Growth from Chaos: Developing Your Firm's Resources to Achieve Profitability without Cost Cutting

GROWTH FROM CHAOS Developing Your Firm's Resources to Achieve Profitability without Cost Cutting Michael L. Pettus PRA...

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GROWTH FROM CHAOS Developing Your Firm's Resources to Achieve Profitability without Cost Cutting Michael L. Pettus

PRAEGER

Westport, Connecticut L o n d o n

Library of Congress Cataloging-in-Publication Data Pettus, Michael L., 1950Growth from chaos : developing your firm's resources to achieve profitability without cost cutting / Michael L. Pettus p. cm. Includes bibliographical references and index. ISBN 1-56720-633-6 (alk. paper) 1. Deregulation—United States. 2. Corporations—Growth. 3. Industries— United States. 4. Industrial policy—United States. I. Title. HD3616.U47P444 2003 338.0973—dc22 2003059690 British Library Cataloguing in Publication Data is available. Copyright © 2003 by Michael L. Pettus All rights reserved. No portion of this book may be reproduced, by any process or technique, without the express written consent of the publisher. Library of Congress Catalog Card Number: 2003059690 ISBN: 1-56720-633-6 First published in 2003 Praeger Publishers, 88 Post Road West, Westport, CT 06881 An imprint of Greenwood Publishing Group, Inc. www.praeger.com Printed in the United States of America

The paper used in this book complies with the Permanent Paper Standard issued by the National Information Standards Organization (Z39.48-1984). 10

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Copyright Acknowledgments The author and publisher gratefully acknowledge permission for use of the following materials: Excerpts from Marketing Management, 8/e by Kotler, Philip, © Reprinted by permission of Pearson Education, Inc., Upper Saddle River, NJ. Reprinted by permission of Harvard Business Review. From "Marketing Myopia" by Theodore Leavitt, Volume 53, Number 5, September/October 1975. Copyright © by the Harvard Business School Publishing Corporation; all rights reserved.

To Juliet, The love of my life

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Contents Preface

ix

Acknowledgments

xi

Introduction 1 Firm Growth Is a Strategic Process

xiii 1

2 Growth over Time Does Not Depend upon a Friendly Environment

15

3 A Framework for Achieving Long-Term Domestic and International Growth

35

4 Deregulation and Growth: An Inhibitor or an Accelerator?

57

5 Trucking Deregulation: Why Firms Failed

79

6 Trucking Deregulation: Patterns of Growth

99

7 The Restructuring of the U.S. Airline Industry

135

8 The Radical Transformation of the U.S. Railroad Industry

173

9 The Future of the U.S. Airline Industry

197

10 Patterns Generating Long-Term Growth

217

Index

231


Preface This book was written to help managers and practitioners better understand the concept of firm growth. The book specifically addresses how a firm can develop its resource base over time to provide for longterm growth. One of the reasons that there are few books on this subject is because it is difficult to ascertain a logical starting point. The act of deregulation provides such a starting point. In a regulated environment the following factors are tightly controlled by the regulatory agency: price, profitability, market share, and entry and exit. In a deregulated environment all these constraints are relaxed. A new environment is created. The book contains a detailed discussion of the evolution of the U.S. airline industry, air freight industry, trucking industry, and North American railroad industry. This book is written for practitioners who wish to gain a deeper understanding of the process of firm growth. The text explains what actions need to take place and when they should occur if a firm wants to achieve a growth advantage over its competitors. Growth is an evolutionary process of both responding to and initiating change. The book provides practitioners, in all industries, with guidelines concerning how to manage both elements of the change process to provide for long-term growth. In the industries studied, firms that developed their resource base in approximately the same sequence generated the highest rates of growth. This book is also written for academic scholars because a comprehensive book about firm growth from a resource sequencing perspective has not been available. Much of the current management literature focuses upon core capabilities and competencies. This book explains

Preface

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h o w to use a firm's resources and core capabilities to achieve longterm growth from a sequencing perspective. Much of the book's content has been developed from m a n y years with m y mentors. It is impossible to mention everyone, but I would like to acknowledge those w h o have h a d a profound impact u p o n me. My sincere thanks to all of you. PRACTITIONER MENTORS Oz Nelson, Former Chairman of the Board, United Parcel Service Dick Green, Former Senior Vice President, United Parcel Service Art Bass, Former President, FedEx Corporation John Emery Jr., Former Chairman of the Board, Emery Worldwide Peter Bott, Former Partner in Charge of Worldwide Operations, Arthur Andersen & Company John Throckmorton, Former Vice President of Worldwide Operations, A. T. Kearney Management Consultants Al Delardo, Vice President, Cresap, McCormick, & Paget, Management Consultants ACADEMIC MENTORS Dr. Joseph Mahoney, Professor of Strategic Management, University of Illinois Dr. D. Sudharshan, Dean, College of Business, University of Kentucky Dr. Fredrick Winter, Dean, College of Business, University of Pittsburgh

Acknowledgments This book is dedicated to all the men and women who have had a direct or indirect impact upon its creation. First, I would like to thank those that had a direct impact upon this book. The entire staff of Air Transport Association, Washington, D.C.; Frank Hardesty of the Association of American Railroads, Washington, D.C.; Mary Geary and the entire staff of Northwestern University Transportation Library; Avery Vise, editorial director of Commercial Carrier Journal; David Humphreys, Arkansas Best Freight; Dr. Jim Rakowski, Professor of Transportation, University of Memphis; and Frank Wilner, scholar, editor, and railroad industry expert. Second, I would like to thank the men and women who spent hundreds of hours word processing the manuscript, Beth Doshan, Stacy Orr, and Bethany Myers. Very special thanks to two brilliant students, Charles Bradshaw and Mounia Lamaiti. Charles was instrumental in the final editing of the book. Mounia has been with me from day one of this book. Without her hard work and dedication, this book would not have been possible. Someday, both of you will walk in the presence of captains of industry and academia. Third, I would like to thank my parents.


Introduction Although Chandler (1990) provides a wealth of evidence in support of Penrose's (1959) perspective that resources and capabilities provide an internal dynamic for the growth of the firm, the literature does not address how these resources and capabilities are developed sequentially over time. This book demonstrates that the pattern of a firm's resource development has a significant impact upon firm growth. The resource development process is viewed from the perspective of how firms utilize existing resources to service current markets and build complementary resource bases to service emerging markets. Penrose (1959) hypothesized that growth involves the development of resource positions to meet existing market needs. This book identifies the process by which a firm can develop its resource base to meet these existing needs and facilitate growth. Growth also involves the development of complementary resources to meet changing environmental conditions. This book shows how a firm's resource development decisions build complementary resources that can facilitate growth. The text argues that the growth potential of any firm depends upon the resource base it develops and that the sequencing of a firm's resource development decisions can be seen as a process to achieve long-term growth. The development of sequential resource positions is important from several perspectives. First, continually developing new resources and capabilities is one way of achieving sustainable growth. The sequential process of continually replacing previously defined sources of competitive advantage and growth with new capabilities that can generate new sources of advantage is one way to provide for long-term growth.

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Introduction

In a world of continuous change, firms must continuously invent and upgrade their resources and capabilities if they are to maintain competitive advantage and growth. It has been shown that firms that consistently build on their core skills and aggressively pursue the competitive advantages that their environment makes available tend to be the most successful over the long term. Second, the sequential development of a firm's resource base is important because the most successful companies are those that have grown by adding new resources sequentially over extended periods. The sequential development of resources makes them unique and rare. Competitors cannot simply buy the resources because they are built over time in a path-dependent process that is difficult for competitors to imitate. The dynamic process of developing new resources must contain routines for efficiently and effectively recognizing change within the external environment and processes for integrating these new resources within the firm. Thus, how a firm changes strategically to meet environmental change becomes important. The contention that astute executives alter their firms' strategies to capitalize on environmental opportunities has not been supported by empirical evidence. The preponderance of the management literature views the firm as continually trying to realign itself within a dynamic environment. The concept of building new resource sets to service emerging markets is a relatively new theme in the literature. Building new resource sets to service new markets extends the traditional view of a firm's playing a reactionary role. Historically, firms are viewed as responding to environmental change. The perspective views the firm as defensive. Firms can and do create environmental change. Firms such as Microsoft, Intel, and Cisco have created industries. By the firm proactively altering the environment, the firm takes an offensive position: As such, competitors' only strategy is to follow. Developing new resource positions provides the firm with continuous growth opportunities. Developing new resource positions is critical when firms are configured with environmental shocks such as the events of September 11, 2001. The aftermath of the events of September 11, 2001, is examined in this book from the perspective of what both the firm and the government need to do to provide for growth within various sectors of the transportation industry. Although the growth process of firms was altered as a result of September 11, 2001, some firms responded better than others to the shock. In this book, firm growth is examined within several industries that have been deregulated. The book identifies the different resource development paths that firms enacted after several industries were de-

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regulated in the United States. The text examines firm-level growth patterns for each industry and demonstrates that a common pattern of resource development exists. The book concludes that the patterns of resource development explained in the book can be generalizable to other industries. REFERENCES

Chandler, A. 1990. Scale and Scope: The Dynamics of Industrial Capitalism. Cabridge, MA: Harvard University Press. Penrose, E. 1959. A Theory of the Growth of the Firm. New York: John Wiley & Sons.


I Firm Growth Is a Strategic Process This book is written for practitioners who want their firms to achieve long-term growth and for academic scholars who wish to obtain a deeper understanding of the process of firm growth. The answer to achieving long-term growth has been a subject of much discussion with both practitioners and academic scholars. This book utilizes the knowledge of both to achieve a much fuller understanding of the process of growth. Indeed, it is important to listen to individuals who have been successful at growing their firms over time. Many years ago I asked Jim Casey, founder of United Parcel Service (UPS), "What is the secret to your firm's growth?" Casey replied, "Determined men, working together, can do anything." I stated, "That seems to be pretty simple." He replied, "Most of it is; it is the 'working together' that is the hard part." Casey was a very wise man who started with nothing and became a billionaire. He started out in Seattle in 1907 with one bicycle; Today UPS generates $30 billion in worldwide revenues. I continued my discussion: "How do you get people to 'work together'?" Casey's reply was simple but powerful: "Give them a piece of the company." Indeed, a fundamental principle of UPS's explosive growth is that the vast majority of the stock is held by company employees. Several years later I was in the boardroom of FedEx. Fred Smith, founder of FedEx, stated that a principal component to the sustained growth of FedEx was "People, Service, Profit." Smith feels that if you hire and train exceptional people, they will provide superior service. "Service is our only product" is a fundamental principle at FedEx. The reasoning is that superior service will lead to firm profitability over time. Fred Smith and Jim Casey are very similar in that they believe

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that human resources, or intellectual capital, is the foundation upon which their firms' growth has been achieved. Between 1907, the year UPS was founded, and 1973, the year FedEx was founded, the concept of firm growth was being developed by Dr. Edith Penrose. In 1959, Penrose wrote A Theory of the Growth of the Firm. This seminal work on growth has a central tenet: "In the long run, the firm's growth is dictated by the senior management team." Years later (1991), Dr. Jay Barney of Ohio State University wrote about the "importance of the senior management team in the growth process." Whether you talk to Casey or Penrose (which I do not recommend, they are deceased) or to Smith or Barney, they would all agree that fundamentally firm growth is a function of managerial resources. How managerial resources develop sustainable growth positions over time is the focus of this book. STRUCTURE OF THE BOOK

A fundamental principle of this book is that any firm can achieve long-term growth by developing specific resource positions over time. The text will show that a specific sequencing of resource positions will result in the firm growing at a much faster rate than the competition. Chapter 1 discusses how nearsighted firms are in the decisions that they make. Firms that experience high growth develop resource positions in the current time period that are fully exploited over time. Chapter 1 discusses how firms that have been successful with growth have developed resource positions. Chapter 2 explores the role that key success factors play with respect to firm growth. To achieve sustained growth, the firm must develop an understanding of the key success factors within the industry and be aware of its relative position versus the competition in terms of these factors. A firm's growth is based upon developing resource positions that address key success factors superior to competition over time. Chapter 3 develops a growth matrix that is utilized throughout the book. Firms can grow by means of acquisitions, strategic alliances, further developing existing markets, developing new markets, and/or international expansion. This book will show that a specific sequencing of these decisions can lead to long-term growth. When discussing firm growth, a fundamental issue is where the firm should start. Chapter 4 introduces the perspective that a logical starting point is when an environmental shock occurs. Shocks occur in the business world all the time. Consider the following: September 11, Enron, Arthur Andersen, WorldCom, recession, inflation, a change in government policy creating new environments for firms (e.g., the tobacco industry), loss of visionary thinkers (e.g., Southwest Airlines), the entry

Firm Growth Is a Strategic Process

3

of a large-scale player into any firm's core business, or a fundamental change in the mission of a firm. The shock that I have selected as a starting point is the time when several industries were deregulated. In fact, deregulation acts as a release of control. Price, profitability, market share, entry, and exit are all controlled in a regulated environment. These controls are eliminated as a result of deregulation and are replaced by an environment where only the strong survive. Chapters 5 and 6 examine firms that have been successful and some that have failed since the trucking industry was deregulated in 1980. Why these firms failed is the topic of Chapter 5. A number of trucking firms flourished in the deregulated environment. Those that grew developed their resource base in a specific sequence over time. Explaining this sequencing will be the focus of Chapter 6. Chapter 7 discusses airlines (actually air freight carriers) that have successfully grown since the airline industry was deregulated in 1978. This new environment provided significant growth opportunities for the air freight carriers. The text explores how these firms developed their resource base over time to generate growth. Growth can also occur by utilizing other firms' resources. The critical role of strategic alliances is discussed in this chapter. It addresses not only why strategic alliances are important for firm growth but also when and where they should be implemented to provide for long-term growth. Chapter 8 examines the rail industry from the time it was deregulated in 1980. There were forty Class I railroads in 1980 that accounted for over 90 percent of the total freight tonnage shipped (Association of American Railroads 2002, 1). Today there are only seven major railroad systems, and they are global, multi-modal transportation enterprises. How these firms developed into global players is the focus of Chapter 8. It is no surprise that these major transportation firms developed their resource base in the same sequence. Chapter 9 explains the future of the airline industry Drawing from responses to a questionnaire mailed to Congress, and integrating the perspective of investment bankers, the text compares the current state of affairs (post-September 11) to that during the Gulf War crisis (1991) period. There are many parallels between the current situation and the Gulf War period. A discussion of what is likely to happen to the U.S. airline industry as a result of the second Gulf War (2003) is provided in Chapter 9. Chapter 10 concludes the book and explores the following issues: Have similar growth patterns evolved within the airline, air freight, trucking, and rail industries? If so, are these patterns generalizable to other industries? Can firms in any industry dictate environmental change to provide for long-term growth? A fundamental principle of the book is that by developing resource positions in a specific sequence,

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Growth from Chaos

your firm can achieve higher growth than that of your competitors. An important point is that it is not the resources themselves that generate growth; rather, it is how they are utilized and sequenced that is important. ADDRESSING THE "HOW" AND "WHY" QUESTIONS OF RESOURCES

The process through which resources provide competitive advantage and growth is perceived as a "black box" (Lawrence 1997; Priem and Butler 2001). It is important to focus less on specific resources but develop a much clearer picture of how resources are accessed, deployed, and combined (Moran and Ghoshal 1999). The book specifically addresses how resources need to be developed and combined over time to generate growth. How resources are developed is important because the conditions under which they are developed or acquired have implications for the strategic advantages of firms in subsequent periods (Barney 2001; Priem and Butler 2001). Moreover, a new combination of resources create new opportunities for the firm because they enhance the potential benefit of all the firm's resources (Penrose 1959; Moran and Ghoshal 1999). New combinations are capable of rendering new productive possibilities; thus, they serve as the basis for the creation of new and better resources or new and better (i.e., more productive) ways of making resources. Why resources are developed is an equally important question. It may be that the resources themselves are not sources of firm growth but, instead, strategic components to other valuable, rare, costly to imitate, and nonsubstitutable resources controlled by the firm (Barney 1995, 1997). Over time, firms that develop resources in a specific sequence grow at a faster rate than their competitors. The growth of any firm depends upon the resource base it develops over time. This book shows (1) how resource development can be seen as a sequential process by which firms achieve long-term growth, and (2) how firms can fully develop their existing resource base and create complementary resource positions to grow at a faster rate than their competitors. THE CONFINING NATURE OF "Fir

The preponderance of the management literature expresses the view that a firm must continuously adapt to fit a dynamic environment (Thompson 1967; Andrews 1971; Chakravarthy and Doz 1992; Barr, Stimpert, and Huff 1992). Some scholars believe that "fit" is a strategic resource


5

that has the capability of creating a competitive advantage and longterm growth (Day and Wensley 1988; Powell 1992; Hall 1992, 1993). However, if a firm's response is totally determined by the environment, there would be little diversity in strategic change behavior resulting from environmental change. Firms would be expected to grow at the same rate as other firms if all firms achieved "fit." This concept of "fit" is emphasized too much in the management literature. It seems likely that a firm would not desire to attempt to "fit" within an environment that is in recession, where there is a high rate of unemployment, where prices and wages are depressed, or where products are perceived to be homogenous. The firm's only response would be price reduction. Only the largest-scale provider would win. Instead, creating positive environmental change that results in real differentiation from competitors would be a better strategic approach. The perspective of the firm as being able to dictate environmental change extends the traditional position of the firm from responding to environmental change after the fact. The concept of building resource sets to service emerging markets is an evolving theme within the management literature (Hamel and Heene 1994; Hamel and Prahalad 1994; Sanchez, Heene, and Thomas 1996). By the firm "stretching" its resource base to acquire new resources, the firm has the potential to create environmental change that alters the competitive environment in the firm's favor to provide for long-term growth (Heene 1994). The development of new resources must be based upon what has been successful in the past and what is likely to create a differential advantage for the firm in the future. One reason that firms are unable to achieve a differential advantage over time is that they are not closely connected to existing and emerging customer needs. STRATEGIC NEARSIGHTEDNESS

Firms often think too narrowly about consumer needs. Many years ago (1960), Theodore Levitt wrote an article entitled "Marketing Myopia" that stated, in essence, "You cannot see the forest for the trees." Many firms suffer from this "strategic nearsightedness." Consider the auto industry There are literally dozens of autos in many different categories, so consumers have unlimited possibilities in terms of ground transportation. However, providers of ground transportation may be thinking too narrowly about auto consumers' real needs. Consumers want transportation from point A to point B utilizing some type of vehicle. Whether they ride in a Lexus or a Jeep does not make much difference. Consumers primarily need to move from point A to point B as quickly as legally permitted. This can be a real problem if you are on the Dan Ryan Expressway in Chicago, the George Wash-

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Growth from Chaos

ington Expressway in New York, or any other highly congested expressway in a major metropolitan area. The problem is ground transportation. From the consumers' perspective, we do not use space effectively. Not much happens between 0 feet and 15,000 feet. Why? Because the auto industry is based upon two-dimensional space. Why not forget ground transportation and focus upon real consumer needs? The process is important (e.g., how we get there), not the product (e.g., what we ride in). What prevents us from thinking in terms of three-dimensional space? For example, the concept of the airplane is not new; why not use that concept to meet existing consumer needs? A major West Coast university is currently working on a prototype of an aero car. How many people in large metropolitan areas could utilize an aero car for commuting from point A to point B? Strategic nearsightedness causes us to think only in ways we have been functioning, not in ways that would benefit consumer needs. However, the auto industry is not the only industry that suffers from a strategic nearsightedness perspective. Many other industries do as well. Even universities suffer from it. THE UNIVERSITY PROBLEM

Universities always want more high-quality students. Universities form councils or committees whose responsibility is to increase enrollment. These councils or committees are the source of great debates about what needs to happen to increase enrollment. Sometimes new courses or new curriculums are designed specifically to attract new students. The councils or committees have extensive, prolonged discussions with the faculty as a whole and with the central administration. Everything needs to be voted upon. Sometimes subcommittees are formed for further study. Worse, sometimes consultants are hired to advise a university about its own students. These processes take a great deal of time, sometimes years. During this time, student needs totally change. In the process from committee to subcommittee, back to committee, to the faculty as a whole, to the administration, back to committee, the one group that is rarely consulted is the consumer (the students). Students can identify exactly what is missing and what is needed to attract additional students. They will provide action steps: they will be very open, candid, and frank. If we truly listen to them, they will provide actions that can be implemented to provide for growth. Universities think too narrowly about students. Yes, students are sources of immediate income. However, they are also future decision makers, and universities have an obligation to train them to succeed in their roles of responsibility. Universities need to be much better at main-

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taining relationships with alumni over time. One reason is that they are valuable sources of endowment gifts. More important, they can provide real-time feedback about what skill sets are needed in the marketplace to succeed. As such, they can be utilized as sources of knowledge to add important real-world skill sets to a university's curriculum issues. These students will then have the opportunity to provide employers with value-added skills that other universities do not offer. In order to prepare students to be productive members of corporations, it is important to ascertain what corporations are desiring in terms of curriculum issues. If you are a parent, do not assume that the university your children attend, or are considering attending, has taken this action. Only recently have universities begun to involve corporations in identifying the skills that are necessary to be successful in a given profession (Stover, Morris, and Byers 1997). However, such involvement by corporations is occurring only at a small minority of universities. Some notable scholars still believe that the curriculum taught in business schools has only a slight relationship to what is important for succeeding in business (Pfeffer and Fong 2002; Mintzberg and Gosling 2002). Whether it be curriculum design or the need for more high-quality students, or both, universities suffer from the same degree of strategic nearsightedness that many corporations do. ORGANIZATIONAL RIGIDITY

Strategic nearsightedness occurs because we are not closely connected to our stakeholders. The reason is partially structural. Much has been written about the benefits of flat organizational structures. Much less has been written about organizational rigidity. Simply put, organizational rigidity occurs when you cannot do your job. When you complete a meeting, ask yourself one question: Has this meeting enhanced my understanding of my customers, my competition, or why my company has evolved as it has over time? Not only is it important to meet immediate consumer needs in a way that is superior to your competitors, but firms must continue to meet the evolutionary needs of consumers over time. If the meeting has not provided a clearer picture, then your firm (or university) suffers from organizational rigidity. This situation is crippling because your organization is not achieving the maximum benefit of its most valuable resources—your employees. A rigid firm will have difficulty responding to environmental change. It will be virtually impossible for such a firm to lead or dictate environmental change. In this sense, rigid firms will at best be second movers. In many cases, they will not be able to respond to change at all. These firms will be at a competitive disadvantage and unable to

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Growth from Chaos

grow to meet consumers' evolving needs. The ability to change is severely constrained in a rigid firm. To reduce organizational rigidity, examine every function in your organizational structure. Identify specifically what and how this function is expected to make a contribution to the growth of your firm in the current time period and in the future. Figure out how each function has contributed to organizational rigidity in the past, and determine how to make this function an accelerator rather than a brake for firm growth. Individuals, whether in firms or universities, make decisions. One way to reduce organizational rigidity so that managers can bring about productive change is to make them stakeholders. This is how Jim Casey built UPS (United Parcel Service) into a dominant, global transportation firm. UPS is the largest privately held corporation in the world. The vast majority of the stock is held by the managers of the firm. Each year, managers receive additional stock bonuses based upon the firm's profitability. If profitability begins to decline, everyone in the firm is focused on why and what needs to be done to improve the firm's position. The more your employees feel they have real decision-making capacity, the less rigid your firm is likely to be. If your firm is to bring about productive change, the role of managerial resources is critical. MANAGERIAL RESOURCES Managerial resources are critical for firm success and for growth. In the long run, a firm will grow or die as a result of the decisions of the management team. In some industries, a firm's managerial resources may be the only true source of competitive advantage. The senior management team is responsible for assimilating and integrating resources throughout the firm to provide for long-term growth. Managers within firms have different perceptions of the environment, the customer base, the nature of competition, and differential rates of learning. Managerial resources drive the development of firm-specific capabilities, which in turn determine what combination of product or services the firm is capable of offering. Managerial resources have important roles and can be the basis upon which firms differentiate themselves and grow. Managerial resources are posited to be the most important factor that determines the direction of firm growth (Penrose 1959). They are instrumental in developing resource positions that can both effectively and profitably manage the core business, and in developing additional resource positions to generate new business to achieve future growth. Managers are responsible for monitoring the environment to identify changes that could provide opportunities for growth and also to identify threats that could impede the growth of the firm over time.

9


The management team must marshal firm-specific resources to maximize these growth opportunities while at the same time developing resources that will minimize threats to the firm (Andrews 1971). Managers must balance the utilization of existing resources to meet current customer needs with the development of new resources to meet future customer needs. My own view is that the management team may require some degree of turnover if the firm is to experience long-term growth. If top managers have spent their careers in an industry and/or a specific firm, they will have limited knowledge from which to conduct a strategic search for new opportunities and would not likely pursue new ideas outside this limited knowledge base. The age of the management team may also impact the ability of the firm to grow (Smith and Grimm 1991). It has been argued that a manager's age is an indicator of his or her flexibility and risk-taking propensity (Chown 1960; Child 1974; Taylor 1975). It is generally accepted that as people grow older they become more inflexible to change and take fewer risks. Hambrick and Mason (1984) contend that because younger managers are more likely to seek growth by pursing novel, innovative change, they may be more likely to change their firm's strategy to seize perceived opportunities. In contrast, older managers would be more committed to the status quo (Smith and Grimm 1991). As such, younger managers may be more flexible than older managers. This flexibility is important in terms of resource development. FLEXIBLE RESOURCES

The development of resources is important if the firm is to grow over long periods of time. To achieve this growth, the firm has to accomplish two interrelated things successfully: (1) it has to manage its current resource base effectively, and (2) it must be able to change this resource position to meet continually shifting future demand conditions (Turner and Crawford 1994). As such, the firm must develop a flexible resource base because changes in future demand cannot be predicted with a great deal of certainty. The firm must have the flexibility to change its resource base in the direction of future demand. This strategic flexibility becomes critical for firm growth (Hamel and Heene 1994). Flexibility is important because it provides the firm with the capability to respond in the direction of needed change. This strategic emphasis upon flexibility will enable the firm to respond to a changing environment and may permit the firm to dictate environmental change. Flexibility is important because it enables the firm to develop resources and capabilities over time to meet changing conditions from a dynamic and evolutionary perspective. Flexibility enables the firm to match its

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resource base to dynamic environmental shifts and to create environmental change. The growth process involves combining and recombining resources that are traditionally scattered over the firm in order to build, develop, and acquire new capabilities that have the potential for shaping longterm growth. Without specific competencies related to reshaping the firm's future capabilities, the growth of the firm is left to chance. Understanding these competencies and developing and sustaining them are therefore key to long-term survival and growth (Turner and Crawford 1994). Developing these positions of sustainability require that a firm continually develop its resource base over time. TIME IS A STRATEGIC ADVANTAGE

Time is important from a growth perspective: The firm must have the capability to leverage its resource position to meet current needs while at the same time build new resource positions to lead environmental change (Hamel and Prahalad 1994; Turner and Crawford 1994; Hamel and Heene 1994; Bogner and Thomas 1994). This focus is one of being able to create the rules of the game by developing resources to acquire new capabilities (Hamel and Prahalad 1994; Levinthal and Myatt 1994; Sanchez, Heene, and Thomas 1996). This is a core competence perspective, and it extends the traditional notion of fit from developing a firm's capabilities to meet changing environmental conditions. The newer orientation holds that a firm can stretch to acquire new competencies that can change the competitive environment in its favor (Hamel and Heene 1994). The emphasis is more toward dictating fit as opposed to responding, after the fact, to maintain fit. In this new view the firm is able to create change through proactive resource development to dictate the future. Firms must be cognizant of what resource positions are necessary to compete in the future. The development of these positions may dictate environmental change, and these positions will dictate what path firms must pursue in the future if they are to experience long-term growth. Firms that have the capability to dictate the rules of the game will be in position to grow faster than their competitors. Let us examine how firms have grown in three different industries. LINKAGES AMONG FAST FOOD, AIR FREIGHT, AND OPERATING SYSTEMS

I provide my readers with the following scenario: What do McDonald's, Microsoft, and FedEx have in common? Conceptually, all three firms are based on speed: It is the advantage that has sus-


II

tained them over the decades. In addition, each of these firms became an industry innovator. Where did we obtain fast food before McDonald's? Where were operating systems obtained before Microsoft? Where did we go for shipping express packages before FedEx? The answer is the same: The industry did not exist. In addition, these firms have retained their dominance by continuing to focus on speed. FedEx was the first firm in this country to offer overnight shipment of packages. When UPS entered the industry in 1982, FedEx immediately changed its own delivery commitment to noon because UPS could not respond. UPS needed to maintain existing delivery and pick-up times for its primary customer base, ground shippers. The noon FedEx delivery commitment could not be matched by UPS until many years later. When UPS did change its delivery commitment to noon, FedEx immediately changed its delivery commitment to 10:30 A.M., maintaining a speed advantage over UPS. Years later, when UPS changed its delivery commitment to 10:30 A.M., FedEx changed its to 8:30 A.M.; FedEx has sequentially utilized this strategy to maintain a speed advantage over its most substantial competitor. The same has been true with Microsoft: Each generation of its operating system provides a speed advantage over previous versions. Microsoft has such an advantage with respect to operating systems that it virtually has no substantial competition. McDonald's also has utilized speed to maintain its advantage over time. McDonald's began with a focus on providing a quick meal for the lunch market and expanded the concept to drive-through. Approximately 55 percent of McDonald's revenue is generated as a result of drive-through business (Peter and Olson 1999). In addition, McDonald's has expanded its focus on speed by offering a fast breakfast. Each of these firms obtained its dominant market position by being an industry innovator and maintained its position by continually enhancing its products and services from a speed perspective. This process is important because it is multigenerational. Children of Microsoft users buy Microsoft products; the same is true for FedEx and McDonald's. Having an evolutionary customer base is one way to generate long-term growth. This focus on meeting customer needs over time can also be applied to international firms. Continuous Customers

Toyota was one of the first auto manufacturers to track its customer base over time. Toyota entered the U.S. market in the early 1970s when the oil embargo in the Middle East led to very high gasoline prices. Toyota was one of the first automakers to offer an economical car (Corolla) that was fuel-efficient and provided a high level of reliability. As

12

Growth from Chaos

oil became more abundant and the economy in the United States began to grow, Toyota introduced the Camry as a mid-priced, very reliable car. The purpose was twofold. First, the existing Corolla customer base began to require a mid-size car with a high level of reliability. Second, the focus on quality provided Toyota a competitive advantage for consumers who had previously purchased mid-size U.S.-made vehicles. As the economy continued to prosper in the United States, Toyota decided to enter the luxury car market with the introduction of the Lexus. With this sequencing, Toyota offered the American consumer a complete range of auto options. Toyota realized that as the Corolla customers had a greater level of discretionary income, they would move into the Camry market. Once their discretionary income reached an even higher level, two additional actions took place: This market began to buy Lexus autos, and their children began to buy Corollas. As such, by maintaining its customer base over time, Toyota has sustained dominance within the U.S. auto market. These examples identify the importance of time in terms of (1) creating goods and services to meet unmet consumer needs, and (2) maintaining the customer base by providing goods and services that continue to excel over time versus those of the competition. Not only can time be utilized to gain an initial position, but it can be utilized to sustain those positions to provide for long-term firm growth. The importance of time will increase as we move further into the twenty-first century. If your firm provides your customers with a time advantage over the competition, your firm will grow; if it does not, it is quite possible that your firm will not grow. The four firms previously mentioned were based upon a principle of time and providing sequential advances in goods or services to maintain an advantage over the competition. Not only is it important to provide your customers with superior goods or services with respect to the competition, but these time-based advantages must continually evolve if your firm is to stay ahead of the competition and generate sustained growth. How your firm can achieve an initial position of advantage is the subject of the next chapter. LESSONS LEARNED

1. To fully understand the growth process we must examine the actions and reactions of firms over time. A firm's historical decisions will "lock in" certain growth paths and "lock out" other growth trajectories. 2. We think too narrowly about what business we are in. For example, in the United States, airlines are in the passenger transporta-

13


tion business. In Europe and Asia, airlines are in the transportation business. The reliance u p o n one segment (e.g., passengers) restricts the utilization of a firm's resources and constrains a firm's profit p o tential. 3. Managerial resources are the difference between a profitable and unprofitable firm. To keep employees focused u p o n continuous profitability, make them shareholders. REFERENCES

Andrews, K. R. 1971. The Concept of Corporate Strategy. Homewood, IL: Irwin. Association of American Railroads. 2002. "Overview of U.S. Freight Railroads." Washington, D.C.: Association of American Railroads. Barney, J. B. 1991. "Firm Resources and Sustained Competitive Advantage." Journal of Management 17: 99-120. . 1995. "Looking Inside for Competitive Advantage." Academy of Management Executive 9:49-61. 1997. Gaining and Sustaining Competitive Advantage. Reading, MA: Addison- Wesley. Barney, J. 2001. "Is the Resource-Based View a Useful Perspective for Strategic Management Research? Yes." Academy of Management Review 26:41-57. Barr, P., L. Stimpert, and A. Huff. 1992. "Cognitive Change, Strategic Action, and Organizational Renewal." Strategic Management Journal 13:15-36. Bogner, W. C , and H. Thomas. 1994. "Core Competence and Competitive Advantage: A Model and Illustrated Evidence from the Pharmaceutical Industry." In G. Hamel and A. Heene (eds.), Competence-Based Competi tion, 111-144. New York: John Wiley & Sons. Chakravarthy, B., and Y. Doz. 1992. "Strategy Process Research: Focusing on Corporate Self-Renewal." Strategic Management Journal 13: 5-14. Child, J. 1974. "Managerial and Organizational Factors Associated with Company Performance." Journal of Management Studies 11:13-27. Chown, S. 1960. "The Wesley Rigidity Inventory: A Factor-Analytic Approach." Journal of Abnormal and Social Psychology 61: 491-494. Day, G., and R. Wensley. 1988. "Assesing Advantage: A Framework for Diagnosing Competitive Superiority." Journal of Marketing 52:1-20. Hall, R. 1992. "The Strategic Analysis of Intangible Resources." Strategic Management Journal 13:135-144. . 1993. "A Framework Linking Intangible Resources and Capabilities to Sustainable Competitive Advantage." Strategic Management Journal 14: 607-618. Hambrick, D., and P. Mason. 1984. "Upper Echelons: The Organization as a Reflection of Its Top Managers." Academy of Management Review 9:193206. Hamel, G., and A. Heene. 1994. Competence-Based Competition. New York: Joh Wiley & Sons. Hamel, G., and C. K. Prahalad. 1994. Competing for the Future. Boston: Harvard Business School Press.

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Heene, A. 1994. Preface. In G. Hamel and A. Heene (eds.), Competence-Base Competition. New York: John Wiley & Sons. Lawrence, B. W. 1997. "The Black Box of Organizational Demography." Organization Science 8:1-22. Levinthal, D., and J. Myatt. 1994. "Co-Evolution of Capabilities and Industry: The Evolution of Mutual Fund Processing." Strategic Management Journal 15: 45-62. Levitt, T. 1960. "Marketing Myopia." Harvard Business Review (July-August): 96. Mintzberg, H., and J. Gosling. 2002. "Educating Managers beyond Borders." Academy of Management Learning and Education 1: 64-76. Moran, P., and S. Ghoshal. 1999. "Markets, Firms, and the Process of Economic Development." Academy of Management Review 24: 390-412. Penrose, E. 1959. A Theory of the Growth of the Firm. New York: John Wiley & Sons. Peter, J., and J. Olson. 1999. Consumer Behavior and Marketing Strategy. Boston MA: Irwin. Pfeffer, J., and C. Fong. 2002. "The End of Business Schools? Less Success than Meets the Eye." Academy of Management Learning and Education 1: 78-95 Powell, T. 1992. "Organizational Alignment as Competitive Advantage." Strategic Management Journal 13:119-134. Priem, R., and J. Butler. 2001. "Is the Resource-Based View a Useful Perspective for Strategic Management Research?" Academy of Management Review 26: 22-40. Sanchez, R., A. Heene, and H. Thomas. 1996. "Towards the Theory and Practice of Competence Based on Competition." In R. Sanchez, A. Heene, and H. Thomas (eds.), Dynamics of Competence Based Competition. Oxford: Elsevier Press. Smith, K. G., and C. M. Grimm. 1991. "Research Notes and Communications Management and Organizational Change." Strategic Management Journal 12: 557-562. Stover, D., J. Morris, and C. Byers. 1997. "Breaking Down the Silos: Attaining an Integrated Business Common Core." American Business Review 1415:1-23. Taylor, R. 1975. "Age and Experience as Determinants of Managerial Information, Processing and Decision Making Performance." Academy of Management Journal 18: 74-81. Thompson, J. D. 1967. Organizations in Action. New York: McGraw-Hill. Turner, D., and M. Crawford. 1994. "Managing Current and Future Competitive Performance—The Role of Competence." In G. Hamel and A. Heene (eds.), Competence Based Competition, 241-265. New York: John Wiley Sons.

2 Growth over Time Does Not Depend upon a Friendly Environment I walked into the CEO's office. He stated, "Our cost structure is too high. I want you to reduce costs by 20 percent." I said, "O.K." Six months later I walked into his office again. He stated, "Our cost structure is too high. I want you to reduce costs by another 15 percent." I said, "O.K." Six months after the second meeting I walked into the CEO's office. Another name was on the door, and another individual was seated at the desk. The new CEO stated, "Our cost structure is too high. Should we reduce costs?" I said, "No." The CEO stated, "If our costs are too high, why should we not reduce them?" I replied, "If we cut costs, we cut value from the customer's perspective. By cutting value, we reduce the attractiveness of our products /services versus our competitors'. When this happens, our revenue stream is adversely affected and we have an even more unprofitable organization." "Your view is interesting," the CEO commented. "Does this process have a name?" "Yes," I said, "it is called the spiral down syndrome. Once a firm begins this spiral, it is very difficult to rectify because each iteration leads to less revenue. One other thing also tends to happen," I stated. "What is it?" the CEO asked. "CEO's tend to lose their jobs," I answered. "O.K." stated the CEO, "Why don't we increase the price of our products/ services?" "I do not recommend that either," I said. "Why not?" asked the CEO. "If you raise your prices, you will be less attractive to your customer base and will generate fewer sales. This will have the same result as the spiral down syndrome." "You mean I will be fired," he commented. "Probably," I responded. "If we cannot cut costs or raise

16

Growth from Chaos

prices, I have no idea h o w w e can return to profitability," the CEO continued. "What should w e do? I w o u l d like to keep this job for a while," he said. "You need to understand our relative position versus the competition on criteria that are important to the customer base," I responded. "What kind of criteria are you talking about?" he asked. I answered, "Customers make decisions about products/services based u p o n how well their needs are met and how well our p r o d u c t s / s e r vices compare to that of the competition. We call these criteria key success factors, and they are at the core of each consumer buying decision. You need to fully understand these factors and determine our firm's position on these factors. You will be in a position to make more informed decisions once this process has been completed." "O.K.," stated the CEO, "but don't take too long, the board wants us to return to profitability rather quickly." This type of discussion is one that I have had with CEOs more than any other type of discussion. The following example illustrates w h a t happens w h e n the process is completed correctly. HOW JAN CARLZON "MARKETIZED" SAS AIRLINES

In 1980, when Jan Carlzon took over as President of SAS, now Scandinavian Airlines, the airline was losing money. In previous years, management had faced this problem by cutting costs. Carlzon saw that as the wrong solution: the airline needed to find new ways to compete and build its revenue. SAS had been pursuing passengers with no focus and no superior advantage to offer; in fact, it was seen as one of the least punctual carriers in Europe. Competition had increased so much that Carlzon had to figure out: Who are our customers? What are their needs? What must we do to win their preference? Carlzon decided that the answer was to focus SAS's services on frequent-flying business people and their needs. But he recognized that other airlines were trying to attract the same segment. They were offering wider seats, free drinks, and other amenities. SAS had to find a way to do this better if it was to be the preferred airline. The starting point was market research to find out what frequent business travelers wanted and expected in the way of airline service. His goal was to find ways to be 1% better in 100 details rather than 100% better in only one detail. The market research showed that the number-one priority of business travelers was on-time arrival. Business travelers also wanted to check in fast and be able to retrieve their luggage fast. Carlzon appointed dozens of task forces to come up with ideas for improving these and other services. They came back with hundreds of proposals; 150 were selected at an implementation cost of $40 million. One of the key projects was to install a total customer orientation into all SAS's employees. Carlzon figured that the average passenger came into contact with five SAS employees on an average trip. Each interaction created "a moment of truth" about SAS. Given the 5 million passengers per year flying SAS, this

Growth over Time Does Not Depend upon a Friendly Environment

17

amounted to 25 million moments of truth where the airline either satisfied or dissatisfied its customers. To create the right customer attitudes within the company, the airline sent 10,000 front-line staff to service seminars for two days; 25,000 managers were sent to three-week courses. Carlzon regarded the front-line people who met the customers as the most important people in the company. As for managers, their role was to help the front-line people do their job well. His role as president was to help the managers support the front-line employees. The result: within four months, SAS achieved the record as the most punctual airline in Europe. Check-in systems were much faster. A service, where travelers who were staying at Scandinavian Airlines hotels could have their luggage sent directly to the airport for loading, was implemented. Scandinavian Airlines developed a much faster process for unloading luggage upon landing. Another innovation is that it partitioned the aircraft into business class and economy class. The airline's improved reputation among business flyers led to an increase in its European full-fare traffic of 8 percent and its full-fare intercontinental traffic of 16 percent. This was quite an accomplishment considering that price cutting and zero growth were taking place in the air travel market in Europe. Carlzon's impact on Scandinavian Airlines illustrates the customer satisfaction and profits that a corporate leader can achieve when he or she creates a vision and mission for the company that excites and gets the employees to all swim in the same direction—namely toward satisfying the target customers' needs. (Kotler 1994,24-26) KEY SUCCESS FACTORS

In the pursuit of the key success factors, a handful of the myriad factors present will determine consumer purchase. These are called key success factors (Ohmae 1982). They are that set of criteria that dictate buying decisions within a specific industry. Key success factors differ on an industry-by-industry basis. For example, taste is a key success factor within the soft drink industry, whereas durability is a key success factor within the athletic shoe industry. Determining key success factors is an important component of firm growth. A knowledge of key success factors can help your firm position itself better with respect to the competition. The use of key success factors in strategic management research has been criticized. Ghemawat (1991) has been critical of the use of key success factors because of issues of uncertainty, complexity, and conflict. I support Amit and Shoemaker's (1993) position that without uncertainty, complexity, and conflict, there would be no need for managerial decision making—all firms w o u l d be expected to make the same decisions. A key element of growth is the ability of the firm's managers to identify key success factors and to develop resources and capabilities to ad-

18

Growth from Chaos

dress these factors better than their competitors.The ability to accurately identify key success factors is the first step toward firm growth. Determining Key Success Factors

Various stakeholders need to be contacted to effectively determine key success factors. One place to start is with the senior management team. It is the responsibility of the senior management team to identify key success factors in the current time period and to develop resources and capabilities to meet these factors in the current time period. It is also the responsibility of senior management to monitor key success factors over time. As such, the perspective of the senior management is crucial if firms are to utilize key success factors to grow. In addition, senior managers in many cases have substantial industry experience. Therefore, these senior managers cannot only identify the existing set of key success factors but also provide a perspective for how those factors have changed over time within a specific industry. They have keen insights into how these factors may change in the future. Personal interviewing is the recommended approach for obtaining key success factors from the management team. In addition, the sales force is an important source of information concerning key success factors. The sales force has responsibility for direct customer contact. They provide the best source, within the firm, of information on customer needs and wants. They are an excellent source of information not only of existing key success factors but also of factors that may be emerging as consumer needs change. The sales force can also provide an understanding of which factors are more important from the customer's perspective. The most important group that needs to be interviewed is the actual customer base. The customer base can not only identify key success factors for a specific industry, but they can also identify which factors are more important and which firms within the industry are more successful at meeting specific key success factors. Sometimes the view of customers is quite different from the view of the senior management team. The reason for this difference is partially structural. Some firms do not have organizational structures that permit a free flow of information from bottom to top. Other firms have very efficient systems that tend to filter out negative information. In either case, senior management is not obtaining accurate information upon which to base decision making. In addition, because of organizational rigidity, there may be an information gap with respect to communication to senior management. One technique that is very successful at dealing with this information gap created by organizational rigidity is the focus group.


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Focus Croups

Focus groups have been very effective when there is a difference of opinion among stakeholders on key success factors or on the firm's relative position versus competitors. Customers are invited to participate in a group discussion concerning key success factors and firms that provide given products or services. Customers are usually paid between $100 and $250 for their time. The focus group room is a rectangular room with a one-way mirror on the side of the room that is closest to the moderator. Behind the focus group room is a small room where the senior management team listens and observes the discussion through the one-way mirror. The moderator begins the discussion with introductions and then is responsible for covering key areas of interest by the sponsoring firm. The participants enter into a free-flowing conversation. The moderator then moves to a discussion of key success factors, their relative importance, and whether the participants feel that specific firms are meeting or not meeting certain key success factors. Because the customers are not aware of who is sponsoring the focus group, a discussion of firms and their relative strengths and weaknesses begins to occur. The management team hears firsthand the position of its firm on key success factors and its relative position versus competitors from the perspective of the customer. This type of discussion tends to provide senior management with a current, unbiased assessment of its position on key success factors. One of the benefits of focus groups is that information about a firm and its competitors is received by senior management in an unfiltered form. As a result of the focus groups, the firm will have a current assessment of its position on key success factors from the perspective of its own customer base. In addition, as the focus group discussion continues, the moderator will enter into a discussion of what factors will be important in the future. The participants not only give their perspectives upon which key success factors will emerge in the future but also provide a candid assessment of which firms are better positioned to meet these emerging factors. Using Key Success Factors

The following represents a simple key success factor study that I conducted for a major, public university many years ago. Based on the results of several focus groups, Table 2.1 identifies the key success factors in order (1—most important; 5—least important) and provides an evaluation of the client university and its competitors on key success factors.

20

Growth from Chaos

Table 2.1 Competitive Position on

Key Success

Factors

Rank of Importance 1

Client University

Competitor Group A

Competitor Group B

Competitor Group C

7

3

9

10

Cost

2

9

10

2

1

Job placement

3

3

5

9

10

Social environment

4

7

7

3

1

Size

5

3

5

8

8

Key Success Factors Reputation

Competitors are ranked on a scale of 1 to 10, where 1 was lowest for each success factor and 10 was highest. Referring to Table 2.1, the number one key success factor was reputation. The client school had a rating of 7 on reputation, which is relatively good. Competitor groups B and C had a higher score (9,10) on reputation. Although it is the most important key success factor, reputation is an intangible factor that is developed over time and is quite difficult to change in the short term. Therefore, because the client is doing relatively well (7) on this attribute, we proceed to the next factor, which is cost. Here a higher score denotes a more favorable position. The client university has a very strong position (9) versus others; the client university is viewed as much less expensive than Competitor Groups B and C. Based upon the first two key success factors, the client university has a solid reputation (7) and is much more economical than the competitors (B, C) that have stronger reputations. At this juncture, based upon the data, the client university does not need to make any major modifications. That is not the case when the third most important key success factor, job placement, is concerned. In terms of job placement the client university is rated a 3, which is the lowest position with respect to all the competitors. This result was not only troubling but also puzzling. When confronted with this type of scenario, I strongly recommend that you conduct substantial personal interviews with the customer base. You need to understand why the score is so low. Extensive personal interviews were conducted in this case. The following issue was identified. Students were allocated a given number of points (100) to select the firms that they wanted to interview with. Let's assume that a student utilized 30 points for each of his or her first three selections. The stu-


21

dents would be virtually guaranteed that they would obtain an interview with these first three firms. However, they would have only 10 remaining points to allocate among all remaining firms that were interviewing. In this case, if a student did not receive a job offer from one of the first three firms, the student's options became very limited. The primary reason this occurred was because recruiters had historically only allocated one recruiting day for this university. The recruiters were not aware that many other students were interested but could not interview, because the recruiters' one-day schedule had been fixed for many years. When recruiters were made aware of this issue, they began to schedule many more interview days at this university. Further, recruiters began to bring firm executives with them to meet with classes and members of the administration. This program, which is now practiced at many universities, is referred to as the "executive in residence" program. This type of program has many benefits. First, the students become familiar not only with firms, but also with how industries are structured. The topic of industry analysis is only now being realized as important by universities. For many years, firms have been requesting graduates with at least a minimum basic understanding of a firm's industry. Universities are now beginning to incorporate industry analysis into undergraduate education. Further, the "executive in residence" program permits some training to be done by industry experts. Universities may not have to incur all the incremental costs. The program also has other substantial benefits. A second benefit is that executives have an opportunity to discuss with administrators how a specific curriculum needs to be altered to meet the needs of a changing economy that has a focus on both technology and globalization. Universities that have strong partnership relationships with firms are perceived as providing value-added students compared with universities that do not have such relationships. It is in this manner that this client university converted a weakness in a key success factor to a position of strength. A third benefit is that those universities that have strong partnership relationships with corporations benefit significantly in terms of endowment awards. Thus, a rather simple adjustment in a key success factor has shown substantial, direct benefits to a university and its students. Does your university have such a program? Let us refer back to Table 2.1. The client university has a strong advantage (7) on the fourth key success factor, which is the social environment. This benefit should not be minimized. Students need an environment that is conducive to learning; but like adults, they also need a good social environment to relax when they are not studying.

22

Growth from Chaos

Universities that provide this type of environment will have a competitive advantage over other universities (Competitor Group C) that do not. In this manner, a firm or university can evaluate its position versus the competition on each key success factor. Where necessary, firms need to make modifications to improve their competitive position. This is a necessary but not sufficient condition. What is important is to meet key success factors superior to the competition over time. Utilizing Key Success Factors over Time In order to grow over time, the firm must develop resources and capabilities to meet the key success factors in the current time period and continuously develop new resources and capabilities based upon the direction in which the key success factors evolve over time. As Amit and Shoemaker (1993) point out, key success factors should not be viewed from a static perspective. Key success factors must be viewed from a longitudinal perspective. When viewed over time they can determine what will constitute a winning position in the current time period, and an understanding of their evolution over time can lead the firm to strategy development in which this winning position is maintained and firm growth is achieved. An understanding of the evolution of key success factors over time can provide the basis for an "emergent strategy" (Mintzberg 1978). A successful stream of strategy decisions over time must be founded on the ability to identify changes in key success factors. To capitalize upon changing environmental opportunities, the firm must not only continually develop its resource base to meet the key success factors of the current time; the firm must also have the flexibility to develop its resource base to respond to emerging key success factors. This identification and development ability is as important for the future as it is in the current time period. The greater the ability of the firm's managers to identify the future key success factors better than its competitors, the better the firm can develop resources and capabilities to meet these emerging key success factors before its competitors. The key to growth is to meet key success factors as they emerge. This evolutionary process may provide the firm with long-term growth. Let us refer to another example. GROWTH OF THE AIR FREIGHT INDUSTRY

The following list identifies key success factors within the air freight industry during the regulated period (pre-1978) and significantly after (1990s) the industry was deregulated.


23

Regulated Period (Pre-1978) • Point-to-point service • On-time reliability • Competitive rates • Market coverage • • • • •

1990s Multi-modal services Global coverage On-line real-time tracking Electronic data interchange Logistics services

Emerging Trends • Globalization • Utilization of technology This list was developed based u p o n m y twenty years of experience consulting for major air freight firms as they grew in the deregulated environment. There are two important differences between the industry during the regulated period (pre-1978) and significantly after deregulation (1990s): the e m e r g i n g t r e n d s of globalization a n d the utilization of technology. During the 1970s, air freight firms w o u l d contract with local picku p and delivery firms to take packages to the airport. At the airport, the air freight firms w o u l d contract with the commercial airlines or "contract" airlines to ship packages to destination airports. Once at destination airports, the air freight firms would contract with other pick-up and delivery firms for delivery to customers. In m a n y cases the air freight firms owned few assets and utilized other firms for the physical transportation of packages from point of origin to point of destination. After deregulation, the transportation of air freight w a s performed by the actual air freight firms. These carriers built h u b and spoke operating systems to make package transportation more efficient. As such, these air freight carriers significantly changed their resource base. Carriers bought a fleet of aircraft and a fleet of pick-up and delivery vehicles. They constructed hub facilities. The acquisition and construction of these resources w a s quite expensive. To leverage this resource base, air freight carriers entered into alliances with rail, trucking, and ocean shipping firms to increase the scope of their resources. These alternative modes of transportation provided the air freight firms with sig-

24

Growth from Chaos

nificant growth potential. The air freight business grew significantly from 1978 to the late 1990s. In 1978, U.S. air freight was a $6 billion industry as measured in revenue ton kilometers (RTK). By 1998, this segment of the transportation industry had grown to a $20 billion RTK business (www.boeing.com). As the industry grew, shippers began to realize that they could utilize air freight for their international shipments as well as for their domestic shipments. Air freight internationally grew to a $100 billion RTK business in the late 1990s (www.boeing.com). One of the most important trends of the last two decades of the twentieth century was the trend toward global expansion. Beginning in the 1970s and accelerating in the 1990s has been the development and expansion of global competition (Czinkota and Ronkainen 2001). Today, virtually all major firms have a significant and growing presence in business outside their country of origin (Cateora and Graham 1999). Furthermore, successful enterprises have realized that to survive and prosper in the business environment of today and tomorrow, they must go beyond the organizational structures and strategic approaches of the past and adopt a worldwide, global view of business (Czinkota and Ronkainen 2001). For an ever-growing number of firms, management is defining the marketplace as global. New markets are opening up and existing markets are expanding worldwide. The economies of the industrialized nations have matured; that is, their economic growth rates have slackened; and as a result, firms in these countries are seeking additional market opportunities abroad. In addition, a global financial network has developed that enables multinational enterprises to expand their operations (Cateora and Graham 1999). Firms have increasingly become more international, as evidenced by the increase in foreign sourcing of raw materials, component parts, subassemblies, and labor. Companies have penetrated new markets throughout the world. For example, in the 1970s and 1980s the United States became an attractive marketing opportunity for many Asian and European firms producing automobiles, electronics, and computers (Lambert and Stock 2001). Similarly, the European Union, China, and the Commonwealth of Independent States (e.g., Russia) are substantial markets for companies producing a variety of goods and services today. Enterprising firms throughout the world have recognized the need to become more globally oriented. In many instances companies have discovered that their international markets exhibit higher growth rates and sales volumes than their domestic markets do (Cateora and Graham 1999). Such high growth rates may provide firms with an advantage in their domestic markets. Moreover, these international developments had a direct impact on the air freight industry.


