skies agreement, which went into effect on 30 March 2008, every US and EU airline
was authorised to operate between airports in the USA and Londons Heathrow, Gatwick and other
airports. As a result of the open skies agreement, Delta announced an expansion of its transatlantic
route network with three new daily nonstop ights to London Heathrow from Detroit, Minneapolis/St.
Paul and Seattle.
References
1 Lori Ranson, US airlines brace for shift of premium trafc to the back cabin, AIRLINE
BUSINESS, 2 February 2009.
2 2008: The Year of the Big Airline Merger?, New York Times, 9 January 2008.
3 The Merger, Delta.com, 15 April 2008.
4 The Merger, Delta.com, 15 April 2008.
Employees: 47,000+
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APPENDIX 2
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APPENDIX 4
Northwest Airlines
Statements of Operations
Balance Sheets
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