25

International air freight helped carriers achieve greater economies of scale. The same shippers that were using the carriers for domestic air freight also had international air freight shipments. The additional international package volume created a scale advantage over those carriers that did not provide international air freight service. In order to service those international shipments, carriers built networks in Europe and Asia. This entry into international air freight increased the profit margins of the carriers because international air freight was charged at premium prices. As the international air freight market was being developed, domestic shippers began to be more demanding in terms of services offered. As the carriers developed these international markets, the package volume domestically began to grow because the international shippers required rail, ocean, and truck service in addition to air freight service. As carriers established strategic alliances with firms that specialized in these other modes of transportation, the carriers began to achieve economies of scope. These alliances further increased the package volume within the domestic network and provided for distribution to final customers for inbound international packages. The alliances resulted in significant economies of scale and scope versus competitors that had not established alliances. After alliances had been established, shippers began to require value-added services. Shippers began to require carriers to identify shipments that were in transit. Therefore, air freight shippers began to develop new tracking resources. The technological capability of being able to track packages in transit was a new resource for the air freight carriers. As such, they needed to hire managerial resources that possessed knowledge of how to develop and implement this capability, which led to a level of differentiation from carriers that did not offer such services. These resources permitted carriers to identify exactly where a package was in transit. In addition, these air freight carriers erected large, centralized call centers so that shippers could communicate easily with carriers. In the early 1990s, shippers began to require additional services from air freight carriers. Logistics and electronic data interchange (EDI) were two services that had a high demand. Logistics refers to the activities used to move products from producers to consumers and other end users. These activities include order processing, inventory management, materials handling, warehousing, and transportation. Planning an efficient logistics system is crucial to developing an effective firm strategy because it can decrease costs and increase customer satisfaction (Pride and Ferrell 2001). Speed of delivery and dependability are often as important to customers as price. Companies that have the right goods in the right place, at the right time, in the right quantity, and with the right support services are able to sell more than competitors

26

Growth from Chaos

that do not (Coyle, Bardi, and Langley 1999). The air freight carriers invested in new resources to meet these emerging logistical needs of customers. Logistical capabilities were needed to service domestic and international markets. International logistics increased in importance during the 1990s. Major changes have occurred in the international distribution operations of many companies. Deregulation of the U.S. ocean liner companies created new opportunities for international shippers to redesign existing distribution channels in order to reduce order-cycle days and shipment costs (Lambert and Stock 2001). Further, as the United States continues to shift toward a technology- and service-based economy, international logistics has become a more important part of the physical distribution function for many firms (Johnson, Wood, Wardlow, and Murphy 1999). The increasing importance of international logistics presents both prospects and problems for distribution professionals. On one hand, firms will gain knowledge with respect to developing close linkages between international product markets (or sourcing) and logistics because of the cross-border supply lines associated with overseas activities. On the other hand, carriers face a larger number of more sophisticated logistics problems stemming from the complex nature of overseas distribution operations (Coyle, Bardi, and Langley 1999). In some instances, a firm's international markets may produce more sales than its domestic markets do. To support non-domestic markets a company must have a distribution system or network that satisfies the particular requirements of each of these international markets (Czinkota and Ronkainen 2001). For example, the distribution systems in the developing countries of Africa, South America, and Asia are characterized by large numbers of intermediaries (middlemen) supplying an even larger number of small retailers. These nations' systems are also marked by inadequate transportation and storage facilities, a large market comprised mainly of unskilled workers, and an absence of distribution support systems (Lambert and Stock 2001). Achieving adequate distribution networks to access customers is quite challenging in these markets. In more highly developed countries such as Japan, Canada, the United States, and most of Western Europe, the infrastructure systems are highly sophisticated (Czinkota and Ronkainen 2001). A firm entering those countries will find distribution networks that have good transportation systems, high-technology warehousing, a skilled labor force, and a variety of distribution support systems. These countries provide significant growth potential for firms engaging in international logistics. The successful air freight carriers in the deregulated period grew with the shippers over time. These carriers were able to modify exist-


27

ing resources or develop new ones as the key success factors (e.g., logistics) in the industry changed over time. Carriers that grew were able to develop resources to meet these emerging key success factors better than their competitors. Several air freight carriers did not develop their resource base to meet the emerging needs of the customer base. These carriers either went out of business or were acquired by carriers that were developing their resource base to increase scale of operations. Firms that experienced growth within this industry were successful at meeting the key success factors during the regulated period (pre1978) and then changing their resource base to meet the needs of shippers during the deregulated period. As identified previously, firms needed to meet a substantially different set of key success factors in the 1990s compared to the regulated period. With respect to the air freight carriers, the firms that experienced growth within the air freight industry evolved as their customer base evolved. Those firms that did not change to meet new key success factors or were unable to adapt to a new environment (global, technology driven) did not grow and went out of business. The two trends that have been previously identified, globalization and utilization of technology, can be used to predict what resources air freight firms will need to develop to compete in the future. First, the trend toward globalization means that air freight firms must have extensive U.S. and international operating infrastructures to meet the needs of a global economy. Not only is an extensive operating network required in the domestic market; the firm also needs an extensive operating network in its international markets. To meet the needs of both domestic and international shippers, each international market will need its own hub-and-spoke operating system. Within this industry, each international market hub needs to be connected to hubs in other international markets and to hubs in the firm's domestic market. Thus, a firm will need to establish a global hub-and-spoke operating system. The reason for such an extensive infrastructure is that the customers require door-to-door service in all markets. Firms that are able to develop these resource positions will have a competitive advantage over those that do not. Once the international operational infrastructure is in place, this network can be utilized to provide service from point of origin to point of destination. In order to service global markets, carriers will need to provide multi-modal services. This is important because the choice of mode of transportation may be limited in many international markets. Many times, carriers will need to utilize multiple modes to move an international shipment from point of origin to point of destination because infrastructure (e.g., roads) is not nearly as well developed in

28

Growth from Chaos

international markets as is the case within the United States. Therefore, firms need to evolve into multi-modal carriers, not just air freight firms, to provide different levels of service. The capability to provide different modes of transportation can also reduce costs of the overall network. Firms that have not integrated these other modes of transportation into their networks (1) may be unable to service some customers because of accessibility problems, (2) may need to charge higher prices because for each shipment the carrier may need to utilize multiple carriers, or (3) may be at a cost disadvantage because they cannot leverage their network to the degree multi-modal carriers can. In addition, global transportation carriers would need to develop technology capabilities such as on-line real-time shipment tracking, electronic data interchange (EDI), and global logistics. An integrated, multi-modal network would enable firms to leverage these resources throughout the system. Air freight firms began to realize that the differential services they provided to domestic shippers were also required by international customers. By developing these technology capabilities to meet domestic and international shippers, firms were able to achieve a level of differentiation from domestic and international competitors that did not provide such services. Firms that grew during the deregulated period realized that they were in the transportation business, not the air freight business. Air freight was simply one mode of transportation. In addition, carriers began to realize that they needed to compete with rail, trucking, and ocean shipping firms in different ways from those by which they were competing with other air freight firms. Another issue that the carriers began to recognize was that because European and Asian airlines carried substantial freight in addition to passengers, the air freight industry internationally was more developed than it was within the United States. Competing with international airlines required the air freight carriers to implement different strategies in international markets. To achieve sustained growth, firms must have the knowledge to change and the ability to grow in different directions than they have in the past. ENVIRONMENTAL SCANNING

The firm must sense a need for change and the key decision makers in the firm must be cognizant of this need (Ginsberg 1988; Zajac and Shortell 1989). One important way through which top managers learn about their environment is environmental scanning. Environmental scanning is the means through which the top managers perceive external events and trends (Hambrick 1982). Scanning is the first link in the chain of perceptions and actions that permit an organization to


29

adapt to its environment (Hambrick 1981). This link is important because it can identify changes in the environment. The better the firm is at ascertaining these changes, the greater the probability that it will be aware that action is needed to address them. Scanning may be a managerial skill that is required if a firm is to address changes in its environment accurately. The environment is made up of factors, external to the firm, over which the firm has little control. Sometimes external factors exert a great influence on the firm (Daft, Sormunen, and Parks 1988). As such, environmental scanning is utilized to provide the firm a better picture of the environment in which it operates. This picture is important when managers are faced with a dynamic, changing environment (Ginsberg 1988). Scanning is a resource to ascertain when the firm needs to change. Scanning can also be utilized to determine the actions and reactions of competitors to a dynamic environment and to identify the strategic changes made by competitors. The top managers' perceptions and interpretations of the actions of competitors and others in the environment can affect decisions of the firm to change strategically (DiMaggio and Powell 1983). What is needed is to develop an accurate assessment of how the environment has changed and to link the firm's strategy to these changed conditions better than its competitors do. Through effective environmental scanning the firm may be able to create environmental change to a greater degree than the competition does. Effective environmental scanning will enable the firm to identify emerging trends in the marketplace. Identification of trends can indicate in what direction a firm needs to grow. Although an accurate assessment of change is important, it is of equal importance for the firm to be able to implement the strategic change. STRATEGIC CHANGE IMPLEMENTATION

Change is a continuous process; as such, the firm must be in position to respond continuously to changing environmental conditions. Not all firms are equally able to change (Ginsberg 1988; Zajac and Shortell 1989). Knowing what change is needed is irrelevant if the firm does not have the ability to handle the necessary change (Fombrun and Ginsberg 1990). Some firms, even though they recognize that change is necessary, may not be able to respond. Other firms, due to earlier strategic choices, may not be able to respond in the direction of the needed change (Gruca and Nath 1994). Still other firms have strongly entrenched organizational belief systems and structures that make the implementation of needed change difficult. These structures may be counterproductive because they ignore the realities of the marketplace and competition (Winter and Thomas 1985). The key is to

30

Growth from Chaos

match changes in the environment to strategy implementation from a dynamic perspective. Successful strategic change is based upon the ability to implement the right strategy at the right time (Ginsberg 1988). The firm must assemble resources to move the firm in the direction needed. As such, a firm's resource base needs to be flexible. As discussed in Chapter 1, organizational flexibility is critical for firm growth. Many times, resources are scattered throughout the firm: the firm that will establish a competitive advantage and grow is the firm that can integrate these resources to generate capabilities that are superior to the competition when viewed from the customer's perspective. Firms that have evolved as their customer base has evolved, such as Toyota, are positioned for long-term growth. Because the direction of growth cannot be predicted with certainty, resources need to be flexible. The creation of resource positions that have the flexibility to change in the direction of customer needs will, over time, establish a foundation for successful firm growth. Markets evolve over time; thus, resource positions need to be flexible enough for the firm to evolve with its customers. If a firm has been successful at meeting key success factors as they change over time, the firm may be able to predict key success factors in the future. DICTATING ENVIRONMENTAL CHANGE

The ability of the firm to dictate key success factors is important because it may help to explain how the firm, through sequential development of its resource base, can dictate change to provide for longterm growth. The concept of altering the environment in the firm's favor was developed by Galbraith (1977) as the ability of the firm to reduce uncertainty and dependence upon the environment "by drawing on its own resources and ingenuity." In the 1980s, Zeithaml and Zeithaml (1984) developed the concept of environmental management. These scholars argue that firms can and do implement a variety of strategies designed to modify existing environmental conditions. They maintain that a firm, through management of its resources and strategies, can become a proactive agent of change by attempting to manage the external environment. Penrose (1985) takes the perspective that the firm can have a significant impact on modifying the environment in the firm's favor. This perspective of the firm as being able to dictate environmental change extends the traditional position of the firm from responding to environmental change after the fact. By developing its resource base to acquire new capabilities, the firm has the potential to create environmental change that alters the competitive environment in the firm's favor to provide for long-term growth (Heene 1994).


31

SUSTAINABLE GROWTH

A firm can either adapt to its environment or create environmental change. Either way, a fundamentally new environment is created. This new environment is shaped, at least in part, by decisions that firms make. As discussed by Schumpeter (1942), "creative destruction" occurs from "within the firm." Because creative destruction occurs within the firm, the decisions of a firm's managerial resources are of critical importance. Managerial resources maybe able to "creatively construct" so that the firm leads environment change. A knowledge of what positions and what factors have been successful in the past can be utilized to determine key success factors in the future. This predictive ability may lead to sustainable growth. Firms that can predict key success factors of the future and develop capabilities to meet them will have a substantial advantage over their competitors. Many of the capabilities the air freight carriers developed, such as the global multi-modal network, required considerable time and investment. Developing the capabilities sooner than the competition will provide firms with a first-mover advantage. What a firm needs to accomplish is to be perceived as better than the competition on key success factors as judged by the customers. In many cases, this is accomplished by utilizing strengths to capitalize upon competitors' weaknesses. When Roadway Package System (RPS) was formed in the mid-1980s, it knew that it could not compete with UPS from a scale perspective. So it attempted to compete from a differentiation perspective. Roadway actually utilized UPS's size to its own advantage by implementing package tracking on its ground shipments. Because of the number of packages UPS ships per day (millions), it was not feasible for UPS to offer a similar service. It was not until many years later that UPS was in a position to offer package tracking on its ground shipments. During the intervening period, Roadway had achieved a differentiation advantage over UPS. This illustrates an important point: A differentiation advantage is only sustainable until the competition can catch up. Once the competition has caught up, another source of differentiation must be achieved. A position of substantial advantage is based upon the firm developing sequential advantages over time. For example, pharmaceutical firms have seventeen years of patent protection in this country. During this period, the firms need to continually develop and market new drugs because of the competition from generic drug companies. If the pharmaceutical firms can continually introduce new drugs, they can stay ahead of competition. Indeed, staying ahead of competition requires that the firm be aware of the key success factors in the current time

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Growth from Chaos

period and build resources and capabilities to capitalize upon emerging key success factors. One of the reasons Boeing acquired McDonnell Douglas was to diversify its product offerings outside of commercial airlines. McDonnell Douglas's core strength was in military aircraft. Boeing knew that it could compete with Lockheed Martin for the $320 billion joint strike force (JSF) aircraft project if it could acquire the capability to manufacture military aircraft. In this case, the acquisition enabled Boeing to diversify its product lines and also become a bidder for the JSF program. Boeing was looking to acquire resources to build its core business and expand into related businesses. Although the government awarded the contract to Lockheed Martin, Boeing now has the capability to become a major player in terms of military aircraft manufacturing. This is a capability that Boeing's primary competitor, Airbus, does not provide. I walked back into the CEO's office six months after the key success factor analysis had been completed. "We are now profitable," he stated. "Congratulations," I replied. "Now we need to grow," he said. "Maybe we should make some acquisitions; what do you think?" "Perhaps," I stated, "but acquisitions are only one vehicle of growth." "How else could we grow?" the CEO asked. "Well, you can grow through internal development. You could also grow through strategic alliance or expansion into international markets," I answered. "O.K., sounds good," he stated; "what should we do first?" "The answer to that question is far more complex than it would seem," I responded; "perhaps we should examine how successful firms have grown over time. Let's fully examine different ways a firm could grow and then examine actually how they have grown," I replied. "Sounds like a plan," the CEO stated; "let's get to work." How firms actually achieve these positions of growth is the subject of the next chapter. LESSONS LEARNED

1. If your firm focuses solely upon cost reduction, you are at maximum risk because your firm is not responding to changing consumer needs. If your competition is more focused upon customers, it is likely to take more and more share from your firm. As such, you have to reduce costs even further. 2. Identify the key success factors within your industry and understand how the customer perceives your firm on these factors with respect to competition. By monitoring key success factors over time, your firm will be able to beat competitors to the punch. This will provide your firm with a sustainable advantage.


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REFERENCES

Amit, R., and P. Shoemaker. 1993. "Strategic Assets and Organizational Rent." Strategic Management Journal 14: 33-46. Cateora, P., and J. Graham. 1999. International Marketing. New York: Irwin McGraw-Hill. Coyle, J., E. Bardi, and C. Langley. 1999. The Management of Business Logistics. St. Paul: West. Czinkota, M., and I. Ronkainen. 2001. International Marketing. Fort Worth, TX: Harcourt Brace. Daft, R., J. Sormunen, and D. Parks. 1988. "Chief Executive Scanning, Environmental Characteristics, and Company Performance: An Empirical Study." Strategic Management Journal 9:123-139. DiMaggio, P., and W. Powell. 1983. "The Iron Cage Revisited." American Socio logical Review (April): 147-160. Fombrun, C , and A. Ginsberg. 1990. "Shifting Gears: Enabling Change in Corporate Aggressiveness." Strategic Management Journal 11: 297-308. Galbraith, J. 1977. Organizational Design. Boston, MA: Addison-Wesley. Ghemawat, P. 1991. Commitment: The Dynamic of Strategy. New York: The Free Pr Ginsberg, A. 1988. "Measuring and Modeling Changes in Strategy: Theoretical Foundations and Empirical Directions." Strategic Management Journal 9: 559-575. Gruca, T, and D. Nath. 1994. "Regulatory Change, Constraints on Adaptation, and Organizational Failure: An Empirical Analysis of Acute Care Hospitals." Strategic Management Journal 15: 345-363. Hambrick, D. 1981. "Specialization of Environmental Scanning Activities among Upper Level Executives." Journal of Management Studies 18: 299-320. . 1982. "Environmental Scanning and Organizational Strategy." Strategic Management Journal 3:159-174. Heene, A. 1994. "Preface." In G. Hamel and A. Heene (eds.), Competence Based Competition. New York: John Wiley & Sons. Johnson, J., D. Wood, D. Wardlow, and P. Murphy. 1999. Contemporary Logistics. Princeton, NJ: Prentice-Hall. Kotler, P. 1994. Marketing Management. 8th ed. Upper Saddle River, NJ: PrenticeHall. Lambert, D., and J. Stock. 2001. Strategic Logistics Management. Boston, MA: McGraw-Hill. Mintzberg, H. 1978. "Patterns in Strategy Formation." Management Science 24: 934-948. Ohmae, K. 1982. The Mind of the Strategist. New York: McGraw-Hill. Penrose, E. 1985. The Theory of the Growth of the Firm Twenty Five Years After. Uppsala, Sweden: Acta Universitatis Upsaliensis. Pride, W., and O. Ferrell. 2001. Marketing. Boston, MA: Houghton Mifflin. Schumpeter, J. A. 1942. Capitalism and Democracy. Cambridge, MA: Harvard University Press. Winter, F, and H. Thomas. 1985. "An Extension of Market Segmentation: Strategic Segmentation." In H. Thomas and D. Gardner (eds.), Strategic Marketing and Management, 253-266. New York: John Wiley & Sons.

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Zajac, E. J., and S. M. Shortell. 1989. "Changing Generic Strategies: Likelihood, Direction, and Performance Implications." Strategic Management Journal 10: 413-430. Zeithaml, C , and V. Zeithaml. 1984. "Environmental Management: Revising the Marketing Perspective." Journal of Marketing 48: 46-53.

3 A Framework for Achieving Long-Term Domestic and International Growth Much of the preceding chapter addressed growth from a key success factor perspective. This chapter will discuss how these factors can be utilized to provide for firm growth. Growth can be achieved by obtaining greater utilization of your existing resource base. Many times, your firm's resource base has excess capacity that is not fully utilized. Let's assume that you are a dean of a business school. DIRECTION OF GROWTH

Your business building is a resource that has substantial excess capacity. In other words, your building is not utilized twenty-four hours a day, seven days a week. The building represents a fixed asset that could be utilized to a much greater extent. Undergraduate classes fill the building during the day; how about at night? It may be possible to offer a night school undergraduate program for individuals who have full-time employment during the day. One benefit, in addition to obtaining greater utilization of your building, is that corporations would provide tuition reimbursement. Programs of this nature may generate higher profit margins than your daytime undergraduate program. The building may also be utilized during the night for certificate programs. Another option is to offer an MBA program at night for individuals who work during the day. What about the weekend? Executive MBA programs normally fit quite nicely into this available time period. Also, the weekend is normally a good time to offer seminar programs sponsored by larger corporations. An additional benefit is

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Growth from Chaos

that the linkage between universities and corporations is made stronger. In some cases, the weekend may be the only time for executive programs because of limited availability of executives during the week. There are many possible alternatives for obtaining greater utilization of your fixed resources. In these examples, I am assuming that there is sufficient demand for these alternative programs and that faculty resources also have excess capacity. If faculties do not have excess capacity, I do not recommend trying to staff these additional programs with adjuncts. With high-profile programs such as executive MBA programs, it is important to utilize your most valuable resources: full-time faculty. Because many of the programs identified represent substantial profit potential for the business school, paying faculty a premium for teaching such courses may suffice to generate enough full-time faculty interest. Universities are not the only resources that have excess capacity. Let us take the example of an airplane. Airlines live and die based upon what is called load factor. Simply put, the more passengers that are on a specific flight, the greater the revenue stream that is generated by that flight. In other words, a full plane is better than a threequarters-full plane. Airlines tend to offer reduced fares on lane segments that do not have total capacity. Partitioning the aircraft into first class, business class, and economy is another attempt by the airlines to generate more incremental revenue per flight. These are just a few examples of utilizing excess capacity to generate firm growth. Underutilized resources exist in all industries. What underutilized resources exist in your industry or firm? A firm may also grow by developing related resources. Continuing with the example previously mentioned, related resource development could entail the development of air cargo as a revenue stream within the U.S. airline industry. Because of fluctuation in passenger demand, many European and Asian carriers utilize the concept of combination carrier. A combination carrier is an aircraft that carries both passengers and freight. In some cases, approximately 40 percent of revenue is generated by freight. In the United States, commercial airlines generate less than 5 percent of their revenue from freight. By developing these related businesses, the airlines would be able to extract additional revenue from their resources. In fact, much of the explosive growth of UPS (United Parcel Service) and FedEx is because the U.S. airlines do not consider air freight an integral part of their business. A firm may also facilitate growth by developing new resources. In fact, the development of new resources is critical if the firm is to lead or dictate environmental change. High growth firms (McDonald's, FedEx, Microsoft), discussed in Chapter 1, developed new resources that created industries. By developing new resource positions, your firm may be able

A Framework for Achieving Long-Term Domestic and International Growth

37

to create significant differentiation (e.g., developing new manufacturing processes such as lean manufacturing) from your competitors. A FRAMEWORK FOR FIRM GROWTH

A firm can grow domestically by means of (1) acquisition, (2) internal development, or (3) strategic alliance. The role of acquisitions is important from a growth perspective. An acquisition is a strategy through which one firm buys a controlling or 100 percent interest in another firm (Hitt, Ireland, and Hoskisson 2001). Acquisitions represent a quick way to generate firm growth and to establish market positions in areas where a firm had previously been absent (Penrose 1959). However, acquisitions take a considerable amount of senior management time and should not be undertaken until much research and due diligence have been completed. The due diligence work is of particular significance because it represents an independent, objective view of a specific acquisition opportunity. Strategic alliances are partnerships between firms whereby their resources are combined to pursue mutual interests in the manufacturing or distributing of goods or services (Hitt, Ireland, and Hoskisson 2001). An important attribute of alliances is that they enable firms to leverage resources without adding incremental costs. By obtaining greater utilization of a firm's existing resource base, economies of scale can be achieved. A firm may choose not to engage in an acquisition or strategic alliance but begin operations in an area from which it has been absent (Yip 1982). This mode of growth is called internal development (Yip 1982). A microbrewery in the northeastern United States establishing operations in the Midwest would be an example of internal development. A firm may grow internationally through acquisition, strategic alliances, or direct entry. Acquisitions represent a quick way to establish positions in international markets. In addition to the assets of the acquired firm, valuable managerial resources can be obtained. These managerial resources can provide important insights with respect to environmental forces (e.g., political), competition, and the customer base. In a later chapter we will see what happens when a firm does not retain the managerial resources of the acquired firm in international markets. In addition, it is not necessary to develop a customer base from scratch. The target firm already has an established customer base. When a firm in one country establishes operations in another country, we use the term direct entry (Yip 1982). The firm is directly entering an international market from which it had been absent without partners. The large oil companies utilize a great deal of direct entry. A firm may also grow internationally by means of strategic alliance.

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Growth from Chaos

An international strategic alliance occurs when two firms in different countries agree to utilize the assets or resources of each other's firm without acquisition. In some international markets, strategic alliances may be the only way to achieve a market position because of government restrictions on direct entry and acquisitions. For example, if you desire a position within the airline industry, strategic alliances may be the only option because several major international airlines are still partially owned by their government. How these alternative modes of growth can be integrated with a firm's resource base must be understood. The matrix in Figure 3.1 provides a framework for examining firm growth in terms of mode of growth and resource utilization. Domestic Growth Process

Cell 1 utilizes internal development to further develop existing resources. Many times, the existing resources of a firm are not entirely utilized. For example, a firm may have a production line that utilizes only one shift. A centralized call center may have unmanned stations. A building may have vacant office space. The central point is to more fully utilize existing resources to achieve greater efficiency and thereby reduce costs. By increasing the utilization of the existing resource base, the firm may be in a position to charge lower prices. As a result, customers may demand more products; this will lead to even greater utilization of a firm's existing resource base. A firm may grow via internal development to increase the utilization of its existing resource base. When FedEx was created in 1973, the company serviced seventeen pair cities through a hub-and-spoke operating network based in Memphis, Tennessee. As the firm grew, additional cities were added to the network which resulted in greater utilization of the entire network. The primary focus of Cell 1 is extracting the maximum benefit from the firm's existing resource base through internal development. Cell 2 refers to the internal development of related resources. Prior to 1982, UPS was not a player in the overnight air express market. In 1982, UPS purchased a fleet of aircraft for $1 billion to begin to compete with FedEx in the overnight air express market. These aircraft represented related resources for UPS. The utilization of related resources is important because the firm may achieve additional economies of scale in its core business and economies of scope in the related business. Economies of scale result by having more total packages (air and ground) in each UPS delivery vehicle. Economies of scope result by providing customers both air and ground package service utilizing the same network.


39

Figure 3.1 Growth Matrix

Related resources should complement existing resources. For example, many trucking firms have developed trailers that can be placed and shipped on railcars. This truck-rail combination (intermodal) has been a source of substantial growth for trucking and rail firms in a deregulated environment. The development of intermodal operations provided rail carriers greater accessibility to markets they had previously been unable to service. The rail carriers benefited by utilizing the trucking firms' resources (trailers) for pick-up and delivery of freight. The trucking firms benefited through the lower costs of rail shipping versus trucking for shipping between major rail markets. Cell 3 represents the development of new resources through internal development. For example, Toyota's development of lean manufacturing was a process innovation that provided the firm with both a cost and quality advantage over its competitors. This system was so efficient that the customer could get a built-to-order car in seven to ten days (Peter and Olson 1999). This resource provided Toyota a competitive advantage over its existing Japanese competition. The pharmaceutical firms spend billions of dollars trying to develop new drugs to treat diseases. If these firms can internally develop new drugs or treatments, they will have a differentiation advantage over

40

Growth from Chaos

their competitors. New drugs represent new growth potential for the firm. This is especially true if the new resources are new to the industry as well. However, care must be taken with the development of new resources. New resources may take the firm too far away for its core capabilities. In the mid-1980s, FedEx attempted to introduce Zapmail to its customers. Zapmail was a new product that utilized satellites for the transmission of documents. Documents were picked up by FedEx drivers and taken to origin Zap sites. These documents were then transmitted to destination Zap sites by satellite. The documents were then delivered by FedEx drivers. This new venture was abandoned after FedEx lost several hundreds of millions of dollars. By the mid-1980s, faxing had become the standard for transmitting documents. Not only did FedEx incur substantial losses, it also lost valuable time in the development of international markets. The key to new resource development is that the resources must add value to existing or related resources. For example, rail carriers have been very successful at internally developing remote control technology to provide better communication between railroads and dispatchers. Training is of critical importance after new resources have been developed. Time must be taken to train employees so that the benefits of the new resources can be obtained. Employees must understand the explicit linkage between the new resources and the firm's existing resource base. In many cases, the new resources represent added value to the customer base. The sales force must be able to communicate the new resource benefits to the customers. Alliances can be utilized to further develop a firm's existing resource base; Cell 4 represents this type of growth. For example, IBM and Dell have formed an alliance through which IBM will sell $16 billion in parts to frequent customers of Dell over a seven-year period (Hitt, Ireland, and Hoskisson 2001). Analysts say that this alliance "positions IBM as a premier parts provider to one of the world's fastest growing computer firms. In exchange, Dell receives reduced royalty rates on technology it currently licenses from IBM at what are believed to be steep prices" (Wall Street Journal 1999). FedEx and the U.S. Postal Service (USPS) have entered into an alliance for the shipping of packages and documents. One of the benefits to FedEx is that it can now pick up and deliver to post office box addresses. This is an advantage because its primary competitor, UPS, does not have this authority. The USPS obtains access to FedEx's distribution network. FedEx's distribution infrastructure is much more fully developed than that of the USPS. This alliance benefits both alliance partners by facilitating greater utilization of existing resources. Many of the railroad's carriers have strategic alliances with each


41

other because any one carrier's network is constrained by its own rail network. To increase the size of its network, carriers establish alliances with other carriers. These rail alliances tend to reduce costs for alliance members because each carrier does not need to build new rail networks. They utilize the existing network of their partners. Cell 5 is the cell in which strategic alliances are utilized to develop related resource positions to generate growth. For example, the strategic alliance between Pepsi and Lipton provides each firm access to the other firm's distribution network. In this manner, firms can obtain access to worldwide distribution networks without incurring significant costs. Some of the U.S. airlines have alliances with major trucking companies to provide for the pick up and delivery of freight. Both alliance partners benefit. The trucking firms benefit by having transit times decreased because of the utilization of aircraft. Airlines benefit by having access to the trucking firms' extensive pick-up and delivery networks. A crucial benefit of alliances is that each firm does not need to incur the expenses of acquiring its partner's assets; both firms have access to and can utilize their partner's resources without additional costs. Further, each firm can remain focused on its core competencies. In the previous example, the trucking firms are responsible for ground transportation whereas the airlines are responsible for air transportation. Alliances permit firms to move into related markets without incurring the expenses and risks of developing such resources necessary to be successful. Alliances also permit firms to establish positions in several markets without incurring development costs. For example, the rail carriers have alliances with both trucking and ocean shipping firms. These alliances enable a firm to further develop related transportation areas much more quickly than with internal development and with considerably less expense than acquisitions. Cell 6 is focused upon alliances which enable firms new resource positions. Ericsson and Hewlett-Packard entered into a strategic alliance to create and market network management systems (Bleeke and Ernst 1995). Ericsson's technological strength in public telecommunications networks, and Hewlett-Packard's strength in computers and software, enable both firms to benefit from the alliance. New resources may be expensive to develop; if firms can acquire these resources via strategic alliance, the firms will be in a position to generate growth. American Airlines' Sabre Reservation Call Center is one of the best in the industry. Because American Airlines has alliances with several smaller carriers, these carriers benefit by having access to a state-of-the-art communication center. The alliance benefit to American is that the airline gains access to markets that it previously did not have operating authority to service. The key to the success and growth of these alliances is to integrate the new resources so

42

Growth from Chaos

that they provide an additional source of value to a firm's existing or related resources. Firms must be cautious with strategic alliances. Although firms can achieve substantial growth potential from these alliances, each partner must put safeguards in place such that technology transfer does not occur between partners. It is quite possible that at a later time these alliance partners may become direct competitors. Resources cannot be instantaneously developed. A firm's inducements to form alliances can be related to its need for resources. Through alliances, firms can obtain access to assets that create value, that are not available for purchase, and that require time to build up. By collaborating with firms that have developed relevant assets, and by sharing those existing assets, firms do not need to internally develop these assets or purchase them. Thus, firms can use alliances to obtain access to new resources. However, in order for a firm to enter into an alliance, the alliance partners must receive some value in return. A firm's alliance opportunities are related to its own possession of relevant resources. The number of potential partners that are willing to align with a firm is a function of the firm's attractiveness to other firms, which in turn depends on the value of the firm's own asset base. The value that a firm can provide to its partners will increase when a firm can make available assets that are difficult for the partners to create on their own (e.g., technology). The greater the perceived value of these resources, the greater the firm's attractiveness to a potential partner and the greater the firm's collaboration opportunities (Ahuja 2000). From a managerial perspective, the alliance partner that is using the new resources may need to acquire human resources that are knowledgeable about the new resources. These new managerial resources can make development, implementation, and integration of new resources into existing and related resources much easier. The new managerial resources may be much more familiar with how new resources can be combined with other resources to create even greater growth potential for the firm. Cell 7 indicates that same-industry acquisitions may generate additional existing resources. At times, it may be desirable to obtain greater utilization of your existing resources by engaging in same-industry acquisitions. For example, FedEx's acquisition of Flying Tigers allowed FedEx to obtain greater utilization of its aircraft in the western United States and on trans-Pacific routes. This is an example of increasing utilization of existing resources. Before the acquisition, FedEx had very limited trans-Pacific service. Same-industry acquisitions can generate growth for the acquiring firm. Acquisition of existing resources can create a scale advantage for the firm. If a trucking company acquires another trucking firm, it ac-


43

quires additional trucks, trailers, and facilities. In addition, the acquiring firm may have its own distinct customer base. These additional resources can be immediately utilized to service the new customer base and provide the firm a scale advantage over its competitors. Scale advantages permit firms to charge lower prices; in turn, the lower prices may generate additional market share, which will make the utilization of existing resources even greater. The additional business may provide the basis for additional acquisitions, and the cycle repeats. With each acquisition, the acquiring firm achieves a greater scale advantage over its competition. The cycle will make it difficult for competitors to catch up. With acquisitions in the same business, implementation becomes easier and the scale advantages to the acquiring firm can be realized more quickly. In addition, training costs are minimized because the firm is simply expanding the geographic scope of its core business. Cell 8 represents the utilization of acquisitions to obtain related resources. Pfizer's acquisition of Pharmacia gave Pfizer access to strongselling drugs in oncology and ophthalmology, where Pfizer does not have a strong presence (Wall Street Journal 2002). This acquisition also increases Pfizer's presence in the over-the-counter drug market, where Pfizer has traditionally had a weak presence. Pharmacia makes Nicorette smoking cessation products and Rogaine hair products (Wall Street Journal 2002). The acquisition by rail carriers of trucking firms provided the acquiring firm access to a fleet of trucks. The trucks were very valuable to the rail carriers because they were now in position to provide service from point of pick up to point of delivery. This combined rail-truck network generated more total packages from each customer. Therefore, the existing rail network achieved economies of scale. In addition to tangible resources, the trucking managers that were acquired provided valuable insights into how the rail carriers could achieve greater scope (e.g., intermodal service) and scale of their existing resources. In addition, the related business will have its own customer base. A principle that is stressed continuously throughout this book is to maintain the management team of the acquired business. The acquired firm's management team may be much more knowledgeable than the acquiring firm's management team about how to utilize and couple resources to provide for optimal growth. We will see that acquiring firms that did not maintain the target firm's managerial resources did not grow. Cell 9 refers to engaging in acquisitions to acquire new resources. Sometimes it is necessary to make acquisitions into new industries to generate cash flow. Due to the severe restrictions that the government has placed on firms within the tobacco industry, firms need to move into other industries to stabilize cash flow. Philip Morris's acquisition of Kraft

44

Growth from Chaos

Foods is one such acquisition; it provides Philip Morris with diversification outside tobacco and also access to new resources. One such new resource is Kraft's extensive distribution system in the United States. Unrelated acquisitions (movement into new industries) need to be undertaken with great care for several reasons. First, it is quite possible that your firm may not be able to utilize its existing resource base in the acquired firm. As such, no economies of scale or scope may be realized. In addition, competition, industry structure, and many other factors may be different than in the acquiring firm's core business. Thus, it may take a considerable amount of time for the acquiring firm's management team to become knowledgeable about the target's customers and competitors. Second, over time, unrelated acquisitions tend to result in lower returns than do related acquisitions (Palich, Cardinal, and Miller 2000). Arguments highlighting the benefits of related diversification and the problems of unrelated diversification have been voiced in the strategic management literature for years (Hitt, Ireland, and Hoskisson 2001). Related diversifiers have advantages whereby they can convert underutilized assets and achieve economies of scope by sharing resources and combining activities along the value chain. Concurrently, arguments concerning the downside of unrelated diversification suggest not only minimal benefits but also that the acquiring firms incur significant implementation costs. These costs negatively impact performance. Unrelated diversification has been found to increase strain on top management and decision making, and it has created problems with control and governance systems. As it becomes more difficult to share activities and transfer competencies between units, the costs of increased unrelated diversification seem to outweigh the potential benefits (Palich, Cardinal, and Miller 2000). However, there are conditions under which unrelated acquisitions may be beneficial. Sometimes the only way to acquire valuable new resources is to acquire the whole firm. If the earnings generated in your core industry are depressed and expected to stay depressed, your firm's only growth option may be to acquire a firm in an industry that has a totally new resource base and customer base. The industry should be one that is profitable and is expected to be profitable for some time. One reason is that there may be few synergies with your existing resource base. In these cases, where the firm is obtaining new resources as a result of acquisition, it is of critical importance to maintain the managerial resources of the acquired firm. The acquired managers must train the acquiring firm's managers concerning the new industry and how the acquired firm's resources are utilized within the industry. In this case, the target firm should be expected to generate its own profit stream without additional resources from the acquiring firm.


45

One benefit to engaging in unrelated acquisitions is to generate new resources quickly; developing these resources via internal development is very time consuming. Another benefit is that the acquiring firm will bring its own customer base. Utilizing internal development, the firm must build a new customer base: This process can take quite a bit of time. The next section will discuss the development of resources in the international marketplace. International Growth Process

Still referring to Figure 3.1, Cell 10 depicts firms that directly enter international markets with existing resources. Several of the large automotive manufacturers have located manufacturing plants in Prague, Czech Republic. The plants manufacture cars for Western Europe, Asia, and the United States. By manufacturing autos for three global markets in one location, the auto manufacturers achieve significant economies of scale from existing resources, which tends to drive down unit variable operating costs. Many times, firms enter international markets to achieve labor savings. Many U.S.-based firms have operations in international markets because of the favorable labor climate. The major advantage of producing products in Third World countries is that a firm has greater opportunities to reduce the costs of production, especially the labor component. An example is the maquiladora, or twin plant (also known as in-bond manufacturing), operation. Companies from throughout the world set up assembly and manufacturing facilities along the Mexican side of the U.S.-Mexican border. The production-sharing aspects are encouraged by special tariff provisions that reduce the duties that would normally be assessed on materials that flow across the border (Fawcett 1990). With direct entry, your firm must do its homework. In international markets, political, economic, legal, cultural, and religious factors may all differ on a market-by-market basis. The key is to make certain that you can utilize your existing resource base in the international market. The unification of the European Union has permitted trucking firms to utilize their resource base as they do in the United States. Many U.S.-based trucking firms now have a European hub-and-spoke operating system. Directly entering an international market can be a high-risk venture. All the macroenvironmental forces (e.g., legal, political) must be fully addressed before international direct entry is attempted. The nature of competition and customer markets may significantly differ from those in a firm's domestic market. The flip side is that if you do not establish positions in international markets, your competitors—or firms

46

Growth from Chaos

from international markets—might establish positions within your own domestic market. Cell 11 represents direct entry into international markets to develop related resource positions. Honda established a manufacturing facility in Eastern Europe to manufacture motorcycles before it began selling motorcycles in Asia. Honda utilized the low labor costs of Eastern Europe and distribution infrastructures of Western Europe to introduce new products before these products were introduced in Japan. As trucking firms began to establish international networks, they had to develop related businesses. The trucking firms began to establish ocean-shipping firms in Europe to provide a transportation link between North America and Europe. These ocean-shipping firms provided related resources that enabled the trucking firms to significantly increase imports and exports; the related resources provided substantial growth potential for the trucking firms in international markets. When establishing resource positions in international markets, make certain that these related resources permit the firm to further leverage its existing resource base. In the example mentioned previously, the trucking firms were able to achieve greater utilization of their truck resources by moving ocean shipments to and from ports. When investing in international resource positions via direct entry, make certain that you also invest in managerial resources that are knowledgeable about the international market and the related resources. The key is to fully leverage these related resources in both domestic and international markets. Cell 12 addresses direct entry in international markets to achieve new resources. Sometimes, firms establish positions in international markets to gain access to new resources. Japanese firms have acquired several small U.S. universities. Japanese businesses value the U.S. educational system, and they have used the universities to educate many of their employees. If your firm is considering international expansion into markets other than its core business, it may be necessary to acquire international managerial resources that are familiar with your potential new venture. These managerial resources may be necessary to run the new businesses because your existing managerial team may not have experience in the new business or the international markets that your firm is targeting. The new resources should have much greater profit potential than your existing and related resources because the risk is higher. One benefit to acquiring new resources in international markets is that you may be acquiring technology that is not yet available in your domestic market. Every effort needs to be made to make certain that the new resources can add value to your firm's existing or related resources. In this manner, growth will result from the new resource positions and from en-


47

hancements the new resources provide to existing or related resources. Cell 13 illustrates utilizing strategic alliances to further develop your existing resource positions. Strategic alliances are very popular in international markets because the firm can achieve an international presence without the risks associated with direct entry or acquisitions. The airlines utilize alliances to gain access to markets without incurring the costs of entering these markets. These alliances have provided the alliance members with extensive coverage. One World and Star are two primary global alliances. One World consists of American Airlines, British Airways, Qantas, Iberia, Lan Chile, Finnair, and Aer Lingus (Murphy 2002). The Star alliance consists of United Airlines, Lufthansa, Singapore Airlines, All Nippon Airways, Air Canada, Thai Airways, Varig, Air New Zealand, Austrian Airlines, Mexicana, and British Midland (Murphy 2002). Alliances of these types permit firms to establish broad international coverage by engaging in multiple alliances. Each alliance allows the other members access to their network. This accomplishes two primary objectives. First, each airline obtains greater utilization of its own airplanes because passengers from alliance members are flying on their network. Second, each alliance partner has access to a global network without incurring the additional costs of acquisition or internal development. With strategic alliances, firms do not need to build infrastructure because it already exists. In addition, the customers of your alliance partners may permit your firm the opportunity to more fully utilize your existing resource base. Another benefit of alliances is that members can leave or withdraw without incurring substantial fixed costs. As your firm's alliance network grows, your firm may be able to reduce price in its domestic market because additional international revenues permit your firm significant economies of scale. From an economies-of-scope perspective, technology may be shared among the strategic partners, which eliminates the need for your firm to acquire or develop such technology. A primary benefit of alliances is that scale and scope of coverage increase by adding new partners. Cell 14 utilizes strategic alliances to develop related resource positions. Internationally, related resources may provide your firm with both a scale and a scope advantage. DHL Worldwide and Lufthansa AG (Germany) entered into a strategic alliance to achieve both scale and scope advantages. Lufthansa utilized DHL ground infrastructure to provide for pick up and delivery of freight. DHL utilized Lufthansa for the air transportation of its shipments. Lufthansa could charge higher prices for point-to-point service, and the additional package volume that DHL generated permitted Lufthansa to achieve economies of scale with respect to its aircraft. DHL was able to achieve a cost advantage by more fully utilizing its ground truck network because of

48

Growth from Chaos

the additional package volume generated by Lufthansa. Because Lufthansa primarily transports heavy freight, DHL now has the air and ground network to move both lightweight and heavyweight freight. In this manner, the alliance provides DHL with a scope advantage. To the degree that international strategic alliances permit your firm access to related resources that provide either a scale or a scope advantage, the alliances may be valuable. First, your competition may not have an alliance network in place. Second, international business generated as a result of the alliances may permit your firm to lower costs and, therefore, provide lower prices than competition in your domestic market. What is important is to link the related international resources to your core business to provide a differentiation or cost advantage versus your competitors. Cell 15 utilizes international strategic alliances to provide your firm with new resources. Siemens and Corning created an alliance to grow the fiber-optic cable business (Bleeke and Ernst 1995). Siemens's presence in a range of telecommunications markets worldwide and cable manufacturing technology coupled with Coming's technological strength in optical fiber, enabled both firms to gain access to new resources. In 2000, GM and Fuji Heavy Industries entered into an alliance. Fuji manufactures Subaru vehicles. This equity strategic alliance was intended to reduce the uncertainty associated with GM's operations in Asia. The alliance provided benefits for both firms. The two companies exchanged technologies, including Fuji's four-wheel-drive systems and continuous variable transmission and GM's technology about fuel cell systems that Fuji had not developed (Hitt, Ireland, and Hoskisson 2001). Furthermore, the alliance with Fuji gives GM a presence in a different market segment as well as access to technologies such as the continuous variable transmission. This technology may be a source of competitive advantage for GM in the global automobile market. Fuji obtains greater access to North American markets (Hitt, Ireland, and Hoskisson 2001). U.S. domestic steel firms utilize what is called cat strip technology. This technology provides steel at lower costs. U.S. steel manufacturing involves highly controlled continuous pouring of molten steel into a narrow mold and onto a conveyor belt to form a continuous twoinch-thick ribbon of semisolid steel—pouring steel much in the same manner as frosting an endless cake using a pastry tube. The process requires sophisticated computer technology and monitoring to ensure constant quality to avert costly and dangerous spills. The precisely sized ribbon of steel is then rolled to the specific thickness using a few smaller-size rolling machines. This results in a much smaller and less expensive plant than a traditional mill for the production of sheet steel (Boyd and Gove 2001).


49

Many international steel firms have engaged in strategic alliances with domestic steel manufacturers to gain access to this technology. In return, the U.S. domestic steel firms are permitted to establish positions in the partner's international market. One reason the U.S. firms are willing to give up this technology is because of the excess capacity that exists within the U.S. steel industry. There is another reason as well: The technology is difficult to implement and requires significant capital expenditures. Many international steel players are at best marginally profitable. In addition to the import duties the Bush administration has implemented, the U.S. steel firms are banking on international firms continuing to have limited funds for process improvements. The U.S. firms believe they can service the U.S. steel consumers with lower prices and higher quality steel. If some international steel firms do implement cat strip technology, this technology resource will provide these firms with a differential advantage over other international competitors who do not utilize the technology. Cell 16 utilizes international acquisitions to add value to the firm's existing resource base. One way to facilitate growth into an international market is to make an acquisition within your existing line of business. International acquisitions provide for rapid growth. Because the acquisition is in the same industry as the acquiring firm, implementation tends to be straightforward. These acquisitions provide the domestic acquiring firm with an existing international customer base. If the management team of the acquired firm is maintained, implementation and integration of the acquiring firm and target are made even easier. The international acquisition may provide additional economies of scale for the domestic firm. In this manner, the acquiring firm may develop a cost advantage over other domestic competition. The additional revenues may be utilized to partly support acquisitions in additional international markets. In this manner, the acquiring firm can incrementally increase share in both domestic and international markets. In 2000, British Petroleum (BP) acquired Amoco and Arco in the United States to achieve a significant market position in North America. The acquisition of Chrysler by Daimler Benz was due in part to achieving a stronger U.S. market position for Daimler Benz. Another example would be South African Breweries' acquisition of Miller Brewing Company. This acquisition made South African Breweries the second largest brewer in the world (behind Anheuser-Busch). Cell 17 depicts international acquisitions that provide related resources. Boeing's acquisition of McDonnell Douglas gave Boeing resources in the military aircraft segment of the industry in the United States and internationally. This additional resource set, military aircraft, provides Boeing with a competitive advantage over its primary

50

Growth from Chaos

competitor, Airbus. The great majority of Airbus's revenues come from the manufacture of commercial airplanes. Acquisitions of this nature can provide a positional advantage in terms of developing international markets. A scope advantage may also result if the existing and related resources can be integrated. Resources that are related to a firm's core business and acquired as a result of international acquisitions can benefit both the target and the acquiring firm. In the 1980s, TNT's Limited (Australia) was a diversified transportation conglomerate that had a strong position in international transportation markets but not in the U.S. trucking industry. TNT's Limited acquisition of several small trucking carriers in the United States gave TNT almost complete coverage of the United States for all its transportation business. As TNT began to develop a network via acquisition to provide for total U.S. coverage, the firm maintained the managerial resources of the acquired trucking firms. The acquired managerial resources were able to integrate the U.S. domestic acquisitions into a national hub-and-spoke operating network. TNT shipments from international markets provided economies of scope for the U.S. trucking operations. This group of U.S. domestic trucking firms has exhibited one of the highest growth rates since the industry was deregulated in 1980 (Rakowski 2000). (This combination of carriers will be discussed more fully in Chapter 6.) Cell 18 illustrates international acquisitions that provide new resources. Emerson Electric Co. has acquired companies partly to reshape its competitive scope. A famous and highly profitable manufacturer of electric motors and electrical components, Emerson is using acquisitions to focus on international telecommunications service sectors and to reduce its investments in electronics. Jordan Industries, a firm competing in manufacturing, is an acquisition Emerson completed to diversify its operations (Hitt, Ireland, and Hoskisson 2001). In many cases, the only way to obtain technology quickly is through acquisition. For example, Nokia acquired many U.S. firms with technology resources that Nokia needed to develop its wireless products. International acquisitions that provide the acquiring firm with new resources need to be carefully analyzed. The acquiring firm's management would be wise to hire consultants with experience in both the firm's core business and the target's new business. It is unlikely that international acquisitions that generate new resources for the firm can be integrated with the acquiring firm's resource to achieve economies of scale or scope. The resources obtained should be, on their own, capable of creating differentiation or lowering costs. With this type of acquisition, the risks are high: Make certain the acquired new resources provide the acquiring firm with a differential advantage over competitors.


51

Integrating Domestic and International Growth Patterns

"This matrix cube that you have developed is quite complex; it is a mystery to me where a firm would start with its growth process," the CEO stated. "The cube is a description of the actions that a firm could take to grow; if we utilize what we have learned about the air freight industry and integrate the insights of academic scholars, we may be in position to predict a growth pattern," I replied. "This sounds like a plan," the CEO said. "Where should we start?" he asked. "It would seem to me that a firm would not begin in an international market; I believe that a firm would have more success if it began the growth process in its domestic market," I replied. "I believe that is quite true," the CEO stated. By initially eliminating international expansion, we are left with finding a starting point in Cells 1 through 9; Cells 10 through 18 are international. The air freight carriers that were successful with growth started with their existing resource base. A firm's existing resource base has excess capacity that drives the growth process (Penrose 1959). Based upon the previous discussion, we could start the growth process with Cells 1, 4, or 7. If a firm has excess capacity, it does not seem reasonable that the firm would engage in alliances. Alliance partners may use significant amounts of this excess capacity. Because the firm will use this excess capacity to more fully develop its existing resource base, we could start with Cells 1 or 7. If the firm is interested in expanding quickly, then acquisitions may be a logical starting point. The acquisition process is driven by a firm's excess capacity (Penrose 1959). On the other hand, although internal development takes longer, greater organizational learning may occur. Learning provides the vehicle for the firm to maintain and expand existing capabilities. Chandler (1990) emphasizes the creation, maintenance, and expansion of resources and capabilities to facilitate growth. Through an interactive process of learning, firms alter their core capabilities in an attempt to maintain dynamic growth in a constantly changing environment (Bogner and Thomas 1994). The firm must evaluate the trade-off between quick growth and learning. The firm may have a choice of where it starts; there are advantages to starting the growth process at either Cell 1 or 7. Whether the firm utilizes acquisitions or internal development, it needs to fully develop its resource base in one market before expanding to other markets (Wernerfelt 1984). The air freight carriers that were successful fully developed a national hub-and-spoke operating system before pursuing other types

52

Growth from Chaos

of expansion. After this network had been established, the carriers realized that this network could support additional product lines such as ground shipping, rail, ocean shipping, and trucking. As such, the air freight players then began to establish alliances with firms in these related transportation areas to further leverage their network. The second step in the sequence was Cell 5, utilizing strategic alliances to obtain related resources. Once a firm has completely developed its existing resources, it can expand into international markets from a position of strength (Wernerfelt 1984). Firms need to exercise care when expanding into international markets. The air freight carriers that were successful with international expansion tended to acquire firms within their core business, air freight. When firms expand internationally, they begin with an investment in their core business (Chang 1995). Firms would make acquisitions in one international market; the market would be fully developed operationally before proceeding to develop another international market. Thus, the next step in the growth process would be Cell 16, international acquisition within the firm's core business. Acquisitions are favored over direct entry in international markets for two reasons. First, the acquisition comes with an existing international customer base. Second, managerial resources within the target firm are more knowledgeable about the industry structure, the political and legal environments, the competition, and the customers than are the acquiring firm's management team. Acquisitions are favored over strategic alliances in international markets because of the knowledge base that exists within a target's management team. The acquiring firm may have no knowledge of the specific international markets that the firm is entering. The target's management team is needed to run the business in the international market. To reduce the risk of failure, these firms are entering their core businesses and those in which they may have stronger competitive advantages over local firms. The learning associated from early entry enables firms to move into areas in which they have the next-strongest competitive advantage. Although learning takes place within firms through learning by doing, firms may also learn from other firms through the transfer or diffusion of knowledge. This process is not automatic, however, and it may be enhanced by membership in a corporate network. By learning from their own sequential entry experience as well as from other firms in corporate networks, firms build capabilities in foreign entry (Chang 1995). Firms may then engage in international alliances to increase their scale of operations. Firms would then move to Cell 13. As such, firms would make acquisitions in their core markets and then utilize alliances to move into new geographic markets. This "stepping stone" approach will provide the firms with continual expansion opportunities (Wernerfelt 1984). Thus, the international sequencing


53

would be from Cell 16 to Cell 13. Alliances could also be utilized to further develop the domestic market. The firm could further develop its domestic positions by engaging in a number of strategic alliances in related transportation modes to further utilize the firm's resource base. As such, the firm would not need to incur additional expenses associated with acquisitions. These strategic alliances domestically are represented by Cell 5. Within the air freight industry, carriers began to develop these related transportation modes via domestic alliances and utilized international alliances to more fully develop these related positions internationally. As such, carriers then moved from Cell 5 to Cell 14 of the matrix. Once the domestic and international infrastructure was in place and shippers had developed related resources, shippers began to require new resources. Carriers began to develop package tracking, logistics, and EDI services for shippers. Because the carriers did not have the managerial knowledge to develop these services, they began to hire new managerial resources to design and implement the services. Carriers then moved to Cell 3 of the matrix. It needs to be pointed out that new resources are developed and implemented by managerial resources. The best bet for your firm to successfully implement new resources is to hire new managerial resources that have experience in developing the types of new resources that your firm is interested in obtaining. The new managerial resources can play an important part in terms of implementing these resources within your firm. In this way your firm can internally develop these new resources once they have acquired the necessary managerial resources. The air freight carriers began to realize that new resources would add value from the perspective of both domestic and international shippers. Logistics became a very high growth business for shippers, domestically and internationally. They began to engage in international strategic alliances to grow their logistics business. Internationally, carriers then moved to Cell 15 of the matrix. An important attribute of strategic alliances is that they enable firms to leverage their resources. At a broader level, some scholars believe that strategic alliances will play an increasingly important role in the consolidation of industries that is anticipated in the twenty-first century (Hitt, Ireland, and Hoskisson 2001). A reason for this is that through alliances, companies overcome barriers (e.g., antitrust provisions) that sometimes prevent a firm's direct competitive entry into another nation's marketplace (Freidheim 1999). The predicted sequencing is illustrated in Figure 3.2. It is a commonly held belief in the strategic management literature that a firm should fully develop its domestic resources before engag-

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Growth from Chaos

Figure 3.2

Predicted Expansion Path

ing in international expansion ( Position 1) (Wernerfelt 1984). Once these domestic resource positions have been developed within a firm's core business, the firm would engage in domestic alliances in related business to obtain greater leverage for the firm's resource base (Position 2). Firms would then expand sequentially into international markets via acquisition to utilize existing resources in international markets (Position 3). Firms would then further develop international markets by engaging in strategic alliances to more fully utilize existing resources internationally (Position 4). Strategic alliances could also be developed domestically to more fully develop the firm's related resource positions domestically (Position 5). To more fully develop these related resources internationally, firms would engage in international strategic alliances (Position 6). At this point, firms would begin to develop new resources to provide new services (Position 7). Firms would then develop strategic alliances in international markets to more fully utilize the new resources and gain access to additional international markets (Position 8). This sequencing would permit firms to fully develop their resource base domestically and internationally. Conceptually, the framework could be utilized to predict firm growth, as illustrated in Figure 3.2. The real test is to ascertain if this framework depicts actual growth within industries. In Chapters 5, 6,


55

7, 8, and 9 several transportation industries are examined over time to ascertain if indeed the framework depicts reality. LESSONS LEARNED 1. Sustainable growth requires a sequencing of decisions that capitalizes u p o n domestic and international opportunities. As such, it is important that your firm has the ability to grow in different ways over time: internal development, acquisitions, direct entry, and by strategic alliances. 2. Because the growth process is complex (see Figure 3.2), a proper sequencing of decisions over time may result in sustained competitive advantage. The further your firm evolves along this growth pattern, the more difficult it will be for competition to catch u p . REFERENCES Ahuja, G. 2000. "The Duality of Collaboration: Inducements and Opportunities in the Formation of Interfirm Linkages." Strategic Management Journal 21: 317-344. Bleeke, J., and A. Ernst. 1995. "Is Your Strategic Alliance Really a Sale?" Harvard Business Review 73 (January-February): 97-105. Bogner, W., and H. Thomas. 1994. "Core Competence and Competitive Advantage: A Model and Illustrative Evidence from the Pharmaceutical Industry/ 7 In G. Hamel and A. Heene (eds.), Competence Based Compet tion, 111-149. New York: John Wiley & Sons. Boyd, B., and S. Gove. 2001. "NUCCR Corp. and the U.S. Steel Industry." In M. Hitt, R. Ireland, and R. Hoskisson (eds.), Strategic Management: Competitiveness and Gobalization. Mason, OH: Southwestern. Chandler, A. 1990. Scale and Scope: The Dynamics of Industrial Capitalism. Cabridge, MA: Harvard University Press. Chang, S. 1995. "International Expansion Strategy of Japanese Firms: Capability Building through Sequential Entry." Academy of Management Journal 18:383-407. Fawcett, S. 1990. "Logistics and Manufacturing in Maquiladora Operations." International Journal of Physical Distribution and Logistics Management 2 13. Freidheim, C. F. 1999. "The Trillion-Dollar Enterprise." Strategy and Business 14: 60-66. Hitt, M., R. Ireland, and R. Hoskisson. 2001. Strategic Management: Competitiveness and Globalization. Mason, OH: Southwestern. Murphy, K. 2002. "U.S. Airlines." Morgan Stanley Dean Witter Equity Research (March). Palich, L., L. Cardinal, and C. Miller. 2000. "Curvilinearity in the DiversificationPerformance Linkage: An Examination over Three Decades of Research." Strategic Management Journal 21:155-174.

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Penrose, E. T. 1959. The Theory of the Growth of the Firm. New York: John Wiley & Sons. Peter, J., and J. Olsen. 1999. Consumer Behavior and Marketing Strategy. Boston, MA: Irwin. Rakowski, J. 2000. "The Changing Face of U.S. Transportation: The Motor Carrier Industry." Journal of Transportation Law, Logistics, and Policy (Witer): 47-62. Wall Street Journal. 5 March 1999. .18 July 2002. Wernerfelt, B. 1984. "A Resource-Based View of the Firm." Strategic Management Journal 5: 171-180. Yip, G. 1982. "Diversification Entry: Internal Development versus Acquisition." Strategic Management Journal 3: 331-345.

4 Deregulation and Growth: An Inhibitor or an Accelerator? There are fundamental differences between regulated and deregulated industries. Table 4.1 shows the severe constraints that are imposed during regulation and eliminated in a deregulated environment. Clearly, firm growth is constrained in regulated industries. RESTRICTIONS IN REGULATED INDUSTRIES

Considering the restrictions identified in Table 4.1, there are several reasons why having a well-thought-out strategy is not as important when regulation is present. First, many competitive strategic actions and reactions are unavailable to firms in regulated environments. For example, pricing freedom is typically limited as firms must obtain approval by regulatory agencies when setting or changing prices. Even when price changes are approved, there are inevitable regulatory lags in the process. Regulatory agencies also provide a certain amount of price stability by setting rates to allow adequate returns on investment in good and poor economic times (Mahon and Murray 1981). As a result, the incentives to pursue pricing strategies are often blunted by the regulatory body (Mahon and Murray 1981). The second reason why a well-developed strategy is less important in regulated environments is that rewards for successful strategy implementation are limited. Regulatory bodies attempt to ensure adequate but not excessive profit levels for all firms (Smith and Grimm 1987). As a result, there may be little incentive for a firm to develop a strategy to lower costs because the prices the firm is allowed to charge may be lowered correspondingly, leaving profits unchanged. Likewise, a

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Growth from Chaos

Table 4.1 Fundamental Differences between Regulated and Deregulated Industries

Existence of Condition Condition

Regulated

Deregulated

Number of firms is controlled

Yes

No

Market share is controlled

Yes

No

Market entry is limited

Yes

No

Price and profitability are controlled

Yes

No

Competition is limited

Yes

No

Scale of operating authority is constrained

Yes

No

Source: Mahon and Murray 1981; Smith and Grimm 1987; Hambrick and Finkelstein 1987; Reger, Duhaime, and Stimpert 1992.

firm pursuing an innovation strategy may not be rewarded by higher profits because of regulatory restrictions on earning (Mahon and Murray 1981). Third, regulated companies benefit from the neutralization of many competitive actions and reactions ordinarily available to firms in nonregulated environments (see Table 4.1). Any competitive edge obtained by a firm is blunted, if not lost, by the common regulatory requirement that firms submit proposals for such new initiatives a specified period in advance of final approval. These filings are usually public knowledge, and this gives others in the industry sufficient time to prepare their own competitive replies. Fourth, strategic choices such as customer selection, and market entry and exit are controlled by the regulatory agencies, which limit market entry by outsiders (see Table 4.1). Actions of competitors are even controlled within a regulated industry. Restrictions and delays commonly limit strategic actions such as innovation and product quality improvement (Smith and Grimm 1987). As a result, firms do not suffer penalties for failing to pursue specific strategies. Snow and Hrebiniak (1980) have empirically shown that in regulated environments the performance of firms with reactionary strategies was not statistically different from that of firms following more well developed strategies. Fifth, in a regulated environment the primary customer is the regulatory agency. "Since many of the traditional market and competitive forces are weakened in a regulated environment, and because of the influence and impact of the regulatory agency, the focus shifts from the consumers to the regulatory body itself" (Mahon and Murray 1981,

Deregulation and Growth

59

255). Because the regulatory body serves as the "control" for the industry, the precise role that the regulatory commission assumes is quite important. It can act as a buffer to change. Regulatory agencies often serve as buffers by protecting the firm from market and competitive forces. In this way, regulation provides stability and certainty in the environment. A firm can contest the actions of its competitors in a hearing before the regulatory agency and attempt to have the agency deny or revoke the change or innovation. As a result, "competitive" responses in regulated industries often lag behind those observed in nonregulated industries. Moreover, the regulatory process usually requires uniformity across the industry in a variety of ways (e.g., internal procedures, methods of rate compilation, methods of rate assessment), which serves to further stifle competitiveness in an industry (Mahon and Murray 1981). A sixth reason why the choice of a firm's strategy is less important in a regulated environment is that the organization's choices are much more clearly limited and the impact of competitive forces is more restricted. This limits the organization's ability to compete within a given product or market. In a regulated environment, the relationship between firms is mandated by law (Post and Mahon 1980). Understanding the impacts of deregulation is complex because regulation is enacted under a particular set of environmental conditions that change as a result of deregulation (Schwert 1981). STRATEGIES FOR NEWLY DEREGULATED ENVIRONMENTS

A deregulation represents a significant change (Meyer 1980). Hambrick and Finkelstein (1987) view the impact of deregulation as similar to a shock in which a new environment is created that would require fundamentally new approaches to doing business. It has been shown that some firms develop an innovative strategy in response to the drastically new environment brought about by environmental deregulation (Mahon and Murray 1981; Smith and Grimm 1987; Gruca and Nath 1994). Miles and Snow (1978) contend that this strategy type is more appropriate in uncertain, changing environments. The flexible strategy, which can be developed to meet new environmental conditions, can impact a firm's resource base. Deregulation permits firms to utilize their resource base differently (Bailey and Williams 1998). Upon deregulation, the firm has the option to more fully utilize its existing resource base (Mahon and Murray 1981). This has been empirically demonstrated by Kelly and Amburgey (1991) in their study of the deregulation of the airline industry. The new environment enables the utilization of excess capacity, which provides the firm with an internal mechanism for growth (Penrose 1959).

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Excess capacity can be used to achieve either economies of scale or economies of scope. As firms achieve economies of scale, unit variable operating costs tend to decline. This reduction may lead to a superior cost position versus competitors. Economies of scope may allow firms to achieve some level of differentiation from their competitors. Such a focus upon differentiation would not have been permitted in the regulated environment. THE EVOLUTION OF DEREGULATED INDUSTRIES

A major environmental change such as deregulation does not simply result in a change in strategy; rather, there is a pattern of strategic change in a nonrandom direction (Zajac and Shortell 1989). The pattern of strategic change within different industries is a primary focus of this book. For example, the trucking industry experienced a fortyfive-year history of regulation before it underwent deregulation, which created a new environment. Trucking Deregulation

Prior to deregulation, the government sanctioned rate bureaus and enforced a highly restrictive entry policy that resulted in an absence of effective competition among trucking carriers (Corsi, Grimm, and Smith 1990). Deregulation occurred within the trucking industry in 1980. Congress passed the Motor Carrier Act in 1980 for two primary reasons: (1) to promote ease of entry into the industry, and (2) to eliminate pricing restrictions (Corsi, Grimm, and Smith 1990). Because the Interstate Commerce Commission (ICC) controlled both market entry and exit into specific ICC regions, there was no incentive for firms to innovate or attempt to achieve efficiencies. Because the firms had no experience in industries other than trucking, growth during the regulated period was constrained (Pettus 2001b). The two primary objectives of deregulation will now be reviewed to ascertain if they were achieved. The first objective—promoting ease of entry into the industry—was clearly met. In addition to a large number of trucking firms entering the industry after deregulation, a significant number of small package, air freight, rail, and ocean shipping firms also entered the industry. These multi-modal carriers provided customers with a variety of shipping options. The result was that shippers had access to extensive national and multi-modal networks. If deregulation had not occurred, it is quite possible that these other modal carriers (e.g., air freight) would not have been permitted to enter the trucking industry.


61

The second objective—eliminating pricing restrictions—was also met because carriers built extensive hub-and-spoke operating networks, which tended to drive variable costs down. The shippers benefited from lower prices as the carriers passed these savings to the customer. From the shippers' perspective, both benefits of deregulation were realized; such was not true from the carrier's perspective. Deregulation of the trucking industry was intended to provide a new competitive environment in which carriers would have much greater freedom to implement specific strategies not available under regulation (Corsi, Grimm, and Smith 1990). A number of strategic responses lead to bankruptcy, which was not the intent of deregulation. Trucking Restrictions during the Regulated Period

From a trucking perspective, the biggest constraint during the regulated period was in terms of operating authority. Firms could only operate within limited geographic markets. Firm growth was constrained to within these restricted geographic markets. Because entry, price, and profitability were determined by the regulatory agency, firms that were inefficient suffered no penalties during the regulated period. This was because other firms were not permitted to operate outside their specific ICC regions. As such, firms were not able to utilize their resource base to achieve maximum economies of scale because expansion to other operating regions was restricted by the ICC. During the regulated period, the ICC divided the United States into nine ICC regions. Operating restrictions during the period of regulation permitted carriers to pick up and deliver packages within ICC regions but not between ICC regions. Each region represented a specific operating authority. The following example illustrates transportation routing during the regulated period. In order for a package to be shipped from Boston to Los Angeles, several carriers needed to be utilized. A carrier servicing the Boston ICC region would pick up the package and transfer it to a carrier servicing the New York region. This carrier would in turn transfer it to a carrier based in Chicago. The package would then be transferred to a carrier based in Kansas City. Next, the package would be transferred to a Denver regional carrier. Finally, it would be transferred to a Los Angeles based carrier for delivery to the final destination. This process is called interlining. In total, the package would be moved by six different carriers from point of origin to point of destination. Thus, it was difficult to hold carriers to specific delivery commitments in terms of service. Also, it was virtually impossible to identify the specific location of a package while in transit. The entire network changed as a result of deregulation.

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Deregulation Fundamentally Segmented the Trucking Industry

All ICC regions were eliminated as a result of deregulation, after which a single carrier could provide for full control of the shipment from point of origin to point of destination (carriers were provided operating authority between ICC regions). The development of carriers that could service customers throughout the United States without applying for operating authority from the ICC provided for substantial growth opportunities for less-than-truckload (LTL) carriers (Rakowski 1988). Interstate deregulation fundamentally restructured the trucking industry, segmenting it into truckload (TL) and LTL niches (Belzer 2000). Most carriers now haul either all LTL freight or all TL freight. TL and LTL carriers are very different types of businesses. The TL segment will be discussed first. The TL market is composed of truckload carriers and contract carriers, as well as specialized carriers that elect to focus on the large shipment of direct pick-up and delivery markets (Belzer 2000). A TL shipment weighs at least 10,000 pounds, with an average of about 26,000 pounds, filling up an entire trailer (Belzer 2000). Truckload shipments require only a single truck and trailer to deliver a load and require no complex pick-up and delivery network. Each driver accomplishes his or her work independently of other drivers. While large TL carriers operate sophisticated networks connected to a control base by direct communication via satellite, anyone willing to work can make a bid and take the freight. This factor enables carriers to keep wages low. Intense wage competition among drivers results (Belzer 2000). The new TL general freight industry, built around both the peripheral truckload haulers in the original common carrier group and a comparatively small group of truckload contract and special commodity carriers, exploded in the years immediately following deregulation (Belzer 2000). Deregulation enabled TL carriers to increase the volume of shipments because restrictions on operating authority were eliminated. This increase in traffic density permitted TL carriers to achieve greater economies by minimizing empty miles. Although truckload carriers did not require extensive hub-and-spoke networks, they did offer lower rates to move freight into a region where they have a surplus of outbound freight, making that region a kind of hub around which they built loads. The more trucks a carrier can position in a revenue-producing region, the closer each truck is to the carrier's customers (Belzer 2000). As a result, transit times are reduced. The LTL segment of the industry is significantly different than the TL segment. The ICC defines LTL carriers as those LTL segment motor carriers who transport freight by placing in their trailers multiple shipments


63

from multiple shippers. Even though each individual shipment represents less than a full truckload of freight, the accumulation of multiple shipments results in a fully loaded trailer. The LTL segment of the industry is the largest single industry segment in terms of total revenue (Corsi, Grimm, and Fietler 1992). It is quite homogeneous in its operating structure and market environment, but it is different from the operating structure faced by other segments of the trucking industry (Corsi, Grimm, and Smith 1990). The LTL market requires a different operating structure. Because the smaller shipments come from different shippers and are delivered to multiple consignees, this system requires an elaborate network of pick-up and delivery drivers, dockworkers, and road drivers. LTL carriers provide service for packages above 50 pounds to under 10,000 pounds. The average LTL shipment weighs about 1,200 pounds, and a truck of LTL shipments may include thirty shipments (Belzer 2000). United Parcel Service (UPS) was not a competitor in 1980 because its shipment limit per package was fifty pounds. Also, LTL shippers had shipments that were too small and did not move at sufficiently regular intervals to make private coverage an option (Corsi, Grimm, and Feitler 1992; Corsi, Smith, and Grimm 1993). With an elimination of geographic restrictions imposed by the ICC, transit times of packages were reduced because the need for interlining was eliminated and carriers were permitted to build integrated networks. An LTL firm must maintain an extensive network of pickup and delivery drivers and terminals. LTL carriers move freight via specific routes, determined by the configuration of their freight terminal network. Some carriers experienced growth in this segment of the industry because of the networks they created. As a result of deregulation, LTL carriers had much greater freedom to design and implement specific strategies without being restricted by the ICC regulations (Corsi, Smith, and Grimm 1993). The LTL carriers learned from the airlines and air express carriers (whose industry had been deregulated in 1978) how to move large volumes of packages efficiently. Within the segment, the majority of the carriers utilize a hub-and-spoke operating system that is distinct from the rail, pipeline, and to a certain extent, the TL segment. A hub-and-spoke operating system provided for faster transit times and higher reliability because a single carrier maintained control of the package from point of origin to point of destination. Unlike the regulated network, carriers were permitted to develop national operating systems, which resulted in substantial cost savings. For LTL carriers, hub-and-spoke systems can (1) generate the kind of traffic flow that keeps trucks full, and (2) allow for economies of scale (Belzer 2000). The new operating network also provided an infrastructure that enabled carriers to track packages within the network. Because of the unique complexity of

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handling small shipments, LTL firms do not face significant competition within their own markets from TL firms (Belzer 2000). Evolution of the Trucking Industry

Changes in operating authority and scope of operations led to the development of a new set of key success factors within the industry. Bardi, Bagchi, and Raghunathan (1989) conducted an extensive study to determine the key success factors within the industry following the period of regulation. Based upon the results of their study, the key success factors in rank order for carriers in the newly deregulated environment are as follows: Rank 1 2 3 4 5

Key Success Factor Transit time reliability or consistency Door-to-door transportation rates Total door-to-door transit time Willingness of carrier to negotiate rate changes Financial stability of the carrier

The results of the study by Bardi, Bagchi, and Raghunathan (1989) were essentially replicated by Farabhod and Logan (1991). The key success factors listed above indicate that door-to-door service was important in the 1980s. Because door-to-door transportation is required, carriers must make large capital investments to create the "critical mass" hub-and-spoke operating systems necessary for success. These operating networks erected significant barriers to entry (Rakowski 1988; Baker 1989). High capital costs are required for expansion within the trucking industry because investments are lumpy. A hub operating system can cost several hundreds of millions of dollars and may not be totally utilized for many years. Trailers and package delivery vehicles are less expensive investments but are also lumpy in that the entire capacity of the vehicle may not be utilized for some time. The entire hub-andspoke operating system represents a costly and lumpy investment. In order to obtain greater utilization of the integrated hub-and-spoke operating network, carriers began to expand into international markets during the mid-1980s (Hamilton 1994). Growth in terms of the scope of the trucking carriers' customer base required that firms offer international service to prevent losing business to air freight carriers. In a personal interview with John Throckmorton, head of the transportation practice at A. T. Kearney, he stated that "once carriers had expanded to service the continental


65

United States, growth could be accelerated by expansion into international markets. To a large extent, this expansion into international markets was driven by the international service requirements of the U.S. customer base" (personal interview 1991). During the late 1980s, customers began to be more demanding of trucking companies to provide a full range of shipping options. The need to become "total transportation carriers" rather than "trucking companies" began to evolve (Hamilton 1994). As such, carriers began to increase their scope of operations by providing ocean service, small package services, and air freight service. Carriers began to offer these additional services because of the evolutionary needs of the customer base. Growth was facilitated by moving beyond providing trucking services to providing a full range of transportation alternatives for the customer base (Hamilton 1994). During the early 1990s, carriers began to provide additional services. In a telephone interview with John Larkin, senior transportation analyst at Alex Brown & Sons, he stated that "during the early 1990s, there was a tremendous move on the part of shippers, distributors, and manufacturers to outsource their logistics and warehousing to carriers. At a minimum, carriers can take one shipper's freight and marry it up with a hundred other shippers' freight in order to achieve economies of scale and systems development efficiencies. Those carriers that have grown have developed these assets and expertise" (telephone interview 1996). The development of logistics and warehousing services has provided many benefits to both carriers and customers. Shippers looked to outsource their distribution and warehousing functions in order to reduce costs (Novack, Langley, and Rinehart 1995). There was a desire on the part of the shippers to work with carriers that could help them to do a better job of selecting the right mode, the right lane, the right carriers, the right sources for raw materials or semifinished products, and the right locations for facilities such as manufacturing facilities and warehouses. Carriers can generate fee income as they provide what amounts to consulting advice, but they also can generate transportation revenue and profits as they extract a brokerage commission and increase the amount of freight generated by their own transportation network (LaLonde et al. 1991). Logistics companies are able to get a "bigger bang" for their transportation dollar because they are pooling freight from hundreds of shippers (Novack, Langley, and Rinehart 1995). The logistics companies also provide better systems because they are able to defray their systems development costs across many different shippers. They also provide the kind of expertise involved in moving freight into hard-toreach foreign markets (LaLonde et al. 1991). This type of expertise

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Growth from Chaos

would be difficult for a shipper to develop internally; moreover, the logisticians provide shippers with variable cost structures. If freight was not moving, there were no fixed costs that would be associated with a private fleet of the shippers' own transportation department. According to Bob Delaney, vice president of Cass Logistics Inc. (a warehousing and logistics firm), "during the early 1990s, there was a strong desire by shippers to work with carriers who provide expertise in terms of logistics and warehousing" (personal interview 1995). Novack, Langley, and Rinehart (1995) believe that the development and integration of a logistics function created added value for trucking carriers in the 1990s. Further, in the 1990s shippers began to require additional valueadded services such as package tracking and electronic data interchange (EDI) (Millen 1992; Walton 1995). During this period, shippers were reducing the number of carriers they utilized while at the same time requiring more services from those they maintained (Hamilton 1994). Package tracking and EDI were attempts by carriers to differentiate themselves from those carriers that survived deregulation by providing value-added services (Elzinga 1994). EDI can be a means for creating closer ties, which foster long-term relationships between carriers and shippers (Millen 1992). Millen found that more than two-thirds of the shippers surveyed specified that there exists a superior relationship with carriers providing EDI versus those that do not offer the service. As a means of becoming more technologically and customer oriented, EDI permits firms that possess EDI a strategic advantage over those carriers that are not utilizing EDI (Walton 1995). Based upon the preceding literature review and interviews with the individuals quoted in this chapter, here are the key success factors in rank order for trucking carriers during the 1990s: Rank 1 2 3 4 5 6

Key Success Factor Transit time reliability Multi-modal shipments International service On-line, real-time tracking Electronic data interchange (EDI) Logistics service

The key success factors changed radically over time. Customers expected carriers to provide multi-modal service capabilities for U.S. domestic and international markets. In addition, they expected carriers to implement and utilize a variety of technology-based features


67

(e.g., real-time package tracking, EDI). The growing emphasis upon logistics capability in the 1990s became a requirement for the success of trucking firms. These developments within the trucking industry had a substantial impact upon the carriers. The motor carrier industry had argued that deregulation would create excessive competition and reduce industry profits (Baker 1989; Rakowski 1988). What actually happened was an enormous shakeout among LTL carriers (Silberman and Hill 1988). Only a small number of the carriers in 1979 are in business today (Rakowski 2000). Before deregulation, the ICC provided carriers with substantial protection from competitive forces. Such was not the case during the deregulated period. Those carriers that had developed a national hub-and-spoke operating network were able to achieve additional economies of scale as a result of intrastate deregulation, which occurred in 1994 (interstate deregulation occurred in 1980). Those carriers that had not developed this national infrastructure were at a competitive disadvantage. Because the trucking industry was deregulated at approximately the same time as the air freight, airline, rail, ocean, and small package shipping industries, the trucking firms that survived acquired valuable managerial resources from these other segments of the transportation industry as they became multi-modal carriers. These managerial resources provided for the future growth of trucking carriers (Pettus 2001a). In addition, many of the related transportation senior managers had extensive international experience. Because carriers were evolving from trucking firms to multi-modal carriers, the new managerial resources become important for meeting the key success factors of the 1990s. The task for trucking carriers was not only to integrate the various modes into their national network but also to develop an international infrastructure (Pettus 2001a). The firms that were successful grew, but most firms were not successful (see Chapter 5). Airline Deregulation

The Airline Deregulation Act was signed by Congress in 1978. This act was to accomplish several benefits: The first benefit was to provide wide-open competition with the free entry of new firms into the industry, which was to ensure adequate, reasonably priced service. A second benefit was substantial fare reductions would occur. Deregulation was to provide the public with new price and service options such as lower-fare, no-frills service. In addition, deregulation would lead to greater efficiency and lower cost by providing freedom to compete in pricing. Another benefit of deregulation was that customers would benefit from the constant threat of competition from new entrants.

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Deregulation was to eliminate scheduling pressure and resulting excess capacity. Even with free entry and free exit, the prior route network was to be served with little disruption. Another objective of deregulation was to alleviate economic distress for the airline industry (Brenner 1988). With respect to providing wide-open competition, the industry in 2001 has about the same concentration than it did in 1978. The top five revenue-based carriers in 2001 represented 60 percent of the total industry revenue; in 1978, the top five airlines accounted for 65 percent of the total industry revenue (ATA Annual Report 1979, 2002). The appearance of new airlines, combined with rapid expansion into new markets by many established airlines, resulted in unprecedented competition in the airline industry (Brenner 1988). By 2001, 85 percent of airline passengers have a choice of two or more carriers, compared with only two-thirds in 1978 (ATA Handbook 2001). The airlines compete intensely with one another in virtually all major markets. This aspect of deregulation has been achieved. The growth of hub-and-spoke systems resulted in increasing competition in small markets that would not normally support competitive service. This objective of deregulation has been met; some airlines own regional carriers outright (e.g., American Eagle). Such ownership gives airlines greater control over utilization of aircraft that fly from outlying areas into a major hub (ATA Handbook 2001). Opponents of deregulation predicted that prices would rise well above the regulated rates. Cunningham (2000) showed that consumers are indeed paying less to fly today than in 1978. This aspect of deregulation has been achieved. With respect to the benefits of deregulation being equally distributed, the industry as a whole has been plagued by many bankruptcies (Brenner 1988). This objective of deregulation has not been met. Chapter 7 discusses the many airlines that went out of business after the industry was deregulated. The growth in the industry has come from air freight carriers, not the airlines. Air freight carriers now occupy the number 3 (FedEx), number 9 (UPS Air), number 12 (DHL), and number 15 (Airborne Express) positions in the industry (ATA Annual Report 2002). In 1977, there were no air freight carriers in the top fifteen revenue-based firms (ATA Annual Report 1978). Another goal of deregulation was to provide the public with nofrills service. This goal of deregulation has been partially met. Southwest Airlines, the "no-frill airline," is now the number 8 revenue-ranked airline (ATA Annual Report 2002). It was not in the top fifteen revenuebased airlines in 1978 (ATA Annual Report 1979). In addition, it is the only airline that has turned a profit every year since deregulation. Southwest was profitable even during both Gulf Wars. Other no-frill


69

airlines such as People Express and ValueJet went out of business. Why Southwest has remained profitable and the other no-frills airlines have gone out of business is discussed in Chapter 7. Another objective of deregulation was that it would lead to greater efficiency and lower costs. The development of the hub-and-spoke operating network made airlines more efficient. Deregulation did lead to lower labor costs—but this was offset by substantial cost increases and inefficiencies in many other areas (e.g., congestion and delay costs due to intense hub-and-spoke scheduling; start-up and shut-down costs of unstable route structures; less-than-optimal seat-mile costs because of pressure from smaller airlines) (Brenner 1988). Another goal of deregulation was to reduce excess capacity. During the deregulated period, excess capacity has gradually decreased. Before the events of September 11, load factors were at a high of 72 percent (Hallett 2002). However, with falling prices and rising costs, the breakeven load factor (the point at which costs are met and profits can begin) rose to a record high of 77 percent (Hallett 2002). Even with declines in excess capacity, the airlines still cannot make profits. Another goal of deregulation was that the regulated route network would continue to be served with little disruption. Due to the substantial number of carriers going out of business since 1978, the turnover of specific routes has been substantial (Brenner 1988). These bankruptcies have created some disruption. Another goal of deregulation was to alleviate economic distress for the industry. Deregulation has been responsible for years of heavy industry losses and dozens of jet carrier bankruptcies, plus many more bankruptcies of commuter carriers (Brenner 1988). The goal has not been met. Since 1978, the entire industry has only made $6.2 billion (Department of Transportation—Form 41 1977-2001). In 2001, the industry lost $7.7 billion, mitigated only by the Air Transportation Safety and System Stabilization Act (Hallett 2002). Increased competition spawned discount fares. From the traveler's perspective, these discounts are the most important result of airline deregulation. Fares have declined more than 35 percent in real terms since deregulation in 1978 (Cunningham 2000). They have become so low, in fact, that interstate bus and rail service has been hard pressed to compete with the airlines (ATA Handbook 2001). In 1999, the Brookings Institute estimated that the traveling public was saving in excess of $20 billion a year as a result of deregulation. Fifty-five percent of the savings resulted from low fares and 45 percent from increased service frequency. More than 90 percent of air travel today involves a discount, with discounts averaging two-thirds off full fares (ATA Handbook 2001). The fare discounting has been a benefit to the consumer, but the airlines cannot make any profit with such deep discounting.

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With greater competition on the vast majority of routes, extensive discounting, and more available flights, air travel has grown rapidly since deregulation. The industry has been very successful in gaining a larger share of the potential market, in terms of both the number of customers and their frequency of purchase (Cunningham 2000). In 1977, the last full year of government regulation of the airline industry, U.S. airlines carried 240 million passengers. The number of passengers flying since 1978 has increased significantly. By 2001, the airlines were carrying 622 million passengers per year (ATA Annual Report 2002). The data show a rapid increase right after deregulation, a recession-induced downturn in the early 1980s, a steady increase until 1988, a leveling off during the early 1990s, and a steady increase in the last part of the 1990s (Cunningham 2000). A recent Gallup survey revealed that 80 percent of the U.S. adult population had flown at least once, more than one-third of them in the previous twelve months (ATA Handbook 2001). One could speculate that the managerial flexibility in a deregulated market to offer different pricing schemes, schedules, and routes as the market dictates contributed to increasing the size of the market. Another result of the deregulation of the airline industry was the development of strategic alliances by the major carriers. Through their alliance partners, the major U.S. airlines now have global networks. Passengers from international origin points help to increase load factors on domestic flights. In addition, U.S. passengers encounter fewer difficulties in reaching international destinations. The combined networks of U.S. and international airlines create global hub-and-spoke operating systems. Deregulation has brought innovation to several airlines. An important development was the advent of computer reservation systems. These systems help airlines and travel agents keep track of fare and service changes that occur very rapidly today (ATA Handbook 2001). The systems also enable airlines to efficiently process the millions of passengers who fly each day. Several major U.S. airlines developed their own systems and utilized them to engage in international strategic alliances. Another innovation has been the development of codesharing agreements. These agreements enable a ticketing airline to issue tickets on the operating airline and to use that operating airline's two-letter code (ATA Handbook 2001). Codesharing agreements can be between a larger airline and a regional airline or between a U.S. airline and a foreign airline. They enable two different airlines to offer better coordinated services to their customers. The major airlines have codesharing agreements with regional carriers and other major airlines. On balance, some of the goals of deregulation have been met whereas others have not. The industry today is different from what was ex-


71

pected as a result of deregulation. What will happen to the airline industry in the future will be discussed in Chapter 9. Railroad Deregulation

The Staggers Rail Act was signed into law by President Carter on October 14, 1980; it gave railroads greater latitude in managing their own affairs. The law was designed "to provide for the restoration, maintenance, and improvement of the physical facilities and financial stability of the rail system of the United States" (U.S. Code 94 STAT 1987). It was designed "(1) to assist the railroads in rehabilitating the rail system in order to meet the demands of interstate commerce and the national defense; (2) to reform federal regulatory policy so as to preserve a safe, adequate, economical, efficient, and financially stable rail system; (3) to assist the rail system to remain viable in the private sector of the economy; (4) to provide a regulatory process that balances the needs of the carriers, shippers, and the public; and (5) to assist the rehabilitation and financing of the rail system" (U.S. Code 94 STAT 1987). The Staggers Act of 1980 was intended to address issues of increased productivity, provide for higher standards of service, and provide for railroads to gain the critical mass to make investments in equipment and technology beneficial (Dobie and Grant 2000). From a productivity perspective, the U.S. Bureau of Labor Statistics has shown that the railroads have indeed increased productivity. Revenue ton-miles per constant dollar of operating expense increased 173 percent from 1981 to 2000 (Association of American Railroads 2002). The railroads have, in some cases, passed these productivity savings along to the customer. However, U.S. rail revenue per ton-mile has fallen, by 29 percent in nominal terms and 59 percent in inflation-adjusted terms since 1981 (Association of American Railroads 2002). Indicators of increased efficiency include productivity measures. The number of employees has been steadily falling. In 1980, there were 458,994 employees at Class 1 railroads. That number fell to 177,981 in 1997. Employee productivity, however, as measured by output per hour worked has risen. In 1980, the productivity index for rail employees was 55 percent. By 1996, it had risen to 168 percent (Dobie and Grant 2000). Deregulation has had mixed results with respect to improving service. Improved track, cars, and locomotive units have provided better service to shippers. Efforts have been made to improve shipment tracking and equipment availability through the incorporation of bar coding and global positioning satellite (GPS) systems (Dobie and Grant 2000). However, equipment availability is still an issue during periods of peak demand. In addition, the customer has not always benefited.

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Consolidation in the rail industry has not produced the results the shipper anticipated. The integration aspect of many mergers has not proceeded smoothly. Congestion in key areas has caused intolerable delays. Shortages in equipment and unmet schedules have resulted in missed dates for shippers engaged in global shipping. Missed delivery dates have led to lost business and poor customer relations. In many cases, the need to meet service commitments to their customers has caused shippers to turn from the rail to the highway when possible (Dobie and Grant 2000). In sum, the lack of communication and marketing has led to misunderstanding, unmet expectations, and counterproductive confrontations (Dobie and Grant 2000). The provision of on-time service on most traffic lanes has lagged far behind what shippers need to meet their service obligations. Efforts to provide a higher level of service to shippers appear to be more aggressively pursued by some rail carriers than others. The more aggressive carriers have achieved an on-time service level in excess of 90 percent. Others still struggle to achieve on-time service 85 percent of the time (Dobie and Grant 2000). Deregulation was to develop an environment in which carriers could make investments in equipment and technology to create shareholder wealth (Dobie and Grant 2000). Since 1980, the railroads have invested $278 billion on equipment and rail infrastructure improvements (Association of American Railroads 2001). One of the most visible results of this effort is the investment in locomotive units. In 1997, over 27 percent of the locomotive units in operation had been built after 1990. Locomotives were manufactured with electronic fuel injection, which increased fuel efficiency with significantly lower hazardous emissions. The newer units incorporate technological improvements that increase pulling power while decreasing energy usage (Dobie and Grant 2000). The benefits of a newer locomotive fleet are reflected in the increased ton-miles of revenue freight moved—from 918,958 in 1980 to 1,348,926 in 1997 (an increase of over 31 percent)—at a decreasing level of energy intensiveness—589 Btus in 1980 compared to 368 Btus per tonmile in 1997 (a decrease of 38 percent) (Dobie and Grant 2000). Railroad companies have utilized technological innovations to improve the manufacture and repair of locomotives and freight cars, the maintenance of right-of-way, and the quality of information systems. Two improvements in the manufacture of freight cars resulted in more efficient units during the early 1990s. First, electronic air-braking systems permitted carriers to achieve better braking performance, reduce brake-related breakdowns, and more readily detect defects. Second, with the limitation of cars to a 286,000 pound weight-on-rail limit, carbuilders began using light-


73

weight aluminum composites in car construction. Such cars permitted increased capacity (Burns 1998). While technological improvements produced greater car capacities, other innovations facilitated quicker track repair with fewer interruptions in service than in the past. New machines such as continuousaction tampers, high-speed undercutters, and wood-tie replacement machines were designed for such purposes. Advances in information systems were expected to enhance customer service and railway performance. Among these were Interline Service Management and Automatic Equipment Identification, both of which were designed to identify and track equipment in transit (Burns 1998). Railroads have achieved much of their dramatic advancements in safety through the introduction of new technology. These innovations include heat-treated, curved plate freight car wheels; new-generation metallurgy for rails; shelf couplers, heat shields, and thermal protection for tank cars; advanced track grinding techniques; improved bearings; durable and effective draft gears and cushioning devices; redesigned brake systems; and improved tie-fastening systems (Wilner 1997). By investing in technology and R&D, railroads have improved safety (Burns 1998). An integrated computer system links computers aboard locomotives to a central computer system. By means of wireless data links, the central computer system monitors the entire industry's traffic, work crews, and stoppages (Burns 1998). As a result, today's railroads are safer and more efficient than during the regulated period. Indeed, railroads have become one of our nation's safest industries (Association of American Railroads 2002). The rail industry's train accident rate fell by 64 percent from 1980 to 2000. Rail industry employee injury rates have fallen by 69 percent since 1980. Fatalities at grade crossings were nearly halved, from 833 in 1980 to 461 in 1997 (Dobie and Grant 2000). According to Bureau of Labor Statistics (BLS) data, the railroad working environment is safer than that of other transportation modes, with railroad employees enjoying lower injury rates than their colleagues in the truck and airline industries (Association of American Railroads 2002). These rates are lower than employee casualty rates of workers in factories, mines, and even some retail industries (Association of American Railroads 2002). One concern of deregulation was that it would lead to monopoly power by the railroads. This concern has not been realized. Railroads consistently fail to earn their cost of capital, and rail profitability consistently ranks in the bottom quartile among U.S. industries (Association of American Railroads 2001). The capital intensity of freight railroads is immense—in fact, such railroads require much higher levels of capital investment than other

74

Growth from Chaos

industries. Freight railroad capital expenditures as a percentage of revenues in 2000 was 18 percent, nearly five times the comparable figure (3.7%) for manufacturing industries (Association of American Railroads 2001). Maintenance expenses on rights-of-way and equipment add another $10 to $12 billion in rail spending each year. This extraordinary level of funding is required year after year to provide the assets necessary for the rail industry to operate efficiently, and it has made the nation's railroads stronger and more effective competitors (Association of American Railroads 2002). Unlike other transportation modes, railroads rely on private financing, not government funds, to pay for their infrastructure and equipment outlays (Association of American Railroads 2002). Because major U.S. freight railroads receive no appreciable government funding, they must earn enough year after year to cover significant spending requirements. However, the industry's internal cash flow is not enough to sustain the capital investment that railroads require. U.S. railroads must access the outside capital markets every year to fund their investment needs. From 1981 to 2000, approximately 63 percent of Class I (major) railroads' capital expenditures was provided from internally generated funds and 37 percent from external capital providers (Association of American Railroads 2001). The "funds shortfall" over this period was nearly $32 billion, highlighting both the importance that access to outside capital has to the railroad industry and the dangers that would be involved if access to capital was to be threatened by legislation or other means (Association of American Railroads 2002). As a result of increasing traffic and change in operations, the financial statistics of some railroads began to show improvement by the end of the 1980s. Railroad return on investment—that is, profit earned on assets utilized in transportation service—averaged 4.9 percent during the 1980s compared to 2.5 percent during the 1970s (Burns 1988). Railroad return on equity—that is, profit earned on stockholder investment—which averaged only 2.3 percent in the 1970s, climbed to 9 percent in the 1980s. Moreover, the ratio of operating expenses to operating revenues declined throughout the 1980s, exemplifying the industry's ability to cut operating costs. Finally, railroads were able to reduce their debt-to-capitalization ratios from a 41 percent average in the 1970s to about 24 percent in 1988 (Burns 1998). As their financial statistics improved, Class I carriers posted improved traffic figures during the early 1990s. Total traffic, measured in billions of ton-miles, has increased every year since deregulation ("Overview of U.S. Freight Railroads" 2002). By the mid-1990s, the finances and operations of the nation's Class I railroads had improved dramatically. Encouraging financial statistics,

75


traffic increases, and greater capital expenditures for track and equipment development demonstrated progress. Operating margin provides a measure of the profitability of the rail carrier (Dobie and Grant 2000). On average, operating margins have fallen steadily since 1980. At that time, the average operating margin was in excess of 100 percent. By 1990, it had fallen to 89 percent. Operating ratios continued to fall to an average of 85 percent in 1997 (Dobie and Grant 2000). Although operating ratios have improved significantly, measures such as return on equity (ROE) and return on assets (ROA) remain low. Rail carriers still seek to earn their cost of capital (Dobie and Grant 2000). In a capital-intensive industry, where there is the need to invest heavily in track and equipment, profitability goals have not been met (Dobie and Grant 2000). The challenge for rail carriers is to prove that with their expanded geographic coverage and investment in equipment and technology, they are now willing and able to provide the levels of service that shippers expect (Dobie and Grant 2000). This deregulated railroad industry is one in which only the strong survive. Of the forty Class I railroads in 1980, only seven rail systems exist today (Association of American Railroads 2002). Those railroads that have survived have become global transportation firms. Similar to the trucking and airline industries, the railroad industry today is different from the one that was predicted as a result of deregulation. LESSONS LEARNED

1. Deregulation is an environmental shock. As with all major environmental shocks (e.g., the Gulf War and September 11, 2001), a new environment is created. Firms that are successful must fully understand the short- and longer-term ramifications of these shocks if they are to survive. Firms need to view shocks as opportunities rather than constraints. 2. Shocks occur with frequency and they are severe (e.g., the 1987 stock market crash, both of the Gulf Wars, and September 11). Use the lessons learned in this book from those firms who have successfully dealt with these shocks as a framework for how your firm should deal with future shocks. "It is good that our industry has not gone through deregulation: we may have gone out of business," the CEO conjectured. "This is quite true; however, all industries go through shocks similar to deregulation. Remember the 1987 stock market crash, the Gulf War, and September 11 attacks," I said. "You are quite correct; it is difficult to insulate a firm from environmental conditions," stated the CEO. "Is there an approach that firms can take to neutralize the impact of such shocks?"

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Growth from Chaos

he asked. "Yes, there is," I replied. "But first we must understand w h a t firms should not do in response to environmental shocks. Let us examine an industry that has been unsuccessful," I added. REFERENCES

Air Transport Association (ATA) Annual Report. 1978, 1979, 2002. Washington, D.C.: Air Transport Association of America. Air Transport Association (ATA) Handbook. 2001. Washington, D.C.: Air Trans port Association of America. Association of American Railroads. 2001. "Rail Industry Restructuring." Washington, D.C.: Association of American Railroads. Association of American Railroads. 2002. "Overview of U.S. Freight Railroads." Washington, D.C.: Association of American Railroads. Bailey, E., and J. Williams. 1998. "Sources of Economic Rent in the Deregulated Airline Industry." Journal of Law and Economics 31:173-202. Baker, J. 1989. "Measures of Effectiveness for LTL Motor Carriers." Transportation Journal (Winter): 47-53. Bardi, E., P. Bagchi, and T. Raghunathan. 1989. "Motor Carrier Selection in a Deregulated Environment." Transportation Journal (Fall): 1-11. Belzer, M. 2000. Sweatshops on Wheels. London: Oxford University Press. Brenner, M. 1988. "Airline Deregulation: A Case Study in Public Policy Failure." Transportation Law Journal 16:179-228. Burns, J. 1998. Railroad Merger and the Language of Unification. Westport, CT Quorum Books. Corsi, T., C. Grimm, and J. Fietler. 1992. "The Impact of Deregulation on LTL Motor Carriers: Size, Structure, and Organization." Transportation Jour nal 32: 24-33. Corsi, T, C. Grimm, and R. Smith. 1990. "Motor Carrier Strategies and Performance." Transportation Journal (Winter): 201-210. Corsi, T, R. Smith, and C. Grimm. 1993. "Determinants of Strategic Change in the LTC Motor Carrier Industry: A Discrete Choice Analysis." Transportation Journal 32: 56-62. Cunningham, W. 2000. "The Changing Face of U.S. Transportation: The Airline Industry." Journal of Transportation Law, Logistics, and Policy 68:16-28. Delaney, Bob. 1995. Interview with author. St. Louis, MO, 3 March. Dobie, K., and J. Grant. 2000. "The Changing Face of U.S. Transportation: The Railroad Industry." Journal of Transportation Law, Logistics, and Policy (Winter): 63-73. Elzinga, K. 1994. "The Relevant Market for Less Than Truckload Freight: Deregulation Consequences." Transportation Journal (Winter): 36-45. Farabhod, K., and L. Logan. 1991. "A Conjoint Analysis Approach to Service in the Motor Carrier Industry." Logistics and Transportation Review 24: 185-196. Gruca, T, and D. Nath. 1994. "Regulatory Change, Constraints on Adaptation, and Organizational Failure: An Empirical Analysis of Acute Care Hospitals." Strategic Management Journal 15: 345-363.


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Hallett, C. 2002. "State of the U.S. Airline Industry: A Report on Recent Trends for U.S. Air Carriers." Washington, D.C.: Air Transport Association. Hambrick, D. C , and S. Finkelstein. 1987. "Managerial Discretion: A Bridge between Polar Views of Organizational Outcomes." In L. L. Cummings and B. M. Staw (eds.), Research in Organizational Behavior 9: 369-406 Greenwich, CT: JAI Press. Hamilton, D. 1994. "Only the Fittest Survive: Trucking Carriers Must Reinvent Their Operations to Stay in the Game." Journal of Commerce (January): 57. Kelly, D., and T. Amburgey. 1991. "Organizational Inertia and Momentum: A Dynamic Model of Strategic Change." Academy of Management Journal 34:591-612. LaLonde, B., J. Masters, A. Maltz, and L. Williams. 1991. The Evolution, Status, and Future of the Corporate Transportation Function. Columbus, OH: Ame can Society of Transportation and Logistics. Larkin, John. 1996. Telephone interview with author, 18 June. Mahon, J. F, and E. A. Murray. 1981. "Strategic Planning for Regulated Companies." Strategic Management Journal 2: 251-262. Meyer, J. 1980. "Transportation Deregulation: Possibilities and Prospects." Journal of Contemporary Business 9: 69-85. Miles, R. E., and C. C. Snow. 1978. Organizational Strategy, Structure and Process. London: Oxford University Press. Millen, R. 1992. "Utilization of EDI by Motor Carrier Firms: A Status Report." Transportation Journal (Winter): 5-13. Novack, L., S. Langley, and T. Rinehart. 1995. "Logistics as Value Added for Trucking Companies." Transportation Journal (Winter): 99-115. Penrose, E. 1959. The Theory of the Growth of the Firm. New York: John Wiley & Sons. Pettus, M. 2001a. "Managerial Resources as a Catalyst for Firm Growth." Advances in Competitiveness Research 9: 57-71. . 2001b. "The Resource-Based View of a Developmental Growth Process: Evidence from the Deregulated Trucking Industry." Academy of Management Journal 44: 878-896. Rakowski, J. 1988. "Marketing Economies and the Results of Trucking Deregulation in the LTL Sector." Transportation Journal (Spring): 11-22. . 2000. "The Changing Face of U.S. Transportation: The Motor Carrier Industry." Journal of Transportation Law, Logistics, and Policy (Winter): 4 Reger, R., L. Duhaime, and J. L. Stimpert. 1992. "Deregulation, Strategic Choice, Risk and Financial Performance." Strategic Management Journal 13:189-20 Schwert, G. 1981. "Using Financial Data to Measure Effects of Regulation." Journal of Law and Economics 24:121-158. Silberman, L., and H. Hill. 1988. "State of the LTL Trucking Industry." Transportation Executive Update 2: 6-13. Smith, K. G., and C. M. Grimm. 1987. "Environmental Variation, Strategic Change and Firm Performance: A Study of Railroad Deregulation." Strategic Management Journal 8: 363-376. Snow, C. C, and L. G. Hrebiniak. 1980. "Strategy, Distinctive Competence, and Organizational Performance." Administrative Science Quarterly 33:317-33

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Throckmorton, John. 1991. Interview with author. Chicago, IL, 24 January. U.S. Department of Transportation. Bureau of Transportation Statistics. 19772001. Air Carrier Financial Report. Form 41. Washington, D.C.: U.S. De partment of Transportation. Walton, L. 1995. "Electronic Data Interchange: A Study of Its Usage and Adoption within Marketing and Logistics Channels." Transportation Journa (Winter): 37-46. Wilner, F. 1997. Railroad Mergers: History, Analysis, Insight. Omaha, NE: Simmons-Boardman Books. Zajac, E. J., and S. M. Shortell. 1989. "Changing Generic Strategies: Likelihood, Direction, and Performance Implications." Strategic Management Journal 10:413-430.

5 Trucking Deregulation: Why Firms Failed Although firms attempted various strategic responses during the deregulation period, the vast majority of firms did not survive. This chapter explores the strategic responses that were unsuccessful. As discussed by Belzer (2000), the trucking industry was segmented into LTL (lessthan-truckload) and TL (truckload) carriers after deregulation. Table 5.1 lists the largest revenue-based TL and LTL firms in 1979 and 2001 and their dispositions. As shown in Table 5.1, few firms survived in the deregulated trucking industry. Only thirteen LTL carriers that were in business in 1979 were still in business in 2002. This group of LTL carriers, along with their 1979 rank, are #1 Roadway, #3 Yellow Freight, #13 Arkansas Best Freight, #49 Watkins, #57 USF Redstar, #60 Old Dominion, #61 Holland Motor Freight, #62 Southeastern Freight, #63 AAA Cooper, #64 Estes Express, #68 USF Dugan, #69 USF Reddaway, and #71 USF Bestway. Redstar, Holland, Reddaway, and Bestway are now part of U.S. Freightways. For the LTL carriers, initial firm size was not a necessary condition for success in the deregulated environment. Much of the growth within the LTL segment came from the smaller LTL firms. Consolidated Freightways, the number 2 revenue-ranked firm in 1979, was spun off by its parent, CNF Transportation, in 1996. Consolidated Freightways went out of business in 2002. Number 1 Roadway was acquired by #3 Yellow in 2003. Initial firm size was also not a good predictor of growth for the TL carriers that survived in the deregulated environment. In general, as shown in Table 5.1, the smaller TL firms grew in the deregulated environment: #33 C&H Transport, #38 Midwest Emery, #39 Refrigerated

Table 5.1 Largest Revenue-Based TL and LTL Firms, 1979 and 2001 Rank 1979 1

Rank 2001 2

2

**

3

3

4

9

5

**

6

**

7

**

8

**

9

**

10

**

11

**

12

**

13

12

14

**

15

**

16

**

17

**

18

**

19 20

** **

21

**

22

**

23

**

24

39

25

**

26

**

27

**

Firm Roadway Express**** Consolidated Freightways* Yellow Freight Lines**** Ryder Truck Lines McLean's Trucking Pacific Intermountain. Express. Spector Freight System Smith's Transfer Transcon Lines East Texas Motor Freight Interstate Motor Freight Overnite Transportation. Co. Arlamsas—Best Freight System American Freight System Carolina Freight Carriers Hall's Motor Transit Mason & Dixon Lines Lee Way Motor Freight TIME—DC Inc. Wilson Freight Co. Preston Trucking Co. IML Freight Associated Truck Lines Central Freight Lines Jones Motor Co. Gateway Transportation Bowman Transportation

Type LTL

Revenue 1979 (million $) 1,098,033

LTL

849,437

Out of Business

LTL

805,304

2,464,971

LTL/TL

560,700

1,607,999

LTL

540,144

Out of Business

LTL

403,037

Acquired

LTL

316,202

Out of Business

LTL

253,303

Acquired

LTL

238,303

Out of Business

LTL

235,021

Acquired

LTL

232,933

Out of Business

LTL

229,456

Acquired

LTL

229,096

1,262,096

LTL

222,539

Out of Business

LTL

215,743

Acquired

LTL

199,323

Out of Business

LTL

184,079

Left Industry

LTL

171,834

Acquired

LTL

169,735

Out of Business

LTL

165,123

Out of Business

LTL

160,302

Acquired

LTL

159,098

Out of Business

LTL

155,675

Acquired

LTL

154,279

IND***

LTL

147,503

Left Industry

LTL

147,387

Acquired

LTL

142,911

Out of Business

80

Revenue 2001 or Disposition (million $) 2,641,628

Table 5.1 (continued) Revenue 2001 or Disposition (million $)

Rank 1979

Rank 2001

Firm

Type

Revenue 1979 (million $)

28

4

Schneider

TL

142,529

2,388,000

29

**

LTL

137,177

Acquired

30

**

LTL

135,862

Acquired

31

**

LTL

135,488

Out of Business

32

**

LTL

133,592

Acquired

33

**

TL

133,006

Out of Business

34

**

LTL

132,167

Out of Business

35

**

LTL

108,874

Out of Business

36

**

LTL

105,201

Left Industry

37

**

LTL

105,135

Acquired

38

**

TL

103,911

Out of Business

39

**

TL

103,434

Out of Business

40

**

LTL

101,525

Out of Business

41

**

LTL

101,504

Out of Business

42

**

LTL

98,307

Out of Business

43

**

TL

98,033

Acquired

44

**

LTL

97,638

Out of Business

45

** **

Delta Lines Garrett Freightlines Branch Motor Express Red Ball Motor Freight C&H Transport Pilot Motor Carriers Illinois-California Express Pacific Motor Trucking Central Transport Inc. Midwest Emery Refrigerated Transport Brown Transport Corp. St. Johnsbury Trucking Commercial Lovelace Schwerman Trucking Gordons Transport CW Transport

LTL

94,666

Out of Business

46

48

** **

49

18

50

**

51

**

52

**

53

**

54

**

47

Johnson Motor Lines System 99

LTL

94,578

Out of Business

LTL

87,956

Out of Business

Thurston

LTL

85,902

Acquired

Watkins Motor Lines Inc. Santa Fe Trail Transportation. Jones Truck Lines Inc. Merchants Fast Motor Lines Murphy Motor Freight Maislin Transport

LTL

81,761

761,220

LTL

80,547

Out of Business

LTL

79,739

Out of Business

LTL

79,639

Out of Business

LTL

77,511

Out of Business

LTL

77,390

Out of Business

81

Growth from Chaos

82 Table 5.1 (continued) Rank 1979

Rank 2001

55

**

56

**

57

52

58

49

59

40

60

27

61

15

62

36

63

Firm

Type

Revenue 1979 (million $)

Motor Freight Express Ligon Specialized Haulers USF Redstar Frozen Food Express National Freight

LTL

75,735

Out of Business

TL

71,911

Out of Business

LTL

69,713

255,722

TL

68,154

275,419

TL

64,465

404,890

LTL

60,007

502,239

LTL

50,284

937,150

LTL

47,175

434,603

40

Old Dominion Freight USF Holland Southeastern Freight AAA Cooper

LTL

37,434

395,608

64

20

Estes Express

LTL

36,426

696,545

65

5

J.B. Hunt

TL

25,519

2,100,305

66

10

TL

23,129

1,403,897

67

11

TL

17,381

1,270,519

68

62

LTL

10,887

206,661

69

51

LTL

4,280

266,206

70

45

TL

3,951

294,617

71

85

Swift Transportation Werner Enterprises USF Dugan USF Reddaway Heartland Express USF Bestway

LTL

2,982

150,466

Revenue 2001 or Disposition (million $)

Sources: Modified from Rakowski 2000; Commercial Carrier Journal 1980, 2002. ""Consolidated Freightways was spun off in 1996 and went out of business in 2002. **Not Applicable. ***IND—Acquired by Roadway in 1993, sold to managers in 1997. ****Roadway was acquired by Yellow in 2003.

Transport, and #56 Ligon Specialized Haulers went out of business. Number 28 Schneider, #58 Frozen Food Express, #59 National Freight, #65 J.B. Hunt, #66 Swift Transportation, #67 Werner Enterprises, and #70 Heartland grew in the deregulated environment. All other firms were acquired or went out of business. The lone exception is Ryder Truck, which was ranked number 4 in 1979. Ryder is now an integrated logistics firm, ranked number 9 in

Trucking Deregulation: Why Firms Failed

83

2001 (Commercial Carrier Journal 1979; Commercial Carrier Journal 2002).

United Parcel Service (UPS) was not classified as an LTL carrier in 1979 because it shipped packages under fifty pounds. UPS revenue in 1979 was $2,321,633 (Commercial Carrier Journal 1979). In 2001, UPS and FedEx were not classified as LTL carriers but as parcel delivery carriers. Revenue for UPS ground in 2001 was $20,312,500; for FedEx, ground $4,671,000 (Commercial Carrier Journal 2002). These two firms are discussed separately in Chapter 7. Many firms had no experience with respect to how to position themselves competitively in a deregulated environment. In fact, many carriers did not even have a marketing function during the regulated period. Because most of the firms in the industry had little knowledge of growth, these carriers did not survive in the deregulated environment. KEY SUCCESS FACTORS AND RESOURCES

Based upon the key success factors of the deregulated trucking environment, the primary focus was upon providing door-to-door service and increasing reliability (Bardi, Bagchi, and Raghunathan 1989; Farabhod and Logan 1991). These factors resulted in firms leveraging their existing resource base to provide a single-carrier operating network throughout the United States. By providing an integrated operating network, variable costs tended to decrease as the network increased capacity The development of such a network was new to carriers because their operating authority had been restricted during the regulated period. It may be the case that a firm's resource development decisions are a function of the key success factors that exist within an industry at a specific point in time. The key success factors in the deregulated environment of increasing service coverage and decreasing transit time were more oriented toward greater resource utilization in terms of fully utilizing excess capacity. In this industry, initially after deregulation, the key success factors were oriented toward more fully utilizing a firm's resource base. The period after deregulation provided firms the opportunity to utilize the excess capacity of their resource base because the scope of operating authority was no longer controlled. Firms that utilized the excess capacity of their resource base in the deregulated environment may have had better and more efficient methods of scanning the environment to correctly identify the direction of change. As Hambrick (1981) points out, scanning is the first link that permits firms to respond to a dynamic environment. This is particularly true when firms are confronted with a dynamic, changing environment (Ginsberg 1988). From Chapter 1, we know it is important for firms to have the ability to scan their environment for changes and

84

Growth from Chaos

develop resource positions that change to meet the changing environmental conditions. Firms that either did not have the ability to respond in the direction of the changed environment or inaccurately assessed environmental change did not survive in the deregulated environment (Pettus 2001). Firms that leveraged their resource base after deregulation experienced higher firm growth than those that either developed new resources or did not further develop their existing resource base. Indeed, all firms that did not leverage their existing resource base in response to deregulation went out of business (Pettus 2001). FAILED RESPONSES TO DEREGULATION BY LTL CARRIERS

A large group of LTL firms did not respond accurately to deregulation. Some of these firms initially responded by engaging in new resource development. The new resources had only minimal utilization for trucking customers. Firms that followed this strategy went bankrupt (Pettus 2001). Another group of firms engaged in unrelated acquisitions as their first strategic response to deregulation. Firms that followed this strategy went out of business. By engaging in diversification they began to incur debt, which restricted cash flow for future expansion. With unrelated acquisitions it is much more difficult to achieve synergies and cost savings. A primary reason is that it is difficult to leverage the existing resource base. With unrelated acquisitions it is very difficult to utilize the existing resource base to either create a cost advantage or obtain a position of differentiation. In addition, because these firms moved into unrelated industries, they could not achieve economies of scope; their existing resource base could not be utilized in the new industry. Industry structure, competition, and customer base may be entirely different in the unrelated industry. Therefore, it became much more difficult for these carriers to grow in new industries. Another group of firms responded to deregulation by developing new resources and then attempted to leverage both existing and new resources. It may be difficult to integrate and achieve significant synergies from two distinct resource bases. In addition, developing some new resources can be expensive. The resources that these firms developed were in nontransportation-related businesses. All these firms went out of business (Pettus 2001). Some firms did not make any resource development decisions after deregulation; they continued to operate as they had in the regulated period. These firms continued to service the same group of customers in the same markets. Because deregulation eliminated restrictions on


85

operating authority, shippers began to do business with carriers that developed the national infrastructure. The elimination of operating authority also h a d another negative consequence with respect to carriers that continued to operate as they h a d during the regulated period. These carriers began to face competition from carriers that had previously been restricted from establishing operations in their markets. They were not oriented toward "competing for the future" (Hamel and Prahalad 1994). All these firms went out of business. The following list shows the 1979 rank of the LTL firms and the years in which the firms went out of business: 1979 Revenue Position #46 #20 #7 #32 #55 #44 #54 #11 #18 #22 #26 #31 #35 #42 #47 #50 #5 #16 #53

Year Firm Went Out of Business 1980 Johnson Motor Lines 1981 Wilson Freight 1982 Spector Red Ball Motor Freight Motor Freight Express 1983 Gordons Transport Maislin Transport 1984 Interstate Motor Freight Lee Way Motor Freight IML Freight Gateway Transportation Branch Motor Express Illinois California Express Commercial Lovelace 1985 System 99 Santa Fe Trail Transportation 1986 McLean's Trucking Halls Motor Transit 1987 Murphy Motor Freight

86

Growth from Chaos

1979 Revenue Position #14 #19 #45 #32 1990 #9 #27 #40 #48

#4 #51

#41

Year Firm Went Out of Business 1988 American Freight (Acquired #8 Smith) Time-DC CW Transport 1989 Pilot Motor Carriers Transcon Lines Bowman Transportation Brown Transport Thurston (Bought by Brown Transport, closed in 1990) 1991 Ryder Trucking Operation (Acquired by UI, Closed in 1991) Jones Truck Lines 1992 1993 St. Johnsbury Trucking 1994 1995 1996

#52 #21 #22

1997 Mechanics Fast Motor Lines 1999 Preston 2002 Consolidated Freightways

As the above list illustrates, initial firm size was not a requirement for success in the deregulated environment. Several of the larger players in 1979—47 Spector, #18 Lee Way Motor Freight, #11 Interstate Motor Freight—went out of business within four years of deregulation. The #5 firm in 1979, McLean's Trucking, went out of business in 1986. As


87

menitoned earlier, #2 Consolidated Freightways went out of business in 2002. Initial firm size was not as important in the deregulated environment as was scope of operating coverage. In the deregulated period, customers wanted carriers to provide total operating coverage from point of pick up to point of delivery. By not expanding their networks to become national carriers, these firms were at a distinct disadvantage during the deregulated period. The carriers that developed the national network after deregulation had a competitive advantage because they could offer one carrier service. Utilizing one carrier for shipments tended to reduce time in transit and improve reliability for those carriers that established national networks. The carriers that survived learned from the airline industry, which had been deregulated in 1978, how to operationally run their firms. Many of the LTL carriers went out of business because they could not afford to expand their networks. A hub-and-spoke operating system is an expensive investment. Unfortunately for these carriers, a national hub and operating system became a requirement in the deregulated environment. Another group of LTL firms continued to operate as they had during the regulated period and were acquired by other carriers (see Table 5.2). Acquisitions by Trucking Firms in the Deregulated Period

As illustrated in Table 5.2, only #13 Arkansas Best Freight and #3 Yellow were still in operation in 2003. One of the reasons Arkansas Best Freight is still in operation is that it made two large acquisitions: #10 East Texas Motor Freight and #15 Carolina Freight. These two acquisitions, in addition to internal growth, provided Arkansas Best Freight with complete U.S. coverage. Yellow used the acquisition of Preston to complete its national network. The Roadway acquisition was made to increase economies of scale. As the remaining carriers began to develop their national infrastructure, they started to acquire other regional carriers because of their existing operating network and because of the acquired firm's existing customer base. Firms that acquired other carriers did not need to develop new customer bases. They simply acquired the customers of those regional carriers that did not attempt to expand their own current operations. These regional carriers provided the acquiring firms with an increase in market coverage and a scale advantage over other carriers. A critical lesson learned from deregulation is that firms could not operate as they had during the regulated period. Those firms either went bankrupt or were acquired by other carriers attempting to establish a national network.

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Table 5.2 LTL Firms AcQuired by Other Firms and Their Disposition Date of Acquisition 1982 1984 1985 1986 1988 1990 1991 1993 1995 2003

Target Firm (1979 Revenue Position) #32 Red Ball Motor Freight #10 East Texas Motor Freight #26 Gateway Transportation #18 Lee Way Motor Freight #23 Associated Truck #30 Garrett Freightways #29 Delta Lines #12 0vernite #8 Smith #37 Central Transport #48 Thurston #4 Ryder (trucking segment) #21 Preston #15 Carolina Freight #1 Roadway*

Acquiring Firm (1979 Revenue Position) #7 Spector Freight #13 Arkansas Best Freight #54 Maisilin Transport #42 Commercial Lovelace Merged into ANR Freight

Disposition Closed 1982 Still in operation Closed 1984 Closed 1984 Closed 1998

#5 McLean's Union Pacific (Rail) #14 American Freight U.S. Truck (Private) #40 Brown Transport UI (Non-Trucking) #3 Yellow #13 Arkansas Best Freight #3 Yellow*

Closed 1986 Still in operation Closed 1988 Closed 1996 Closed 1990 Closed 1991 Still in operation Still in operation Still in operation

Source: Mergers and Acquisitions Journal. *Wall Street Journal, July 9, 2003.

Acquisitions and Reasons for Failure

Another critical lesson learned from deregulation is that the acquisition process may be a necessary condition, but it is not sufficient for survival. As identified in Table 5.2, the vast majority of the acquiring firms went bankrupt shortly after making acquisitions. There are several reasons why the acquisitions may have been ineffective. First, they did not make enough acquisitions to develop the national infrastructure. Firms were restricted in terms of operating authority during the regulated period; therefore, acquiring firms needed to make several acquisitions to provide national coverage. Second, the entire acquisition process is very time consuming. Typically, substantial managerial time and energy are required for acquisition strategies to contribute to a firm's strategic competitiveness. Activities with which managers become involved include (1) searching for viable acquisition candidates, (2) completing effective duediligence process, and (3) preparing for negotiations. Due-diligence is a process through which a firm evaluates a target firm for acquisition. An effective due-diligence process examines hundreds of items in areas as diverse as those of financing the intended transaction, differences in cultures between the acquiring and the target firm, tax consequences of the transaction, and actions that would be necessary to successfully meld the two workforces. Due diligence is commonly performed by investment bankers, accountants, lawyers, and management consultants specializing in that activity, although firms actively


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pursuing acquisitions sometimes form their own internal due-diligence team (Hitt, Hoskisson, and Ireland 2001). The failure to complete an effective due-diligence process often results in the acquiring firm paying a premium—sometimes an excessive one—for the target company. In fact, research shows that without due diligence, "the purchase price is driven by the pricing of other 'comparable' acquisitions rather than by a rigorous assessment of where, when, and how management can drive real performance gains. [In these cases], the price paid may have little to do with achievable value" (Morais 2000). In a broader sense, one of the most important responsibilities the top management team has in terms of acquisition strategies is to make certain that the target is utilized effectively. Studies have shown that company executives who are responsible for, and participate in, many of the activities that are part of an acquisition strategy can divert managerial attention from other matters (e.g., thinking seriously about the firm's purpose, competition, customers, and external stakeholders) that are linked with long-term competitive success (Hitt, Hoskisson, and Ireland 2001). Acquisitions can consume significant amounts of managerial time and energy in target firms as well as in the companies that acquire them. Because of the uncertainty that an acquisition creates, some researchers suggest that target firms find themselves in a state of virtual suspended animation during an acquisition (Hitt, Hoskisson, and Ireland 2001). For example, while the target firm's day-to-day operations continue, most of the company's executives are hesitant to make decisions with long-term consequences, choosing to postpone such decisions until negotiations have been completed. Thus, evidence suggests that the acquisition process can create a short-term perspective and a greater averion to risk among top-level executives in a target firm (Hoskisson, Hitt, and Ireland 1994). Another issue of concern is the possibility that managers who are overly focused on acquisitions may fail to objectively assess the value of outcome achieved through the use of the firm's acquisition strategy, compared with outcomes that might be achieved by concentrating on using the firm's other strategies more effectively (Hitt, Hoskisson, and Ireland 2001). Acquiring firms need to be aware of all expenses when searching for targets. Firms experience several expenses when trying to create synergy through acquisitions. Synergy is created when the value created by business units working together exceeds the value those same units create working independently. Firms incur significant costs as a result of aacquisition inplementation. Transaction costs are expenses incurred when firms use acquisition strategies to attempt to integrate two firms

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(Williamson 1999). Direct costs include legal fees and charges from investment bankers who compete due diligence for the acquiring firm. Firms also incur indirect costs. Managerial time to evaluate target firms and then to complete negotiations is an example of an indirect cost, as is the loss of key managers and employees following an acquisition. Affecting an acquisition's success is a firm's ability to account for costs that are necessary to create anticipated revenue- and cost-based synergies. Of the two types of costs, firms tend to underestimate the sum of indirect costs and overvalue the synergy that may be created by combining and integrating the target firm with the acquiring firm (Hitt, Hoskisson, and Ireland 2001). Integrating two companies following an acquisition can be difficult. Integration issues include those of melding two disparate corporate cultures, linking different financial and control systems, building effective working relationships (particularly when management styles differ), and resolving problems regarding the status of the newly acquired firm's executives (Devoge and Spreier 1999). One of the primary reasons that firms fail after acquiring another firm concerns the amount of debt the acquiring firm must incur. Large debt loads require substantial interest payments: the funds needed to service debt preclude the firms from using the funds for alternative growth purposes. Firms may have failed after acquisition for any number of the factors discussed. For firms in newly deregulated industries, the acquisitions process was made even more difficult because none of the acquiring firms had made any previous acquisitions. During the regulated period, there were few acquisitions and those were closely monitored by the Interstate Commerce Commission (ICC). Having managerial resources with previous acquisitions experience is important. Without managerial experience, the integration process of merging the target into the acquiring firm's operations becomes very complex even though both were LTL firms. Entering Other Industries

Another response to deregulation was to move into areas outside transportation. A small number of firms (three) felt that they could achieve great profitability and growth by entering industries unrelated to transportation. Number 17 Mason and Dixon, #25 Jones Motor, and #36 Pacific Motor Trucking all left the trucking industry and moved into nontrucking ventures. All three firms went out of business shortly thereafter. There were two primary reasons these firms went out of business. First, the firms ventured into industries in which their managerial resources had no experience. Because this industry had been regulated


91

since 1935, the senior managers had little experience in industries other than trucking. Venturing into industries where the management team has limited or no experience is normally not beneficial. Such was the case with these firms. Second, the firms' existing trucking customers began to switch to carriers that could provide an increased scale of coverage, and the firms did not try to further develop their original trucking business. Because they were losing customers in their core business (trucking) and attempting to enter industries in which they had no experience or existing customers, they went bankrupt quickly. The lesson learned here is that if you are going to enter new industries, make certain that your firm acquires the necessary managerial resources with experience in these industries. Internal Development

Other types of actions that firms took in the deregulated environment led to them going out of business. The actions of these firms can be classified into two general internal development decisions: (1) firms not expanding U.S. domestic operations but instead choosing to expand into international markets, and (2) firms attempting to internally develop their operations rather than growing by acquisition. First, some firms decided not to fully expand their existing U.S. market coverage but chose to enter international markets instead. The rationale for this decision was that their existing customers had international service needs in addition to U.S. domestic needs. However, establishing operations in international markets takes considerable time and money These carriers perceived that by offering international service they would provide a competitive advantage over carriers that did not. These firms overspent in the international markets and lost a considerable amount of money. At the same time, they were losing domestic customers to competitors that provided more comprehensive coverage of the United States. As a result, all these carriers went out of business (Pettus 2002). The lesson learned in this case is twofold. First, fully develop your domestic infrastructure before attempting to establish international operations. By fully developing your domestic infrastructure, you can establish a scale advantage over firms that do not. You provide your customer base with complete point-of-origin to point-of-destination service. Recall that this complete coverage is a key success factor in a deregulated environment. The group of carriers that went out of business began to offer international service to many international markets. This action may link to Wernerfelt's (1984,176) position that for

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single business firms, "although the general idea is to expand your position in a single resource, it is not always optimal to go full force in several markets simultaneously even with experience curve effects. Quite often it is better to develop the resource in one market." You must be very careful when establishing international operations. You will be competing against established competitors that have significant market presence. Normally it is best to develop international markets sequentially rather than going full force into many international markets. It may be the case that firms that directly entered international markets became good acquisition candidates because they had developed an existing international customer base. Second, a modest number of firms attempted to grow by internally developing their U.S. market coverage. They began to establish operations in ICC regions that they had been prevented from servicing during the regulated period. All these firms were acquired by other trucking firms that chose to expand their U.S. market positions through acquisitions as opposed to internally developing those markets. Internal development may take too long in a newly deregulated environment. The Demise of Consolidated Freightways

Consolidated Freightways was the second largest trucking firm in 1979; its demise occurred in 2002. Consolidated Freightways had been spun off by its parent, CNF, in December 1996 (CNF Annual Report 1996). Consolidated Freightways was primarily an LTL trucking firm: 93 percent of its revenues were LTL shipments (CNF Annual Report 2001). The remaining 7 percent of revenues were predominately logistics services (CNF Annual Report 2001). The reasons that Consolidated Freightways was spun off from the rest of the company will be discussed now. First, Consolidated Freightways was a unionized, national, long-haul LTL carrier. During the spring of 1994 there was an LTL strike that convinced the board of directors that Consolidated Freightways "was headed in a different direction than the rest of the company" (Durr and Cantelon 1999, 444). The board felt that long-haul trucking had little growth potential and that Consolidated Freightways trucking was bringing the price of CNF's stock down at least $10 per share (Durr and Cantelon 1999). A second reason was related to the customer base. Shippers expected long-haul carriers to handle more short-haul, time-sensitive freight in the 1990s. This brought Consolidated Freightways in direct competition with its own nonunion regional carriers, Con-Way Transportation (Durr and Cantelon 1999). The CF board felt that this redundancy was confusing to customers who sought a one-stop carrier for long-haul


93

and regional shipping. Con-Way Transportation was a leader among regional LTL carriers and one of the most profitable (Durr and Cantelon 1999). By spinning off Consolidated Freightways as a separate company, CNF could invest more money in Con-Way regionals to meet the shippers' needs for just-in-time shipping, faster delivery times, and smaller-sized shipments. Investors felt that the winners in the transportation industry in the 1990s would be broad-based carriers that had nonunion regional trucking, air freight, and logistics (Durr and Cantelon 1999). The board of directors felt that Con-Way Transportation was better suited to meet these emerging customer needs. By 1997, the Con-Way network could offer coast-to-coast service in three days: one day faster than the long-haul carriers (Durr and Cantelon 1999). This nonunion network provided superior service at lower costs than the long-haul, unionized carrier Consolidated Freightways. Because Consolidated Freightways was now an independent firm, it did not have access to the related businesses of CNF Transportation (Menlo Logistics, Emery Worldwide, Vector SCM, and the short-haul Con-Way Network). The trouble for Consolidated Freightways began in 2000. It lost money in the fourth quarter of 2000 and began to lose some of its retail business because of price competition in 2000 (CNF Annual Report 2000). During 2001, Consolidated Freightways continued to lose business from a price perspective and began to incur substantial costs with its Mexican operation, CF Mexico. CF spent $17 million to build its Mexican infrastructure and completed a 51,000 square foot terminal on the U.S.-Mexican border (CNF Annual Report 2001). This expense began to cause cash flow problems. In April 2001 wages and benefits increased, which caused further problems on margins. To attempt to compensate for these increases in wages, the company instituted a 5 percent price increase. As mentioned in Chapter 2, when a firm is unprofitable it is not wise to implement price increases in an attempt to compensate. To complicate matters, the September 11 tragedy further reduced tonnage and Consolidated Freightways began to incur major losses (CNF Annual Report 2001). To compensate, CF cut 6 percent of its hourly workforce and 10 percent of its management. Again with reference to Chapter 2, when confronted with this state of affairs across-the-board cuts normally do not work. They did not work in this case either. During the first quarter of 2002, CF was able to obtain $45 million in real estate-backed loans. During mid-2002, John Brincko was hired to attempt to return the firm to profitability Brincko had extensive experience in turning around companies plagued with financial woes through aggressive restructuring. He began to explore all manners of financing to keep the company from going out of business. Unfortu-

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nately, none of these avenues resulted in any additional financing for the firm. Thus, on September 4,2002, CF closed its doors and went out of business (Wall Street Journal 2002). Unions and the Deregulated Trucking Industry Unions play an important role in the development of this industry. During the 1980s, the Teamsters Union allowed major changes in work practices, such as flexible starting times and flexible workweeks. Many contracts also froze wages and diverted automatic cost-of-living adjustment wage increases to benefit plans (Belzer 2000). The competitive environment brought about by deregulation had a significant impact upon the cost structure of the trucking industry. Transportation economists had argued that the competitive market would drive every transportation producer to offer a large proportion of service at prices that covered average variable costs but did not cover average total costs (Locklin 1972). This became a special problem in the trucking industry As a declining base of motor carriers were expected to pay fully allocated costs, the carriers generated insufficient revenue to maintain a healthy return on equity (ROE). In fact, ROE has declined because income from continuing operations after taxes has declined in terms of real dollars since regulatory reform. Chronic bouts of low rates, excess capacity, and poor returns have plagued motor carriers since deregulation. As a result of these events, the growth of nonunion carriers reduced the union membership considerably (Belzer 2000). American Freightways, the Con-Way family of CNF, and Old Dominion (formerly a southern regional carrier) are all examples of nonunion LTL carriers that have grown significantly in the deregulated environment (Belzer 2002). For large companies that specialize in LTL freight, the union has retained considerable bargaining power. The relatively high union density within the LTL sector of general freight enables the Teamsters to continue to try to keep wages up. These higher wages enable carriers to maintain the skilled and reliable workforce needed to provide the level of service demanded by their customers. The firms' commitment to the employees remains high: Large LTL firms do not usually risk confrontation to reduce unit labor costs (Belzer 2000). But the development of a large nonunion truckload industry, along with the growth of the specialized trucking and logistics industries, has diluted the Teamsters' strength. Bargaining has become much more difficult in trucking. The National Labor Relations Act allows collective bargaining at individual worksites. This means that a unionized carrier can legally open up a new nonunion terminal as long as it does not violate a contract, or as long as the union allows it, or if the company has the leverage to do so. This strategy worked quite well as the


95

decentralized Teamsters, beset with regional rivalries, were unable or unwilling to challenge such carriers (Belzer 2000). This issue is especially true in the TL segment of the industry. The relative low value of TL freight encouraged carriers to establish low-wage, special commodity divisions to haul TL freight, or it caused them to reconstitute themselves as low-wage (union or nonunion) TL carriers (Belzer 2000). The surging growth of nonunion LTL carriers and TL carriers is reducing the impact of unions in the deregulated trucking industry. Although TL carriers may have had a more favorable labor climate, many of them went out of business after the industry was deregulated. FAILED RESPONSES TO DEREGULATION BY TL CARRIERS

Four of the largest TL carriers in 1979 went out of business after deregulation. These firms were #33 C & H Transportation, #38 Midwest Emery, #39 Refrigerated Transport, and #56 Ligon Specialized Haulers. They chose not to increase their scale of operations and continued to operate as they had during the regulated period. The TL carriers that did not expand their operations as a result of deregulation encountered some of the same problems experienced by the LTL carriers that did not develop their resource base. Eight of thirteen TL firms that were in business at the time of deregulation are still in business: #28 Schneider, #58 Frozen Food Express, #59 National Freight, #65 J.B. Hunt, #66 Swift Transportation, #67 Werner Enterprises, #70 Heartland, and the logistics business of #4 Ryder. The expansion of these successful TL carriers is discussed in Chapter 6. LESSONS LEARNED

A number of lessons can be learned through the examination of failing strategies. These lessons are not necessarily specific to the trucking industry; indeed, they may be applicable to a large number of industries. 1. When confronted with environmental change, your firm must adapt to the new environment. Doing business as it has been done in the past will likely lead to failure. In addition, your firm must adapt in the same direction as the change. Because deregulation eliminated restrictions in terms of market coverage, the only firms that grew were those that developed an infrastructure to increase their scale of operating coverage. 2. Enter new industries with caution. If your firm cannot utilize its existing resource base, it is not a wise decision to move into the industry. In all cases, retain the existing senior management team of the target. The nature of competition, customers, and industry structure are all different in the unrelated industry. Thus, it is important to maintain the managerial knowledge base of the acquired firm. Unrelated

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acquisitions take a great deal of managerial time; do not utilize this time at the expense of your existing business and customer base. 3. Do not enter international markets until you have fully developed your domestic market. Because international markets are an excellent source of growth, make certain to enter these markets from a position of strength. International markets require additional resources; make certain you have extracted the m a x i m u m growth potential from your existing domestic resources first. For example, lean manufacturing w a s fully developed in Japan before it was implemented in the United States and Europe. Also, enter international markets sequentially. Do not try to go full force into several international markets simultaneously. Your senior management team will become overextended. 4. The spiral d o w n syndrome that was discussed in Chapter 2 is very relevant to the demise of Consolidated Freightways. When confronted with unprofitable operations do not institute across-the-board cost cuts or raise prices. If you do, your firm may go out of business as Consolidated Freightways did. The key to resolving an unprofitable operation is to understand w h y the losses exist. This will entail a critical analysis of key success factors and your firm's relative position on these factors (see Chapter 2). 5. Remember that the growth process may require a sequencing of decisions. In all cases, firms that only attempted to increase operating coverage by internally developing LTL operations went bankrupt. In addition, firms that acquired other LTL carriers as their only response to deregulation, with the exception of Arkansas Best Corporation and Yellow, all went bankrupt. Firms that were successful and grew within the LTL trucking industry developed a sequencing of decisions that led to their growth within the industry In the next chapter, w e focus on those decisions that lead to long-term growth. "Well, so much for m y idea of acquisitions," stated the CEO. "Acquisitions may generate growth but w e are interested in profitable growth," I replied; "by entering unrelated industries, it may be more difficult to utilize the existing resources of the firm." "It seems to me that the international markets would be an excellent source of growth," the CEO said. "That's possible," I answered. "Let's examine those firms that have been successful with growth in this industry." REFERENCES

Bardi, E., P. Bagchi, and T. Raghunathan. 1989. "Motor Carrier Selection in a Deregulated Environment/' Transportation Journal (Fall): 1-11. Belzer, M. 2000. Sweatshops on Wheels. London: Oxford University Press. CNF Annual Report. 1996,2000, 2001. Palo Alto, CA. Commercial Carrier Journal. 1979,1980, 2000, 2002. Tuscaloosa, AL: Randall Publications.


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Devoge, S., and S. Spreier. 1999. "The Soft Realities of Mergers." Across the Board (December): 27-32. Durr, K., and P. Cantelon. 1999. Never Stand Still: A History of CNF Transportation Jnc. Rockville, MD: Montrove Press. Farabhod, K., and L. Logan. 1991. "A Conjoint Analysis Approach to Service in the Motor Carrier Industry." Logistics and Transportation Review 24: 185-196. Ginsberg, A. 1988. "Measuring and Modeling Changes in Strategy: Theoretical Foundations and Empirical Directions." Strategic Management Journal 9: 559-575. Hambrick, D. 1981. "Specialization of Environmental Scanning Activities among Upper Level Executives." Journal of Management Studies 18: 299320. Hamel, G., and C. K. Prahalad. 1994. Competing for the Future. Cambridge, MA: Harvard University Press. Harper, D., and J. Johnson. 1987. "The Potential Consequences of Deregulation of Transportation Revisited." Land Economics 62:140-141. Hitt, M., J. Hoskisson, and R. Ireland. 2001. Creating Value through Mergers and Acquisitions: A Complete Guide to Successful M&A. Mason, Ohio: Southwestern. Hoskisson, R., M. Hitt, and R. Ireland. 1994. "The Effects of Acquisitions and Restructuring (Strategic Refocusing) Strategies on Innovation." In 1st ed., Managing Corporate Acquisitions, 144-169. Mason, Ohio: Southwestern. Locklin, D. 1972. Economies of Transportation. Boston, MA: Irwin. Mergers and Acquisitions Journal. Vols. 16,18,19, 22, 24, 25, 27, 30. New York: Thompson Financial. Morais, R. 2000. Takeover Bait. Boston, MA: Irwin. Pettus, M. 2001. "The Resource-Based View of a Developmental Growth Process: Evidence from the Deregulated Trucking Industry." Academy of Management Journal 44: 878-896. . 2002. "Acquisitions Strategy within a Deregulated Environment: The Case of the U.S. Trucking Industry." SAM Advanced Management Journal 67:42-47. Rakowski, J. 2000. "The Changing Face of U.S. Transportation: The Motor Carrier Industry." Journal of Transportation Law, Logistics, and Policy (Winter): 47-62. Wall Street Journal. 2002. 4 September. Wall Street Journal. 2003. 9 July. Wernerfelt, B. 1984. "A Resource-Based View of the Firm." Strategic Management Journal 5: 171-180. Williamson, O. E. 1999. "Strategy Research: Governance and Competence Perspectives." Strategic Management Journal 20:1087-1108.


6 Trucking Deregulation: Patterns of Growth This chapter focuses upon firms that grew in the period following deregulation. As discussed in Chapter 5, many firms did not survive in the deregulated trucking industry The larger LTL (less-than-truckload) firms that survived deregulation were #2 CNF Transportation (the holding company of Consolidated Freightways), #3 Yellow, #13 Arkansas Best Freight System, and #49 Watkins Motor Lines (see Chapter 5, Table 5.1). Several smaller LTL carriers grew significantly during the deregulated period. All other LTL firms were acquired, went out of business, or left the industry. Much of the growth in the deregulated trucking industry was in the TL (truckload) segment. The TL carriers were very small firms during the regulated period. As a result of deregulation, they grew significantly. As noted in Chapter 5, the firms that grew in the deregulated industry made a series of moves to take advantage of the new environment. EVOLUTION OF THE DEREGULATED TRUCKING INDUSTRY

The number of licensed trucking companies doubled in the first few years after deregulation; just as quickly, a majority of the new entrants fell into financial ruin (Belzer 2000). The rising number of bankruptcies created more than $41 billion in extra business for those that survived (Belzer 2000). The firms that were successful with growth learned from the airlines that an integrated hub-and-spoke operating system not only provided for national service from any origin point to any destination point, but that this network also provided for more rapid

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transit times and total control of packages from point of origin to point of destination. Due to the point-to-point benefits of this network, those firms that established a national infrastructure held a competitive advantage over those that did not. As discussed in Chapter 5, this was one reason why many firms began to acquire other trucking firms during a very short period after deregulation. Acquisition is a much quicker mode of growth than internal development. Also, acquisitions that are within the same Standard Industrial Classification (SIC) group (e.g., trucking) tend to have fewer implementation problems than other types of acquisitions. Once the domestic infrastructure was in place, carriers began to develop international infrastructure networks. Carriers were able to utilize the benefits of the North American Free Trade Agreement (NAFTA) and the development of the European Union to establish international networks. Providing international service to domestic U.S. customers created a scale advantage for those carriers providing the service. Because existing trucks were picking up domestic freight from shippers each day, the addition of international shipments provided a scale advantage because trucks could be more fully filled with freight. Customers perceived that those carriers that offered international service provided value-added capabilities over competitors. An additional benefit was that large multinational firms were able to both ship and receive international shipments. Thus, the scale of advantage for these trucking firms grew even greater as the inbound international shipments were delivered within the same national infrastructure. As carriers began to work more closely with the shippers, the carriers began to realize that shippers had not only trucking shipments but also air freight, rail, and vessel shipments. To service these additional customer needs, the successful carriers made a decision to expand the nature of their business. Shippers were demanding that carriers grow to become full-service transportation carriers as opposed to just trucking firms. In order to service shippers as full-service transportation carriers, trucking firms engaged in a number of related acquisition decisions. Firms that grew began to acquire air freight, small package, rail, and vessel firms. These firms fully leveraged the national hub-and-spoke operating system by offering the customer base a full range of shipping mode options. These acquisitions benefited trucking firms in several ways. First, the additional package volume that was generated by other modes provided the full-service transportation firms a scope advantage over other trucking firms. Second, shippers began to utilize these carriers not only for domestic but also for international shipping requirements. In addition to international trucking shipments, shippers

Trucking Deregulation: Patterns of Growth

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needed international service for air freight, small package, rail, and vessel shipments. Carriers that offered multiple modes of transportation provided shippers with options. These firms began to expand and upgrade their international network to provide for air freight, small package, rail, and vessel shipments. The successful carriers in this industry grew with their customer base. As these shippers became multinational firms, carriers began to build national and international networks that could be utilized for all modes of shipping. By becoming truly full-service, multi-modal, international transportation carriers, these firms developed a distinct competitive advantage over shippers that did not offer such a complete range of shipping options. Some firms were successful with growth by acquisition. The firms that grew by related acquisitions were very successful at incorporating the senior management team of the acquired firms into their business operations. The successful firms focused upon a period of internal development after the related acquisitions to fully integrate the networks of the target and acquiring firms. One reason is because the target's senior management team needed to be trained in the acquiring firm's business. Academic scholars refer to this period of internal development as the Penrose Effect. Simply put, the trucking senior manager had to train the acquired management team in the mechanics of the trucking business. On a parallel note, the acquired senior managers needed to train trucking senior managers on the air freight, rail, small package, and vessels modes of transportation. The nature of competition is different in these related industry segments. Each transportation mode has different industry characteristics from the trucking segment. As such, it was important for the acquiring senior managers to learn from the acquired senior managers and vice versa. Thus, the Penrose Effect is both an accelerator and a brake for the growth process (Starbuck 1965). When making acquisitions of a related nature, it is important to maintain the senior management team of the acquired firm. If this does not occur, reciprocal learning cannot take place. After the full-service transportation carriers had evolved, the nature of the transportation industry changed from a technology perspective. The technology revolution directly affected the transportation industry As shippers became more sophisticated, they began to require technology capabilities. Initially, shippers began to require value-added features such as package tracking and EDI (electronic data interchange) (Millen 1992). The carriers that grew began to acquire firms that had developed these capabilities for other firms. The transportation carriers realized that once these capabilities had been acquired, they would have a

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competitive advantage over carriers that did not develop these capabilities. Next, the trucking firms began to acquire additional new capabilities so as to grow in the direction that their customer base dictated. Logistics began to emerge as an area of growth for shippers. There are several reasons logistics generated growth. An efficient and economical logistics system is similar to a tangible asset on a corporation's books. It cannot be readily duplicated by the firm's competitors. If a company can provide its customers with products quickly and at low cost, it can gain market share advantages over its competitors (Lambert and Stock 2001). The firm may be able to sell its product at a lower cost as a result of logistics efficiencies, or provide a higher level of customer service, thereby creating goodwill. Although firms may not identify this "asset" on their balance sheets, it theoretically could be shown as an intangible asset, a category that includes such items as patents, copyrights, and trademarks (Lambert and Stock 2001). To obtain this new capability, the transportation firms began to acquire logistics firms. Technological and logistics-based systems were required by both international and domestic shippers. As such, carriers began to integrate these new capabilities into their international networks. As technology made communication between shipper and carrier easier, carriers that offered these capabilities were perceived as providing value-added services as opposed to those that did not. A central principle why these firms were able to grow in a deregulated environment was that they were able to modify and enhance their resources and capabilities to meet the evolutionary needs of the customer base (Pettus 2001). The biggest winners were the TL carriers and the smaller LTL carriers in 1979. The TL carriers will be discussed first. TL (TRUCKLOAD) CARRIERS The TL carriers of the industry grew significantly in the deregulated period. An analysis of the TL segment before and after deregulation shows some interesting findings. Table 6.1 identifies TL carriers by pattern of growth. The table shows two distinct trends for the TL carriers. First, many firms that were larger-scale TL revenue players in 1979 (#33 C and H Transportation, #38 Midwest Emery, #39 Refrigerated Transport, #56 Ligon Specialized Haulers) went out of business. Second, many TL firms that were small players in 1979 grew to become large-scale players in the trucking industry in 2002. This group of firms that followed Pattern 1 consists of J.B. Hunt, Swift Transportation, and Werner Enterprises. These carriers and Heartland Express experienced the highest growth rate of all TL carriers (see Table 6.1).

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Trucking Deregulation: Patterns of Growth Table 6.1 TL Carriers, 1979 and 2001 Rank 2001

Pattern

Firm Growth Index1

Pattern Growth Index2

#33 C & H Transportation

*

N.A.

N.A.

N.A.

#38 Midwest Emery

*

N.A.

N.A.

N.A.

*

N.A.

N.A.

N.A.

*

N.A.

N.A.

N.A.

Acquired

N.A.

N.A.

N.A.

#65 J.B. Hunt

5

1

81.30

#66 Swift Transportation

10

1

59.69

#67 Werner Enterprises

11

1

72.09

#28 Schneider Transportation

4

2

15.88

#58 FFE

49

2

3.04

#9 Ryder

4

3

1.86

1.86

#70 Heartland Express

45

4

73.56

73.56

#59 National Freight

40

5

5.28

5.28

Carrier

#39 Refrigerated Transport #56 Ligon Specialized Haulers #43 Schwerman Trucking

72.3

12.64

*Out of business N.A. = Not Applicable ^Revenue 2001-Revenue 1979)/Revenue 1979. 2

S(Revenue 2001-Revenue 1979)/SRevenue 1979.

.B. Hunt J.B. Hunt was ranked #65 in 1979; in 2001, it was the fifth largest trucking firm and one of the largest revenue-based truckload carriers in the United States (Gallman 1996). In the early 1980s, J.B. Hunt expanded its network through internal development. To provide for nationwide coverage, J.B. Hunt made a number of small acquisitions of

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Growth from Chaos

carriers that were going out of business. In an attempt to attract more drivers, J.B. Hunt opened a driving school in 1988 (Gallman 1996). In 1990, J.B. Hunt added a flatbed division to its services (Gallman 1996). In 1992, it began installing on-board laptop computers in its trucks to improve communications between drivers and dispatchers (J.B. Hunt Annual Report 1992). The company formally began offering logistics transportation services in 1992 through a wholly owned subsidiary, J.B. Hunt Logistics (JBL). JBL service provided shippers the option to outsource a substantial portion of their entire distribution and transportation process to JBL (J.B. Hunt Annual Report 1992). J.B. Hunt was one of the first carriers to offer intermodal service. It expanded its intermodal alliances during the early 1990s to include Burlington Northern Santa Fe, Norfolk Railway, CSX, and Tex-Mex (J.B. Hunt Annual Report 2001). These alliances enabled the company to service the entire forty-eight states, Mexico, and Canada from a rail, trucking, and intermodal perspective. In 1992, an alliance with Transportation Maritima Mexicana, Mexico's largest maritime steamship company, gave J.B. Hunt a position in the ocean shipping market (Gallman 1996). In 1993, J.B. Hunt made an acquisition to offer dedicated contract carriage as a service option. This segment of operations specializes in the design, development, and execution of supply chain solutions (J.B. Hunt Annual Report 1993). Capitalizing on advanced systems and technologies, this service offers engineered transportation solutions that support private fleet conversion, dedicated fleet creation, and transportation system augmentation (J.B. Hunt Annual Report 1992). Effective July 1, 2000, the company started Transplace.com (TPC). TPC is an Internet-based global transportation logistics company (J.B. Hunt Annual Report 2000). TPC commenced operations in July 2000 and initially included substantially all of the logistics business of the following carriers: Covenant Transport, Swift Transportation Co., U.S. Xpress Enterprises, and Werner Enterprises (J.B. Hunt Annual Report 2000). Swift Transportation

Swift Transportation was the sixty-sixth ranked carrier in 1979; it was the tenth largest trucking company in 2001. In the 1980s, Swift Transportation's established niche was the short- and medium-haul trucking market (Woodward 2002). During the mid-1980s, Swift internally developed to service most of the southwestern United States. To further develop its coverage, Swift engaged in a number of acquisitions in the late 1980s and early 1990s. These acquisitions provided the company with total U.S. geographic coverage.


105

In 1990, Swift developed a computerized on-board tracking system to provide for real-time shipment tracking (Swift Annual Report 1990). The next year, Swift introduced logistics service for its customers (Swift Annual Report 1991). During the early 1990s, Swift entered the intermodal segment by developing alliances with several rail carriers (Woodward 2002). These alliances permitted Swift access to Canadian and Mexican markets. Swift acquired M.S. Carriers for $383 million in 2000 (Swift Annual Report 2001). M.S. Carriers owned 50 percent of the Mexican carrier Transports EASO. In 2000, Swift purchased 49 percent of the trailer/ truck carrier, Trans-Mex Inc. S.A. de C.V. This carrier focused on shipments to and from Mexico (Swift Annual Report 2000). The company plans to acquire the remainder of the firm by the year 2004, when U.S. laws restricting ownership of Mexican companies will change (Woodward 2002). The services of Trans-Mex and Transports EASO are complementary because Transports EASO is the largest domestic truckload traffic transporter in Mexico, whereas Trans-Mex is primarily involved in international freight movement (Swift Annual Report 2001). By combining Swift's Canadian and Mexican operations with the operations of M.S. Swift carriers, Swift provides total North American service coverage (Swift Annual Report 2001). In April 2000, Swift joined with five other truckload carriers to start Transplace.com, an Internet-based transportation logistics company The company contributed its transportation logistics assets to Transplace.com upon its formation. Its equity interest in Transplace.com is approximately 15 percent. In December 2001, BNSF (Burlington Northern Santa Fe) and Swift Transportation joined forces to offer intermodal services for domestic and international shipments (Swift Annual Report 2001). Werner Enterprises will be discussed next. Werner Enterprises Werner Enterprises was the sixty-seventh ranked carrier in 1979 but ranked #11 in 2001. During the early 1980s, Werner expanded from a regional carrier to provide nationwide truckload service (Knight 1999). In 1992, Werner Enterprises greatly broadened its service offerings by acquiring firms in the temperature-controlled, regional short-haul, and dedicated-fleet segments of the trucking industry (Werner Annual Report 1992). By 1993, the company's trucks had on-board computers that connected truckers to headquarters via satellite. This provided both the trucker and the home office with real-time information (Knight 1999). Werner also created a division to offer logistical services to its customer base.

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Growth from Chaos

By 1993, Werner Enterprises had moved into intermodal transportation by establishing strategic alliances with several rail carriers (Werner Annual Report 1993). These intermodal alliances provided Werner with service to Canada and Mexico. In April 1997, it acquired Hub Group, the largest intermodal marketing company in the United States, to market services to both firms' customer bases. In 2000, Werner became a partner in the Transplace.com alliance (Werner Annual Report 2000). Schneider Transportation and Frozen Food Express (FFE) followed a different expansion patttern (#2 on Table 6.1). Frozen Food Express

Frozen Food Express was the fifty-eighth-ranked revenue carrier in 1979; in 2001, it was ranked #49. From the beginning the company was a specialist in transporting products requiring refrigeration (Halasz 1998). Because refrigeration tractor-trailers, or "reefers," cost nearly three times as much as regular trailers and consume more fuel, big trucking companies were willing to leave this niche market to smaller carriers (Halasz 1998). In the early 1980s, FFE grew by internal development. In 1982, the company began to transport nonperishable cargo (FFE Annual Report 1982). Between 1983 and 1986, FFE acquired the operations of four regional LTL companies, which permitted the firm to provide service to all forty-eight contiguous states (Halasz 1998). In 1988, FFE acquired the assets of Lisa Motor Lines, Inc., of Fort Worth, Texas, for $4.6 million (FFE Annual Report 1988). FFE began full-truckload, refrigerated services to and from Mexico in 1990 (FFE Annual Report 1990). In 1992, the company purchased the LTL division of Temperature Controlled Carriage Inc., a refrigerated-truck company based in Nashville, Tennessee (FFE Annual Report 1992). In 1994, FFE introduced satellite tracking (FFE Annual Report 1994). In 1995, it formed Alliance Shippers, an intermodal strategic alliance for temperature-sensitive shipments among the United States, Mexico, and Canada (FFE Annual Report 1994). In 1999, Frozen Food Express Industries Inc. announced it had acquired the operating assets of Nordic Trucking Inc., a regional LTL refrigerated carrier primarily serving the Midwest and West Coast areas of the United States (Halasz 1998). Schneider Transportation will be discussed next. Schneider Transportation

Schneider Transportation improved its revenue position from #28 in 1979 to #4 in 2001. In 1981, Schneider was granted the authority by


107

the ICC to operate in the forty-eight states (Schneider Annual Report 1981). Schneider began a period of extensive internal development to achieve national coverage. It then began to acquire firms such as International Transport Inc. in 1984 to complete its national network. Deregulation enabled the company to hire nonunion drivers (Schneider Annual Report 1984). In 1979, all 1,500 drivers belonged to the Teamsters union. As the company grew, the percentage of unionized drivers became smaller. By the early 1990s, only 500 Teamsters were left, out of a crew of roughly 10,000 drivers (Woodward 2001). In 1984, Schneider acquired International Transport Inc., the largest flatbed carrier (Schneider Annual Report 1984). In 1986, Schneider was the first carrier to install satellite communications in its trucks; the same year, Schneider implemented EDI (Schneider Annual Report 1986). Schneider pioneered the use of satellite technology in trucking (Woodward 2001). The company made a large investment in computer and satellite technology in 1988 to provide real-time communication with drivers (Schneider Annual Report 1998). It spent an estimated $50 million initially and installed a satellite dish and communication console on every truck it owned (Woodward 2001). In 1989, Schneider National Canada was formed to provide service to Canada (Schneider Annual Report 1989). In 1992, Schneider formed Schneider Logistics. In Mexico, Schneider National utilized Schneider trailers for international transportation between Mexico and the United States and Canada. Now covering most of the Mexican Republic, Schneider National Mexico began service in 1991 (Schneider Annual Report 1991). In the early 1990s, Schneider also began investing in equipment in truck trailers (intermodal) that could be used on railways. Schneider entered the intermodal transport industry in 1991, working with Southern Pacific Railway to serve routes between the Midwest and southern California (Schneider Annual Report 1991). Schneider believed that by combining modes the company could generate more efficient routes, which would reduce variable costs. By 1992, Schneider had worked out intermodal shipping agreements with several more railroads (Union Pacific, Norfolk Southern, BNSF, and CSX), giving it access to most major markets in the United States, Canada, and Mexico (Woodward 2001). During 1998, Schneider made several trucking acquisitions: Highway Carrier Corporation, Builders Transport, and Landstar Poole (Schneider Annual Report 1998). In June 1999, the company launched a new subsidiary, Schneider Brokerage, that handled a Web-based service. By the year 2000, Schneider's logistics subsidiary had grown so rapidly and profitably that the parent decided to spin it off to the public. Schneider wanted cash to help pay for more technological development at Schneider Logistics and to enable the subsidiary to expand

108

Growth from Chaos

into international markets (Woodward 2001). The two smaller TL players, Heartland Express and National Freight, followed a different expansion path (Patterns 4 and 5 in Table 6.1). Heartland and National, both privately held, survived in the deregulated period and are rather small revenue-based firms when compared to the other TL firms. Heartland grew primarily through domestic acquisitions and National grew primarily through internal development into unrelated transportation industries. Heartland Express will be discussed next. Heartland Express

Heartland Express was the seventieth-ranked carrier in 1979; in 2001, Heartland was the forty-fifth-ranked carrier. Heartland started out as a regional truckload carrier based in Iowa (Cohen 1997). By 1986, it had doubled its revenues to nearly $22 million. Also in 1986, Heartland became a public company (Heartland Annual Report 1986). In 1989, Heartland continued its expansion, purchasing the assets of PDQ Transportation Inc., a Tennessee-based trucking line. This move enabled Heartland to extend its trucking services beyond the Midwest region into the Southeast (Cohen 1997). In 1994, Heartland acquired Munson Transportation Inc., a trucking company based in Monmouth, Illinois (Cohen 1997). Acquiring Munson's Northeast and West Coast markets expanded Heartland into a national trucking line. In 1997, Heartland acquired A+M Express (Cohen 1997). This acquisition enabled Heartland to increase the density of its national network and thereby reduce costs. In 2001, Heartland began e-business shipments (Heartland.com). National Freight will be discussed next. National Freight

National Freight was the fifty-ninth largest trucking firm in 1979; in 2001, it was ranked #40. National Freight began in 1932 with a single dump truck. A privately held firm that has grown significantly beyond trucking, National Freight has expanded its trucking operations significantly since deregulation—as well as diversifying to become one of America's top-ten warehousing corporations and leading real estate development companies serving the logistics industry (natlfreight.com). The logistics division specializes in dedicated asset management, logistics consulting, and integrated third-party logistics (natlfreight.com). In 2001, National Freight, together with other NFI Industries companies, generated $400 million in logistics services (natlfreight.com).


109

The real estate division provides construction management and consulting services for warehouse, industrial, office, and retail projects (natlfreight.com). Recently, National Freight's contract manufacturing division has been focusing upon customized, engineering-based manufacturing solutions (natlfreight.com). National Freight has internally developed all these divisions. National is the only TL firm from 1979 that has been successful in utilizing internal development to move from trucking to unrelated transportation ventures. Expansion Pattern of High-Growth TL Carriers

TL firms were success stories in the deregulated trucking environment. The expansion pattern of the high-growth TL carriers is illustrated in Figure 6.1. In terms of sequencing of decisions, the TL carriers followed a consistent pattern of incremental growth steps. As Rakowski (2000) points out, the carriers started out as regional players servicing Figure 6.1 Growth Patterns of TL Carriers

110

Growth from Chaos

specific market segments within the United States and internally developed their networks to begin to establish a national infrastructure. During the late 1980s, the TL carriers acquired firms to offer complete U.S. service. These acquisitions permitted the TL carriers to increase the scope of their geographic coverage. TL carriers then began to internally develop logistics capabilities during the early 1990s. These benefits included the development of a totally integrated logistics transportation system that would be specific to the needs of each shipper (Rakowski, Southern, and Jarrell 1993). The TL companies with a focus on logistics have grown rapidly and have been dubbed advanced truckload firms, or ATLFs (Rakowski, Southern, and Jarrell 1993). These TL carriers were sophisticated operators, much larger in size, and utilized their own sales forces. Although pricing is not irrelevant for these firms, they tend to emphasize service and dependability; rates often are a secondary consideration. This type of carrier is an unexpected result of deregulation (Rakowski, Southern, and Jarrell 1993). Nevertheless, they fill an important niche in the nation's logistics system (Rakowski, Southern, and Jarrell 1993). Once these carriers fully developed their operational infrastructure (mid-1990s), they began to develop an informational infrastructure. Carriers internally developed satellite technology in an attempt to differentiate themselves from other carriers. Each vehicle was installed with a computer that permitted instantaneous access to dispatchers and provided real-time information with respect to customers, pick ups, and deliveries. After the development of these services, the TL carriers began to engage in intermodal alliances with rail carriers. This partnering changed the adversarial orientation that had existed between trucking and rail firms to a mutually beneficial relationship that resulted in additional value creation for the final customer (Sparkman 1992). Rail carriers and trucking firms both derived advantages from these alliances. Rail carriers benefited from increased market share. Rail carriers were seeking (1) to recover from the loss of traffic to motor carriers that occurred when the industry was deregulated in 1980, and (2) to gain a larger share of the market providing transportation services for international shippers (Rakowski and Dobie 1996). Without improved levels of service offered by trucking firms, rail carriers would be unable to respond to customer demands for improved transit times (Rakowski and Dobie 1996). Motor carriers also derived benefits from intermodal alliances. The TL carriers benefited from the alliances with rail carriers by lowering costs, increasing market share, and gaining access to international markets (Rakowski and Dobie 1996). TL carriers improved profit


111

margins through cost reductions from the combination of lower handling costs and the substitution of higher variable costs (e.g., fuel and driver wages) by the lower costs of rail (Rakowski and Dobie 1996). Just as important, they were concerned with increasing market share. Motor carriers recognized the increased role being played by the intermodal alternative (Rakowski and Dobie 1996). In an era of increased competition and global markets, intermodal transportation was an area of significant potential growth (Rakowski and Dobie 1996). An additional benefit of the alliances with rail carriers was that it gave the TL carriers access to international markets. The rail carriers had already established positions in international markets through their previous acquisitions of ocean shipping carriers. Intermodal combinations made rail transportation and TL carriers global enterprises by providing trucking firms access to the international customer base of ocean shipping firms. Shipping vessels provided the vehicle for international expansion. At the same time, right-of-way no longer blocked railroads from door-to-door markets. TL carriers facilitated access to points across the country that were not accessible for railroads. Intermodal combinations gave the TL carriers the opportunity to grow into different modes of transportation. To offer the customer a complete range of shipping options, TL carriers engaged in a period of related acquisitions. The additional acquisitions permitted carriers to achieve an increase in economies of scope. Once carriers had fully implemented these acquisitions, the TL carriers began to engage in international strategic alliances. In 2000, the major TL firms developed the Transplace.com strategic alliance. The Transplace alliance of Covenant Transport, J.B. Hunt, Swift, Werner, and U.S. Xpress provides global logistics solutions to shippers. This Internet-based transportation alliance permitted the TL carriers to become global transportation logistics firms. As TL carriers began to realize these benefits, they started to engage in alliances with other major rail carriers. By 2001, most of the TL firms that had survived deregulation had made strategic alliances with most of the remaining large rail carriers. This is a case in which (1) firms utilized alliances to establish an increase in scope of services offered, and (2) carriers gained access to international markets from which they previously had been absent. This growth pattern was followed by J.B. Hunt, Swift, and Werner. Schneider and FFE also followed this pattern, but they did not engage in the transplace.com alliance. Instead, after developing logistics and satellite tracking, FFE formed an intermodal alliance for temperaturecontrolled shipments among the United States, Mexico, and Canada. Schneider made a series of domestic acquisitions to increase its scale of operating coverage. Ryder followed a different expansion path.

112

Growth from Chaos

Ryder In 1979, Ryder was the number 4 revenue-based carrier; in 2001, Ryder was the number 9 revenue-based carrier. Since 1979, Ryder has significantly expanded beyond trucking. In the 1980s, Ryder established a position in aviation leasing. Aviations Sales Co. Inc. and General Hydraulics Corporation, an aircraft leasing firm and spare parts firm, were acquired during the earlier 1980s. In 1985, Ryder bought Aviall, Inc., a turbine engine repair and overhaul firm located in Dallas; Aviall was also a parts distributor. By late 1986, aviation services made up about one-fifth of Ryder System's revenues. In 1987, the division branched out overseas with the purchase of Caledonian Airmotive, Ltd. This Scottish subsidiary serviced the engines on British Caledonian Airways' DC-10 and 747 aircraft. Caledonian Airmotive complemented Aviall's operation both geographically and in services offered (Ryder Annual Report 1987). By 1988, Ryder System was the world's largest jet engine overhaul and rebuilding company, the largest aviation parts distributor, and one of the largest aircraft and jet engine leasing companies (Ryder Annual Report 1988). Ryder's aviation division consisted of 300 commercial airlines as well as dozens of private operators. In 1988, revenues from aviation neared $1 billion. Ryder entered other transportation industries in the 1980s. Between 1983 and 1987, Ryder System spent $1.1 billion on sixtyfive acquisitions. In 1985, it entered the school-bus leasing business and quickly grew to be the second-largest private student transport company in the United States. Ryder also entered into public transportation system consulting and leasing at about the same time. Dedicated contract carriage was an area of growth in the 1980s. Ryder provided trucks, drivers, and management system designs to Emery Air Freight, Montgomery Ward, Sears, J.C. Penny, Dow Jones, and the Miami Herald (Ryder Annual Report 1986). Ryder continued to expand its truck fleet; between 1984 and 1988, it nearly doubled. In 1990, Ryder moved 39 percent of the automobiles shipped in the United States and Canada (Ryder Annual Report 1990). As Ryder System entered the 1990s, its full-service truck leasing, contract carriage, jet turbine aircraft overhaul and maintenance, and new aviation parts-distribution units were performing well. During the 1990s, Ryder disposed of businesses that once accounted for more than 50 percent of its revenue but were cyclical and/or generated less-than-satisfactory returns. Perhaps the most significant action was the 1996 sale of the U.S. consumer truck rental business—the famous Ryder "yellow trucks." The sale of the consumer truck rental business represented a $574 million deal, stripping the company of more than


113

$400 million in annual revenue (Ryder Annual Report 1996). Less than a year later, Ryder sold its automotive carrier business, reaching an agreement with Allied Holdings, Inc., for a $111 million sale price. The revenues of these divested businesses were replaced through the expansion of logistics and transportation management services (Ryder Annual Report 1996). In the early 1990s, Ryder Dedicated Logistics was the company's "growth engine," and Ryder predicted that it would dominate the market for third-party logistics providers (Ryder Annual Report 1993). In 1993, Ryder's integrated logistics division accounted for $300 million in revenue. By 1998, this division accounted for over $1.5 billion in revenue (Ryder Annual Report 1998). By 1999, Ryder Logistics provided about 30 percent of its revenues and represented its fastest-growing segment (Ryder Annual Report 1999). In July 1999, Ryder Public Transportation Services (RPTS) was sold for $940 million (Ryder Annual Report 1999). The RPTS sale continued Ryder's transition from providing transportation services to providing logistics and transportation management solutions. Ryder Integrated Logistics, Inc. provides global integrated logistics support of customers' entire supply chains, from in-bound raw materials supply through finished goods distribution, including dedicated contract carriage, the management of carriers, and inventory deployment. Services include varying combinations of logistics system design, transportation management, vehicle dispatch, inbound and outbound just-in-time service to assembly plants, and factory-to-warehouse-to-retail-facility service. In addition, Ryder Integrated Logistics provides a wide variety of highway transportation services in international markets, including full-service leasing of trucks, tractors, and trailers; commercial truck rental; and contract truck maintenance (Ryder Annual Report 1999). Ryder felt that logistics growth helped develop stronger contractual relationships and alliances with its clients and suppliers. In addition, Ryder felt that logistics helped maintain consistent, profitable growth through economic cycles (Ryder Annual Report 1999). Logistics and supply-chain solutions were the primary drivers of growth for Ryder. The contract logistics services market has expanded by nearly 20 percent annually. Ryder is one of the logistics market leaders in the United States, with established customer bases in automotive, electronics, high technology, telecommunications, aerospace, and consumer packaged goods. Ryder also has logistical operations in Europe, South America, Canada, Mexico, and the Pacific Rim (Ryder Annual Report 2000). In 2000, Ryder formed TTR Logistics, a joint venture with Toyota Tsusho America, Inc., and its Japanese parent company, Toyota Tsusho Corporation. The new entity, with equal participation by Ryder and

114

Growth from Chaos

Toyota, focused on supply chain opportunities related to Toyota and other Japanese automotive industry companies operating in North America. In subsequent phases, the venture extended its services to global transportation management, distribution management, and supply-chain logistics and design (Ryder Annual Report 2000). In 2001, Ryder internally developed its Transportation Management Center (TMC). The TMC consolidates the previously separate service areas of shipment management, carrier management, and freight management. With these capabilities under one roof, Ryder gained efficiency and synergy for more than $2 billion in customer freight orders annually. Ryder maintained contractual relationships with more than 1,500 outside providers of ground, air, ocean, and rail transportation (Ryder Annual Report 2001). Housed within the TMC, the Ryder Logistics Network gives customers the opportunity to post their shipment needs and offer space available on trucks traveling between specific locations. Customers of Ryder's other product lines are now posting shipment needs and available capacity. They save money by placing cargo at attractive rates on the undercapacity routes of other carriers or companies, and they can make money by selling underutilized load capacity to other participants in the system (Ryder Annual Report 2001). In 2001, Ryder acquired Ascent Logistics PTE to increase its logistics presence along the Pacific Rim (Ryder Annual Report 2001). Ryder is the only firm within the industry that has followed this specific expansion path. Such was not the case for a number of smaller LTL firms that followed similar expansion patterns. LTL CARRIERS

Table 6.2 identifies the surviving LTL carriers by pattern. As pointed out by Rakowski (2000), the Big 3 LTL carriers in 1979 (Roadway, Yellow, Consolidated Freightways) have shown only moderate growth and exhibited lower profit margins when compared to other LTL carriers that have grown in the deregulated period. On September 4,2002, the Big 3 was reduced to the Big 2 when Consolidated Freightways went out of business (Wall Street Journal 2002). On July 9, 2003, the Big 2 was reduced to one with the $1.1 billion acquisition of #1 Roadway by #3 Yellow. Yellow said it would pay $966 million, half in cash, half in stock, and assume about $140 million of Roadway debt making the deal worth $1.1 billion (Wall Street Journal 2003). When Consolidated Freightways went out of business in 2002, both Roadway and Yellow benefited. However, because both Yellow and Roadway are unionized, they had difficulty competing from a price perspective with respect to CNF's, Con-Way nonunion operations. Yellow is hoping that the acquisition will provide operating synergies to effectively compete with Con-Way and other nonunion carriers.

Table 6.2 Surviving LTL Carriers by Pattern Carrier Old Dominion Southeastern Freight AAA Cooper Estes Express USF Subsidiaries Holland Reddaway Redstar Dugan Bestway Roadway Express** Consolidated Freightways (CNF)* Yellow Freight** Arkansas Best Freight Watkins

Pattern

1 1 1 1

2 2

Firm Growth Index1 7.36 8.21 9.56 18.12

2 2 2 3 4

17.63 61.19 2.66 17.98 49.45 1.40 N.A.

5 6 7

2.06 4.51 8.31

Pattern Growth Index2

10.20

11.08

1.40

N.A. 2.06 4.51 8.31

'(Revenue 2001-Revenue 1979)/Revenue 1979. 2(Revenue 2001-Revenue 1979)/2Revenue 1979. "Consolidated Freight was spun off by its parent (CNF) in 1996 and closed in 2002. CNF's LTL trucking was performed by its Con-Way regional operations which were formed after deregulation. **Roadway was acquired by Yellow in 2003. N.A.—Not Applicable. 2

116

Growth from Chaos

Yellow is the financially stronger of the two because Roadway took on millions of dollars in debt two years ago when it bought Arnold Industries, parent of New Perm Motor Express, an overnight freight carrier. The companies said they do not expect antitrust problems. Although the combined enterprise will control about $6 billion of the nation's estimated $30 billion LTL industry, Yellow will control only about 1 percent of the world's $600 billion transportation market, which includes air freight and package delivery (Wall Street Journal 2003). Profitability may have been constrained by the fact that these firms are all unionized (Belzer 2000). As Rakowski (2000) points out, the "Shining Stars" are the major interregional carriers that have grown since deregulation. This group of firms is identified as Pattern 1 in Table 6.2. Old Dominion, Southeastern Freight, AAA Cooper, and Estes Express followed a similar pattern and were the highest growth pattern of all LTL carriers that survived deregulation (Pattern 1 in Table 6.2). The USF subsidiaries were combined into one firm and will be discussed later. These firms started out as regional players in 1979 and internally grew their networks in the period following deregulation. These firms then engaged in a number of strategic alliances with other LTL carriers to provide service to the continental United States and then made international strategic alliances to provide international service. To meet the more current needs of shippers, all carriers have internally developed shipment tracking for domestic and international shipments. Their growth pattern is illustrated in Figure 6.2. Old Dominion

Old Dominion is based in Thomasville, North Carolina, and internally expanded its service area after deregulation to become a regional carrier servicing the Southeast. By the 1990s, Old Dominion had internally grown to provide service to the southeastern, south central, northeastern, and western United States. Old Dominion then established alliances with other trucking partners to service the remainder of the forty-eight states. To offer complete coverage of North America, Old Dominion formed alliances with Transline in Mexico and Concord in Canada. Old Dominion then internally developed shipment tracking for all shipments. Southeastern Freight also followed a similar growth pattern. Southeastern Freight

Southeastern was founded in Lexington, South Carolina, and internally grew to service the southeastern portion of the United States. The company then entered into a number of strategic alliances to ful-


117

Figure 6.2 Expansion Path of High-Growth LTL Carriers

fill its goal of servicing the entire continental United States. Southeastern entered into strategic alliances with Motor Cargo to service California and the southwestern United States (Rakowski 2000). Southeastern also entered in alliances with Dayton Freight to service the Midwest, Central Freight to service the Southwest, Oak Harbor Freight to service the Pacific Northwest, and Wichita Southeast Kansas Transit to service the central United States (sefl.com). More recently, Southeastern has entered into an alliance with Quick X Transportation to service the Canadian market (Rakowski 2000). After forming these alliances, Southeastern developed shipment tracking for all packages. AAA Cooper Transportation also followed a similar growth pattern. AAA Cooper

AAA Cooper was founded in Dothan, Alabama, and internally grew to service primarily the southeastern states. The company entered into a number of strategic alliances: one with New England Freight which provided coverage to the northeastern United States; one with Vitran Express which provided coverage to the Midwest; one with Condor

118

Growth from Chaos

Freight which provided service to southern California and Arizona, and one with Oak Harbor Freight which provided service to northern California and the Pacific Northwest (Rakowski 2000). These alliances were followed by others with Manitoulin Transport to provide service to Canada, and with Logistica Inmex to provide service to Mexico. An alliance with Tropical provides service to the Caribbean and Central and South America. AAA Cooper then established partnerships with trucking firms in Europe, Asia, Australia, and New Zealand (aaacooper.com). AAA Cooper then internally developed shipment tracking for all packages. Estes Express followed a similar growth pattern. Estes Express

Estes Express was founded in Richmond, Virginia, and internally grew after deregulation to service the southeastern United States. After this internal growth, Estes engaged in a number of alliances to provide coverage to the continental United States. The company entered into a strategic alliance with Allen's Expedited to service the Northeast, with Lakeville Motor Express to service the North Central states, and with G.I. Trucking to service the West Coast (Rakowski 2000). Then Estes entered into an alliance with TST Overland Express to provide service to Canada (estes-express.com). Estes internally developed package tracking for all shipments. USF Subsidiaries (Formerly TNT)

The deregulation of the trucking industry greatly benefited USF. The USF subsidiaries are identified as Pattern 2 in Table 6.2. After deregulation, TNT Freightways Corporation was formed from of a number of regional carriers that were acquired. These acquired carriers formed a network that serviced most of the United States and Canada. Holland Motor Freight became the first member of TNT Freightways in 1984. Thereafter, TNT made the following acquisitions: TNT Best Way in 1985; TNT Red Star in 1987; TNT Dugan, TNT Reddaway, and TNT United in 1989 (Rakowski 2000). All these firms were LTL firms. The TNT subsidiaries divided the United States into six overlapping regions: Best Way covers the Southwest from California to Texas; Dugan serves the central United States from the Dakotas to Texas, the Gulf states, Florida, and the Carolinas; Holland services the Southeast up to the Great Lakes; Reddaway covers the entire West Coast in addition to Alaska and Canada; Red Star services the East Coast, the Carolinas, Georgia, Quebec, and Ontario; United handles the Pacific Northwest and Rocky Mountain states (Salamie 1999). TNT Limited of Australia was the parent of TNT Freightways. (TNT Limited is fully


119

discussed in Chapter 7). In 1991, TNT Limited decided to spin off its U.S. trucking interest. However, TNT Limited maintained a 25 percent share of the U.S. trucking firm. At the time of its Initial Public Offering (IPO), TNT Freightways' LTL trucking units served most of the United States and some of Canada. In addition to the regional trucking operations were TNT Contract Logistics, TNT Distribution Services Inc., and TNT Auto Warehousing (Salamie 1999). TNT Contract Logistics, founded in 1990, provided a wide range of logistics solutions for North American companies needing dedicated transport vehicles as well as warehousing, administrative, inventory management, and customer service functions (Salamie 1999). In 1992, the company also launched Nationwide Logistics Corp. (TNT Annual Report 1992). By 1994, TNT's regional truck lines served 90 percent of the continental United States. Because the Southeast wasn't adequately serviced, the New Jersey-based Red Star Express (which covered the New England and Mid-Atlantic states as well as Ontario and Quebec) announced plans to expand into the Carolinas and Georgia (Salamie 1999). Red Star also partnered with Dugan and Holland for more extensive coverage of the southeastern states (Salamie 1999). In January 1995, the company acquired Coast Consolidators, Inc., a freight-forwarding company based in Los Angeles providing shipments to and from Hawaii (Salamie 1999). Later in the year, TNT opened new transportation routes to Alaska and completed a new agreement to service Puerto Rico (Salamie 1999). In 1996, TNT changed its name to US Freightways (USF). During the mid-1990s, USF developed a number of partnerships in Europe and Asia to provide for air freight, ocean shipping, warehousing, and distribution (Salamie 1999). TNT Limited was very instrumental in developing these partnerships for USF. In 1998, USF acquired Glenn Moore Trucking, a TL carrier (USF Annual Report 1999). Recently, USF formed e-logistics to utilize the Internet and other emerging technologies to provide supply-chain management solutions (USF Annual Report 2001). As illustrated in Table 6.2, the USF subsidiaries have made substantial growth. The growth pattern of USF is illustrated in Figure 6.3. Evolution of the Big 3 LTL Carriers

A study of growth within the deregulated trucking industry would not be complete without a discussion of the evolutionary growth paths of the Big 3 LTL carriers in 1979. Consolidated Freightways (CNF) Inc., Yellow, and Roadway were the largest LTL players during the regulated period; Yellow and Roadway are also the largest players in 2002 in terms of sheer size. How these three firms positioned themselves

Figure 6.3 Growth Pattern of USF Subsidiaries in the Deregulated Period


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during the deregulated period provides insights into the growth process. As discussed earlier, Consolidated Freightways went out of business in September 2002. It had been spun off by its parent, CNF, in 1996. The growth of CNF will be discussed first. CNF The CNF approach to growth in the deregulated trucking industry is a story of extensive internal development within the United States and growth by acquisition in international markets. CNF was one of the first carriers to offer an integrated hub-and-spoke operating system for the transportation of LTL shipments (Gasbarre 1996). By 1983, CNF had completed the process of internally developing its Con-Way network (CNF Annual Report 1983), which consisted of Con-Way Central, Con-Way Southern, Con-Way Southwest, and Con-Way Western. The purpose of the network was to provide for shipment of packages from any origin location to any destination location within the continental United States. In this manner, CNF was able to provide its customer base a fully integrated domestic LTL shipping network (Durr and Cantelon 1999). In 1984, CNF began its acquisition strategy into related transportation segments. During 1984, it acquired Milne and Craighead, an ocean freight forwarder. It also acquired Big 3 Container Freight Corporation, which primarily moves ocean containers between international ports and inland U.S. ports (CNF Annual Report 1984). These ventures into the ocean segment of the industry were in direct response to LTL customers that had a need for such services (Durr and Cantelon 1999). Because these ventures represented related industry acquisitions, CNF retained the senior management team of both firms. After 1984, CNF more fully developed its domestic Con-Way infrastructure to achieve additional economies of scale (Gasbarre 1996). By more fully developing its ocean services, CNF was able to obtain a scope advantage over its competition. In 1989, CNF acquired Emery Worldwide (CNF Annual Report 1989). At that time, approximately two-thirds of Emery's revenue was generated from next-day U.S. air delivery of heavy freight shipments, and approximately one-third of Emery's revenues was generated in international markets (Durr and Cantelon 1999). The primary objective of this acquisition was to provide a comprehensive international service to its customer base and a new service to its existing customer base: guaranteed overnight air shipments. The acquisition itself was not a mistake; but the way in which it was implemented created substantial losses for CNF for many years to come. Most of Emery's senior management team was released, an ac-

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Growth from Chaos

tion that led to substantial losses because the CNF's management team had only limited international experience. In addition, integrating an air freight network with a ground distribution network is not as easy as it may seem. The air freight business is dependent upon a fully integrated air-truck, hub-and-spoke operating system. CNF's decision not to maintain the Emery senior management team to fully integrate the two networks caused CNF major losses for many years. This is an example of how important it is to retain the target's senior management team. In 1990, CNF acquired Menlo Logistics to capitalize upon the growth of the logistics market (CNF Annual Report 1990). The logistics acquisition was not fully developed for several years because the CNF senior management team had to commit substantial time and funds to resolve the problem with the implementation of the Emery Worldwide acquisition (Durr and Cantelon 1999). This points to an important lesson concerning acquisitions: Do not move into new market segments until your firm has fully implemented its related acquisitions. In 1996, Consolidated Freightways changed the holding company name to CNF Transportation and spun off Consolidated Freightways as a separate company (Rakowski 2000). CNF retained Con-Way Transportation Services, Emery Worldwide, and Menlo Logistics (Gasbarre 1996). In 2001, Emery lost all of its Express Mail business from the U.S. Postal Service when the Postal Service signed a contract with FedEx for all Express and Priority Mail shipments. This resulted in approximately $200 million a year of lost revenue to Emery To complicate matters, Emery's fleet was grounded in mid-2001 as part of an interim agreement with the FA A concerning safety issues (Value Fine 2002). The regional trucking business Con-Way also began to lose business because of a weakened economy. During the fourth quarter of 2001, Emery was shut down permanently. In 2002, CNF dramatically changed the structure of its nontrucking operations. Emery (without its fleet of planes), Menlo Logistics, and Vector SCM combined to create Menlo Worldwide. Through the merger, Emery's customers receive total logistics service with information technology expertise, while Menlo gains access to Emery's international network. Vector is a joint venture with GM to operate that manufacturer's distribution. In 2002, Menlo Worldwide expanded logistics centers to Europe, Asia, Latin America, and Australia (CNF Annual Report 2001). Roadway

Initially, Roadway took the same approach to developing the trucking business after deregulation that CNF did. Roadway internally developed its network in the early 1980s to establish a fully integrated


123

national hub-and-spoke operating system for trucking shipments. In 1982, the holding company Roadway Services, Inc., was set up with Roadway as its chief operating subsidiary. In 1984, Roadway Services acquired Spartan Express, Inc.; Nationwide Carriers, Inc.; and Roberts Express, Inc. (Woodward 1999). Spartan Express, Roadway's first acquisition, operated as a short-haul carrier in the South handling shipments with twenty-four and forty-eight-hour service requirements. Nationwide Carriers specialized in irregular route truckload shipments throughout the continental United States. Nationwide hauled dry freight, temperature-controlled freight, and freight requiring flatbed transport. Roberts Express specialized in critical or fragile shipments needing special handling or speedy delivery. Roadway was the first trucking firm to offer tracking of freight shipments (Woodward 1999). This system was developed and implemented once Roadway had established its national network. In 1985, Roadway internally developed and launched Roadway Package Service (RPS) (Roadway Annual Report 1985), a small-package express service designed to compete directly with United Parcel Service (UPS). Roadway had correctly forecasted that on a shipment basis, margins from small packages were much higher than for heavy freight. RPS provided the customer with a viable alternative to UPS with the added benefit of package tracking, a service UPS did not offer until much later. Roadway internally developed this business segment but made a very smart move before even starting with the design of the service: RPS hired a number of UPS middle managers to design and implement the service. This points to another important lesson: If you are planning on internally developing a related industry segment, hire managerial resources that have substantial experience with both the design and the implementation of the related business. This service provided funds for Roadway to engage in its next growth option. In 1988, Roadway acquired Viking Freight, the largest regional carrier in the western United States (Roadway Annual Report 1988). Viking had two operating subsidiaries: Viking Freight System, a regional LTL carrier; and VFS Transportation, an irregular-route truckload carrier (Woodward 1999). During the late 1980s, Roadway internally developed the international market. During this period, Roadway grew operations in Mexico, Europe, the Pacific Rim, and the Middle East (Woodward 1999). The company further developed its international infrastructure during the early 1990s. In March 1990, Roadway's Roberts Express unit launched a European subsidiary, Roberts Express, B.V, headquartered in Maastricht, The Netherlands (Roadway Annual Report 1990). The subsidiary offered Roberts's traditional services in Belgium, France, Luxembourg, The

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Growth from Chaos

Netherlands, and Germany. In 1990, Roadway Express set up a Mexican subsidiary, Roadway Bodegas y Consolidacion, and expanded operations in Canada (Woodward 1999). In 1991, Roadway began offering services to twenty countries in Europe (Roadway Annual Report 1991). It developed services to the Middle East in 1993 (Roadway Annual Report 1993). It also extended its reach to twenty-four ports in the Pacific Rim. Also in 1993, Roadway developed an advanced Internet tracking system to handle its international shipping (Woodward 1999). In 1995, Roadway implemented a real-time satellite and tracking system for both U.S. domestic and international systems (Roadway Annual Report 1995). Also in 1995, Roadway Systems changed its name to Caliber System, Inc. Its components were then Roadway Package System, its small-package carrier; Roadway Global Air, its air freight package carrier; and a group of small, nonunion regional carriers including Roberts Express, Viking Freight, and Coles Express of Maine. Roadway was spun off as a debt-free company, with its own stock, listed on NASDAQ. When Caliber decided to make Viking a national carrier, it absorbed Coles and Roberts into the Viking network. Unfortunately for Caliber and Viking, this strategy failed dismally; in 1997, Viking withdrew from its West Coast base and shed all other operations. Caliber, having lost millions of dollars, sold out to FedEx in 1998 (Belzer 2000). In 1997, Roadway spent $15 million to acquire a Canadian trucking firm, Reimer Express Lines (Roadway Annual Report 1997). It expanded its access to Asia by launching Asian Roadway Express, and it released a new computerized tracking system that allowed its agents worldwide quicker access to shipping information (Roadway Annual Report 1997). In 1997, Roadway began an emergency shipping service to provide for same-day delivery of critical shipments (Roadway Annual Report 1997). In 1999, the company introduced e-shipment services (Roadway Annual Report 1999). In both ventures, although they were internally developed by the firm, Roadway hired senior-level managerial resources to design and implement the services (Roadway Annual Report 1999). In 2001, Roadway developed a strategic alliance with Integers Global Logistics to capitalize upon the growth of logistics domestically and internationally (Roadway Annual Report 2001). Yellow

Yellow took the same approach to developing the trucking business as CNF and Roadway After deregulation, Yellow quickly internally developed its own fully integrated, national hub-and-spoke operating system (Politson 1999). Yellow chose a hub-and-spoke design similar


125

to those used by commercial passenger airlines following the airline industry deregulation in 1978 (Politson 1999). This network was fully developed by 1983. In 1984, Yellow developed Freightcor services to compete in the TL segment of the industry (Yellow Annual Report 1984). During the mid to late 1980s, Yellow began to make a number of acquisitions to develop the international market. It acquired RBS Enterprises, ICL International Carriers Limited, and Customer Courier Services to fully develop the Canadian market (Politson 1999). Yellow was (and still is) the most conservative of the larger carriers in terms of international expansion. Yellow made certain that it had obtained synergies within its Canadian operations before venturing into other international markets. During the late 1980s, it began to lose money to other LTL carriers from a cost perspective. Its national hub-and-spoke operating system had substantial excess capacity, and many carriers began to undercut Yellow from a pricing perspective (Martin 1992). In 1992, Yellow acquired Preston Corporation, SAIA Motor Freight Lines, and Smalley Transportation to attempt to utilize its excess capacity (Politson 1999). At that time, Preston was the eighth largest LTL trucking firm and SAIA was the twenty-ninth largest trucking firm (Rakowski 2000). These two same-industry acquisitions benefited Yellow by providing economies of scale for its domestic LTL network. Because the acquisitions were in the same industry segment, implementation was quick and there were only minor integration difficulties (Politson 1999). In 1993, Yellow developed a strategic alliance with Royal Frans Maas Group of the Netherlands. This was the first time Yellow offered service to Europe (Politson 1999). Yellow Freight System established this alliance in order to offer customers international capabilities between North America and Europe. The two companies introduced an international service called YFM Direct. It was built on a marketing plan to offer door-to-door service between the continents using one bill of lading (Politson 1999). In Mexico, a partnership with a Mexican carrier established Yellow Freight Mexicana, which opened service to the Mexican interior (Politson 1999). In 1995, Yellow began to develop service to Asian markets by establishing strategic alliances with freight forwarders in Hong Kong, Singapore, and Thailand (Politson 1999). In 1996, Yellow further expanded its Asian service by internally developing service to twelve additional Asian markets (Politson 1999). By 1999, Yellow had overseas alliance partners in Europe, Latin and South America, the Caribbean, and the Asia/Pacific Rim countries. These alliances enabled Yellow to provide comprehensive international coverage (Politson 1999). The markets are linked with the same management information system to provide instantaneous rate quotes, as

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Growth from Chaos

well as Internet-based track and tracing capabilities. During the same year, Yellow Logistics Service was formed. Yellow felt that the logistics industry would be a high-growth industry. Before internally developing the venture, Yellow hired a number of senior-level logistics professionals because the Yellow management team had little experience with logistics (Politson 1999). In 1998, Yellow Corporation ended its relationship with Preston Trucking by divesting the carrier to a group of its senior managers. Shortly after the divestment Yellow bought Action Express, a small nonunion regional carrier serving the Pacific Northwest (Politson 1999). Also in 1998, Yellow introduced Exact Express, an integrated ground and air transportation service (Yellow Annual Report 1998). This internally developed network was made easier from an implementation perspective by hiring of a number of experienced air freight managers. In 2002, Yellow established 14 new alliances with transportation providers throughout Europe to meet the growing demand of its customers (Yellow Annual Report 2001). The partners include: Air Cargo Estonia AS (Estonia, Lithuania, Lativa), Alloin International (France), Road Air Distribution (The Netherlands, Belgium, and Luxembourg), Cargo Partner AG (Hungary, Poland, the Czech Republic, Croatia, Slovenia, Slovakia, Bulgaria, Romania), Cargo Shuttle LTD/Emerald Freight Express (Ireland), Continor A/S (Norway), Waco Finland (Finland), Enterprise Forwarding Limited (United Kingdom), Hamann International GmbH & Co. (Germany), and Hamann & Hellman International Nakliyat Ltd. (Turkey), Inter-Scan Airfreight A/S (Sweden, Denmark), MAT Transport AG (Switzerland), Space Cargo, S.A. (Spain), Tecnocarga AG (Portugal), Tuvia S.PA. (Italy), and Tuvia Hellas S.A. (Greece) (www.yellowfreight.com). The new alliances resulted in a more aggressive and localized approach to global business and relied on in-country expertise and coverage of the employees to promote and expand Yellow Global services. "After nearly a year of due diligence and planning, we believe we have partnered with companies that have the best in-country proficiency and breadth of services to meet the needs of our customers," said Jim Ritchie, president and CEO of Yellow Global. "These partnerships are part of a long-term business strategy for Yellow Global to create a strong in-country logistics and distribution network for its global customer base," he continued (Yellow Annual Report 2002). ABF

In 1979, Arkansas Best Freight (ABF) was the number 13 revenuebased carrier; in 2001, it was the number 12 revenue-based carrier. After


127

deregulation, ABF changed from being a TL operator to an LTL carrier. By the mid-1980s, ABF was one of the five leading competitors in the industry. David Humpherys, director of investor relations, was very helpful in terms of compiling a history of ABF since deregulation: the following events are those identified by Humpherys. In 1982, ABF purchased East Texas Motor Freight Lines, Inc. (ETMF). The primary advantages of this purchase were to increase the existing ABF network and to provide additional route densities. The purchase also added new service into the Pacific Northwest. In addition, in 1982 electronic data interchange (EDI) was implemented. ABF offered customers the ability to electronically track shipment information including point of origin, point of destination, transit status, and freight bill charges. During 1983-1985, ABF fully integrated the ETMF acquisition. This integration resulted in a nationwide hub-and-spoke operating system. In 1985, a freight management system was developed. This internal ABF system generated enhanced information sharing throughout the company. As a result, data were exchanged among systems for billing, linehaul movements, freight bill tracing, linehaul and city manifesting, and local shipment pick up and delivery. In 1995, ABF completed the purchase of WorldWay Corporation (ABF Annual Report 1995). The major reason for this acquisition was to acquire Carolina Freight Carriers, Inc. The addition of Carolina Freight Carriers strengthened freight densities in the eastern portion of the country (Covell 1997). In addition to the WorldWay Corporation acquisition, ABF acquired G.I. Trucking, a regional LTL carrier servicing the western states, the southwestern states, and Mexico (ABF Annual Report 1995). Humpherys further stated that in 1995 the ABF Internet Web site was introduced. ABF also acquired an international ocean shipping firm, Cargo Trans, and two logistics firms, Innovative Logistics and Complete Logistics (ABF Annual Report 1995). Cargo Trans provides ocean service (ABF Annual Report 1996). In 1996, ABF created Clipper Worldwide (ABF Annual Report 1996), which provides worldwide logistics and intermodal service. Clipper Worldwide also offers services through Carotrand International, a vessel-operating common carrier providing import and export, door-to-door and door-to-port service to more than 140 countries (Covell 1997). In addition, Clipper Global Air was introduced to provide domestic and international air freight services (ABF Annual Report 1996). Clipper Freight management was implemented in 1996. One of the largest intermodal marketing companies in the country, Clipper Freight Management offers nationwide truckload service and rail service (ABF Annual Report 1996).

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Growth from Chaos

Humpherys stated that in 1998, the imaging of freight bill documents was introduced. With the imaging of freight bills and associated shipment documents, ABF was able to improve the efficiencies of its local terminals and general office personnel. This enhanced the ability of ABF to provide information directly to its customers by way of the ABF Web site. In 1999, ABF entered into an agreement with NationsWay Transport Service, Inc., to provide LTL freight services to former NationsWay customers (ABF Annual Report 1999). NationsWay was a bankrupt western states carrier, and the addition of this business improved freight densities in the West (ABF Annual Report 1999). Watkins Motor Lines

Watkins Motor Lines is the only other LTL carrier firm in business in 1979 that is currently still in business. Watkins was the number 49 revenue-based carrier in 1979; in 2001, it was number 18. Watkins is a privately held corporation; therefore, it is difficult to obtain information with respect to its growth process. The company's Web site shows that it offers LTL service to the continental United States, Canada, and Mexico. Watkins also offers TL services, satellite tracking, and logistical services. Growth of the Major LTL Carriers

The large LTL carriers (prederegulation) that survived during the deregulated period achieved different levels of growth by utilizing different sequencing patterns. All carriers initially developed a national hub-and-spoke operating network. CNF and Yellow developed this network primarily through internal expansion. ABF and Roadway utilized a combination of acquisitions and internal development to develop their national infrastructure. USF developed its hub-and-spoke system primarily through acquisition. After the carriers had fully developed their domestic infrastructure, they utilized acquisitions to move into related business for two reasons: (1) to grow into related transportation business, and (2) to establish international market positions. CNF acquired Milne and Craighead to move into ocean shipping; the acquisition of Emery established a position in global air freight. Yellow acquired Freightcor to compete in the truckload business, and it acquired RBS Enterprises, ICL International, and Customer Courier to increase the scope of its international network. ABF's acquisition of WorldWay Corporation allowed it to establish positions in ocean shipping and logistics. As a result of its


129

acquisitions, USF moved into TL and related businesses. USF's acquisition of Coast Consolidated enabled the company to move into ocean shipping. Roadway's acquisition of Roberts Express enabled it to enter the same-day market. Roberts Express was later expanded to provide same-day service to Europe. Roadway acquired Reimer Express to move into the Canadian market. These firms all recognized that logistics was a high-growth business. CNF and ABF acquired logistics firms. Yellow and Roadway internally developed their own logistics function. Roadway, United Airlines, American Airlines, Unisys, G-Log, and UTI Worldwide have formed Integers Global Logistics: This logistical alliance is aimed at servicing the expedited and international heavy-freight transportation industry (Freeze 2001). Strategic alliances have become an important growth vehicle for the major LTL trucking firms. Yellow formed fourteen strategic alliances in 2002 to gain access to major markets in Western Europe, Eastern Europe, the Commonwealth of Independent States, and the Middle East. CNF has created a strategic alliance with General Motors to create a supply-chain management system. CNF also has alliances with Delta and Continental Airlines for air express service. LESSONS LEARNED

The success stories in the deregulated trucking industry point to some valuable lessons learned. 1. Growth is a process of developing resources in different combinations and configurations over time. Firms that experienced the highest growth rate over time developed resource combinations to position trucking firms as full-service transportation carriers in a global market with value-added capabilities. 2. Initial firm size is not a sufficient condition for success in a deregulated environment. Many of the LTL and TL carriers that grew in the deregulated period were small firms in 1979. 3. Sequencing of decisions is of crucial importance for growth. a. All high-growth LTL firms followed the same sequencing pattern. These carriers started out as firms serving regional markets during the regulated period. The firms grew by internal development after deregulation to begin to service more U.S. markets. The carriers utilized strategic alliances to more fully develop their domestic infrastructure. The carriers then developed strategic alliances with international LTL firms to provide their customer base with international service. These carriers then

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internally developed shipment tracking for both U.S. domestic and international shipments. b.The smaller TL carriers that became major players in the deregulated trucking industry all followed the same expansion path. These carriers also started out as regional players. After deregulation, they began to internally develop their domestic infrastructure networks. These carriers then engaged in acquisitions to provide their customers with total U.S. geographic coverage and to obtain economies of scale from their resources. During the early 1990s, these carriers recognized the importance of logistics and internally developed logistics capabilities. They then engaged in a period of internally developing technology features to provide real-time tracking in an attempt to create differentiation from their competitors. These carriers then engaged in alliances with rail carriers to reduce their overall cost structure and gain access to the international markets the rail carriers had already developed. Subsequently, the carriers engaged in related acquisitions to achieve economies of scope from their resource base. The carriers' last sequencing move was to engage in international strategic alliances to obtain global coverage. 4. Acquisitions can be utilized to create advantage in a deregulated environment. The firms that grew most rapidly in the deregulated environment utilized acquisitions for three purposes: First, acquisitions were utilized to establish a national scale of operating coverage. Second, firms utilized acquisitions to establish a scope of advantage by moving into related, higher-margin transportation services. Third, firms acquired targets that had positions in both the U.S. and international markets. Thus, acquiring firms did not need to establish international positions from scratch. 5. Retaining managerial resources of acquired firms is of critical importance. The firms that grew most rapidly retained the senior management teams of related acquisitions. With the exception of Ryder, the firms that grew in the deregulated environment made very few unrelated acquisitions. For businesses in noncore markets (other trucking), firms should retain the necessary managerial resources to make implementation of the acquired business easier and quicker. 6. Firms need to respond to changing consumer needs to maintain long-term relationships. As shippers' needs changed from trucking to full-service transportation, firms that experienced the highest growth rate developed into full-service, global transportation providers. 7. Taking advantage of competitor's strategic errors can lead to growth. The larger LTL carriers made a strategic error by trying to


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internally develop a national, fully integrated hub-and-spoke operating system. Remember from Chapter 1 that time can be a source of advantage. Smaller LTL carriers utilized acquisitions to develop this national infrastructure. In doing so, these firms were able to establish the national infrastructure more quickly than the larger LTL carriers. These firms then h a d an advantage because their network was in place earlier than the larger LTL carriers'. As a result, they grew at much faster rates than the larger LTL carriers. "The majority of the larger firms did not survive in the deregulated industry," stated the CEO. "You would think that initial firm size would be an advantage. " "Not necessarily," I said. "Firms that develop their resource base over time in very distinct patterns tended to grow and prosper." "The airline industry has had great difficulty recently. H o w have firms grown in that industry?" asked the CEO. "Let us take a comprehensive look at h o w this industry has evolved over time," I suggested. REFERENCES

AAA Cooper Transportation. 2002. Available at: http://www.aaacooper.com (Accessed 2 July 2002). Arkansas Best Freight Annual Report. 1995,1996,1999. Fort Smith, Arkansas. Belzer, M. 2000. Sweatshops on Wheels. London: Oxford University Press. CNF Annual Report. 1983,1984,1989,1990,2001. Palo Alto, California. Cohen, M. 1997. "Heartland Express." International Directory of Company Histories 18: 225-227. Covell, J. 1997. "Arkansas Best Corporation." International Directory of Company Histories 16: 39-41. Durr, K., and P. Cantelon. 1999. Never Stand Still: A History of CNF Transportation Inc. Rockville, MD: Montrose Press. Estes Express Lines. 2002. Available at: http://www.estes-express.com (Accessed 12 July 2002). Freeze, M. 2001. "Roadway, United, American Form Strategic Partnership." Transportation and Distribution 42 (July): 13-14. Frozen Food Express Annual Report. 1982,1988,1990,1992,1994. Dallas, Texas. Gallman, J. 1996. "J.B. Hunt Transport." International Directory of Company Histories 12: 277-279. Gasbarre, A. 1996. "Consolidated Freightways." International Directory of Company Histories 5: 432-434. Halasz, R. 1998. "Frozen Food Express Industries." International Directory of Company Histories 20:233-235. Heartland Annual Report. 1986. Coralville, Iowa. J.B. Hunt Annual Report. 1992,1993,2000,2001. Lowell, Arkansas.

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Knight, J. 1999. "Werner Enterprises." International Directory of Company Histories 26: 531-533. Lambert, D., and J. Stock. 2001. Strategic Logistics Management. Boston, MA: Irwin / McGraw-Hill. Levitt, T. 1960. "Marketing Myopia." Harvard Business Review (July-August). Martin, J. 1992. "Yellow Freight System." International Directory of Company Histories 5: 539-541. Millen, R. 1992. "Utilization of EDI by Motor Carrier Firms: A Status Report." Transportation Journal (Winter): 5-13. National Freight. 2002. Available at: http://www.natlfreight.com (Accessed 16 July 2002). Pettus, M. 2001. "The Resource-Based View as a Developmental Growth Process: Evidence from the Deregulated Trucking Industry." Academy of Management Journal 44: 878-896. Politson, K. 1999. Legends and Legacy. Overland Park, KS: Yellow Freight Publishing. Rakowski, J. 2000. "The Changing Face of U.S. Transportation: The Motor Carrier Industry." Journal of Transportation Law, Logistics, and Policy (Winter): 47-62. Rakowski, J., and K. Dobie. 1996. "Strategic Alliances between Motor Carriers and Railroads: An Exploratory Analysis." Journal of Transportation Law, Logistics, and Policy 1 (Fall): 61-72. Rakowski, J., R. Southern, and J. Jarrell. 1993. "The Changing Structure of the U.S. Trucking Industry: Implications for Logistics Managers." Journal of Business Logistics 14:111-130. Roadway Annual Report. 1985, 1988, 1990, 1991, 1993, 1995, 1997, 1999, 2001. Akron, Ohio. Ryder Annual Report. 1986,1987,1988,1990,1993,1996,1998,1999, 2000, 2001. Miami, Florida. Salamie, D. 1999. "TNT Post Group N.V." International Directory of Company Histories 27:473-476. Schneider Annual Report. 1981,1984,1986,1989,1991,1998. Green Bay, Wisconsin. Southeastern Freight Lines. 2002. Available at: http://www.sefl.com (Accessed 8 July 2002). Sparkman, D. 1992. "Intermodal Finds Its Niche." Transport Topics (March). Starbuck, W. H. 1965. "Organizational Growth and Development." In J. G. March (ed.), Handbook of Organizations, 451-533. Chicago, IL: Rand McNally. Swift Annual Report. 1990,1991, 2000,2001. Phoenix, Arizona. TNT Annual Report. 1992. Rosemont, Illinois. USF Annual Report. 1999, 2001. Rosemont, Illinois. "Value Added Trucking." 1988. Purchasing (March 31): 63-67. Value Line. 2002. September 14. Wall Street Journal 2002. September 4. . 2003. July 10. Werner Annual Report. 1992,1993, 2000. Omaha, Nebraska.


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Woodward, A. 1999. "Roadway Express." International Directory of Company Histories 25: 396-398. . 2001. "Schneider National." International Directory of Company Histories 36: 411-413. . 2002. "Swift Transportation." International Directory of Company Histories 42: 363-365. Yellow Annual Report. 1984,1998,2001, 2002. Overland Park, Kansas. Yellow Freight. 2001. Available at: http://www.yellowfreight.com (Accessed 5 July 2002).


7 The Restructuring of the US. Airline Industry The deregulation of the airline industry has had a major impact upon most carriers within the industry Table 7.1 identifies the position of the major U.S. airlines in 1977 (the year before deregulation) and in 2001. During the regulated period, five airlines accounted for approximately 60 percent of total airline revenues. The top fifteen carriers accounted for over 93 percent of total airline revenues. Mergers and bankruptcies were relatively uncommon during the regulated period (Brenner 1988). Such was not the case after the deregulation of the industry. The following list identifies those firms that have gone bankrupt or out of business since 1978. Aeroamerica Air Atlanta Air Florida Air Illinois Air New England Air North Air One Altair American Central American International Apollo Airways Arrow Airways Braniff Capitol Cascade Airways Cochise Airlines Continental*

Emerald Air Freedom Airlines Frontier Golden Gate Airlines Golden West Airlines Hawaiian Airlines** Imperial Airlines Mackey International McClain Airlines Northeastern International Oceanair Pacific East Pacific Express Pride Air Southeast Airlines Swift Aire Lines Texas Air

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Transamerica Wien Alaska United** World U.S. Air*** Wright *Renewed operations after going through bankruptcy twice. **Currently in bankruptcy protection as of 2003. ***Renewed operations after going through bankruptcy . Although many of the firms that went bankrupt were small, regional carriers, some were not. For example, Braniff held the number 8 revenue position in 1977, but it ultimately went out of business. During the early 1980s, there were a number of mergers as firms attempted to gain U.S. market share and develop a totally integrated hub-and-spoke operating network. The following list (modified from Brenner, 1988) identifies the mergers that have occurred since 1978 and the resultant impact u p o n the combined firms. Merged Carrier Air Cal Air Florida Braniff rs Latin American Division Britt Continental Eastern Empire Frontier Henson Hughes Air West Jet America National New York Air North Central Ozark Pan Am's Pacific Division PBA People Express Piedmont PSA Ransome Southern Transtar Western

Result into American into Midway, then out of business into Eastern, then Texas Air, then out of business into People Express, then Texas Air, then out of business into Texas Air, emerged from bank ruptcy as Continental into Texas Air, then out of business into Piedmont, then U.S. Air into People Express, then Texas Air, then out of business into Piedmont, then U.S. Air into Republic, then Northwest into Alaska Airlines into Pan American, then Delta into Texas Air, then out of business into Republic, then Northwest into TWA, then American into United into People Express, then Northwest into Texas Air, then out of business into U.S. Air into U.S. Air into Pan American, then Delta into Republic, then Northwest into Southwest into Delta

Table 7.1 The 15 Largest Airlines of 1977 and 2001 Ranked by Operating Revenue, Individual Share, and Cumulative Percentage Share Airline (1977)

Share 1977

Cumulative Share (1977)

Rank (2001)

Airline (2001)

Share 2001

Cumulative Share (2001)

United American Trans World Eastern Delta Pan American Northwest Braniff Western

14.92 12.03 11.41 11.10 10.33

14.92 26.95 38.36 49.46 59.79

1 2 3 4 5

16.4 14.4 13.6 11.9 8.6

16.4 30.8 44.4 56.3 64.9

8.16 5.23 4.12 3.73

67.95 73.17 77.29 81.02

6 7 8 9

7.4 7.2 5.0 2.4

72.3 79.5 84.5 86.9

3.46 3.04

84.47 87.51

10 11

1.8 1.6

88.7 90.3

2.66

90.17

12

1.3

91.6

13

Continental National Allegheny (U.S. Air) Hughes Air West

1.35

91.53

13

1.1

92.7

14

Frontier

1.23

92.67

14

1.0

93.7

15

North Central

1.13

93.89

15

American United FedEx Delta Northwest U.S. Airways Continental Southwest UPS Air America West Alaska DHL Airways American Eagle American Trans Air Airborne Express

1.0

94.7

Rank (1977) 1 2 3 4 5 6 7 8 9 10 11 12

Source: Rakowski and Bejov 1992, ATA Annual Report 1978, 2002. Courtesy of Air Transport Association of America, Inc. Reprinted with permission. Copyright © 2002 by Air Transport Association of America, Inc. All rights reserved.

138

Growth from Chaos

Many airlines did not fare well in the deregulated environment. Most of the dominant carriers in 1977 have gone out of business or been acquired. The only carriers that remain from the top fifteen in 1977 are #1 United (currently in bankruptcy protection), #2 American, #5 Delta, #7 Northwest, #10 Continental, and #12 U.S. Air (Table 7.1). Southwest Airlines, Alaska Airlines, and American Trans Air were very small airlines in 1977 and are still in operation today. The firms that went out of business will be discussed first. CARRIERS THAT WENT OUT OF BUSINESS

TWA was the third largest revenue-based carrier in 1977. In 1978, it established a U.S. domestic hub in St. Louis and an international hub in New York. From 1985 to 1992, TWA was in Chapter 11 bankruptcy (Rakowski and Bejov 1992). In 1986, it was acquired by corporate raider Carl Icahn. He also acquired Ozark Airlines in 1987 (TWA Annual Report 1987). TWA began to incur many problems in 1987: an underdeveloped hub-and-spoke operating network, a rapidly declining market presence, and a heavy debt load as the result of the Ozark acquisition. The airline had a $4 billion debt in 1987 (Rakowski and Bejov 1992). TWA emerged from bankruptcy protection in 1993. It has had difficulty maintaining its position within the U.S. domestic market, and its share of the international market declined significantly in the 1990s. In 2001, TWA was acquired by American Airlines (American Airlines Annual Report 2001). Eastern, #4 in 1977, became part of Texas Air Corporation. Other carriers that were part of Texas Air were #10 Continental, People Express, New York Air, and Braniff's Latin American Division. In 1986, Texas Air was the largest revenue-based airline in the United States (Rakowski and Bejov 1992). Frank Lorenzo, who orchestrated this series of acquisitions, was unsuccessful at integrating these separate airlines. Texas Air went out of business in 1991, and only Continental came out of bankruptcy in 1993. Pan Am, #6 in 1977, was acquired by Delta during the Gulf War crisis in 1991 (ATA Annual Report 1991). Pan Am was a much smaller airline in 1991 than in 1977 because United had acquired many of its international routes. United acquired Pan Am's London and Latin American routes in 1986 to increase its global network. Western Airlines, #9 in 1977, was acquired by Delta. National (#11) was acquired by Pan Am, which was then acquired by Delta. Hughes Air West (#13) was acquired by Republic, which was then acquired by Northwest. Frontier Airlines (#14) was acquired by People Express, which was then acquired by Texas Air, which went out of business. North Central (#15) was acquired by Republic, which was then acquired by Northwest.

The Restructuring of the U.S. Airline Industry

139

CARRIERS SURVIVING THE INDUSTRY DEREGULATION Delta Airlines

Delta was the #5 revenue-based carrier in 1977. After the Airline Deregulation Act of 1978, Delta began to offer international service. Transatlantic service to London began in 1978 and service to Germany began in 1979 (Delta Airlines Annual Report 1978, 1979). In the 1980s, Delta began to develop its hub-and-spoke operating system within the United States (Simley 1995b). Atlanta became the primary hub, with secondary hubs in Dallas-Fort Worth, Boston, Memphis, and Cincinnati. This network gave Delta complete U.S. domestic operating coverage (Simley 1995b). Also during the 1980s, Delta developed its computer reservations system (CRS) to provide customers with online, real-time reservations capability. In 1987, Delta acquired Western Airlines (#9 in 1977) to provide service along the Pacific coast. Delta began transpacific service to Japan and other major markets along the Pacific Rim in 1987 (Delta Airlines Annual Report 1987). Delta acquired Pan Am's European network in 1991. Also in 1991, Delta substantially increased its size and scope of operating coverage by acquiring Pan Am's transatlantic routes and the Pan Am shuttle (Simley 1995b). In 1996, Delta opened its Web site for customer ticket purchase and started Delta Express, a low-fare service to growing markets such as Orlando, Florida (Delta Airlines Annual Report 1996). In 1997, Delta initiated service to Latin America and began purchasing Boeing's new 777 mid- to long-range aircraft (Delta Airlines Annual Report 1997). In 1998, Delta and Swiss Air began a strategic alliance to transport international cargo (Delta Airlines Annual Report 1998). In 2000, Delta became a member of Sky Team alliance, a global strategic alliance among Delta, Aeromexico, Air France, and Korean Air (Delta Airlines Annual Report 2000). As a member of this alliance, Delta could offer its customers expanded service to Mexico, Europe, and the Pacific Rim. The alliance has been expanded to include Alitalia, Czech Airlines, and Aeroflot (Murphy 2002). Also in 2000, Delta acquired two regional carriers, Atlantic Southeast Airlines and Com Air (Delta Airlines Annual Report 2000). As of 2003, Delta is the fourth largest U.S. airline behind American, United, and FedEx. American Airlines

American Airlines was the second-ranked carrier in 1977. Following deregulation, Dallas became the site of American's primary hub. In 1982, the airline began service to London (American Airlines An-

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Growth from Chaos

nual Report 1982). To provide for total U.S. coverage, American introduced American Eagle, a regional airline providing service to secondary markets (Simley 1995a). The American Eagle system was the thirteenth largest U.S. airline in terms of revenues in 2001 (ATA Annual Report 2002). In 1987, American enhanced its Sabre reservation system so that customers could access via personal computers. Also in 1987, American acquired Air Cal to provide service along the West Coast (American Airlines Annual Report 1987). In 1991, American acquired TWA's routes between New York, Los Angeles, Boston, and London (American Airlines Annual Report 1991). In 1995, American formed an alliance with Canadian Airlines to provide service between the United States and Canada (American Airlines Annual Report 1995). Also in 1995, American opened its Web site, AA.com. In 1998, American acquired Reno Air and American Eagle acquired Business Express (American Airlines Annual Report 1998). The acquisition of Reno Air increased service along the West Coast. The Business Express acquisition provided greater passenger traffic on the American Eagle system. In 2000, American attempted unsuccessfully to acquire U.S. Airways. At the time, U.S. Air was the sixth largest U.S. carrier in terms of passenger revenues (ATA Annual Report 2000). In 2001, American completed the purchase of TWA for $600 million. At the time of the acquisition, TWA was the eighth largest U.S. passenger carrier (ATA Annual Report 2001). This acquisition was intended to increase American's coverage both in the United States and Europe (American Airlines Annual Report 2001). TWA's operations were integrated into American's in 2002. In order to increase its global presence further, American was one of the first members of the One World global airline strategic alliance. The alliance also consists of British Airways (U.K.), Cathay Pacific (Pacific Rim), AER Lingus (Ireland), Finnair (Northern Europe), Iberia (Spain), Lan Chile (South America), and Qantas (Australia) (Murphy 2002). With the acquisition of TWA's international routes and membership in the One World strategic alliance, American has significantly increased its international coverage. American Airlines narrowly averted a Chapter 11 bankruptcy filing in 2003. On April 28, 2003, the Association of Professional Flight Attendants agreed to steep pay cuts and other changes that would help avoid a bankruptcy filing. The deal followed similar pacts with American's two other unions, the flight attendants and mechanics. These agreements came after Donald Carty, American's CEO, stepped down. Carty did not disclose provisions for special bonuses and pension protections for senior executives to the unions during negotia-


141

tions (Wall Street Journal, 28 April 2003). This failure to disclose could easily have driven American into Chapter 11. Northwest Airlines

Northwest Airlines was the number seven ranked revenue carrier in 1977. Like the other surviving airlines, Northwest began to develop its domestic hub-and-spoke operating system immediately after deregulation. Northwest's primary hubs are located in Minneapolis, Detroit, and Memphis. During the early 1980s, the airline began to expand its service to Europe. In 1984, Northwest and Mesaba Airlines announced a regional airline partnership; Mesaba became Northwest's short-haul carrier (Simley 1995c). In 1985, Northwest tried to purchase Pan Am's Asian routes but was outbid by United, which acquired the rights in 1986 (Northwest Airlines Annual Report 1986). In 1986, Northwest purchased Republic Airlines (Northwest Airlines Annual Report 1986), which was comprised of Southern Airlines, the #19 revenue-based carrier in 1977; North Central Airlines, #15; and Hughes Air West, #13 (Rakowski and Bejov 1992). As a result of these acquisitions, Northwest acquired hubs in Detroit, Minneapolis, and Memphis. In 1987, Northwest began service to Tokyo and Thailand. In 1988, Milwaukee became the fourth domestic hub. In 1988, Northwest and Horizon Air announced a code-sharing agreement for the Pacific Northwest (Northwest Airlines Annual Report 1988). In 1989, Northwest was acquired by Wings Holding, an investment group that controlled KLM Royal Dutch Airlines, and Bankers Trust New York, an investment banking firm. In 1990, Northwest spent $922 million to upgrade its service and to build brand name. The same year, Northwest and Honeywell signed an Aircraft Satellite Navigation Development Agreement with the Soviet government (Simley 1995c). In addition, Northwest entered into a strategic alliance with Hawaiian Airlines (Northwest Airlines Annual Report 1990). In 1991, Northwest acquired gates and landing slots formerly held by Eastern Airlines at Washington, D.C., to create a "mini-hub" at the nation's capital (Simley 1995c). Also in 1991, Northwest pioneered the first satellite navigation and communication link (Northwest Airlines Annual Report 1991). In 1993, the U.S. Department of Transportation approved the Northwest/KLM global strategic alliance (Simley 1995c). This alliance provided Northwest access to markets in Europe, the Middle East, and Africa (Northwest Airlines Annual Report 1993). In 1994, Northwest developed Northwest Aerospace Training Corporation (NATCO), which provides pilot training to more than 100

142

Growth from Chaos

outside customers (Simley 1995c). Also in 1994, Northwest signed a strategic alliance with Asiana (Korea) (Northwest Airlines Annual Report 1994). In 1995, Northwest reached an agreement with Air Tran Corporation, a travel club charter carrier, for Northwest to increase its ownership to 30 percent. Also in 1995, Northwest and Alaska Airlines entered into a strategic alliance (Northwest Airlines Annual Report 1995). In 1996, Northwest introduced its World Wide Web home page and began electronic ticketing. Also in 1996, Northwest entered into a strategic alliance with Air China. Further, Northwest entered into an alliance with Mahalo Air to provide service to the Hawaiian island markets (Northwest Airlines Annual Report 1996). In 1997, Northwest and Garuda Indonesia entered into a strategic alliance (Northwest Airlines Annual Report 1997). Also in 1997, Northwe and KLM Royal Dutch Airlines signed a ten-year agreement to expand their current areas of cooperation for scheduling, inventory, passenger processing, computer reservations systems, and databases. Northwest, Jet Airlines of India, and Aloha Airlines entered into a strategic alliance in 1997 (Northwest Airlines Annual Report 1997). Also in 1998, Nort west signed an alliance with Air Galel Netherlands BV. In 1999, Northwest and Japan Air System entered into a strategic alliance. Also in 1999, Northwest signed strategic alliances with Malaysian Airlines and Alitalia (Italy) (Northwest Airlines Annual Report 1999). In 2000, Northwest entered into a code-sharing agreement with Continental Airlines. In 2001, Northwest obtained a ten-year extension of the strategic alliance with KLM and established an alliance with Nippon Cargo Airlines (Northwest Airlines Annual Report 2001). Also in 2001, Northwest entered into a strategic alliance with Transavia Airline and Hungarian Airlines to provide service to Eastern Europe (Northwest Airlines Annual Report 2001). These alliances helped improve Northwest's U.S. domestic market position to #5 in 2001. CARRIERS IN CHAPTER II IN 2003 United Airlines

United, the largest carrier in 1997, and U.S. Air, the twelfth revenueranked airline in 1977, both went through bankruptcy proceedings in 2002 and 2003. After the Airline Deregulation Act of 1978, United began a period of significant expansion within the U.S. domestic passenger market. By 1982, United had completed its national hub-and-spoke operating network with primary hubs in Chicago; Washington, D.C.; Denver; and San Francisco (United Airlines Annual Report 1982). In 1983, United began service to Tokyo. In 1986, United acquired Pan Am's Pacific division to give the airline a presence along the Pa-


143

cific Rim (United Airlines Annual Report 1986). In 1991, United began service to Paris and acquired Pan Am's U.S. routes to London. The same year, United began service to Spain. By the end of 1991, United was servicing most of the major markets in Europe (United Airlines Annual Report 1991). In 1992, United began service to many major South American markets (United Airlines Annual Report 1992). In 1994, the UAL board of directors approved a proposal for employees to exchange portions of their salaries and benefits for UAL stock. On July 12, 1994, United became one of the largest employeeowned companies in the world (United Airlines Annual Report 1994). In 1997, United became one of the principal carriers in the Star global alliance. Other members of this alliance are Lufthansa (Germany), Air Canada, Air Nippon Airway (Japan), Austrian Airlines, Lauda Air (Austria), SAS (Scandinavia), Thai Airways, Air New Zealand, British Midland (U.K.), Mexicana Airlines, Singapore Airlines, Tyrolean Airways (Austria), and Varig (Brazil) (Murphy 2002). This alliance gives United access to virtually all international major markets with the exception of the Commonwealth of Independent States (CIS). In 2002, United Airlines filed for a federal loan guarantee to cover $1.8 billion of a $2 billion private loan. This loan petition was rejected by the government, and United entered Chapter 11 bankruptcy protection on December 10, 2002. U.S. Air

U.S. Air was formerly Allegheny Airlines, an East Coast short-haul carrier prior to deregulation. In 1979, Allegheny changed its name to U.S. Air and expanded its network to include service to Arizona, Texas, Colorado, and Florida (U.S. Air Annual Report 1979). In order to remain competitive with other airline companies that were merging to form larger companies, U.S. Air announced in 1986 that it would be acquiring Pacific Southwest Airlines (PSA) for $400 million (Simley 1995d). The announcement surprised many industry analysts because U.S. Air's predominately East Coast airline network had few integration points with PSA, which was concentrated along the West Coast (Simley 1995d). The merger increased the amount of traffic on U.S. Air's network by 40 percent and gave U.S. Air landing rights in a number of cities on the West Coast (Simley 1995d). In 1989, U.S. Air acquired its primary rival, Piedmont. The merger included Piedmont's international routes as well as its Charlotte, Baltimore, Dayton, and Syracuse hubs (Simley 1995d). In 1990, U.S. Air expanded international service to Germany (U.S. Air Annual Report 1990). In 1992, U.S. Air and Trump Shuttle began a marketing affiliation under which the service became the U.S. Air Shuttle (Simley 1995d).

144

Growth from Chaos

The shuttle provided hourly service between New York and Boston and between New York and Washington, D.C. In 1992, British Airways (BA) PLC announced that it had arranged to form an alliance with U.S. Air for $750 million. In early 1993, BA and U.S. Air restructured their agreement into a $400 million BA purchase of 25 percent of U.S. Air (Simley 1995d). This agreement, under which U.S. Air gave up its London routes, received U.S. government approval. The government also approved a code-sharing arrangement that enabled the partners to offer their customers travel utilizing a single ticket (Simley 1995d). In 1997, U.S. Air ordered a number of Airbus A320s, scheduled for delivery from 1998 through 2009. The new airplanes would enable U.S. Air to continue as a major airline rather than being forced to shrink into a regional one (Simley 1995d). In 1998, U.S. Air purchased full control of U.S. Air Shuttle, in which it had held a minority stake since 1992. Also in 1998, U.S. Air launched the low-cost, low-fare Metrojet carrier to help it compete against Delta Express and Southwest Airlines (U.S. Air Annual Report 1998). In 2000, U.S. Air launched Potomac Air, a short-haul service out of Washington's National Airport. In 2001, United made a bid to acquire U.S. Air: The bid was withdrawn in 2001. U.S. Air began to incur heavy losses in 2001, which continued in 2002 and 2003. In 2002, U.S. Air asked for assistance from the Air Transportation Stabilization Board. It had mentioned bankruptcy as a possibility after losing $2.1 billion during 2001 and more than $500 million in 2002. Although U.S. Air did not lose any planes on September 11, 2001, its business was severely hurt when Reagan National Airport, the airline's main hub, was shut down for three weeks and then reopened with a limited schedule. U.S. Air, hard hit by slumping travel following the September 11 terrorist attacks, filed for Chapter 11 bankruptcy in August 2002—the first major carrier to declare bankruptcy after the attacks put the industry in a tailspin. The airline listed $7.81 billion in assets and $7.83 billion in liabilities in its petition, filed with the U.S. Bankruptcy Court for the Eastern District of Virginia. U.S. Air received $500 million in private financing to keep operating while it reorganizes. The airline's interim financing came from a group led by Credit Suisse, First Boston, and Bank of America Corp., with participation from Texas Pacific Group. On March 31, 2002, U.S. Air emerged from Bankruptcy protection (Wall Street Journal, 1 April 2003). Emerging from Chapter 11 has allowed it to tap $1.24 billion in new financing and move forward with its plans to add hundreds of regional jets to the fleets of its commuter affiliates. Once U.S. Air repays its interim bankruptcy financing, it will wind up with about $900 million in fresh liquidity. A fundamental problem for U.S. Air is that its cost per available seat mile is the second highest in the industry ($10.95), behind United's


145

$11.00 (Wall Street Journal, 5 December 2002). U.S. Air has tried to become a national carrier: first with its acquisition of PSA in 1986, its acquisition of Piedmont in 1989, and its entry into the short-haul market (e.g., U.S. Air Shuttle). The result of these acquisitions is that U.S. Air has too much excess capacity in its network, which leads to a higher cost position than its rivals. In times of economic recession, this high cost position becomes even more precarious. It would have been beneficial for U.S. Air to learn from the success of Southwest. Both airlines started out as regional players, but their approaches to growth have been fundamentally different. The primary reason that Southwest has the lowest costs in the industry is that Southwest examines each pair city lane segment. If Southwest cannot be profitable on a specific pair city combination, it does not offer the service. Because U.S. Air has primarily grown by acquisition, it has not had the luxury of evaluating each lane segment. The result is that its entire airline network has more excess capacity, which results in the high cost structure. U.S. Air's approach of trying to reduce network costs will not be beneficial because the problem exists at the lane segment level. Until U.S. Air examines the profitability of each of its lane segments, the airline may never be profitable. United suffers from a related issue. United has grown domestically by developing its hub-and-spoke network through internal development. Internationally, it has grown through direct entry and acquisition (e.g., Pan Am's Pacific division). This growth process has created excess capacity within its domestic hub-and-spoke network and international infrastructure. Because it is the largest carrier, it suffers from the greatest amount of excess capacity. This is a principal reason that its cost per available seat mile is the highest of all U.S. carriers. United's cost position is made higher because it generates its revenue base from only one primary source: passengers. This is a crucial weakness of all U.S. carriers and one reason they all (except Southwest) are losing significant amounts of money. Other large international airlines are more diversified in terms of their revenue streams. Many international airlines, such as Lufthansa, generate significant portions of revenue from air freight and other services. Lufthansa has revenue streams in cargo, catering, leisure travel, information technology services, and financial services (Lufthansa Management Report 2001). Lufthansa posted a net profit of 630 million euros in 2002. GLOBAL POSITIONING

In 2001, United, Delta, and American accounted for over 40 percent of total U.S. airline revenues. The year before deregulation, the three largest U.S. passenger airlines accounted for approximately 38 per-

146

Growth from Chaos

cent of U.S. passenger revenues. In order to grow, carriers must survive the economic recession. In addition, the second Gulf War caused additional financial problems for the U.S. carriers. The growth patterns of American and Delta during the deregulated period have been relatively similar. The general growth pattern is depicted in Figure 7.1. This industry is very similar to the trucking industry in that the development of a hub-and-spoke operating system is of critical importance in a deregulated environment. Immediately after deregulation in 1978, carriers began to internally develop their hub-and-spoke operating systems. Once this operational infrastructure was in place, carriers began to acquire other airlines to more fully develop the system and to obtain operating authority into international markets. Much of Pan Am was acquired by Delta, which provided Delta access into European markets. American Airlines' acquisition of TWA's European routes provided American with a stronger position in transatlantic markets.

Figure 7.1 Growth Path of "Big 2" U.S. Passenger Airlines (American and Delta) during Deregulation


147

After this international expansion, the large carriers acquired other smaller, U.S. carriers to provide for greater passenger density within their domestic hub-and-spoke operating networks. These carriers then embarked upon fully developing their international market positions by becoming members of international strategic alliances, which provided access to global markets without incurring additional costs of acquisition. Both carriers are members of global, strategic alliances, and they have access to most international major markets as a result of their membership. The smaller U.S. carriers do not have the same scope of international coverage. This can be a significant advantage in a global economy. Also, many other international markets are not as severely affected by the U.S. economic recession and September 11 tragedy. The big difference between Delta and American is that American acquired TWA in 2001 and integrated operations in 2002. This network created substantially more excess capacity than Delta's network. With the continuation of the economic recession, this excess capacity has created greater excess costs for American when compared to Delta. American's cost per available seat mile is the third highest in the industry (behind United and U.S. Air) (Wall Street Journal, 5 December 2002). As a result, American incurred substantially greater losses in 2001 and 2002 than Delta. SMALLER SURVIVING CARRIERS Southwest Airlines

One of the smallest airlines in 1977, Southwest Airlines has grown significantly in the deregulated environment. This U.S. airline has been very successful at growing without international expansion. Southwest Airlines is the only U.S. passenger airline that has made a profit every year since the industry was deregulated in 1978. Its share of the market grew from less than 1 percent to 5 percent in 2002 (ATA Annual Report 2002). It is now the eighth largest U.S. airline (ATA Annual Report 2002). It has grown primarily from internal growth: Its only acquisitions were of Muse Air Corporation in 1985 and Morris Air in 1993 (Rakowski and Bejov 1992). Southwest has been able to achieve its profit position because of its strategy. Southwest utilizes only 737 aircrafts, which are the most fuel-efficient aircraft. In addition, these planes only require a two-person cockpit crew. Southwest is referred to as the "no frills" airline. Meals are not served, and each seat in the plane is the same as all the others. Southwest does not utilize a hub-and-spoke operating system. It takes the position that each lane segment (pair city) must pay for itself. For

148

Growth from Chaos

example, if the lane segment between Tucson and Santa Fe will not yield a profit, Southwest will not offer the service. There is a flip side to Southwest's strategy. Although the 737 is the most economic aircraft, it has very limited range: It can only fly approximately 2,200 nautical miles. Because Southwest cannot fly to transoceanic international markets, this is a significant disadvantage in a world where international travel is common. More important, this limitation may prevent Southwest from entering into one of the major, global strategic alliances. Because most of Southwest's segments are short haul, it competes with ground transportation to a greater degree than the major airlines. The other major carriers have much longer average hauls and are not affected as much by other modes of transportation. Alaska Airlines

Alaska Airlines was the #11 revenue-based carrier in 2002 (ATA Annual Report 2002). In the late 1970s and early 1980s, Alaska began to service cities along the West Coast of the United States. Anticipating further expansion, the airline formed Alaska Air Group as a holding company in 1985. Horizon Air, a Seattle-based regional commuter airline serving the Pacific Northwest, was purchased in 1986 (Alaska Airlines Annual Report 1986). Alaska Air then pressed ahead with further expansion into the California market (Rourke 2000b). In 1987, the company bought California-based Jet America Airlines, which was merged into Alaska Airlines. In an effort to compensate for the seasonal imbalance in travel to Alaska, much of which takes place during the summer, in 1988 the airline inaugurated service to the Mexican resort cities of Mazatlan and Puerto Vallarta. By 1989, the company served thirty cities in six western states outside Alaska, and 70 percent of its passengers flew south of Seattle (Rourke 2000b). Alaska Airlines continued it emphasis on customer service, stressing higher-quality food and more legroom on its flights than other airlines (Rourke 2000b). The airline further expanded in 1991, adding international destinations in Russia and Toronto (Rourke 2000b). In early 1995, Alaska and Horizon Air expanded West Coast routes to capitalize upon a new "open skies" agreement between the United States and Canada. Alaska Air also added new destinations in Russia (Rourke 2000b). In 1996, Alaska Air conducted the first commercial passenger flight using Global Position System (GPS) navigation technology. It announced plans to become the first airline in the world to integrate GPS and Enhanced Ground Proximity Warning System (EGPWS) technology. This technology utilizes a real-time, three-dimensional display of


149

the terrain. The system became operational in all the carrier's Boeing 737-400s in 1999 (Rourke 2000b). With the growing success of low-cost-low-fare carriers, Alaska Airlines changed its strategy in the late 1990s. By streamlining its cost structure, increasing aircraft utilization, and maintaining a competitive advantage in customer service, Alaska Airlines reshaped itself into a profitable airline (Rourke 2000b). With its market presence on the West Coast, Alaska Airlines was able to increase its passenger traffic and improve profitability. An aggressive fleet modernization plan and a nationally recognized commitment to technological innovation have positioned the airline well early in the twenty-first century (Rourke 2000b). Continental Airlines

Continental Airlines was the #10 revenue-based carrier in 1977 and #7 in 2001. However, it has gone through Chapter 11 bankruptcy twice. The deregulation of the airline industry resulted in substantial competition from other airlines in some of Continental's most profitable markets (Whiteley 1998). In 1980, Texas Air Corporation increased its ownership of Continental from 4 percent to more than 50 percent (Whiteley 1998). Texas Air completed the full acquisition of Continental Airlines in 1982. Continental filed for Chapter 11 bankruptcy protection in 1983 and emerged from such protection in 1984. Texas Air then began acquiring numerous other airline companies facing bankruptcy, including Eastern Airlines, People Express Airlines, and Frontier Airlines. These new subsidiaries combined with Continental to place Texas Air Corporation more than $4.6 billion in debt (Whiteley 1998). In late 1990, fuel prices were at a high point and passenger traffic was at a low point due to the effects of the Persian Gulf War. Continental once again filed for protection under Chapter 11 of the federal bankruptcy code, joining fellow subsidiary Eastern Airlines. Eastern could not recover and was forced to liquidate in 1991 (Whiteley 1998). In 1993, Continental emerged from bankruptcy and underwent an extensive reorganization. All of the Continental Airlines Holdings, Inc., subsidiaries and divisions were merged into Continental Airlines, and new stock was issued to replace any previously outstanding publicly held interests in the former parent company (Whiteley 1998). As the 1990s drew to a close, the company focused on high-paying business travelers. To do so, it created bonuses for on-time performance as a means of improving the company's dismal last-place standing among major airlines for on-time performance in 1994. By early 1995, the airline had risen to a first-place rank for the first time in the company's history for on-time performance (Whiteley 1998).

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Growth from Chaos

Continental ended 1995 with the largest annual profit in its history ($224 million) (Continental Airlines Annual Report 1995). In 1997, Continental ended with its largest annual profit ($640 million) and began service to Brazil (Continental Airlines Annual Report 1997). In 1998, Continental and Northwest Airlines began a code-sharing alliance on domestic and international flights (Continental Airlines Annual Report 1998). In 1999, Continental began code-sharing alliances with Alaska Airlines and COPA Airlines (South America) (Continental Airlines Annual Report 1999). Also in 1999, Continental's fleet became the youngest among the ten largest U.S. airlines, and the company acquired a minority position in Gulfstream International Airlines, a Florida-based regional carrier (Continental Airlines Annual Report 1999). In 2001, Continental and Trans Brazil formed a strategic marketing code-sharing alliance (Continental Airlines Annual Report 2001). As of 2002, Continental Airlines had strategic alliances with the following carriers: Air China, Air Europa (Spain), Alaska Airlines, America West, CommutAir (New England), Copa Airlines (South America), Emirates (United Arab Emirates), EVA Air (Asia, Australia), Gulfstream International Airlines, Hawaiian Airlines, Horizon Air (West Coast), KLM Royal Dutch Airlines, Northwest Airlines, and Virgin Atlantic Airways (United Kingdom) (Continental Airlines Annual Report 2001). American Trans Air (ATA)

ATA was originally founded as Ambassadair in 1973; its original market was the travel club charter market. In 1981, ATA received its certification as a charter carrier and added eight Boeing 707s to the fleet. It began flying charters for the U.S. Department of Defense (Ingram 2000). In 1985, ATA became the largest charter in North America and added Lockheed L-lOlls to its fleet (Ingram 2000). In 1986, ATA launched scheduled service between Indianapolis, Indiana, and four destinations in Florida. As a scheduled passenger carrier, ATA sought to distinguish itself by keeping its fares low and imposing few restrictions on travel times (Ingram 2000). In 1989, ATAbegan operating four Boeing 757s, and created ATA ExecuJet, a corporate jet and helicopter charter service. A freight-handling subsidiary was created in 1991. During the Persian Gulf War, ATA carried more troops (108,000) for the U.S. military than any other civilian airline (Ingram 2000). In 1992, ATA initiated service from ChicagoMidway and added Boeing 727s to its fleet. ATA completed an initial public offering (IPO) on the NASDAQ in May 1993. Until that point, founder George Mikelson had been the company's sole shareholder; after the IPO, he retained a 73 percent


151

stake in ATA. The $40 million ATA raised through the IPO helped strengthen its debt-heavy balance sheet, while the remainder of the funds were used for buying planes (Ingram 2000). ATA opened a new reservations center in Chicago in 1993. Scheduled flights accounted for 20 percent of ATA's revenues of $468 million in 1993. Vacation traffic accounted for 80 percent of its revenues. In 1994, ATA aligned with Pleasant Hawaiian Holidays, the largest Hawaiian tour operator, to provide scheduled service to Honolulu and Maui from both Los Angeles and San Francisco. In 1996, ATA and Chicago Express Airlines launched ATA Connection linking Grand Rapids, Des Moines, and Dayton with ATA's Chicago-Midway operation. ATA also launched its Web site, www.ata.com. In 1997, ATA added scheduled service to New York's JFK Airport and San Juan, Puerto Rico, from its mid western gateways. By 1998, ATA was the fourteenth largest airline in the country, as well as the country's largest charter operator (Ingram 2000). In March 1999, ATA bought out T.G. Shown Associates, Inc., which owned half of Amber Air Freight (Ingram 2000). Also in 1999, ATA surpassed $1 billion in annual revenues. In 2000, ATA received the designation of "Major Airline" by the U.S. Department of Transportation. In 2001, it developed a state-of-the-art training facility located in Chicago. ATA added e-ticket kiosks at Chicago-Midway and Indianapolis airports in 2001. In 2002, ATA initiated scheduled service to international destinations including Aruba, Cancun, Grand Cayman, and Guadalajara. The airline also began nonstop service to New York-LGA and Phoenix from Indianapolis. In 2002, ATA applied for assistance under the Air Transportation Stabilization Act. America West

America West Airlines is a major airline founded in the wake of the deregulation of the American airline industry. It is the only major passenger airline that began operations after deregulation that is still in business (Rourke 2000a). America West was incorporated in 1981 by ten investors. The carrier initiated service on August 1,1983, with three aircraft. In November 1984, the airline announced its first profitable month of operations, and in the following month it rejected an offer by rival Southwest Airlines to purchase the company (Rourke 1992). America West grew rapidly, and by 1990 it had achieved major-airline status, with annual revenue more than $1 billion. The company's strategy was to make Phoenix an east-west transfer point for travelers from midwestern cities to California. With business

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travelers as its targeted market, America West aimed to increase passenger traffic on the routes it served through a combination of fullquality service, frequent flights, and low fares (Rourke 2000a). By 1987, America West had opened a second hub of operations in Las Vegas. In May 1987, America West began service to Chicago's O'Hare International Airport. Later in 1987, it began to offer service from Phoenix and Las Vegas to Baltimore and New York (Rourke 2000a). In 1987, a one-fifth stake in America West was purchased by Ansett Airlines, an Australian airline (Rourke 2000a). In 1990, America West was reclassified as a major airline by the U.S. Department of Transportation, and the company's sales rose as the airline carried 40 percent more revenue passenger miles than it had in the previous year (Rourke 1992). However, high fuel costs and heavy interest payments on its large debt depressed earnings. To counteract its higher costs, America West raised fares by 10 percent in August 1990 (Rourke 2000a). This action turned out to be a mistake. The war in the Persian Gulf in early 1991 had cut air traffic dramatically. By the middle of the year, it was clear that America West's expansion had left it with too small a financial cushion. Although the airline had grown to the point of serving fifty-four cities with a fleet of 109 planes, 87 of those aircraft were leased from their owners. The need to make interest payments on these planes forced the airline to file for bankruptcy under Chapter 11 of the Federal Bankruptcy Code on June 27, 1991. The airline petitioned for protection from its creditors while it attempted to reorganize its finances without being forced to suspend operations (Rourke 1992). America West developed a new strategy as it exited Chapter 11. America West's strategy was to open a hub in Columbus, Ohio. By operating from the Ohio hub, the company could avoid damaging competition from Southwest Airlines and gain profitable business fliers from the area's high concentration of corporate headquarters. In March 1992, America West began to service the Florida market (Rourke 2000a). Record profits in 1995 fueled further expansion around the Phoenix hub. The airline added six routes from Acapulco to Anchorage. America West felt there was enough room for it and Southwest Airlines to coexist in Arizona, which had one of the fastest-growing economies in the United States. America West specialized in longer trips than Southwest, which typically operated point-to-point routes (Rourke 2000a). America West utilizes its Phoenix and Las Vegas hubs as gateways for travel throughout its route network. The airline has a complete line of aircraft consisting of Airbus A320s, Boeing 757s, and Boeing 737s. By the end of 2004, America West expects to take ownership of thirty-one Airbus aircraft—including the new 110-seat A318, which will be integrated in 2003 (Rourke 2000a).


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America West Express regional service is provided by code-sharing agreements with Mesa Airlines, Air Midwest, and Chautauqua Airlines. Through an agreement with Mesa Airlines Group, America West will continue to extend its route system as the America West Express regional flight grows from twenty-four to seventy-seven aircraft by 2005. America West further enhances its operational strength through a code-sharing agreement with Continental Airlines, the nation's seventh largest domestic carrier. This code-sharing agreement was the first extensive agreement of its kind between two major U.S. carriers. America West also maintains code-sharing agreements with British Airways, Northwest Airlines, Big Sky Airlines, and Taiwanese Airways (Rourke 2000a). Following the tragedies of September 11, demand for air travel dropped precipitously, security and insurance costs increased dramatically, and potential sources of financing became very scarce. Under the Air Transportation Safety and Stabilization Act, America West received approval in January 2002 for approximately $380 million in federal loan guarantees. This enabled it to close a term loan in the amount of $429 million and triggered more than $600 million in contributions and concessions from aircraft lessors, suppliers, and creditors. As part of this financial restructuring, America West issued warrants to the U.S. government representing approximately one-third of the company's common stock. The loan conditions also called for a commitment on the part of America West to control the growth of its labor costs over the course of its seven-year business plan. AIR FREIGHT

Up to this point, we have been discussing the U.S. passenger airline industry. In terms of total operating revenues, four air freight firms occupy top positions: #3 FedEx, #9 United Parcel Service, #12 DHL, and #15 Airborne Express. None of these firms were among the top fifteen firms in 1977 (ATA Annual Report 1978). We do not think of them as airlines because they transport air freight. However, they are classified as airlines. UPS and FedEx

Two firms, FedEx and UPS, dominate this transportation segment (Valentine 2002). The growth of these firms since deregulation is depicted in Table 7.2. Table 7.2 identifies the growth patterns of FedEx and UPS in a deregulated airline industry. The patterns of the two firms are similar. Immediately after the industry was deregulated, FedEx began to in-

Table 7.2 Growth Paths of FedEx and United Parcel Service (UPS)

Date 1978 Early 1980s 1982

UPS More fully developed ground hub-and-spoke operating system

FedEx More fully developed air network—began flying 727, DC-10 aircraft

Acquired international courier firms

Developed secondary hubs

Entered air express market

1984

Acquired Gelco—positions in Europe, Asia

1985

Acquired Road Package Service (RPS)

1989

Tracking, international acquisitions

Acquired Flying Tigers

1993

Logistics service

Logistics service

1994

Web site functional

Internet service

1995

Acquired Sonic Air—same-day service

Acquired Evergreen Int.

1997

International expansion

1998

UPS capital-financial products and services

Opened hub in Subic Bay, Philippines

1999

Sold 10 percent of stock on NYSE

Electronic shipping system

2000

Formed e-logistics, e-business supply chain management

Acquired Tower Group

2001

Service to China alliance with Sinotrans

Alliance with United States Postal Service

Source: FedEx: Adapted from Bruner and Buckley (1995), and FedEx Annual Report and UPS Annual Report 1978-2001.


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ternally develop its air infrastructure network. With deregulation, FedEx was permitted to fly 727 and DC-10 aircraft as opposed to falcon jets. Falcons were the only aircraft FedEx was permitted to fly during the regulated period. Operating larger aircraft gave it a tremendous scale advantage because the payload of a falcon aircraft is approximately 5,600 pounds; a 757 freighter can carry approximately 80,000 pounds; a 767 freighter can carry approximately 125,000 pounds; a DC-10 freighter can carry approximately 155,000 pounds; and a 747 freighter can carry approximately 240,000 pounds (Freighters 2001). This provided FedEx with a substantial scale advantage over its competition. For UPS, the deregulation of the trucking and airline industries enabled it to more fully develop its national ground hub-and-spoke operating system. After deregulation, UPS began to utilize the commercial airlines to significantly increase its presence in the second-day air market. During the early 1980s, UPS made a number of international acquisitions to begin to build its European network. About the same time, FedEx acquired Gelco, which gave FedEx access to eighty-three other countries. During the 1980s, both firms began to enter their competitors' core markets. In 1982, UPS paid $1 billion for a fleet of aircraft and opened its primary air hub in Louisville, Kentucky. This made UPS a direct competitor of FedEx in the overnight air package market. FedEx responded to the challenge in 1985 by purchasing Caliber from Roadway Trucking. A primary subsidiary of Caliber was Roadway Package Service (RPS), the second-largest (UPS was first) carrier of ground packages. Both firms now had integrated, air-ground hub-andspoke operating systems. During the 1980s, UPS acquired several courier firms in Europe. In 1989, it engaged in additional international acquisitions. In 1989, FedEx further expanded its air freight business to Asia with the purchase of Flying Tigers for $880 million. This acquisition provided FedEx access to many Pacific Rim markets (FedEx Annual Report 1989). In 1993, both firms internally developed logistics service to take advantage of the growth in that industry segment. In 1994, both firms launched Web sites. In 1995, UPS acquired Sonic Air, a same-day service provider, to compete with FedEx's same-day service. In 1995, FedEx acquired Evergreen International. In 1999, UPS formed a strategic alliance with 7-Eleven in Hong Kong for drop-off service. Also in 1999, UPS and Hewlett-Packard developed an alliance for sending and tracking paper-based documents over the Internet. Both firms began e-commerce services in 2000. In 2001, FedEx was granted permission by the U.S. Department of Transportation to offer direct service to China. FedEx then opened an intra-Asian hub in the Philippines. In 2001, FedEx entered into an alii-

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ance with the U.S. Postal Service and also acquired American Freightways and Viking Freight. The same year, UPS entered into a strategic alliance with Sinotrans, an intra-China transportation firm. In 2001, UPS entered into an alliance with Tandata to provide shipment tracking and rating for small and medium businesses. Also in 2001, UPS established an alliance with Expresso Mercurio, Brazil's largest ground transportation carrier. UPS acquired Tandata in 2002. In 2002, UPS also developed a hub-and-spoke system in the Philippines for intra-Asia shipments. In 2002, FedEx developed oceanground distribution and air-ground distribution, which offers ocean transportation from Asia and Europe to ports within the United States. Also in 2002, FedEx entered into an alliance with Fran Maas Group N.V., a European firm specializing in international freight forwarding and logistics. The actions and reactions of both UPS and FedEx have been a classic example of competitive dynamics (Hitt, Ireland, and Hoskisson 2001). When one firm makes a move, the other firm makes a countermove. Although complex, their growth patterns have been quite similar. There is only one fundamental difference between their growth processes: how each firm entered the other's core business. UPS internally developed its own air fleet and air hub system to enter the overnight air market. FedEx acquired RPS to compete in UPS's core market of ground delivery. Both firms now have significant revenue and profit stream that are not in their core business. UPS's core business, ground shipping, represents only 51 percent of its total revenue; domestic U.S. air service represents 27 percent and international operations represents 19 percent (Valentine 2002). FedEx's core business, domestic air, represents only 55 percent of its total revenue in 2001; U.S. ground shipping accounts for 16 percent and international operation accounts for 20 percent (Valentine 2002). The other 8 percent of UPS revenue and 7 percent of FedEx's revenue are made up of other related transportation services (e.g., logistics) (Valentine 2002). One important fact is that neither firm developed or acquired totally new resources. We will see throughout this book that the development of new resources is not required to generate firm growth. It is interesting to compare and contrast the growth of the U.S. airlines with UPS and FedEx. Since deregulation, the U.S. airlines' cumulative industry profit has been negative (Department of Transportation—Form 41,1978-2002). On the other hand, FedEx's cumulative profit has been $4.38 billion (FedEx Annual Reports 1979-2001). UPS's cumulative profit has been $38,875 billion (UPS Annual Reports 1979-2001).


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Airborne Express

FedEx and UPS are not the only air freight carriers that have entered the top fifteen airlines. Airborne Express was the fifteenth ranked revenue-based airline in 2001 (ATA Annual Report 2002). Today, Airborne Express is the third largest player in the U.S. freight industry. Although Airborne is a primary competitor of FedEx and UPS, it is a much smaller player: Its revenues for 2001 were $2.85 billion compared to UPS's revenues of $30.6 billion and FedEx's of $19.6 billion (Airborne Express, UPS, FedEx Annual Reports 2001). During the 1970s, Airborne Express maintained the role of air freight forwarder. An air freight forwarder does not own its aircraft; it either leases aircraft or uses the commercial airlines or contract carrier airlines. In the late 1970s, Airborne became interested in the air express business and began expanding operations by purchasing its own aircraft and constructing a hub in Ohio (Jeromski 2000). Deregulation of the airline industry in 1978 gave air carriers the liberty to fly anywhere in the United States using any size aircraft. A carrier could construct a hub, purchase a fleet of aircraft, and directly enter the air express industry. In 1980, Airborne purchased Wilmington Airport, a former Strategic Air Force Command base in Wilmington, Ohio, to be used as its primary hub (Jeromski 2000). While upgrading the airport into a modern sorting and delivery center, the company increased its fleet of aircraft to include more than sixty DC-8s, DC-9s, and YS-lls (Jeromski 2000). Airborne faced tough competition in launching air courier services during the 1980s. The industry leader, FedEx, dictated market conditions. Emery Worldwide, the U.S. Postal Service's Express Mail, and Purolator Courier Corporation battled with Airborne for second place in the market and for a share of the profits (Jeromski 2000). UPS entered the industry in 1982. Competition among air express companies remained strong during the latter part of the 1980s due to several consolidation moves. In 1986, Emery Air Freight bought Purolator Courier Corporation; in 1989, FedEx purchased Flying Tigers for $880 million. Also in 1989, Consolidated Freightways bought the Emery and Purolator combination. Although Airborne did not make any acquisitions during this period, it grew by internally developing its network. In 1989, Airborne began negotiations to consolidate Airborne's Japanese interests with those of Japanese transport giant Mitsui & Company. Under the terms of the agreement, Airborne's operations in Japan would merge with Panther Express International, which was owned by Mitsui and Tonami Transportation Co.—also based in Japan. Airborne would receive $100 million for aircraft financing, and Mitsui

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and Tonami would invest $40 million in Airborne stock, allowing one member from each company to sit on Airborne's board (Jeromski 2000). Negotiations were successful and Airborne Express Japan became a reality in 1990, with Airborne owning 40 percent, Mitsui possessing 40 percent, and Tonami holding 20 percent of the new company. The company shipped freight, packages, and letters worldwide, providing Airborne, now the fourth largest air courier in Japan, with a solid Asian base of operations in a market growing at 25 percent per year (Jeromski 2000). The following year, Airborne entered into an alliance with Purolator Courier Ltd. to begin service to Canada. In addition to Japanese and Canadian interests, Airborne had offices in the Far East, Australia, New Zealand, and the United Kingdom. In 1991, Airborne reached ninety international markets, but international sales accounted for only 20 percent of its overall revenue (Airborne Express Annual Report 1991). I addition, Airborne's U.S. domestic market share was only 1 percent. The air carrier hoped that foreign expansion would increase its profits in the 1990s (Jeromski 2000). In the early 1990s, cutthroat competition reduced industry prices by 20 percent (Jeromski 2000). Unable to reduce costs any more, Airborne focused on finding high-growth related businesses. Logistics was an important source of new revenues; this service was begun in 1996 (Airborne Express Annual Report 1996). Airborne Logistics Services doubled in size between 1996 and 1999, when it accounted for $150 million in revenues (Airborne Express Annual Report 1999). In 1999, Airborne established a partnership with the U.S. Postal Service for the residential delivery market (Jeromski 2000). In 2001, Airborne launched ground delivery service and 10:30 A.M. air service (Airborne Express Annual Report 2001). DHL DHL is the twelfth largest U.S. airline. While FedEx and UPS were developing the U.S. air freight market, DHL was developing the international air freight market. DHL is often referred to as the FedEx of the international markets. In 1969, Adrian Dalsey, Larry Hillblom, and Robert Lynn (the D, H, and L in the company name) began DHL by operating a door-to-door express delivery service transporting documents only between San Francisco, California, and Honolulu, Hawaii. By the time FedEx commenced operations in 1973, DHL had existing service to the U.S. West Coast, much of the Pacific Rim, and Australia (Gross 1999). In 1974, DHL began operations in Great Britain (Gross 1999). In 1975, it began service to continental Europe and the Middle East. In 1977, it began to ship small packages; up until this time, its service had been for documents only (Gross 1999). Also in 1977, DHL


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began service to Canada. In 1978, DHL introduced operations in South America and Africa. In 1983, DHL began overnight service within the United States utilizing the U.S. airlines. Prior to 1983, it had not pursued business in the United States. To bolster its share of the American market, DHL built two major hubs at airports in Cincinnati and Salt Lake City and added nine mini-hubs in major cities across the country. The company also bought Boeing 727s and Learjets, as well as new sorting equipment (Gross 1999). In 1985, DHL began service to Europe and opened an international hub in Brussels, Belgium. In 1986, service to the People's Republic of China was formalized with a joint venture between DHL and Sinotrans. In 1988, DHL expanded the Cincinnati hub to provide for continued growth of its U.S. market. DHL Budapest was established as a joint venture with Hungary's state-owned transport company, Hungarocamion, in 1989 (Gross 1999). Also in 1989, DHL Worldwide provided service to 184 countries. In 1989, DHL had 5 percent of the U.S. domestic market (Gross 1999). In 1990, in order to infuse the company with fresh capital and take advantage of the resources of larger airlines, DHL sold parts of its business to three companies. Japan Air Lines and the German airline Lufthansa each purchased 5 percent, while Nissho Iwai, a Japanese trading company, purchased 2.5 percent (Gross 1999). To increase its position in the cargo market, DHL entered the freight services industry and began carrying heavier cargo. In June 1992, all three of DHL's major shareholders exercised their option to increase their shares in DHL International; Japan Air Lines and Lufthansa each increased their stake to 25 percent, and Nissho Iwai's holdings grew to 7.5 percent (Gross 1999). This was also the year DHL began service to Albania, Estonia, Latvia, Greenland, and Kuwait. In addition, DHL signed an agreement to share transatlantic and European aircraft operations with one of its competitors, Emery Air Freight (Gross 1999). In 1996, DHL opened its Asia Pacific hub in Manila, Philippines. A high-tech Express Logistics Centre was opened in Singapore, and Internet tracking of shipments was introduced in 1997 (Gross 1999). By 1998, DHL served 227 countries (Gross 1999). In 2001, it announced expansion of its existing next-day express delivery service to all major business centers in the European Union. The same year, DHL and Northwest Cargo entered into an alliance to transport freight between the United States and Asia. This agreement with Northwest reinforced DHL's leading market position along the Pacific Rim. In 2002, Deutsche Post became a majority shareholder by acquiring 51 percent of DHL (Deutsche Post Management Report 2002). This own-

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ership position is important because Deutsche Post owns Danzas, a Swiss air freight forwarder and logistics firm that was acquired in 1998. Danzas had made several air freight acquisitions before being acquired by Deutsche Post. Danzas

Danzas's international expansion began with the acquisition of British Gentransco Group in London, after which it established new subsidiaries in Belgium and The Netherlands. In 1984, Danzas began service to Australia. In 1985, it acquired several distribution companies in France and Spain. To service the United States, Danzas Tuya S. A., a Panamanian-registered company, was started in Miami, Florida (Siewert2001). In 1987, Danzas acquired SBT NV in Belgium. Also in 1987, it began service to Japan, Taiwan, and Hungary. With the purchase of Northern Air Freight of Bellevue, Washington, in 1989, Danzas had established service to forty-one U.S. states (Siewert 2001). In April 1999, Danzas acquired Sweden's ASG AB for E374 million. The company immediately followed that purchase with the acquisition of The Netherland's Nedlloyd's ETD. In 1999, Danzas announced its intention to acquire Air Express International, the leading freight forwarder in the United States, for $1.4 billion. These three purchases helped to triple the company's sales; by the end of 2000, Danzas had become an international giant with sales of nearly SFr 12 billion and leading positions in global markets, including the European leadership position in cargo and worldwide leadership in air cargo transport (Siewert 2001). The acquisition of Air Express International (AEI) was important for Danzas: AEI was a large air freight forwarder based in Connecticut but with substantial positions in international markets. AEI

In 1960, AEI operations expanded into the South Pacific and the Far East. By 1968, AEI also began doing business in Africa. AEI continued to grow in the United States and Canada during the 1970s, and it opened offices in South America in 1979 and in the Middle East in the early 1980s. AEI introduced innovations such as scheduled charter services across the Atlantic and door-to-door package service. In 1986, it created a worldwide shipment tracking system (Keeley 1996). In 1987, AEI became one of the first U.S. forwarders to develop a European freight network by acquiring Pandair (AEI Annual Report 1987). AEI also maintained its technological edge by achieving the first


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mainframe-to-mainframe electronic data interchange (EDI) with several airlines in 1990 (Keeley 1996). In 1993, the company purchased Votainer International, one of the world's largest vessel operating common carriers (AEI Annual Report 1993). Headquartered in Rotterdam, Votainer had offices in twelve European countries with annual revenues of more than $100 million. AEI thus acquired an instant network of global offices and ocean freight positions. It also acquired two air freight companies in the United Kingdom, as well as Banner International in New Zealand and Pace Express Pty. Ltd. in Australia. These companies, which had combined annual revenues of $50 million, were blended into AEI's existing operations (Keeley 1996). By the end of 1994, sea-freight forwarding accounted for about 12 percent of AEI's revenues. Also in 1994, AEI became the first major U.S. transportation company to obtain ISO 9002 status (Keeley 1996). This designation, part of the ISO 9000 quality standards series set by the International Organization of Standardization, was highly valued by European clients (Keeley 1996). In May 1995, AEI acquired Radix Group, Inc., a leader in customs brokerage services. Radix had a network of twenty-three domestic offices, gross revenues of $65 million, and air freight and ocean freight forwarding divisions (Keeley 1996). The acquisition of AEI by Danzas made the combined firms the number one air freight forwarder in the world and one of the top five revenuebased ocean freight firms (Siewert 2001). In addition to owning DHL, Danzas, and AEI, Deutsche Post had previously acquired majority positions in ground parcel delivery companies in Austria, France, Poland, Belgium, Italy, Spain, Portugal, and the United States. As a result of these acquisitions, Deutshe Post has become one of the largest transportation firms in the world. U.S. AIRLINE INDUSTRY'S STRATEGIC WEAKNESSES

In 1977, there were no air freight carriers in the top fifteen revenuebased airlines (ATA Annual Report 1978). By 2001, FedEx was the #3 airline, UPS Air was #9, DHL Airways was #12, and Airborne Express was #15. Because the U.S. airlines do not address freight, these air freight carriers now have the only profitable positions (except Southwest) within the top fifteen revenue-based airlines. In contrast, the airlines have remained focused upon the same customers since 1978—the passengers. Initial firm size may be important but may not be a sufficient condition for long-term growth. The numbers 1, 2, 5, 7, and 12 revenuebased airlines in 1977 have survived in a deregulated environment. However, Southwest and Alaska Airlines, which were not even in the

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top fifteen revenue-based carriers in 1977, have been successful in the deregulated environment. United Airlines, the #1 ranked revenuebased airline in 1979, is in Chapter 11 bankruptcy protection. American Airlines, the #2 airline in 1979, is very close to entering Chapter 11. Delta, the #5 carrier in 1979, and Northwest, the #7 carrier in 1979, have posted their largest losses ever during the past three years. U.S. Air, the #12 carrier in 1979, was in Chapter 11 for the first quarter of 2003. It has continued to incur significant losses. The growth pattern of the major airlines (Figure 7.1) shows that they have substantially increased the scale of their coverage but have not moved into related segments. Remember the discussion of flexibility from Chapter 1. The airline industry has not utilized strategic flexibility to move into related transportation segments as the air freight industry players have. The U.S.-based airlines have not undertaken related expansion of their resource base. This is not true of airlines in Europe and Asia. Many airlines in these markets are combination carriers, which transport both passengers and freight. These airlines remained profitable during 2001 and 2002. Freight represents a very small portion of the U.S. airlines' revenue stream. Had the U.S. airlines fully developed air freight as a business, UPS and FedEx might not have achieved the dominant position they hold in air freight transportation today Remember the discussion of organizational rigidity in Chapter 1. The entire U.S. domestic airline industry is a good example in which rigidity negatively impacts growth and profitability. By the airlines rigidly focusing upon one customer (the passenger) since deregulation, other types of carriers (air freight) have established significant positions with the airline industry Is it too late for the U.S. airlines to engage in development of related transportation? For carriers such as United, American, and most of the other players in the industry, it probably is. The air freight business is very different from the airline business. U.S. airline carriers cannot simply begin to offer air freight. Refer back to the discussion of air freight in Chapter 2. Shippers require door-to-door service with technology features such as package tracking and other support services. For the airlines to develop and integrate a ground hub-and-spoke operating system and integrate this network with their air hub-and-spoke network and add technology features may be too much of a stretch of their resource base. More important, these capabilities are too expensive: Many U.S. airlines are too financially leveraged; most have debt-to-equity ratios in excess of 60 percent (Hallett 2002). This inability to enter related transportation segments is complicated by the economic recession and the aftermath of the events of September 11 and the second Gulf War. However, a small number of airlines may have some other options.


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GROWTH OPTIONS FOR THE U.S. AIRLINE INDUSTRY

To buffer against fluctuations in passenger demand, one of the large airlines, such as Southwest, may benefit significantly from an alliance with DHL. The airline would need to make a commitment to air freight, which it has not done. The benefit for making a commitment to freight is that the U.S. airline may achieve economies of scope from its resources. Air freight predominately moves at night whereas passenger traffic moves predominately during the day. Dual utilization of these aircrafts would provide economies of scope and may significantly reduce the variable cost structure of the airlines. By undertaking dual utilization of the fleet to transport both passengers and freight, variable costs would be reduced versus competitors that do not offer such services. Variable costs are substantial for the U.S. airlines. According to reports filed with the Department of Transportation in 1999, airline costs were as follows: Flying Operations, 27 percent— essentially any cost associated with the operation of aircraft, such as fuel and pilot salaries; Maintenance, 16 percent—both parts and labor; Aircraft and Traffic Service, 16 percent—basically the cost of handling passengers, cargo, and aircraft on the ground and including such things as the salaries of baggage handlers, dispatchers, and airline gate agents; Promotion/Sales, 13 percent—including advertising, reservations, and travel agent commissions; Passenger Service, 10 percent—mostly inflight service and including such things as food and flight attendant salaries; Administration, 10 percent; and Ground Operations, 8 percent (ATA Handbook 2001). Labor costs are common to nearly all of these categories. When taken as a whole, labor accounts for 35 percent of the airlines' operating expenses and 75 percent of controllable costs (ATA Handbook 2001). With variable costs dominating the cost structure of the U.S. airlines, it would be advantageous for them to achieve economies of scale and/or economies of scope. By engaging in this type of strategy, they would be able to lower their costs through growth rather than through the massive cost cutting they are now implementing. The benefit to DHL would be an increase in U.S. coverage, where it would become a much more significant competitor to UPS or FedEx. The U.S airlines do not have the ground networks in place that UPS and FedEx have. Virtually all DHL shipments require door-to-door service (from point of pick-up to point of delivery), which puts the U.S. airlines at a distinct advantage versus the U.S. air freight carriers. The alliance with DHL would help to eliminate this limitation. Strategic alliances with LTL trucking firms would be another possibility for the U.S. airlines; alliances with major railroad systems would be yet another. For the U.S. airlines, joint alliances with both LTL truck-

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ing and railroads may be an even more attractive option. The key point is that if the airlines do not move to develop, acquire, or establish strategic alliances in related businesses, their revenue stream will continue to be dependent upon passengers. Remember Levitt's (1960) depiction of the rail industry: The airline industry has too narrowly focused its customer base upon passengers rather than transportation. The air freight players have developed related transportation businesses and have greater flexibility than the U.S. airlines. In addition, these carriers have capital to fund significant growth investments. GROWTH OPTIONS FOR THE U.S. AIR FREIGHT INDUSTRY

In what direction will the air freight players move in the future? They already have a hub-and-spoke operating system that equals that of the airlines. Further, this system is not fully utilized. Although it is possible that the airlines do not have the capabilities to move into air freight, the reverse argument is not true for the air freight players. Because the resources of the air freight players are predominantly utilized at night, it may be possible for them to enter the U.S. passenger industry The aircraft would be utilized during the day for passenger traffic and at night for air freight. The air freight players already have the network in place to begin passenger service. The aircraft would be back at their origin airports significantly before freight would need to be loaded at night. At most airports, air freight aircraft remain parked during the day and evening. In addition, if the planes are utilized during the day, same-day freight transportation may be another growth opportunity for the air freight players. This dual utilization of aircraft for passenger and freight is not as straightforward as it appears. However, European and Asian airlines have been carrying substantial amounts of passengers and freight for years. The international market represents a significant growth opportunity for the U.S. air freight carriers. An alliance with DHL, Danzas, or both, through Deutsche Post, would provide one of the major U.S. freight players a distinct advantage over other competitors. DHL has the most comprehensive global coverage of any air freight firm. An alliance between DHL and FedEx or UPS would put the other U.S. air freight carriers at a distinct disadvantage internationally. DHL would benefit by having access to a much more extensive U.S. network. There is one other possibility. An alliance with Danzas would provide the major U.S. air freight players with an established infrastructure in Europe and, to a lesser degree, in Asia. With the established infrastructure comes an existing customer base in Europe and Asia. These additional Danzas customers could provide additional economies of scale for the U.S. air freight


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players' domestic network. In addition, this would provide U.S. air freight carriers access to the substantial network that Danzas holds from an ocean shipping perspective. The benefit to Danzas would be an existing infrastructure for the U.S. market. The U.S. air freight market is one in which Danzas has a smaller position than its position in Europe or Asia. A most interesting possibility would be an alliance between Danzas and major LTL carriers. The LTL carriers have more experience than either UPS or FedEx at handling the heavy freight that Danzas ships. Heavy freight door-to-door service within the United States would be very intriguing to Danzas. The benefit to the LTL carriers would be access to the infrastructure Danzas has in Europe and Asia. At present, the major U.S. LTL carriers do not have a substantially developed infrastructure in Europe or Asia. "How about if Danzas developed an alliance with one of the major U.S. airlines? You said the airlines need to expand into freight," the CEO said. "That is quite true," I replied; "the problem is the U.S. airlines have not developed the U.S. domestic air freight market. This is important because the major U.S. airlines do not have an integrated ground operating network to provide door-to-door service. The major LTL carriers do." "O.K, would Deutsche Post in its entirety benefit from an alliance with anyone?" the CEO asked. "Very much so: TNT Post Group," I said. "You need to explain this possibility," the CEO said. "TNT Post Group needs to be reviewed first," I stated. TNT Post Group (TPG)

TNT Post Group is a diversified transportation firm. It began in 1946 in Sydney, Australia, and expanded into New Zealand in 1964, the United States in 1969, Canada in 1970, and the United Kingdom in 1972 (Brass 1999). In 1973, TNT went into partnership with two West German companies to form an international ship brokering company, Montana TNT Pty Ltd. It also formed Kwikasair Ltd., an express delivery service between the United Kingdom and continental Europe. TNT's U.S. base also was expanded through the purchase in the same year of Overland Western Ltd., a trucking company operating in Ontario, New York, and Michigan. TNT also acquired Acme Fast Freight Inc. in the United States. The company also began developing a strong South American presence in 1973 when it bought 70 percent of the Brazilian transport group Pampa OTT and established Kwikasair Brazil (Brass 1999). TNT began ocean shipping across the Atlantic when it formed Trans Freight Lines in 1975. In 1980, the company changed its international focus to concentrate on the United Kingdom and Europe as its most

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important growth area. TNT continued to expand into Europe and in the United States, buying another trucking and warehousing company, Pilot Freight Carriers. Trans Freight Lines, an ocean subsidiary of TNT Limited, doubled its size by buying another container line, Seatrain International (Brass 1999). TNT took a significant step toward building a European freight network in 1983 when it brought Skypak, IPEC Holdings Ltd.'s international courier operations, which operated in twenty-six countries. Combined with TNT's existing courier networks, this gave TNT bases in forty-nine countries and provided access to Middle and Far Eastern markets. Four months after the Skypak acquisition, TNT bought IPEC Europe, the leader in the European international express freight market (Brass 1999). During the late 1980s, TNT expanded into Eastern Europe just in time for the collapse of the Eastern Bloc in 1989 and 1990. The company formed a joint venture with the Hungarian airline Malev in 1988, created TNT Aeroflot—a joint venture with Russia's Aeroflot—in 1989, and started a joint venture with Yugoslavia's airline JAT in 1990. As other countries in the region became liberalized, TNT began service throughout Eastern Europe. It also expanded in Southeast Asia, investing in joint ventures with the Philippine Aerospace Development Corporation to develop the Philippines as a regional hub (Brass 1999). In March 1992, TNT spun off its six U.S. regional motor carriers into TNT Freightways (renamed U.S. Freightways in February 1996). The initial public offering of 75 percent of the new company's stock raised $280 million and left TNT Limited with a 25 percent stake. Also in March 1992, TNT completed the acquisition of Chronoservice, a leading French express carrier, which filled a gap in the company's network of domestic express carriers in Europe. In 1992, TNT reached an agreement with FedEx whereby it would subcontract the delivery of inbound FedEx packages to ten European countries. Later in 1992 came the establishment of GD Express Worldwide (GDEW)—which enabled TNT to remove $600 million in long-term debt from its balance sheet— and the start of the TNT-PTT Post relationship (Brass 1999). In 1996, Koninklijke PTT Nederland (KPN) completed a friendly $1.58 billion takeover of TNT in one of the largest mergers in Dutch history. KPN also gained full control of GDEW as the other postal service partners in the venture sold out. The combination of PTT Post and TNT created the most extensive express mail network in Europe and one of the world's four largest time-sensitive distribution and logistics groups (along with United Parcel Service, FedEx, and DHL) (Brass 1999). TNT activities related to mail, express, and logistics were integrated into PTT Post. In 1998, PTT announced that it was splitting into two entirely independent, publicly listed companies: Royal KPN, which contained the


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company's telecommunications activities; and TNT Post Group (TPG), which took over the company's postal, logistics, and express mail services (Brass 1999). Also in 1998, TPG opened its European Express Centre (EEC) in Liege, Belgium. The EEC contains six state-of-the-art sorting units. It operates three sorting systems: one for documents, one for parcels, and one for aircraft containers. It processes all freight consignments within Europe and forms the link with the rest of the world. It is designed to handle 1,000 tons of freight per night, with the ability to add capacity for future growth. In 1999, TPG announced its acquisition of the Italian logistics company Tecnologistica, which operates in Italy, Germany, and France. Also in 1999, TPG and Kintetsu World Express established a strategic cooperation for the supply of integrated logistic solutions to customers in Europe and Asia. TPG will benefit from Kintetsu's strong and longstanding customer base in Japan and Asia and its global expertise in logistics and distribution services. Kintetsu will benefit from TPG's Asian and European networks, its global presence, and its expertise in express and logistics. Also in 1999, TPG and the Swiss Post established a strategic alliance in express and courier services. In 2000, TPG announced the acquisition of logistics provider CTI LOGISTX from rail carrier CSX Corporation. CTI is one of the leading third-party logistics providers in North America. As a result of this acquisition, TPG will further strengthen its leadership in automotive logistics and move into the top three largest logistics companies worldwide. TPG paid $650 million for CTI LOGISTX, which had annual revenues of around $500 million in 1999. On March 9, 2000, TPG, the British Post, and Singapore Post established a global joint venture in cross-border mail. The new company will have its headquarters in Belgium. TPG will have the major 51 percent stakeholding in the new alliance, with the British Post and Singapore Post each taking a 24.5 percent stake. TPG and the British Post provide the alliance with well-developed services throughout Europe and North America. Singapore Post has a state-of-the-art operation and established relationships throughout the Asia Pacific region. "How does Deutche Post benefit from this?" the CEO asked. I replied, "With the acquisition of CTI LOGISTX from CSX Corporation in 2000 and the strategic alliance with Kintetsu World Express in 1999 and Singapore Post in 2000, TPG has become a major player in logistics in Europe, Asia, and North America. Deutche Post would benefit greatly from this substantial logistics business and the extensive LTL network TPG has within the United States." "How does TPG benefit?" the CEO asked. I replied, "Both firms have extensive global transportation networks. TPG would benefit in terms

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of providing extensive international air freight and small-package coverage for TPG's U.S. domestic shippers and international customers that have multi-modal international needs. Remember, Dutsche Post has controlling interests in both DHL and Danzas." "This sounds as if the alliance would make both firms even stronger internationally," the CEO stated. "Very much so," I said; "in fact, within the United States, TPG would benefit from DHL's overnight air network and Danzas would benefit from TPG's extensive trucking network." LESSONS LEARNED—AIRLINES

1. Fully develop your infrastructure. It is of critical importance that your customers have access to a fully developed distribution network. Within the airline industry, the carriers that survived built national networks. Be certain to fully leverage this network. European and Asian airlines have remained profitable by having multiple revenue streams. By relying upon only passenger revenues, many of the U.S. airlines are sustaining record losses. 2. Utilize acquisitions to achieve multiple purposes. In this industry, acquisitions were utilized to obtain greater U.S. geographic coverage and to gain access to international markets. Delta's acquisition of Pan Am and American's acquisitions of TWA gave the acquiring carriers access to a substantial number of international markets. 3. Engage in international strategic alliances. Strategic alliances have much less risk in international markets than pursuing either direct entry or acquisition. Engaging in multiple strategic alliances enabled the U.S. airlines to establish global networks. LESSONS LEARNED—AIR FREIGHT

1. Integrate your resource positions. By fully developing a hub-andspoke system for air freight and ground delivery, resource positions can be fully utilized to achieve economies of both scope and scale. 2. Resources need to have flexibility. Much of the growth of both UPS and FedEx was in areas other than their core markets. Both firms utilized their resources (trucks, airplanes) and capabilities (hub-andspoke network) to fully develop integrated transportation networks. 3. The development of your infrastructure can be a barrier to entry. Developing both air and ground hub-and-spoke operating systems is very expensive. In addition, the acquisition of a large fleet of aircraft and delivery vehicles is quite expensive. Very large capital expenditures make it difficult for competitors to catch up. Most competitors cannot afford to purchase a fleet of airplanes and a large fleet of delivery vehicles. Integrating these two networks becomes even more ex-


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pensive. Other industries do not require the fixed costs that the air freight industry requires. 4. Use acquisitions wisely. Firms made acquisitions of targets that not only had U.S.-based operations but also had established international networks and customers. 5. Development of the international markets is critical for growth. Based upon the success of their U.S. domestic air freight business, UPS and FedEx were able to develop networks internationally. These networks provided additional economics of scale for their U.S. domestic systems. 6. Invest in logistics. Firms realized that logistics was a very high growth segment, and the air freight players developed logistics capabilities for both U.S. domestic and international shippers. 7. Be wary of international competitors. Competitors such as Deutsche Post and/or TPG could become very significant players in the U.S. transportation industry. This is a significant issue because President Bush proposed to increase permissible foreign ownership of U.S. airlines from the current 25 percent to 49 percent. This proposal would raise the maximum percentage of an air carrier's voting stock that can be held by foreign citizens to 49 percent, but would not affect current law or Department of Transportation precedent that requires U.S. airlines to be controlled by U.S. citizens (Wall Street Journal, July 22,2003). "These results are very interesting," stated the CEO. "Some firms were quite successful, while a majority of the others did not survive. I wonder if these results would be the same in other industries?" "Well, the only way to know is to conduct the research. Do you have a specific industry that you would like me to analyze?" I asked. " If I remember, Theodore Levitt was critical of the rail industry," the CEO stated. "Yes, Levitt was quite critical of the railroads," I replied. In 1960 Levitt observed the following: The railroads did not stop growing because the need for passenger and freight transportation declined. That grew. The railroads are in trouble today not because the need was filled by others (cars, trucks, airplanes, even telephones), but because it was not filled by the railroads themselves. They let others take customers away from them because they assumed themselves to be in the railroad business rather than in the transportation business. The reason they defined their industry wrong was because they were railroad-oriented instead of transportation-oriented; they were product-oriented instead of customeroriented, (p. 46) "O.K., let's see what happened to the railroads," the CEO decided.

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REFERENCES

Air Express International (AEI) Annual Report. 1987,1991,1993. Airborne Express Annual Report. 1990,1991,1996,1999,2001. Seattle, Washington. Air Transport Association (ATA) Annual Report. 1978, 1991, 2000, 2001, 2002. Washington, D.C Air Transport Association (ATA) Handbook. 2001. Washington, D.C. Alaska Airlines Annual Report. 1986. Seattle, Washington. American Airlines Annual Report. 1982,1987,1991,1995,1998,2001. Dallas, Texas. Brass, A. 1999, "TNT Post Group." International Directory of Company Histories 24:472-474. Brenner, M. 1988. "Airlines Deregulation: A Case Study in Public Policy Failure." Transportation Law Journal 16:179-228. Bruner, R., and D. Bukley. 1995. "The Battle for Value: Federal Express Corporation vs. United Parcel Service." University of Virginia Darden School Case. Continental Airlines Annual Report. 1995,1997,1998,1999,2001. Houston, Texas. Delta Airlines Annual Report. 1978,1979,1987,1996,1997,1998,1999,2000. Atlanta, Georgia. Deutsche Post Management Report. 2002. Hamburg, Germany. FedEx Annual Report. 1978,1979,1980,1981,1982,1983,1984,1985,1986,1987, 1988,1989,1990,1991,1992,1993,1994,1995,1996,1997,1998,1999,2000, 2001. Memphis, Tennessee. Freighters. 2001. United Kingdom: Tabmag Publishing. Gross, D. 1999. "DHL Worldwide Express." International Directory of Company Histories 24:133-135. Hallett, C. 2002. "State of the U.S. Airline Industry: A Report on Recent Trends of U.S. Air Carriers." Washington, D.C: Air Transport Association. Hitt, M., R. Ireland, and R. Hoskisson. 2001. Strategic Management: Competitiveness and Globalization. Mason, OH: Southwestern. Ingram, L. 2000. "Amtran Inc." International Directory of Company Histories 34: 31-33. Jeromski, G. 2000. "Airborne Freight Corporation." International Directory of Company Histories 34:15-17. Keeley, C. 1996. "Air Express International." International Directory of Company Histories 13:19-21. Levitt, T. 1960. "Marketing Myopia." Harvard Business Review (July-August). Lufthansa Management Report. 2001. Dusseldorf, Germany. Murphy, K. 2002. "U.S Airlines Presentation." Morgan Stanley Dean Witter. Northwest Airlines Annual Report. 1986,1988,1990,1991,1993,1994,1995,1996, 1997,1999,2001. Eagan, Minnesota. Rakowski, J., and D. Bejov. 1992. "Structural Change and the Nature of Competition in the Deregulated U.S. Airline Industry." Transportation Practitioners Journal 5. Rourke, E. 1992. "America West Airlines." International Directory of Company Histories 6: 72-74. . 2000a. "America West." International Directory of Company Histories 34: 22-26.


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. 2000b. "Alaska Air Group." International Directory of Company Histories 29:11-13. Siewert, C 2001. "Danzas." International Directory of Company Histories 40:136139. Simley, J. 1995a. "American Airlines." International Directory of Company Histories 1. . 1995b. "Delta Airlines." International Directory of Company Histories 1. . 1995c. "Northwest Airlines." International Directory of Company Histories 1. . 1995d. "U.S. Air." International Directory of Company Histories 1. TWA Annual Report. 1987. New York. United Airlines Annual Report. 1982,1985,1986,1991,1992,1994. Chicago, Illinois. United Parcel Service (UPS) Annual Report. 1978, 1979, 1980, 1981, 1982, 1983, 1984,1985,1986,1987,1988,1989,1990,1991,1992,1993,1994,1995,1996, 1997,1998,1999,2000,2001. Atlanta, GA. U.S. Air Annual Report. 1979,1990,1998. Arlington, Virginia. U.S. Department of Transportation. Bureau of Transportation Statistics. 19772001. Air Carrier Financial Report, Form 41. Washington, D.C: U.S. Department of Transportation. Valentine, J. 2002. "Freight Transportation Industry and Valuation Overview." Morgan Stanley Equity Research. Wall Street Journal. 2002. July 12. . 2002. December 5. .2003. April 1. . 2003. April 28. Whiteley, L. 1998. "Continental Airlines." International Directory of Company Histories 21:140-143.


8 The Radical Transformation of the US. Railroad Industry This chapter examines changes in the rail industry after the Staggers Act of 1980, which partially deregulated rail transportation. In addition to retaining authority over a variety of nonrate areas, the Interstate Commerce Commission (ICC) retained the authority to set maximum rates or take certain other actions if a railroad was found to have abused its market power or engaged in anticompetitive behavior. Thus, rail customers retained a "safety net" to protect against unreasonable railroad behavior (Association of American Railroads 2001). However, the rail industry was radically transformed as a result of this act. According to the ICC's 1980 transport statistics, there were forty Class I railroads in 1980. The ICC classifies railroads based upon revenue. Class I railroads are the largest railroads and account for the majority of freight transported. Over time, the ICC revenue threshold for designation of a Class I railroad has changed. Beginning in 1978, the threshold has been adjusted annually for inflation; in 1980, it was $66.8 million. Effective July 20,1992, it was dramatically increased from approximately $96 million to $250 million in 1991 dollars. In 2000, the threshold was $261.9 million. This change in the threshold value has had a dramatic effect on the number of Class I railroads over time (Association of American Railroads 2002). For example, the 2000 threshold of $261.9 million is equivalent to approximately $140 million in 1980 dollars. If the 1980 Class I revenue threshold had been $140 million instead of $66.8 million, there would have been twenty-seven Class I railroads that year, not forty. In 2001, there were eight Class I railroads: the Burlington Northern Santa Fe Railroad (BNSF), CSX Transportation (CSX), Grand Trunk

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Western Railroad (GTW), Illinois Central Railroad (IC), Kansas City Southern Railway (KCSR), Norfolk Southern Railroad (NS), Soo Line Railroad (Soo), and Union Pacific Railroad (UP). GTW and IC are both owned by Canadian National Railway (CN); Soo is owned by Canadian Pacific Railway (CP). Thus, it would be accurate to say that the eight Class I railroads in 2001 were part of seven major North American railroad systems (BNSF, CN, CP, CSX, KCS, NS, and UP) (Association of American Railroads Annual Report 2001, 1). The forty Class I railroads or railroad systems in 1980 have been merged and/or combined in various ways to form the eight Class I railroads in existence today (Association of American Railroads Annual Report 2001,1). Table 8.1 illustrates the change in revenues for the eight major railroads from 1979 (the year before deregulation) to 2001. Today, the Burlington Northern Santa Fe and Union Pacific service the western United States. CSX and Norfolk Southern are the two primary railroads that service the eastern United States. The Kansas City Southern provides service from Kansas City to the Gulf of Mexico. The Illinois Central provides service from Chicago to the Gulf of Mexico for the Canadian National Railway. The Grand Trunk Western provides service from the state of Michigan with extensions to Chicago and Cincinnati for the Canadian National Railway. The Soo Line provides service from Louisville to Detroit and Minnesota utilizing a hub in Chicago for the Canadian Pacific Railway. Very few railroads survived in the deregulated period. The Burlington Northern, ranked #2 in 1979, the Union Pacific, #5 in 1979, and the Kansas City Southern, #20 in 1979, are the only three railroads that exist from the forty Class 1 railroads in 1979. Most of the others underwent mergers. Union Pacific acquired Southern Pacific, the #3 ranked railroad in 1979, and is currently the largest revenuebased North American railroad. Burlington Northern's acquisition of the Atchison, Topeka, and Santa Fe (ranked #4 in 1979), made BNSF the second largest railroad in 2001. Norfolk Southern was created as a result of a merger between #7 Norfolk and Western and #6 Southern Railway to become the third largest railroad in 2001. CSX was the fourth largest railroad system in 2001. It was formed as a result of a merger between the Chessie System and Seaboard Coast Lines. The Chessie System was made up of the #13 Chesapeake and Ohio Railroad, the #11 B&O Railroad, and the #31 Western Maryland Railroad in 1979. Seaboard Coast Lines was the #9 railroad in 1979. Conrail, the #1 ranked railroad in 1979, was divided up between CSX and Norfolk Southern in 1997. The Grand Trunk Western, the #21 ranked railroad in 1979, and the Illinois Central, #12 ranked in 1979, are a part of the Canadian National Railway generating $3,946 billion in 2001, and the Canadian National Railway is the fifth largest North American railroad. The Soo Railroad,

Table 8.1 Rail Carriers Remaining since Deregulation

Revenue (millions $) Railroad Kansas City Southern

1979

2001

221,415

537,720

Burlington Northern Santa Fe

9,201,022

Burlington Northern

2,446,402

Atchison, Topeka, and Santa Fe

1,872,619

SOO Line*

290,511

561,647

Union Pacific

1,742,294

10,613,89

CSX Chessie : Chesapeake and Ohio : Baltimore and Ohio : Western Maryland

6,082,282 812,635 922,248

Seaboard Coast Lines

78,411 1,049,747

Grand Trunk Western**

213,185

359,223

Illinois Central**

853,296

650,237

Norfolk Southern

6,169,823

Norfolk and Western

1,430,894

Southern Railway

1,467,270

Source: Association of American Railroads Annual Report 1979, 2001. ^Subsidiary of Canadian Pacific Railway. **Both subsidiaries of Canadian National Railway.

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#17 in 1979, is part of the Canadian Pacific Railway. Generating $2,344 billion in 2001 (Canadian Pacific Railway Annual Report 2001) the Canadian Pacific Railway is the sixth largest railroad in North America. The Kansas City Southern is the seventh largest North American railroad. Table 8.2 identifies mergers since 1980 that have resulted in the seven Class I railroad systems. CONRAIL

Conrail, the largest (revenue-based) railroad at the time of deregulation (1980), became integral to the growth of both CSX and Norfolk Southern. In the early 1970s, railroads had lost business to the trucking industry because trucking carriers could offer door-to-door service and were not subject to the same price restrictions as railroads. During the regulated period, railroads handled only 36 percent of the nation's freight (Burns 1998). The government then passed the 1973 Regional Rail Reorganization Act, which gave birth to the United States Railway Association (USRA). A plan was devised by USRA for the consolidation of six bankrupt lines into a single system (Conrail) with the backing of federal funds (Keeley 1992). The initial investment was $2.1 billion (Keeley 1992). Shortly after 1980, Conrail began to make acquisitions. Among its acquisitions were Merchants Dispatch Transportation, Philadelphia Reading & Pottsville Telegraph, Detroit Terminal Railroad, and Pennsylvania Car Leasing Company. Meanwhile, Conrail sold Excelsior Truck Leasing, Illinois Terminal Railroad, Lake Erie Eastern Railroad, and Toledo Railroad (Burns 1998). By 1985, the government had spent more than $7 billion in an attempt to make Conrail profitable. In 1985, Conrail sold the Canada Southern Railway and the Detroit River Tunnel. In 1989, the company raised its interest in Trailer Train to 21.8 percent; Trailer Train was an intermodal operation (Burns 1998). In 1991, Conrail purchased the Monongahela Railway for $40 million. This acquisition was important because it increased Conrail's coalhauling competitiveness. Although Conrail was the fourth largest hauler of coal in the nation, it was far behind the Burlington Northern, CSX Transportation, and Norfolk Southern. This acquisition of the seventh largest coal hauler improved Conrail's market position (Keeley 1992). In 1993, Conrail completed two additional major transactions. In April, the company joined with the Norfolk Southern Corporation to form Triple Crown Services. The new company was a domestic intermodal venture designed to compete with trucking companies between major markets in the United States (Norfolk Southern Annual Report 1993). By the time it joined with Norfolk Southern Corporation to exploit intermodal markets, Conrail operated in fourteen states. It

Table 8.2 Major Class I Unifications Effective Date of Unification

Applicant Railroads

Controlling Railroad/Company

6/24/1980

Grand Trunk Western & Detroit and Toledo & Ironton

Grand Trunk Western

11/1/1980

Cheessie System and Family Lines Seaboard Coast Lines

CSX Corporation

11/21/1980

Burlington Northern and St. Louis-San Francisco

Burlington Northern

4/13/1981

Grand Trunk Western and Detroit & Toledo Shore Line

Grand Trunk Western

1/1/1982

Burlington Northern, Colorado & Southern, Fort Worth & Denver, Burlington Northern (Oregon-Washington) and Walla Walla Valley

Burlington Northern

6/1/1982

Southern and Norfolk Western

Norfolk Southern

12/22/1982

Union Pacific, Missouri Pacific and Western Pacific

Union Pacific

2/19/1985

SOO Line and Chicago, Milwaukee, St. Paul and Pacific

Canadian Pacific

3/26/1988

Conrail - 85 percent government

Conrail

8/12/1988

Missouri-Kansas-Texas and Union Pacific

Union Pacific

4/27/1995

Chicago and North Western and Union Pacific

Union Pacific

9/22/1995

Burlington Northern and Atchison, Topeka, and Santa Fe

Burlington Northern Santa Fe

9/11/1996

Union Pacific and Southern Pacific

Union Pacific

6/1/1997

Conrail, CSX, Norfolk Southern

CSX, Norfolk Southern

7/1/1999

Illinois Central Railroad

Canadian National Railway

Source: Association of American Railroads Annual Report 2001.

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operated service north to Quebec, west to Chicago and St. Louis, and south to Virginia. In 1997, the government approved the division of Conrail between CSX and Norfolk Southern (Burns 1998). In 1998, CSX and Norfolk Southern became the two dominant railroads in the eastern United States. Burlington Northern Santa Fe

In 1983, Santa Fe Industries (the holding company for the AT&SF railway) merged with the Southern Pacific Company (the holding company of the SP) to form Santa Fe Southern Pacific Corporation (SFP) (shortened to Santa Fe Pacific Corporation in 1989). In the late 1980s, Santa Fe Pacific entered into an intermodal partnership with J.B. Hunt, the first such partnership between a railroad and a trucking firm (Wilner 1997). In 1994, Santa Fe Pacific was at the center of a bidding war between Burlington Northern and Union Pacific (Burns 1998). In 1995, Burlington Northern, Inc. (the parent company of the Burlington Northern Railroad) acquired Santa Fe Pacific Corporation (along with AT&SF) and renamed the merger company as Burlington Northern Corporation. The Burlington Northern and Santa Fe Railway Company (the formal name of the railroad) takes its name from the merger between the Burlington Northern Railroad and the AT&SF. In 1996, the Santa Fe Pacific operations were merged into Burlington Northern. The merger had significant benefits for both companies. For SFP, it provided capital to stabilize the company's financial condition and also provided access to new trackage and new shippers (Wilner 1997). Advantages to Burlington Northern included access to trackage and new shippers throughout the SFP railway system and a vastly improved competitive position throughout the western United States and Canada (Wilner 1997). The merger also provided Burlington Northern a single-line route from British Columbia to San Diego, California, and virtually total coverage west of the Mississippi. In 1999, the Burlington Northern Santa Fe began merger talks with the Canadian National Railway (BNSF Annual Report 1999). As pointed out by Wilner, these discussions broke down in 2000 because the Surface Transportation Board, successor to the ICC, imposed a merger moratorium while it reviewed its own merger rules (telephone interview 2003). As of 2001, the Burlington Northern Santa Fe offered service to Mexico, e-business, and shipment tracking. CANADIAN NATIONAL RAILWAY

Although the Canadian National Railway and the Canadian Pacific Railway were not affected by the deregulation of the U.S. rail industry,

The Radical Transformation of the U.S. Railroad Industry

179

both railroads now have significant positions within the United States. The Canadian National Railway (CN) is the parent of several U.S. railroads: the Grand Trunk Western; the Duluth, Winnipeg, and Pacific; the Illinois Central; the Wisconsin Central; and the Gulf, Mobile, and Ohio Railroad (Burns 1998). The Gulf, Mobile, and Ohio Railroad had been owned by the Illinois Central since 1972. During the 1980s and early 1990s, the Canadian National acquired firms in transportation, communications, and real estate. Among its acquisitions were the Northern Alberta Railway; Lakespane Marine Incorporated; EID Electronic Identifications System; OCRA Communications; Detroit, Toledo & Ironton Railroad; Railroad Association Insurance; and Dome Consortium Investments (Moody's Transportation Manual 1994). In 1995, the government of Canada completed the sale of all its shares of Canadian National Railroad in a public offering. Thereafter, CN was a private Canadian corporation. The two primary subsidiaries of the Canadian National Railway are the Wisconsin Central and the Illinois Central. Wisconsin Central

During the early years of deregulation, Wisconsin Central (WC) concentrated on upgrading track and equipment so that it could improve service and attract new business (Wilner 1997). WC turned a profit in the first year of deregulation and has been profitable throughout the deregulated period. In January 1992, Wisconsin Central created a new subsidiary, Fox Valley and Western Ltd., to acquire two smaller Wisconsin railroads: the Green Bay & Western (GB&W) and the Fox River Valley (FRV) (Burns 1998). In August 1992, WC began an intermodal service with J.B. Hunt (Wisconsin Central Annual Report 1992). In 1993, Wisconsin Central expanded internationally by acquiring New Zealand Rail (Bodine 1999). By making this acquisition, Wisconsin Central transformed itself into a player in the international rail market. In January 1995, Wisconsin Central acquired Algoma Central Railway, a 321-mile regional Canadian line operating between Sault Ste. Marie and Hearst, Ontario (Burns 1998). In December 1995, Wisconsin Central acquired ownership of Great Britain's Rail Express Systems Limited (RES), the letter-carrying rail service for the Royal Mail, a division of Britain's Post Office (Wisconsin Central Annual Report 1995). In 1996, Wisconsin Central bought 90 percent of Britain's freight rail service from British Rail (Bodine 1999). In April 1996, WC obtained additional coverage to the Canadian markets by entering into a new

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intermodal agreement with Illinois Central (IC), CSX Intermodal, and Canadian National (Wisconsin Central Annual Report 1996). In 1997, Wisconsin Central acquired Railfreight Distribution Limited from the British government. This gave Wisconsin Central a share of the freight traveling through the Channel Tunnel and access to the continental European market (Bodine 1997). It also created a new subsidiary, Australian Transport Network Limited, to acquire one-third of Tasrail, the commercial rail freight service on the Australian island of Tasmania (Bodine 1999). In 2001, Wisconsin Central was acquired by Canadian National Railway (Canadian National Railway Annual Report 2001). The other major subsidiary of the Canadian National Railway is the Illinois Central. Illinois Central

During the 1980s, Illinois Central Industries and its subsidiaries acquired many firms in a diverse group of industries. The years 1988 to 1990 represented a pivotal period in the life of the Illinois Central Railroad (IC). During that time, IC was restructured to focus upon railroad operations. In March 1989, an investment company, The Prospect Group, acquired the railroad following a tender offer. At that point, IC became a pure railroad no longer affiliated with a wide range of nonrail businesses. The di vesture of nonrail businesses in the early 1990s is the primary reason that Illinois Central revenues were less in 2001 than they were in 1979 (see Table 8.1). As the 1990s progressed, the Illinois Central quickly earned a reputation as North America's most efficient railroad. From 1990 through 1997, it was the industry's best in terms of operating margin and return on capital (Burns 1998). It was the only U.S. railroad to achieve earnings consistently exceeding long-term cost of capital during the 1990s (Burns 1998). By the mid-1990s, IC had begun developing a strong relationship with Canadian National Railway. In 1996, the two railroads, along with Wisconsin Central and CSX Intermodal, became partners in the Superior Connection. This intermodal service linked western Canada with Chicago and stretched from eastern U.S. markets to the Gulf of Mexico (Wisconsin Central Annual Report 1996). In 1996, IC acquired the Chicago, Central and Pacific Holdings, Inc. (CCP), and Cedar River Railroad (Illinois Central Annual Report 1996). These acquisitions helped IC to capitalize on its north-south positional route through the heart of America. In addition, IC formed strategic alliances with Burlington Northern Santa Fe and Conrail (Burns 1998). In 1999, the Canadian National Railway acquired the Illinois Central (Canadian National Railway Annual Report 1999). The primary ben-


181

efit the Illinois Central provided to Canadian National was complete service from Chicago along the Mississippi River to the Gulf of Mexico. CANADIAN PACIFIC RAILWAY

Canadian Pacific Limited (CP) was engaged in rail freight and container shipping; motor-carrier operations; exploration and production of oil, natural gas, coal, and other minerals; real estate and hotel operations; telecommunication services; and environmental management during the early 1980s (Heaver 1978). During the 1980s, Canadian Pacific reduced its transportation interests by selling CP Air, divesting its trucking operations, and winding down CP Bermuda (a bulk shipping company). In 1989, CP increased its ownership of the Soo Line Railroad from 55.8 percent to 100 percent for C$108.2 million (Burns 1998). The Soo Line provided CP with service from Detroit and Louisville through Chicago to points in Minnesota, North Dakota, and south to Kansas City. The company's rail business grew in 1990 because of a resurgence in grain shipments. Early in 1991, CP bought another rail company, the Delaware and Hudson (D&H) Railway, which operated in the northeastern United States (Canadian Pacific Railways Annual Report 1991). The D&H was acquired after Guilford Industries took the railroad into bankruptcy. During the early 1990s, CP's transportation operations continued to grow. In 1993, the company increased its ownership of Canada Maritime Limited from 67 percent to 100 percent. It then reorganized its rail operations—CP Rail, Soo Line, and Delaware & Hudson—under a newly formed CP Rail System (Wilner 1997). Canadian Pacific was involved in the shipping business in a major way ever since the completion of the transcontinental railway in 1885. Over the years it operated passenger lines, cargo ships, container ships, and bulk ships. CP Ships was implemented in 1994. One of the world's top ten container shipping companies in 1994, CP Ships provides international transportation services in four key regional markets: transatlantic, Australia, Latin America, and Asia (Canadian Pacific Railways Annual Report 1994). Since 1996, its revenue has increased at a compound annual rate of 36 percent, and its profits have doubled (Canadian Pacific Railways Annual Report 2001). Canadian Pacific Railway is North America's first transcontinental railway and is the only transcontinental carrier with direct service to the U.S. eastern seaboard (Canadian Pacific Railways Annual Report 2001). CPR's 14,000 miles of track serve the principal centers of Canada, from Montreal to Vancouver, and the U.S. Northeast and Midwest regions. Its track feeds directly into the Chicago hub from the East and West

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Coasts. Alliances with several Mexican railroads extend CPR's market reach into Mexico (Canadian Pacific Railrays Annual Report 2001). In 2001, Canadian Pacific distributed its holdings in the five operating subsidiaries—CPR, CP Ships, Fording Coal, PanCanadian Energy, and Fairmont Hotels & Resorts—to the Canadian Pacific shareholders. CPR is now an independent company; it does not have a corporate affiliation with either Canadian Pacific (the former parent company, which no longer exists) or any of the former Canadian Pacific subsidiaries. CSX The merger in 1978 between the $1.5 billion Chessie and the $1.8 billion Seaboard created CSX. The Chessie System was a major midAtlantic Class I railroad in 1978. The Chessie System consisted of 11,464 miles of tracks in fourteen eastern and midwestern states, the District of Columbia, and Ontario. It consisted of three major carriers: the Chesapeake & Ohio (C&O), the Baltimore & Ohio (B&O), and the Western Maryland (WM). Seaboard Coast Lines provided the railroad service to thirteen southeastern states. The merger with Seaboard produced a 27,500-mile supersystem stretching from Michigan to Miami (Burns 1998). The merger gave the Chessie a relatively inexpensive expansion into the Southeast and provided a useful capital infusion for Seaboard (Burns 1998). The ICC approved the merger in September 1980, and the two systems were consolidated into CSX Corporation on November 1,1980 (Wilner 1997). In 1981, CSX formed CMX Trucking (CSX Annual Report 1981). In 1982, CSX merged three railroads: Carolina, Clinchfield, and Ohio Railroad; Georgia Railroad; and Louisville and Nashville Railroad (CSX Annual Report 1982). In 1986, CSX made an $800 million acquisition of Sea-Land Corporation, the largest U.S. ocean container-ship line (later known as SeaLand Service Inc.) (CSX Annual Report 1986). This purchase was a continuation of a policy of structuring CSX as an intermodal transportation company capable of serving both national and international markets (Burns 1998). In 1987, CSX formed CSX/Sea-Land Intermodal (later known as CSX Intermodal Inc.), which became the nation's only transcontinental full-service intermodal company (CSX Annual Report 1987). In 1990, CSX made a decision to focus on the traditionally strong rail operations to earn a better return on the company's $12 billion asset base (CSX Annual Report 1990). In 1991, CSX acquired the Richmond, Fredericksburg and Potomac Railroad. Also in 1991, it announced a rail partnership between CSX and Soviet Railways (CSX Annual Report 1991). In 1992, the company joined with American Air-


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lines and PTT Telecon Netherlands to establish Encompass Europe NV, a company designed to create logistics and information management systems (CSX Annual Report 1992). In 1992, American Commercial Lines (ACL), a subsidiary of CSX, increased its barge capacity by more than one-third through the purchase of the Valley Line Companies (CSX Annual Report 1992). Four years later, ACL acquired the marine assets of Conti-Carriers & Terminals Inc. (Burns 1998). In 1993, CSX acquired Customized Transportation Inc. (CTI), one of the leading logistics companies for the automotive industry, providing distribution, warehousing, and assembly on a contract basis for just-in-time delivery systems (CSX Annual Report 1993). CTI later a d d e d service to Europe and South America to its existing U.S. operations. In 1996, CTI began to service new industries: electronics, retail, and chemicals (CSX Annual Report 1996). Also in 1996, it entered into a global alliance with the Danish shipping c o m p a n y Maersk Lines, which involved the sharing of vessels and terminals (CSX Annual Report 1996). In the same year, CSX, Netherlands Railway, and Deutsche Bahn AG announced a partnership (CSX Annual Report 1996). CSX benefited from the break-up of Conrail. After Conrail was integrated into CSX, CSX began extensive expansion in the late 1990s. In 1999, it developed CSX Lines, a container shipping operation. Also in 1999, CSX launched CSX World Terminals (CSX Annual Report 1999). In 2001, CSX held a 40 percent interest in American Commercial Lines, a family of marine companies providing a wide range of services to the shipping public and other inland waterway carriers (CSX Annual Report 2001). CSX h a d previously held 100 percent interest in American Commercial until a recapitalization reduced its ownership to about 40 percent. As of 2001, CSX had the following holdings (CSX Annual Report 2001): • CSX Transportation Inc., a major eastern railroad, providing rail transportation and distribution services over a 22,700 route-mile network in twentythree states, the District of Columbia, and two Canadian provinces; • CSX Intermodal Inc. (CSXI), operating a network of dedicated intermodal facilities across North America. CSXI runs more than 300 dedicated trains between its thirty-three terminals weekly; • CSX Lines, providing domestic ocean liner service and operating sixteen U.S. flag vessels and 27,000 containers along six service routes between the continental United States and Alaska, Guam, Hawaii, and Puerto Rico. The company also operates offshore domestic port terminals in Anchorage, Kodiak and Dutch Harbor, Alaska; Honolulu, Hawaii; San Juan, Puerto Rico; and Guam;

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• CSX World Terminals, operating terminals in Hong Kong, China, Australia, Europe, Russia, and the Dominican Republic. The company also provides services relating to terminal and warehouse management, equipment maintenance, and terminal systems. NORTHFOLK SOUTHERN

In 1982, the Norfolk Western Railway and Southern Railroad were consolidated to form the Norfolk Southern (Table 8.2). The Norfolk Southern (NS) services markets primarily east of the Mississippi. In 1984, NS purchased North American Van Lines, Inc. (NAVL). After the acquisition was completed in 1985, NS became a multi-modal carrier, developing a transportation system that provided both motor carrier and rail service (Norfolk Southern Annual Report 1985). Norfolk Southern began international service in 1986 (Norfolk Southern Annual Report 1986). In the mid-1980s, NS pursued the purchase of Consolidated Rail Corporation (Conrail) from the U.S. government. The unsuccessful bid to take over Conrail resulted in a profitable cooperation between the two companies that enabled NS and Conrail to offer competitive services over the same areas (Norfolk Southern Annual Report 1986). In 1988, the Carolina and Northwestern Railroad was merged into Norfolk Southern. In 1990, computerized, centralized crew dispatching was implemented (Norfolk Southern Annual Report 1990). In 1991, the Wabash Railroad was merged into the Norfolk Southern (Norfolk Southern Annual Report 1991). In 1993, Norfolk Southern engaged in a joint venture with Conrail to create triple-crown service, a domestic intermodal operation to compete against trucking carriers (Norfolk Southern Annual Report 1993). In March 1997, Conrail was split roughly in half between NS and CSX following a joint merger application. This led to what one analyst, William Withuhn, called "the most complicated merger in history," (Wall Street Journal, June 10,1998). The two acquiring companies spent more than a billion dollars each expanding tracks, terminals, and equipment, and they had difficulties such as integrating their computer systems into Conrail's (Burns 1998). The merger was complete on June 1, 1999, when Conrail's rail lines went into use by CSX and Norfolk Southern. The Conrail acquisition was viewed as a long-term investment for Norfolk Southern. The company was about the same size as CSX, splitting the eastern United States between them. NS was convinced it would be a stronger company with Conrail's addition, as the expanded mileage opened many more markets to it (Norfolk Southern Annual Report 1999).


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In 1998, after a $12 million improvement project, NS and Canadian Pacific rededicated the "Bridge Route" through central Pennsylvania. This "Sunbury Line" from Sunbury to Scranton is part of a joint NS/ CP route linking southeastern and central Pennsylvania to upstate New York, New England, and eastern Canada (Norfolk Southern Annual Report 1998). Several developments occurred for Norfolk Southern during 2001: (1) Norfolk Southern and Burlington Northern Santa Fe entered into an alliance to provide coast-to-coast, intermodal service, (2) Norfolk Southern and Union Pacific entered into an alliance to provide intermodal service between Los Angeles and Atlanta, and (3) Norfolk Southern and Canadian Pacific entered into an alliance to provide service between ports in New York and eastern Canada (Norfolk Southern Annual Report 2001). KANSAS CITY SOUTHERN

Kansas City Southern Railway (KCSR) runs through the Sun Belt. The Kansas City Southern runs from Kansas City along the Mississippi River to the Gulf of Mexico. It also provides service from Dallas to Jackson, Mississippi. KCSR's profits grew in the early 1980s because of an increase in coal transport and a favorable mix of other freight traffic yielding high revenues (Burns 1998). In the early 1990s, the company streamlined its railway operating procedures and was poised to handle an increased volume of coal, its primary moneymaker (Wilner 1997). Kansas City Southern Industries (KCSI), the parent of KCSR, had tightened its financial services division, paring off unprofitable ventures. The company had learned to concentrate its energies in the areas in which it excelled: transportation and financial services (Burns 1998). The success of its financial asset management segment enabled KCSI to invest in improvements to its railroad segment. Between 1987 and 1993, the company spent $500 million to modernize track and facilities and to purchase modern diesel locomotives (Burns 1998). In 1992, KCSI purchased MidSouth Corp. for $220 million (Wilner 1997). The acquisition added approximately 1,200 miles of track in Mississippi and Alabama, almost doubling the size of the railroad. This acquisition also strengthened KCSR's position in the lucrative chemical hauling and intermodal segments (Burns 1998). In 1995, the Texas Mexican Railway was acquired by Kansas City Southern. This gave Kansas City Southern operating authority between the southern United States and Mexico (Kansas City Southern Annual Report 1995). In 1997, Kansas City Southern acquired the Gateway Western Railway, which provided service between Kansas City, St. Louis, and Springfield, Illinois. This provided Kansas City Southern a

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major interchange point between eastern and western Class I railroads (Kansas City Southern Annual Report 1997). During the mid-1990s, Kansas City Southern Railway and Janus, its financial subsidiary, were separated. After this change, Kansas City Southern became a pure rail player. In 1997, KCSI teamed with Transportacion Maritma Mexicana S.A. de C.V (TMM) to bid on Mexico's northeastern railroad. At $1.4 billion, the KCSI/TMM bid won the fifty-year concession to operate the northeast line of Ferrocarriles Nacionales de Mexico. With the addition of this line, KCSR offered service from Chicago to Mexico City, forming what was being called "the NAFTA Railroad" (Kansas City Southern Annual Report 1997). In 2001, a joint venture was completed between Mi-Jack products and Kansas City Southern to create the Panama Canal Railway. This is an ocean-to-ocean transshipment service between the Atlantic and Pacific oceans on a railway that runs parallel to the Panama Canal. This railway serves as an important link among European, North American, and Asian markets (Kansas City Southern Annual Report 2001). UNION PACIFIC

In 1980, the Union Pacific Railroad submitted an application to the ICC to merge with the Missouri Pacific and Western Pacific Railroads. Missouri Pacific operated some 11,500 miles of track in Texas, Oklahoma, and Missouri and also provided service between Chicago and Omaha. The Missouri Pacific also had three key gateways to Mexico. The Western Pacific operated a route between Ogden, Utah, and San Francisco (Burns 1998). The objective of the merger was to create a rail system that provided single-carrier service between the Pacific Northwest, the Southwest, and ports along the Gulf of Mexico (Union Pacific Annual Report 1982). In 1982, the merger was approved. In 1986, Union Pacific acquired Overnite, a national trucking firm. One of the primary purposes of this acquisition was to develop and expand the scope of intermodal services that the firm offered its customer base (Union Pacific Annual Report 1986). In 1988, UP further expanded its railroad operations through the acquisition of the Missouri-Kansas-Texas. This acquisition provided additional gateways into Mexico (Wilner 1997). In 1989, UP acquired a 25 percent stake in the Chicago & North Western Railway (C&NW) (Union Pacific Annual Report 1989). In 1991, UP acquired the remaining 75 percent of the Chicago & North Western Railway. CNW was fully merged into UP during the early 1990s, giving it the shortest direct line to the Lake Superior shipping ports of Duluth, Minnesota; Superior, Wisconsin; and access to Canadian markets (Burns 1998).


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In 1994, UP entered into a battle with Burlington Northern for control of the Atchison, Topeka & Santa Fe. UP's bid failed, and Burlington Northern and the Santa Fe merged in 1995 to form Burlington Northern Santa Fe. UP was able to gain significant trackage rights from Burlington Northern as a merger concession (Wilner 1997). By 1995, the Union Pacific was among the largest carriers of the West. The carrier extended from Seattle and San Francisco on the West Coast to Chicago, New Orleans, and Galveston, Texas (Moody's Transportation Manual 1996). In 1995, the Chicago and Northwestern was acquired by Union Pacific (Union Pacific Annual Report 1995). The Chicago and Northwestern serviced points from Kansas City and St. Louis to Canada. In November 1995, Union Pacific filed an application with the ICC to acquire Southern Pacific in a $3.9 billion takeover. The UP-SP deal was opposed by the Departments of Justice, Transportation (ICC), and Agriculture and by Kansas City Southern and Conrail (Burns 1998). One month later, the U.S. Congress abolished the ICC, creating the Surface Transportation Board (STB) as the new railroad industry oversight body (Wilner 1997). In July 1996, the STB approved the merger. Union Pacific acquired Southern Pacific Rail for $3.9 billion in September 1996. Union Pacific expected to (1) obtain large returns from the acquisition through reduced costs, and (2) improve delivery times by 20 percent after the acquisition. Neither of these benefits materialized (Burns 1998). Union Pacific faced substantial challenges because the Southern Pacific was not an efficient railroad (Hitt, Ireland, and Hoskisson 2001). It had suffered from inadequate investment and performed poorly. Union Pacific underestimated the crews and locomotives needed to staff the trains and to transport the freight. The consequences of Union Pacific's miscalculations were significant traffic snarls and delays, along with mishaps such as derailments and equipment breakdowns. Furthermore, because Union Pacific encouraged many key Southern Pacific personnel to leave, there was a substantial loss of institutional knowledge (Hitt, Ireland, and Hoskisson 2001). The same key personnel had kept the Southern operating under bad conditions. With these people gone, there was no one to help solve the problems when they occurred. This acquisition created many hardships for Union Pacific customers that depended on the railroad to move their goods to market. Many customers could not get their goods to their customers. Union Pacific was not able to achieve synergy through its acquisition of Southern Pacific Rail. Union Pacific spent several years integrating Southern Pacific Rail into its network (Vantuono and Kaufman 2002). It was not until 2002 that the acquisition began to provide the benefits that had been antici-

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pated. Union Pacific began infusing capital into those parts of its system that formerly were part of the SP while continuing to improve its original system. Service over the former SP Sunset Corridor from Southern California to N e w Orleans became more dependable. In conjunction with the original UP lines east of El Paso, the railroad's line to Memphis became more competitive with the BNSF line between Southern California and Memphis (Vantuono and Kaufman 2002). Union Pacific Corporation has developed a broad array of technology assets (Fenix) focused on enhancing the operations of its core transportation businesses. Fenix is currently a wholly owned subsidiary formed to capitalize on an extensive portfolio of technology companies, assets, and expertise. A s u m m a r y of the Fenix companies is as follows (Union Pacific Annual Report 2001): Nexterna: offers an extensive suite of wireless data software products used to enable remote computing for mobile enterprise professionals, field service workers, and fleet management. Timera: a workforce management software program. In addition to serving the railroad industry, the company is targeting applications of this technology in other industries, such as public transit, mining, heavy construction, and manufacturing. Transentric: focuses on providing solutions for supply chain performance in the business-to-business marketplace. The company offers a range of transportation software and services including shipment monitoring, item level tracking, inventory management, operations management, and electronic gateway messaging. Ekanet: a broadband telecommunications company with capabilities in the wireless access market. Ekanet's current assets include more than 33,000 miles of right-of-way, most of which are located throughout the southern and southwestern United States. Ekanet also has rights to use more than 1,400 fixed wireless towers throughout the same area (CSX Annual Report 2001). In 2002, Union Pacific implemented remote control technology (Union Pacific Annual Report 2001). GROWTH PATTERNS

The general growth pattern followed by the remaining rail carriers is illustrated in Figure 8.1. Throughout the 1980s, railroad companies expanded through acquisition of other U.S. railroads. Railroads merged with other rail systems a n d their respective subsidiaries to form megacarriers that covered the continental United States. In order to eliminate dependence on other systems, carriers attempted to provide the best rail access for shippers by owning all the rail access points (Burns 1998).

Figure 8.1 Growth Pattern of Surviving Railroads

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The only way to achieve such extended access and virtual control over the large rail transportation markets was through acquisition of existing railroads (Burns 1998). By the early 1980s, mergers included combinations with other modes of transportation. The acquisition by rail companies of water and motor carriers resulted in the emergence of diversified supersystems capable of delivering freight "door-to-door." These acquisitions allowed the rail carriers greater access to points within the United States and to ports around the world (Rakowski and Dobie 1996). By the late 1980s, the rail carriers began to realize that they could obtain the benefits provided by other modes through strategic alliances as opposed to acquisitions. As such, the rail carriers began to divest their motor carrier and shipping subsidiaries and engaged in strategic alliances with companies engaged in other modes of transportation. In this manner, the rail carriers were able to utilize the resources of the other modes of transportation without incurring the costs of acquisition and administration. The alliances lead to the growth of intermodal operations. Railroads took the opportunity to combine with trucking and shipping companies to create intermodal carriers. By 1990, the carriers engaging in intermodal service were the Burlington Northern Santa Fe, Canadian National, Union Pacific, and CSX Corporation (Wilner 1997). Rail-truck intermodal movements spread so rapidly that carriers began to consolidate movements into hub-and-spoke networks to organize traffic flow (Wilner 1997). Motor-carrier operations would radiate from a given rail terminal. Rail-truck hub-and-spoke networks helped consolidate large volumes of traffic into concentrated areas for more efficient interchange. The most important advantage that cooperation with motor carriers provided railroads was access to new markets. At the outset, the inability of railroads to reach off-line points was what gave the trucking industry its opportunity to expand. Only when the railroad industry learned to cooperate with its trucking carriers where they were able to provide point-to-point service. Rail-truck intermodal operations enabled railroads to share in those markets that required "doorto-door" service (Burns 1998). The railroad industry had essentially been given access to a larger market, and carriers exploited this opportunity to the fullest. Rail systems constructed high-tech intermodal truck, barge, and port facilities to maximize operating efficiency (Burns 1998). They rebuilt bridges, tunnels, and overpasses that restricted the movement of double-stacked container traffic, and they pursued the acquisition of additional motor and water carriers (Wilner 1997).


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Intermodal combinations made rail transportation a global enterprise by providing railroads the avenue to overcome geographical constraints (Burns 1998). Although holding companies tended to maintain separate operations for each subsidiary mode, these conglomerates more readily coordinated different modal services. Ocean-going vessels provided railroads the avenue for international expansion (Burns 1998). At the same time, right-of-way no longer blocked railroads from "door-to-door" markets. Their motor-carrier affiliates facilitated access to points within the nation that railroads could not service. Intermodal combinations gave the railroad industry the opportunity to grow (Rakowski and Dobie 1996). Recognizing the importance of this new form of traffic, Congress passed the Intermodal Surface Transportation Efficiency Act in 1991. Although the legislation was designed as a subsidy bill for the nation's highways, it represented the commitment of the federal government to the cause of new forms of cooperative transportation. The legislation stated that the policy of the United States was "to develop a National Intermodal Transportation System that is economically efficient and environmentally sound, provides the foundation for the nation to compete in the global economy, and will move goods in an energy efficient manner" (Intermodal Surface Transportation Efficiency Act of 1991, U.S. Code 105 STAT 1914). Early in the 1990s, the nation's Class I systems sought to achieve seamless interline quality service without the coordinating problems interline operating agreements generated. Shippers preferred singleline service as opposed to interline arrangements, and railroads represented an important link in which cooperation with other modes was necessary to reach markets and reduce costs. After the railroads invested in other transportation modes, they invested in technological improvements. Technological advances permitted carriers to haul more tonnage, reduce employment, and achieve better fuel economy; new innovations offered modern systems the hope of more efficient service in the future (Burns 1998). By the mid-1990s, financial improvement and reduced restructurings afforded railroads the opportunity to embrace new technology (Welty 1994a). Gus Welty, senior editor of Railway Age, stated it was not until this time that railroads were capable of embarking on the full exploitation of high-tech innovations. Greater efficiencies in container movements by railroads attracted shippers dependent on time-sensitive deliveries. Innovations started to make possible the containerization of such bulk commodities as petroleum, grains, and ores. The development of advanced computerized data systems facilitated the interchange of technology and the

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coordination of movements with governments, transportation operators, and customers (Burns 1988). Railroad companies utilized technological innovations to improve the manufacture and repair of locomotives and freight cars, the maintenance of right-of-way, and the quality of information systems. Locomotives were emerging with electronic fuel injection and increased fuel efficiency. These advanced units achieved greater fuel efficiency with significantly lower hazardous emissions (Welty 1994b). As railroads sought to achieve greater revenue and traffic gains through technological improvements, they were becoming total transportation companies. As explained by both Alvin Carpenter and Dick Davidson, CEOs of CSX and Union Pacific, respectively, the purpose of innovation in the modern age was to create seamless interline quality transportation (Vantuono and Kaufman 2002). Shippers wanted timely and quality service in a single transaction. In the mid to late 1990s, the Class I railroads entered into strategic partnerships with international carriers to grow into international markets. The 1996 alliance between Wisconsin Central (now a subsidiary of Canadian National Railway), CSX Intermodal, and Canadian National Railway linked western Canada to Chicago and continued east to the Atlantic seaboard and south to the Gulf of Mexico. Wisconsin Central entered into an alliance with the Great Britain Rail Express System in 1996, and with Railfreight of Great Britain in 1997. The latter alliance connected Great Britain with Europe through the English Channel. Also in 1996, CSX entered into an alliance with Netherlands Railway and Deutsche Bahn AG. In 1997, Kansas City Southern Railroad entered into a joint venture with Grupo Transportation. This rail venture connected Mexico City to Chicago and provided service along the Mississippi River into Mexico. In 2001, Canadian Pacific Railways entered into an agreement with Norfolk Southern to launch a new truck-competitive rail service between the New York-New Jersey market and eastern Canada. Also in 2001, Kansas City Southern Railway entered into an alliance with MiJack to provide service for ocean-to-ocean transshipments between the Atlantic and Pacific oceans. In 2001, Canadian National Railway and Union Pacific Railroad established an agreement to provide expedited intermodal service between central Canada, Michigan, Texas, and Mexico City. At the beginning of the twenty-first century, technology began to be important to rail carriers. All Class I carriers began to offer e-business services. In 2001, Union Pacific developed Fenix, a broad array of technology-focused assets in enhanced operations of core transportation businesses (Union Pacific Annual Report 2001). Wilner stated that by 2002, all Class I railroads began to offer remote control technology


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to support rail operations (telephone interview 2003). Remote control technology utilizes a portable transmitter, called the operator control unit, to communicate with a computer, or receiver, in the cab of the locomotive. An on-board computer operates the locomotive based on the signals received from the employee on the ground. THE FUTURE OF THE RAILROADS

The railroads of today are being transformed into global, multi-modal transportation firms. With respect to the United States, the Kansas City Southern is the only U.S. railroad that has not merged with a larger U.S. western, U.S. eastern, or Canadian rail network. Kansas City Southern holds a strategic location advantage by providing service from Kansas City to major markets within Mexico. This railroad might be of interest to the Canadian National Railway. Canadian National has a fifteen-year marketing alliance with KCS. A Canadian National-Kansas City Southern merger would provide coverage from major markets in Canada to major markets in Mexico. An alliance or merger between Kansas City Southern and BNSF would provide a network from Seattle and Portland to New Orleans and to markets in Mexico for BNSF. Due to the sheer size of the other remaining railroads, it is unlikely that further acquisitions would take place in the United States. What may be more likely is the forming of an alliance between the large rail systems. BNSF has few points of service east of the Mississippi. An alliance with CSX or Norfolk Southern would create a transcontinental network. Union Pacific also services few points east of the Mississippi. An alliance with CSX or Norfolk Southern would also provide transcontinental service. With respect to international expansion, the carriers have been very successful in expanding via strategic alliances. This trend is likely to continue so that the railroads can establish global networks. These alliances may be further expanded to include international trucking and ocean shipping in addition to international railroads. The evolutionary path that has been described within the United States may be a way for the railroads to establish operations within international markets. Where mergers are permitted, many existing rail carriers may engage in rail acquisitions. However, many international markets have restrictions on the degree of ownership by foreign firms with respect to transportation firms. Strategic alliances are an alternative to mergers for international markets that have such restrictions. U.S. rail carriers may form additional strategic alliances with international rail carriers. These alliances could provide both domestic and international carriers with economies of scale without needing to invest in additional acquisitions. The international rail carriers could then

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develop additional alliances with motor carriers and ocean shipping firms. Economies of scope would also result from the alliances with international trucking and ocean shipping firms. In this manner, carriers would evolve into global intermodal carriers. In addition to substantial exports for the U.S. carriers, the import tonnage could provide economies of scale and provide new services to the rail carriers' U.S. customer base. In this manner, global intermodal carriers would evolve. The next evolutionary step for these carriers may be international logistics. Logistics costs comprise between 10 and 30 percent of the total landed cost of an international order (Czinkota and Ronkainen 2001). International firms have already achieved many of the cost reductions that are possible in financing and production, and they are now beginning to look at international logistics as a competitive tool. Research shows that the environment facing logistics managers in the next ten years will be dynamic and explosive (Coyle, Bardi, and Langley 1999). Logistics may well become the key dimension by which firms distinguish themselves internationally (Czinkota and Ronkainen 2001). Given the speed of technological change and the efficiency demands placed on business, international success will increasingly depend on the logistics function (Lambert and Stock 2001). LESSONS LEARNED

Several important lessons can be derived from this analysis of the railroads since the Staggers Act of 1980. 1. Acquisition can provide a scale advantage. The surviving railroads have grown by acquiring other rail carriers. As a result of these acquisitions, the railroads are able to achieve economies of scale. 2. The evidence is not compelling that the ownership of motor carriers brings long-term benefits to railroads. Both CP and CN had significant trucking interests for many years, but each railway divested itself of these interests in the 1980s and 1990s. In the United States, none of the railroads have acquired and maintained ownership in a major trucking company (as NS disposed of its ownership of North American Van Lines in 1998 and UP plans to sell Overnite in 2003). Strategic alliances can be a low-risk option to develop related businesses domestically. By forming alliances with motor carriers and shipping firms (as opposed to acquisitions), the railroads obtain the utilization of resources and market positions without incurring the costs of acquisitions. 3. Strategic alliances can be a low-risk option to further develop international markets. Strategic alliances with other rail carriers enabled firms to develop global infrastructures for not only rail shippers but for other modes of transportation as well. In this manner, the rail carriers are becoming global transportation firms.


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"Wow! This industry changed significantly as a result of deregulation," said the CEO. "Yes, the surviving carriers are growing into multimodal, global corporations," I replied; "the railroads are achieving m a x i m u m utilization of their resources by developing alliances with other modes of transportation and with international carriers." "This appears to be an excellent way of achieving growth in a global economy: Have any industries not followed this trend?" asked the CEO. "Yes, the U.S. airline industry," I replied. "What do you believe will h a p p e n to the U.S airline industry?" the CEO asked. REFERENCES Association of American Railroads Annual Report. 1979,2000, 2001. Association of American Railroads. 2001. Rail Industry Restructuring. Washington, D.C: Association of American Railroads. Association of American Railroads. 2002. "Overview of U.S. Freight Railroads." Washington, D.C: Association of American Railroads. Bodine, P. 1999. "Wisconsin Central." International Directory of Company Histories 24: 33-36. Burlington Northern Santa Fe (BNSF) Annual Report. 1993,1999. Fort Worth, Texas. Burns, J. 1998. Railroad Merger and the Language of Unification. Westport, CT: Quorum Books. Canadian National Railway Annual Report. 1999, 2001. Montreal, Quebec. Canadian Pacific Railways Annual Report. 1991,1994, 2001. Calgary, Alberta. Coyle, J., E. Bardi, and C Langley. 1999. The Management of Business Logistics. St. Paul: West. CSX Annual Report. 1981,1982,1986,1987,1990,1991,1992,1993,1996,1999, 2001,2002. Czinkota, M., and I. Ronkainen. 2001. International Marketing. Ft. Worth, TX: Harcourt Brace. Heaver, 1978. "Multi-Modal Ownership—The Canadian Experience." Forbes 122 (October 16): 127-128. Hitt, M., R. Ireland, and R. Hoskisson. 2001. Strategic Management: Competitiveness and Globalization. Mason, OH: Southwestern. Illinois Central Annual Report. 1996. Chicago, Illinois. Intermodal Surface Transportation Efficiency Act of 1991. U.S. Code 105 STAT 1914. Kansas City Southern Annual Report. 1995,1997,2001. Overland Park, Kansas. Keeley, C 1992. "Consolidated Rail Corporation." International Directory of Company Histories 5: 435-437. Lambert, D., and J. Stock. 2001. Strategic Logistics Management. Boston, MA: McGraw-Hill. Moody's Transportation Manual. 1994,1996. Norfolk Southern Annual Report. 1985,1986,1990,1991,1993,1998,1999, 2001. Norfolk, Virginia. Rakowski, J., and K. Dobie. 1996. "Strategic Alliances between Truckload Motor Carriers and Railroads: An Exploratory Analysis." Journal of Transportation Law, Logistics and Policy (Fall): 61-72. Union Pacific Annual Report. 1982,1986,1989,1995,2001. Dallas, Texas.

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Vantuono, W., and L. Kaufman. 2002. "The Road Travelled: The Road Ahead." Railway Age (October): 26-30. Wall Street Journal. 1997. October 2. . 1998. June 10. Welty, G. 1994a. "Pull Together, Prosper Together." Railway Age (May): 41-44. . 1994b. "The High-Tech Explosion." Railway Age (September): 55. Wilner, F. 1997. Railroad Mergers: History, Analysis, Insight. Omaha, NE: Simmons-Boardman Books. . 2003. Telephone interview with author, January 13. Wisconsin Central Annual Report. 1992,1995,1996. Madison, Wisconsin.

9 The Future of the US. Airline Industry The early 1990s were difficult years for the airline industry. During the period from 1990 to 1992, the airlines lost as much profits as they had made since the industry was deregulated in 1978 (Cunningham 2000). There were several reasons why these losses were incurred. First, the United States was in an economic recession, which resulted in a reduction in air traffic. Second, the Gulf War in the early 1990s reduced load factors to all-time lows. Third, the price of jet fuel was the highest it had ever been (Cunningham 2000). As a result, the airlines had to pay much higher prices for fuel compared to average long-term oil prices (Thomchick 1993). To compensate, airlines raised fares, which led to declines in demand (Pilkarski 2001). Fourth, a perceived terrorism threat caused a substantial drop in traffic. The year 1990 was the industry's worst ever. Virtually all the losses were in the fourth quarter, when the cost of fuel doubled as the result of the Iraqi invasion of Kuwait (ATA Annual Report 1991). It did not take long for the Persian Gulf crisis to start taking its toll on the cash flow in the airline industry. Delta Airlines, one the strongest U.S carriers, reported its first operating loss since deregulation (Thomchick 1993). In 1990, Continental Airlines declared Chapter 11 bankruptcy protection. Eastern Airlines was already operating under federal bankruptcy protection (Lawrence 1991). Despite setting new records in passengers carried in 1990, the U.S. airlines lost $4 billion. The year 1991 was also a difficult one for the airlines. It was the industry's second worst year ever—less disastrous than 1990 only because the price of fuel declined. Losses amounted to $2 billion in 1991 (ATA Annual Report 1992). In January 1991, Pan Am Corp. filed for

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Chapter 11 bankruptcy protection. Midway sold its Philadelphia hub to U.S. Air. Later in that year, Midway Airlines filed for Chapter 11 bankruptcy protection (Fotos 1991). Also in 1991, Trans World Airlines (TWA) and America West both filed for Chapter 11 bankruptcy protection ("World Airline Report 1991" 1992). The war and the recession caused the first yearly decrease in air travel in the previous decade. The airlines scaled back orders for new aircraft, a move that affected thousands of jobs and the nation's economic growth (ATA Annual Report 1992). The industry's downsizing also resulted in the loss of jobs in aircraft manufacturing and other airline support industries. These industries relied on a healthy air transport system to generate profits (Thomchick 1993). The airline industry lost another $4 billion in 1992 (ATA Annual Report 1993). From 1990 to 1992, U.S. air carriers collectively lost more than $10 billion, and tens of thousands of industry employees were furloughed or laid off (ATA Annual Report 1993). SEPTEMBER II CRISIS

Analysts see a number of parallels between the first Gulf War crisis (1991) and the events of September 11 (2001), but they also are skeptical that lessons learned last time will provide solutions for the current crisis. Many of the actions that restored the industry to profitable status after the Gulf War are not repeatable in the current environment (Flint 2002). The early 1990s (especially 1990) were years of very high oil prices. The situation in 2003 is better in that oil prices, while high, are nowhere near the levels experienced a decade ago. However, labor costs have been on an upward trend, which has increased total costs versus those in the early 1990s. Unless some labor agreements are amended, costs overall are a minus compared to the early 1990s (Pilkarski 2001). Even before the September 11 attacks, analysts were predicting that the U.S. airline industry would lose $2.5 billion in 2001. This was a result of the slowing economy and a large decline in business travel. After the attacks on the United States on September 11, the airline industry spiraled into its largest annual loss in history. The fallout from the attacks caused losses to exceed $7 billion, mitigated only by the Air Transportation Safety and System Stabilization Act (Hallett 2002). Without the compensation provided by the federal government, industry losses would have reached double digits and the impact on airlines would have rippled even more severely across other sectors of the U.S. economy (Hallett 2002). After the attacks, air carriers grounded hundreds of planes and canceled thousands of flights. Industry capacity was slashed by at least 25 percent, and thousands of employees

The Future of the U.S. Airline Industry

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were laid off (Phillips 2001). In an effort to attract customers, airlines instituted dramatic fare reductions that cut prices by a much as 40 percent in some markets. Despite those moves, air travel demand collapsed further and the airlines incurred enormous daily financial losses. Six weeks after the attacks, airlines reported record fourth-quarter losses—"hemorrhaging money," in the words of former United Airlines CEO James Goodwin. Analysts correctly predicted that several carriers would be forced to file for bankruptcy in 2002. Airports responded to the financial crisis by lobbying for federal aid and delaying or deferring new terminal and runway projects. Before September 11, these projects had been deemed essential to relieve congestion and reduce delays. The airports also are considering imposing higher fees on airlines and concessionaries to cover the cost of installing new security measures. On September 22,2001, President Bush signed into law the Air Transportation Safety and System Stabilization Act (H.R. 2926). This act provides $15 billion in funding to implement new security measures and offset the financial losses experienced by the airlines (Phillips 2001). The act provides $5 billion in cash for air carriers ($4.5 billion for passenger carriers and $500 million for cargo carriers) as compensation for the direct and incremental losses incurred as a result of the September 11 attacks. Any carrier that can demonstrate to the U.S. Department of Transportation that it is has incurred such losses is eligible for assistance, regardless of its financial status before the attack or the carrier's long-term prospects. The act also authorizes the secretary of Transportation to take appropriate action to ensure that all communities that received scheduled passenger service before September 11 continue to receive "adequate" service. This provision could be used to justify partial reregulation of the industry. The distribution of the $5 billion is based on a simple market-share formula (share of available seat-miles for passenger airlines and share of revenue ton-miles for air cargo carriers). The Stabilization Act also provides for other items such as protection against certain insurance coverage increases, delaying payments of excise taxes, and protection against law suits for the airlines directly involved in the attacks (Barry, Stegich, and Carroll 2002). Other factors complicate the current situation. For the past several years, airlines had been ordering new aircraft at a rapid pace, well in excess of historical levels. As the economy pushed traffic demand up, there did not seem to be too much risk. It was commonly understood that if push came to shove, aircraft orders could be reduced to ease any excess-capacity situation that developed (Flint 2002). The industry was profitable, although analysts noted that earnings actually had peaked a few years earlier, and airlines were clearly on the reverse

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slope of the profit cycle. Labor unions, which had suffered through several concessionary contracts, were looking for a payback and put further pressure on airlines' eroding margins (Flint 2002). Recovery is dependent upon a number of factors. First, continued improvement of the U.S. economy is essential. As of 2003, this does not appear to be occurring. The continued recession has had a direct impact upon the airlines. For 2002, losses for the airline industry—in excess of $11 billion—were the largest in history (Wall Street Journal, 5 February 2003). The poor financial health of the airlines has a direct bearing on their ability to invest in new equipment. The industry is losing money and is deeply in debt (Velocci 2002). Moreover, respectable profit levels may not return before 2004 (Hallett 2002). In addition, customers are concerned about air travel. The FAA predicted an increasing sensitivity of business travelers with respect to air travel for three reasons. First, there is an increased availability of substitutes. Not only is new technology, such as video conferencing, expanding rapidly, but corporate aircraft have given business travelers more flexibility and are perceived as less risky than commercial flying. Second, concerns over security have reduced the popularity of business travel, especially over short distances. Since September 11, the advantage of air travel over other modes of shorthaul transportation (less than 350 miles) has been reduced (Bond 2002). It remains to be seen whether this becomes a long-running trend or dissipates. Third, as the relative price of business travel increases visa-vis discounted travel, business travelers may become more tolerant of the conditions of discounted travel (advance purchase, Saturday night stays, etc.) in order to qualify for the discounts (Bond 2002). The government will be forced to address another costly issue if air travel does return to pre-September 11 levels. Aircraft delays were at an all-time high in 2001. The delay problem has temporarily receded since September 11 due to the reduction in flights. However, as airlines return to their pre-September 11 schedules, the number and duration of delays will increase. Aircraft delays cost American businesses an estimated $3.2 billion in lost productive time in 2000 (Hallett 2002). Direct costs to the airline industry totaled an additional estimated $3.2 billion (Hallett 2002). It is critical to long-term economic prosperity that the industry continue to move forward on expanding capacity, building runways, and improving the air traffic control system. The airlines have taken on significant amounts of debt. The nation's ten largest airlines increased their balance-sheet debt to $56 billion at the end of 2002—more than double the $27 billion at the end of 1999. When off-balance sheet aircraft leases and airport rental payments are factored in, the industry's adjusted debt load soared to $125 billion at the end of 2002 from $86 billion three years prior. More worrisome, big chunks


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of the debt are being used to meet day-to-day obligations rather than to fund revenue-producing programs (Wall Street Journal, 1 July 2003). Adding to the pressure on U.S. carriers, access to fresh capital at reasonable prices has withered. Even though interest rates have fallen to their lowest levels in decades, airlines often get penalized with rates and loan terms accorded to risky business ventures. On top of that, the major carriers are staring at tens of billions of dollars in debt maturing in the next few years. In addition, the airlines need to fund their ballooning pension liabilities, pay for aircraft on order, and meet current debt obligations (Wall Street Journal, 1 July 2003). Airline debt has increased to well above norms for other industries, and it will take several years following a return to profitability to pay down debt to more acceptable levels. Airline debt-to-capital ratios are pushing 60 percent, versus 35 percent for other U.S. industries (Hallett 2002). Cutting costs is of critical importance to the airline industry. Labor costs are the airlines' largest cost component, amounting to approximately 35 percent of operating costs (Hallett 2002). However, based upon recent contract settlements, labor rates are expected to increase steeply (Hallett 2002). Even more troubling, with falling prices and rising costs the break-even load factor (i.e., the point at which costs are met and profits can begin) has risen to a record high of 77 percent (Hallett 2002). Table 9.1 illustrates overall airline industry earnings since deregulation. The airline industry has made money during times of economic prosperity but has lost significant amounts of money during three shocks. The first shock was the deregulation of the industry in 1978. In the early 1980s, many carriers incurred significant losses and went out of business after the industry was deregulated because they could not survive in the new competitive environment. During the mid to late 1980s, the U.S. economy was healthy and the airlines made money. As shown in Table 9.1, even during periods of a strong U.S. economy the airline industry did not achieve significant cumulative profits. The second shock was the Gulf War of 1991. The Gulf War crisis turned the industry unprofitable. It was not until 1997 that the airline industry began to show cumulative positive earnings. During the late 1990s, the U.S. economy was good and the airline industry began to show cumulative positive earnings. Then, on September 11, 2001, the industry was changed drastically. As a result of this third shock, it lost over $7 billion, most in the fourth quarter of 2002. With $11 billion in losses for 2002, the airline industry has now lost more money than it made since the industry was deregulated in 1978 (see Table 9.1). In the early 1990s, when airlines were confronted with similar circumstances, the industry had gone through a period of consolidation. Pressure is building again for the U.S. airline industry to resume con-

Table 9.1 U.S. Airline Earnings since Deregulation (1978) Year

Annual Profit/Loss (Thousands $)

Cumulative Profit/Loss (Thousands $)

1978

1196.5

1196.5

1979

346.8

1543.3

1980

17.4

1560.7

1981

-300.8

1259.9

1982

-915.8

344.1

1983

-188.1

156.0

1984

824.7

980.7

1985

862.7

1843.4

1986

-234.9

1608.5

1987

593.4

2201.9

1988

1685.6

3887.5

1989

127.9

4015.4

1990

-3921.0

94.4

1991

-1940.2

-1845.8

1992

-4791.3

-6637.1

1993

-2135.6

-8772.7

1994

-344.1

-9116.8

1995

2313.6

-6803.2

1996

2804.0

-3999.2

1997

5167.6

1168.4

1999

5360.0

11431.8

2000

2486.2

13918.0

2001

-7710.0

6208.0

2002*

-11200.0

-5088.0

Source: Department of Transportation—Form 41 (1978-2001). ^Estimate (Wall Street Journal, 5 February 2003).


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solidation (Velocci 2002). Some airlines may be better positioned than others. Dan Lewis, president of the Booz Allen Hamilton's commercial airline business, stated that "the air transport industry has been hit by a perfect economic storm with the convergence of high oil prices, the economic recession, the terrorist attack of September 11th, and widespread cost increases. The industry also has to address a number of long-standing problems," Lewis continued. "The airline industry has not been healthy for a long time. A 'systemic breakdown' has left the industry highly fragmented and subsidized. This is true even though almost a quarter of a century has passed since the U.S. airline industry deregulated and nearly a decade since European deregulation started in earnest" (Wall Street Journal, 19 August 2002). This view has also been expressed by others within the industry. Jurgen Weber, CEO of Lufthansa AG, stated, "It's time that subsidizing ailing airlines [should] be stopped, not only in Europe, [but] everywhere." Former CEO of American Airlines Bob Crandell stated, "We had subsidization in the United States after September 11. This is a distortion for this industry, and this will [prevent] this industry from developing in a normal way." Crandell acknowledged that regulation would smooth out booms and busts, but at the cost of slowing advances in technology. "One thing that regulation is very good at doing is suppressing technological progress," he said. Take your pick: stability or innovation; you cannot have it both ways (Coy 2002). "Restoring travelers' confidence is a critical priority," Lewis noted. "This will take enormous will on the part of government" (Wall Street Journal, 19 August 2002). Views of Congress with Respect to September II

In order to obtain current views about these concerns from Congress, I sent a mail questionnaire to all members of Congress in July 2002. The results of their responses follow. The members of Congress agreed with Dan Lewis's view of the industry before September 11. The respondents felt that the industry had been plagued by low growth and profitability since the industry was deregulated in 1978. Most of the respondents felt that air travel would not resume to preSeptember 11 levels until 2004. The respondents felt that the airlines would incur significant losses in 2002 and 2003 and that some carriers would return to profitability in 2004. The issue of re-regulating the industry generated quite a bit of discussion. Most of the respondents felt that the government should not play an increasing role in the airline industry, in terms of re-regulating or

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other subsidies, unless another catastrophe occurred. Many of the respondents felt that re-regulation or additional subsidies would deter innovation. It was noted by some respondents that hub-and-spoke operating systems would not have developed if the industry had not been deregulated. In addition, there would have been less incentive for firms to engage in global strategic alliances if the industry had remained regulated. The labor issue of efficiencies was also raised with the members of the Congress. All respondents felt that labor unions had a significant impact upon firm-level profitability. However, the respondents felt that the existence of labor unions was not negative. Many respondents felt that the existence of labor unions provided a competitive environment for the airlines. Many respondents stated that the firms that designed and implemented the best strategies in this competitive environment would survive. The respondents felt that this was the essence of free enterprise. One issue on which there was total agreement was security. Basically, the public will not return to normal airline patterns until they feel safe. It was the feeling of most of the respondents that the updated technology to screen passengers and baggage would be in place at the major U.S. airports by the end of 2002. During 2002, more than 50,000 people were hired to screen passengers and baggage at 424 commercial airports. However, on September 20, 2002, the Commerce Committee of the Senate agreed to extend the deadline to the end of 2003 (Wall Street Journal, 20 September 2002). Safety concerns may be one reason why the respondents felt that air travel would not return to normal levels until sometime in 2004. In addition, all respondents felt that utilizing law enforcement officers or the military negatively impacted customer service. The respondents felt that the more flexible airlines would survive the aftermath of September 11. (Remember that in Chapter 1, flexibility was discussed in terms of firm growth. Flexible and simple models are important when confronted with a significant environmental shock.) The respondents felt that during uncertain times, simpler is normally better than complex. A simple business model will be more responsive in changing circumstances—one reason that the low-farelow-cost concept will remain robust (Forsberg 2001). Southwest Airlines is an example of an airline that has great success with a simple business model. The respondents agreed that the industry will further consolidate into an industry with a few large competitors having global reach through the development of additional international strategic alliances. The respondents felt that the industry will go through another period of consolidation through acquisition. Growth by acquisition is considerably faster than by market expansion. It is also riskier, but usually


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more efficient, because infrastructure can be imported intact or divested en masse if already replicated (Forsberg 2001). However, the industry received another shock on March 21, 2003. THE SECOND GULF WAR

The second Gulf War has had a dramatic impact upon the airline industry. As a result of this war, passenger revenues have been running below 1995 levels (Heimlich 2003). When this revenue decline is coupled with labor costs accounting for between 40 to 50 percent of revenues, the airlines experienced record losses for the first quarter of 2003. Losses for the second quarter were improved only as a result of the $3 billion the government allocated to the industry as additional wartime aid resulting from the second Gulf War. As of August 2003, the industry had lost 127,000 jobs since September 11, 2001 (Heimlich 2003). With the increased federal aid, the industry is still expected to incur $7.3 billion in losses (Heimlich 2003). This comes on the heels of the industry's record loss of over $11 billion in 2003. Some airlines are not likely to survive as the industry experiences further consolidation. AIRLINES ARE UNLIKELY TO SURVIVE THE INDUSTRY CONSOLIDATION

U.S. Air, United Airlines, and American Airlines are in the most precarious positions as of 2003. United Airlines is in Chapter 11 bankruptcy protection, along with Hawaiian Airlines. American Airlines narrowly escaped a Chapter 11 filing in 2003, and U.S. Air emerged from Chapter 11 bankruptcy protection in the first quarter of 2003. U.S. Airways will be discussed first. U.S. Airways

During 2002, U.S. Airways moved to discontinue most of its unprofitable operations. It has closed its low-fare Metro-Jet subsidiary, which had posted deficits. The carrier withdrew from its least profitable routes and grounded inefficient aircraft. It has made deep cuts in its capacity to align the number of its planes with passenger demand and intends to make further cuts (Murphy 2002). U.S. Airways is unlikely to achieve sustained profitability (Murphy 2002). During 2001, U.S. Airways lost $2.12 billion; for 2002, it lost $1.65 billion. U.S. Air focuses primarily on the East Coast. So far, it has not entered into any international alliances. It also has a more fundamental problem: It is struggling from a price perspective because of competition into its core markets by low-fare carriers. Due to this fact, U.S. Air

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may not be an attractive target for a larger airline. It entered Chapter 11 bankruptcy protection in the summer of 2002. U.S. Air exited from bankruptcy protection on March 31, 2003. Despite aggressive cost-cutting, the nation's seventh largest carrier is still operating in the red, and is facing challenges caused by the war in Iraq, the continuing expansion of low-cost airlines on the East Coast, the poor economy, and an unprecedented industry downturn. The carrier has access to a $900 million government loan that it was awarded upon exit from Chapter 11 (Wall Street Journal, 30 July 2003). U.S. Air plans to utilize a portion of these funds to purchase a large number of regional jets to focus more heavily upon its short-haul markets. U.S. Air said the new fifty to seventy-five-seat jets will allow it to replace unpopular turboprop aircraft on some commuter routes, and to substitute the more efficient smaller jets in smaller routes now serviced unprofitably by larger planes. The new planes also will allow U.S. Air to start new routes that were too distant from its hubs for turboprop operations and will free up larger jets for new routes and additional service to profitable destinations such as the Caribbean. The longer-term prospects for U.S. Air are not positive. United Airlines will now be discussed. United Airlines

United Airlines (UAL) is the second largest airline in the United States (American is larger). Due to its extensive infrastructure, it suffers from substantial excess capacity. Its sheer size is a disadvantage because it generates more excess capacity, and therefore losses, than other U.S. airlines. Size is not a prerequisite for survival in the airline industry: Texas Air was the largest airline in the United States in the mid-1980s, and it no longer exists. United may be parceled up similar to Pan Am. On June 25, 2002, United Airlines filed for a federal loan guarantee to cover $1.8 billion of a $2 billion private loan. On December 5,2002, the Bush administration rejected the request, ending months of intense lobbying by the company and its rivals (Wall Street Journal, 10 December 2002). On December 10, 2002, United Airlines filed for Chapter 11 bankruptcy protection in an attempt to overhaul its operations and drive down costs. The Chicago-based company, which lost nearly $4 billion in two years, is bleeding millions of dollars in cash every day. UAL became the largest airline and sixth largest U.S. company by assets to file under Chapter 11 of the federal bankruptcy code. The filing represents the start of what will be a long and probably difficult process of deliberations as UAL seeks to lower its debt payments and reduce the wages and benefits it provides to workers. Although United Airlines is the industry's second largest, it is number one in costs. UAL


207

said it expects to remain in bankruptcy proceedings for about eighteen months. For 2002, United lost $3.2 billion. On January 13, 2003, United obtained a 29 percent cut approved by its pilots, a 9 percent cut approved by its flight attendants, a 13 percent cut ratified by its dispatchers, and a 13 percent cut for mechanics, ramp workers, and customer service agents imposed by the bankruptcy judge (Wall Street Journal, 23 January 2003). By implementing these cuts, UAL said it will remain on track to meet the strict cost-cutting requirements set out by the lenders who are providing it with $1.5 billion in interim financing. The interim pay cuts also give the airline more time to try to hammer out new contracts with the unions that would provide deeper and longer-lasting savings through reduced benefits, streamlined work rules, and increased productivity (Wall Street Journal, 23 January 2003). Early in 2003, United began to unveil its strategy. United is focusing upon the development of a new airline, Starfish, as a low-cost provider because United believes it competes with low-cost providers on 70 percent of its network (Wall Street Journal, 6 February 2003). Doug Hacket, United's executive vice president of strategy, said that United will pursue four specific segments: (1) the mainline airline, catering to business fliers with its strong network but with lower costs; (2) the low-cost carrier; (3) the expanded use of regional jets by United's commuter affiliation to reach smaller cities; (4) and increased coordination with United's international foreign and domestic airline partners. American Airlines In 2002, American integrated TWA's network into its own. Leveraged earnings gains are possible from its TWA Airlines integration if the economy recovers. American Airlines has extensive coverage in North America, Latin America, Europe, and the Pacific Rim. In addition, it has many alliance partners. Its membership in the One World alliance further increases its international coverage. Its alliance partners include AerLingus, British Airways, Cathay Pacific, Finnair, LanChile, Qantas, and Iberia. These partners could help American Airlines compete with other carriers in global markets as well as providing international customers (Murphy 2002). The partnerships should boost the company's earnings ability, as the carrier will have greater reach and opportunities to engage in additional alliances without using additional resources. American Airlines also has a strong position in short- and long-haul markets. Its subsidiary, American Eagle, is the regional airline servicing short haul markets. This combined network may result in additional cost savings. American has a comprehensive network that meets

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the needs of most business travelers (Murphy 2002). In addition, American improved its on-time performance from fifth in the industry in 2001 to second in 2002 (Wall Street Journal, 13 January 2003). However, American has been hit hard by the economic downturn. For the year 2002, American reported a net loss of $2 billion before special items, and $3.5 billion—$22.57 per share—after special items. For 2001, the company reported a net loss of $1.4 billion before special items, and $1.8 billion—or $11.43 per share—after special items. While American still has $2 billion in unrestricted cash and was able to borrow $650 million in December 2002, it continues to burn about $5 million in cash a day. "It remains a treacherous time for our company," former Chairman and Chief Executive Donald Carty said. "While there are many factors that impacted our results during 2002, including a sluggish economy, high fuel prices, lingering concerns over terrorism and the possibility of a war in the Middle East, the core issue for American remains a cost structure that is out of step with the revenue environment facing domestic airlines. We believe that a permanent shift has occurred in the airline revenue environment which will require us to reduce our annual costs by at least four billion dollars." Although American continues to modify its operations to be more competitive with low-fare carriers, Carty acknowledged that the future of the company cannot be ensured until ways are found to lower significantly its labor and other costs (Wall Street Journal, 23 January 2003). American has been periodically consulting with bankruptcy attorneys since the September 11 terrorist attacks. Bankruptcy attorneys say airlines regularly want emergency filings at the ready should disaster strike, and they also have been recently employed by airlines to look at possible asset sales in the bankruptcies of UAL Corp.'s United Airlines and U.S. Airways Group Inc. Now, with labor battles ahead with unions reluctant to agree to the kind of wage concessions that United and U.S. Air have won in bankruptcy court, bankruptcy concerns have increased (Wall Street Journal, 23 January 2003). American Airlines narrowly averted a Chapter 11 bankruptcy filing on April 28, 2003. During the first quarter of 2003, American lost over $1 billion (Wall Street Journal, 17 July 2003). American's second quarter loss was $75 million: However, this included a $358 million cash payment from the U.S. government as part of a federal subsidy to help the airline industry during the wartime downturn (Wall Street Journal, 17 July 2003). HAWAIIAN AIRLINES

Hawaiian Airlines filed for bankruptcy protection on March 21,2003. Hawaiian Airlines proposed to a bankruptcy court judge that its chairman and chief executive officer, John W. Adams, should resign as part


209

of a deal to avert the appointment of a trustee. The company also asked the court to appoint an examiner to investigate creditor allegations that Adams committed acts of fraud (Wall Street Journal, 7 August 2003). U.S. Bankruptcy Court Judge Robert Farris denied a motion by Hawaiian's current management that an examiner be appointed to investigate creditors' allegations that Adams committed acts of fraud and self-dealing. Hawaiian Airlines continues to lose money in 2003. America West Airlines

America West Airlines is also in a high-risk position for several reasons. Notwithstanding the carrier's improving operational performance, higher insurance as well as airport and security costs prompted higher unit costs in 2002 than was forecasted by the airline (Murphy 2002). America West Airlines will have annual deficits through 2003 (Murphy 2002). It has slightly more than 3 percent of the domestic market and, because of its size, might not be able to control price, and subsequent profitability, in the markets it serves (Murphy 2002). In February 2003, America West Airlines shut down its hub operation in Columbus, Ohio, eliminating the carrier's attempt to establish a greater presence on the East Coast (Wall Street Journal, 11 February 2003). Moreover, the airline participates in few alliances; these are becoming increasingly important in the airline industry. America West Airlines may be attractive to a major airline such as Delta, which needs to increase its presence along the West Coast. If America West Airlines is not acquired, it may be forced into Chapter 11 bankruptcy. On December 14, 2001, America West filed for $429 million in federal loan guarantees. For 2001, America West lost $148 million. For 2002, it lost $430 million. Northwest Airlines

Northwest Airlines will probably not return to profitability, without government assistance, until after 2004. The SARS epidemic has significantly hurt its trans-Pacific revenues. With its high-fixed cost structure and high fuel costs, Northwest is not in a good position because its domestic revenues have been flat. Northwest has developed code-sharing with Continental and Delta, which gives it access to domestic markets not otherwise accessible to it. Northwest's code-sharing arrangements with KLM and similar agreements with Japan Air System, Air China, and Nippon Cargo Airlines may provide medium term benefits. However, its high-cost structures will continue to generate significant losses. Northwest is unlikely to gain a competitive advantage, even as some rivals shrink their operations. For example, Delta Air Lines, United,

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and U.S. Air are reducing their low-cost flight operations on the East and West Coasts, but Northwest will not benefit from this as other airlines will (Murphy 2002). Air fares in Northwest's principal markets, in the upper Midwest, have been the nation's highest and thus could attract more competition from low-fare operators. Northwest lost $798 million in 2002 compared to $423 million in 2001. For the first quarter of 2003, Northwest lost $396 million; for the second quarter of 2003, Northwest made a profit of $227 million. However, this included $209 million in reimbursement from the U.S. government for the second Gulf War and a $199 million gain from the sale of Northwest's interest in Worldspan (Wall Street Journal, 7 August 2003). POSSIBLE SURVIVING AIRLINES

Continental Airlines and Alaska Airlines are the carriers that (1) have the liquidity to survive the current downturn, or (2) have been able to get labor concessions, or (3) have strategic assets (Murphy 2002). Continental Airlines

Continental has imposed tight cost controls, such as the move to eliminate travel agent commissions (Murphy 2002). These controls and Continental's new fleet are beginning to reduce unit operating costs. Once normal operations return, Continental could upgrade its product to appeal to higher-yielding business travelers and build more critical mass at its hub airports (Murphy 2002). An international airline with extensive service to Europe and Asia, Continental has formed seventeen strategic alliances with international carriers. These actions may help to increase Continental's growth. In 2002, Continental's net loss was $290 million, which significantly outperformed other major U.S. airlines. Alaska Airlines

Alaska Airlines should see a continued improvement in its business mix with expanded capacity. The carrier is utilizing its hub in Seattle to launch more long-haul routes. It plans to introduce service to Washington, D.C, from Seattle and to launch flights to Los Angeles, California, and Cancun, Mexico (Murphy 2002). The carrier is pursuing technology improvements to boost productivity. Operationally, its move to a more advanced global positioning system for its aircraft should allow for some cost savings. Its principal markets are the West Coast of the United States and Canada. This is important because the West Coast markets may be less affected by potential future terrorist actions (Murphy 2002). Alaska Airlines should benefit from the can-


211

cellation of the United Shuttle. Alaska Airlines is one airline that is actually adding flights. It is quite likely that Alaska Airlines will survive the industry consolidation. During 2001, Alaska Airlines lost $43.4 million; for 2002, the airline lost $118.6 million. Delta Airlines

Barring another major shock, Delta's cash position should be sufficient to support operations. Delta utilizes a three-tiered strategy: (1) operate close to break-even cash, (2) retain a highly liquid balance sheet, and (3) continue to develop alliances. Thus, it stands to gain the most market share, as its major rivals will be unable to re-establish their franchises (Murphy 2002). Delta's flight attendants rejected a proposal to be represented by a labor union, which reflects favorably on employee relations. Only its pilots have a union. Delta does not expect to report a profit before 2004. For 2002, Delta posted a loss of $1.27 billion, or $10.44 a share, compared with a loss of $1.22 billion, or $9.99 a share, in 2001. In 2003, Delta began to post significant losses. For the first quarter of 2003, Delta lost $466 million. Its second quarter profit of $184 million included a U.S. government reimbursement for the Gulf War and a gain from the sale of Worldspan (Wall Street Journal, 9 August 2003). Delta is expected to use $400 million in cash during 2003 (Greene and Susman 2003). It launched its low-cost carrier, Song, to compete with other low-cost carriers in 2003 (Wall Street Journal, 6 February 2003). This new subsidiary could eventually compete with low-cost carriers such as Jet Blue. Delta may gain market share as other airlines are forced into bankruptcy protection or are unable to fully restore their networks domestically. Delta and its four Sky Team alliance partners—AeroMexico, Air France, CSA Czech Airlines, and Korean Air—were the first to apply to the U.S. Transportation Department for flight code-sharing rights on international routes and for antitrust immunity. This move would enable the Sky Team members to aggregate their seat inventories in the transatlantic market, which could open the door to global branding (Murphy 2002). For a carrier of Delta's size, it could improve its international presence by pursuing other alliances. On October 1,2003, Air France merged with KLM. With the Air France/KLM combination joining the SkyTeam alliance, this will make it the largest of the three major global alliances. Southwest Airlines

The other airline that will likely survive the industry consolidation is Southwest Airlines (Murphy 2002). In 2002, Southwest Airlines was

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the best positioned airline. With the rest of the commercial airline system having cut about 20 percent of capacity following the terrorist assaults on September 11, Southwest was the only carrier that maintained its full flight schedule. Southwest is financially the strongest carrier in the United States, if not the world (Murphy 2002). For 2002, Southwest reported its thirtieth consecutive year of profitability. For 2002, net income was $198 million compared to $413 million in 2001. James F. Parker, Vice Chairman and Chief Executive Officer, stated, "In the context of what has been the worst year in commercial aviation history, we are very proud and grateful to report another profitable quarter and our 30th consecutive year of profitability. As a result, we are pleased to be able to reward our dedicated employees for their valiant efforts over the past year with a $71 million contribution to the company profit-sharing plan. Although our fourth quarter $42 million and full-year $241 million 2002 financial results are disappointing relative to historical standards, our performance relative to that of the industry as a whole has been excellent" (Southwest Annual Report 2002). For the first quarter of 2003, Southwest earned $24 million; for the second quarter of 2003, it earned $246 million (Wall Street Journal, 22 July 2003). In addition, Southwest has recently signed new collective bargaining agreements with its pilots and mechanists, and it has extended collective bargaining agreements with fleet service until 2008 and with flight instructors until 2012. Southwest Airlines is a low-cost provider that is financially strong and gaining market share (Murphy 2002). The company derives its cost advantage from productivity rather than from labor rate advantages. In addition, it has not had the type of contested labor negotiations that have affected most of the industry (Murphy 2002). Southwest's lack of airline alliance partners is one of its few weaknesses. It is likely to gain market share because some carriers have shut down their low-cost airline subsidiaries (Murphy 2002). Southwest may survive the industry consolidation and significantly increase size without acquisition by acquiring routes from carriers that go out of business. FUTURE OF THE U.S. AIRLINE INDUSTRY

There is nothing to prevent a scenario in which fuel prices go up, the economy goes into a recession, and /or the nation is confronted with some type of catastrophe similar to that of September 11 or March 21, 2003. It happened in the early 1990s, it occurred on September 11, and, unfortunately, it probably will occur again. Therefore, the airlines


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must examine how their resources are being utilized to buffer themselves against future shocks. The U.S. airlines do not utilize the flexibility that their resources provide. For decades, the airlines have been in the business of transporting people. Until this changes, they will always be at risk of losing money. As long as passengers constitute the significant majority of revenues for the U.S. airlines, there will always be a substantial risk associated with this single revenue stream. The airlines need to obtain greater utilization of their resources. Airplanes have the capacity to move substantial amounts of freight. In addition, freight revenues are much less dependent upon economic and environmental conditions. In the years following deregulation, during both Gulf Wars, and during the current economic downturn, air freight carriers made profits. Because most commercial aircraft are parked at night, there is limited utilization of the airlines' resources. Because the majority of air freight is moved at night, these aircraft could be utilized to generate significantly more revenue from freight operations. These periods of resource inactivity are very costly to the U.S. airlines. United, American, and Delta are members of global alliances. Their alliance partners, in many cases, generate a significant portion of their revenues from freight. The surviving U.S. airlines need to attempt to achieve greater scale and scope economies from their aircraft. These economies could be realized by entering the air freight market directly, through their alliance partners, or through alliances with domestic air freight firms. The critical point is that by increasing the utilization and flexibility of their resources, the airlines would be less dependent on passengers as a single revenue system. With the exception of DHL, the U.S. airlines, through their alliance partners, have much greater international coverage than do the U.S. air freight carriers (e.g., UPS). The international positions that the U.S. airlines provide may be appealing to air freight carriers as they further expand their coverage to additional international markets. The U.S. airline industry is very similar to the rail industry prior to deregulation. Remember Levitt's (1960) point that the railroads focused their business position too narrowly. During the regulated period, railroads had one primary source of revenue. Now the railroads are global, multi-modal enterprises. The surviving airlines need to understand that they are in the transportation business rather than the passenger airline business. If they do not move into related areas of transportation, they may survive the current period but not the next recession, catastrophe, and/or high fuel prices. One of the fundamental principles that this book has shown is that firms need to develop related businesses. Those firms that do, grow; those that do not, do not survive.

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LESSONS LEARNED

1. A focus upon a single utilization of your resources does not provide flexibility to respond to significant environmental changes. Because passengers represent the primary source of airline revenues, the carriers do not have additional revenue generating options when the demand for passenger travel declines. 2. A focus on strict cost reduction will not result in long-term profitability. Remember the SAS example in Chapter 2. It was only after SAS identified its key success factors and developed resource positions to meet them superior to competition, that the financial performance of SAS improved. A focus on cost reduction is too oriented upon internal operations: Cost reductions rarely address existing and changing customer needs. 3. Solid strategic decision making is rewarded. Southwest has the opportunity to significantly increase its market positions as other carriers reduce their networks. These additional market positions will provide additional economies of scale, which will further increase flexibility. "You are not very optimistic about the United States airlines," said the CEO. "Think back to the 1960s, were you optimistic about the United States railroads?" I asked. "No, I was not," replied the CEO. "The airlines have been servicing the same customer for decades," I said; "how many firms have made money by providing the same service to its customer base for decades, while others in their industry have expanded to provide services to many related customer segments?" "I am not aware of any such firms," stated the CEO. "Firms that focus solely on cost reduction do not have viable business models. Long-term growth should be focused upon an understanding of environmental trends, a knowledge of existing and potential competition, and the development of a firm's resources in a specific pattern," I said. "Explain the last statement more fully," stated the CEO. REFERENCES

Air Transport Association (ATA) Annual Report. 1991,1992,1993. Barry, D., S. Stegich, and N. Carroll. 2002. "September 11 Attacks Spawn Airline Industry Help." Defense Counsel Journal (January). Bond, D. 2002. "Optimism on Surface, Skepticism Beneath." Aviation Week and Space Technology (March 18). Coy, P. 2002. "Deregulation: Innovation vs. Stability." Business Week (January 28). Cunningham, W. 2000. "The Changing Face of U.S. Transportation: The Airlines Industry." Journal of Transportation Law, Logistics and Policy Flint, P. 2002. "Those Who Can't Remember the Past." Air Transport Wor (February).


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Forsberg, D. 2001. "Strategies for Long-Term Growth." Airfinace Journal (December). Greene, W., and R. Susman. 2003. "Delta Air Lines." Morgan Stanley Equity Research. Hallett, C. 2002. "State of the U.S. Airline Industry: A Report on Recent Trends for U.S. Air Carriers." Washington, D.C: Air Transport Association. Heimlich, J. 2003. U.S. Airlines: The Road to Resurrection. Washington, D.C: A Transport Association. Lawrence, J. 1991. "Several Airlines Face Crash Dive." Advertising Age (January 14). Levitt, T. 1960. "Marketing Myopia." Harvard Business Review (July-August): 96. Murphy, K. 2002. "U.S. Airlines." Morgan Stanley Equity Research (March). Phillips, L. 2001. "A Crisis of Security and Economics." Regulation (Winter). Pilkarski, A. 2001. "Return to 1991?" Asset Finance International (October). Southwest Annual Report. 2002. Phoenix, Arizona. Thomchick, E. 1993. "The 1991 Persian Gulf War: Short-Term Impacts on Ocean and Air Transportation." Transportation Journal (Winter). U.S. Department of Transportation. Bureau of Transportation Statistics. 19772001. Air Carrier Financial Report, Form 41. Washington, D.C: U.S. Department of Transportation. Velocci, A. 2002. "Analysts Take Cautious Measures of Near-Term Uncertainties." Aviation Week and Space Technology (March 18). Wall Street Journal. 2002. January 23. . 2002. August 19. . 2002. September 20. . 2002. September 23. . 2002. December 5. . 2002. December 10. . 2002. December 13. . 2003. January 13. . 2003. February 5. . 2003. February 6. . 2003. February 11. . 2003. March 22. . 2003. May 6. . 2003. May 20. .2003. July 1. . 2003. July 17. . 2003. July 22. . 2003. July 30. . 2003. August 7. . 2003. August 9. "World Airline Report 1991." 1992. Air Transport World (June).


10 Patterns Generating Long-Term Crowth This book has examined how firms grow when confronted with significant environmental change. We have learned some fundamental lessons that will help your firm grow and prosper to a greater degree than your competitors. LESSONS LEARNED The first lesson learned involves the crucial role that resources play in firm growth. Those firms that have grown have assimilated resources from throughout the firm to build positions of advantage. It is not the resources themselves that are valuable, but how they are utilized that is important (Pettigrew, Woodman, and Cameron 2001). In the industries studied, resources were combined and reconfigured to build capabilities that provided firms with growth potential. These resource combinations were not only utilized effectively in the firm's core business but also were developed in such a manner that they could be leveraged across related businesses. For example, the benefit of a huband-spoke operating system is that this capability can be utilized for trucking, rail, air freight, airline, and ocean shipping segments of the transportation industry. Because this capability is utilized across industries, both a scale and a scope advantage are achieved. New resources played an interesting role in the industries studied. Firms that were successful at growing in deregulated environments utilized new resources in a very specific manner. New resources were not developed to generate firm growth by themselves; their role was to add value to existing or related resources. For example, by the air-

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lines developing customer service call centers, passengers could more easily communicate with the airlines. The addition of technology to those call centers permitted customers to obtain real-time information with respect to many aspects of the specific airline they were interested in. Technology permitted customers to book reservations on domestic and international carriers. Web access made communication even easier. Trucking firms learned from the air freight firms that tracking was a resource that could add value from a shipper's perspective. The development of TOFC's (trailer on flatcars) permitted trucking firms to load trailers directly into rail cars. This resource enabled the trucking firms to reduce their costs because rail transportation is more economical than truck transportation. The air freight firms learned that they could significantly reduce transit time by developing an integrated air-ground, hub-and-spoke operating system. By developing global hub-and-spoke operating systems, carriers could provide shippers with total global coverage. The significant point with respect to new resources was that they made existing and/or related resources better from a differentiation perspective and/or more efficient from a cost perspective. The new resources added value. They permitted carriers to establish a position of temporary advantage with respect to competitors. The firms that experienced the highest growth rates were able to develop a sequence of temporary advantages that were linked over time to provide longterm growth. It is how resources are combined with existing and/or related resources that provides for long-term growth. Resources that are combined into capabilities that have the potential to grow as the firm grows are of critical importance. As firms grew from rail, trucking, or air freight carriers to full-service transportation carriers, resources were developed to support the expansion of the firms into different modes of transportation. Resources were developed that grew in the direction that the industry was evolving. A second lesson learned is that over time, in order to move in the d rection the industry expands, resources need to have flexibility. Resource flexibility is crucial for growth. In many cases, the direction a firm will grow is not known before the fact. Resources need to be developed with maximum flexibility to grow with the customer base. For example, Toyota has been successful because its production processes are designed to support different models of cars with minimal modification. The future cannot always be predicted with certainty; therefore, resources need to be flexible enough to grow in the direction the customer base dictates. Even in the industries studied, where resources appear to be lumpy (e.g., trucks, planes), they can be uti-

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lized to service related industries and provide the firm with both a scale and a scope advantage over competitors. Although trailers are utilized for trucking shipments, they can also carry rail, small package, and air freight shipments. This resource flexibility becomes important if the firm is to meet the evolutionary needs of the customer base. Those firms that developed their operational infrastructure to support multiple modes of transportation grew faster than their competitors. FedEx and UPS are two examples of this principle. The third lesson learned concerns firm size. Size may be a necessary but not a sufficient condition for long-term firm growth. To achieve growth in the industries that we studied, the successful firms grew into global, multi-modal transportation carriers. Initial firm size does not appear to be an indicator of success in deregulated environments. For example, many airlines that were initially large (e.g., Pan Am, Eastern) went out of business or are in Chapter 11 bankruptcy (United). Southwest Airlines and Alaska Airlines, very small airlines in 1977, have grown significantly in the deregulated period. Virtually all the TL (truckload) firms that grew to be major players within the trucking industry started out as small, regional players. Several of the LTL (lessthan-truckload) firms that survived deregulation were small before deregulation. Several of the rail carriers that survived and grew significantly were started as a result of deregulation. One reason that firms grew significantly was that they changed the composition of their managerial resources. As these successful firms acquired related businesses to add value to their core business, they also gained valuable managerial resources to help lead the integration of the related business into the core business. These new managerial resources had significant experience in the related transportation segments. This principle becomes even more important when firms expand into international markets. Expansion internationally is both a blessing and a curse. International markets provide enormous expansion potential. However, these markets are all quite different—politically, economically, technologically, legally, and culturally. In order to be successful in international markets, a firm must have managerial resources that are knowledgeable about each market. After all, each international market has its own distinct set of competitors and customers. For example, Disney was initially unsuccessful in Paris because it made very minor changes to its theme park concept. The same was true of Mattell when it introduced the American Barbie doll into Japanese markets. Having managerial resources that are familiar with these markets would have saved each firm significant time and money. The fundamental underlying principle is that managerial resources develop firm-specific resources that are configured into capabilities that provide the firm a founda-

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tion for growth and competitive advantage. The role of managerial resources is critical for growth by acquisition. The fourth lesson learned is to maintain the target's managerial resources. The more unrelated an acquisition is to the firm's core business, the more important it is to retain the senior management team of the acquiring firm. Customers, competition, industry structure, and degree of product substitutability are all different in an unrelated industry. Therefore, it becomes of critical importance that the target's management team be made an integral part of the acquiring firm's senior management team. Unrelated acquisitions also bring managerial resources that are different from those of the acquiring firm. The acquiring firm's managers must take valuable time to train the new managers in the firm's core business. Penrose (1959) asserted that training new managers would lead to a period of low growth as these new managers are trained by the acquiring firm's managers. Due to this constraint on managerial time, the acquiring firm's managers have less time to devote to further developing existing and related resources. This brings up an interesting point: Are unrelated acquisitions valuable for firm growth? Unrelated acquisitions give the firm a size advantage, which may be important in industries where there is little product differentiation. In addition, unrelated acquisitions give the acquiring firm new resources. However, size and new resources do not necessarily lead to long-term growth. In the industries studied, the firms that were successful made very few unrelated acquisitions. One reason for this may be that it is more difficult to achieve synergies with unrelated acquisitions. Integrating new resources into the acquiring firms existing resource base is time consuming, and the new resources may not be effectively utilized in combination with a firm's existing resource base. There is some evidence that unrelated acquisitions can create synergies (Seth 1990a, 1990b). However, the preponderance of the literature, and the decisions of firms discussed in this book, shows that related and same-businesses acquisitions provide the firm with greater synergies. In the industries studied, firms that engaged in unrelated acquisitions went out of business. Many of these firms felt that they could obtain higher profitability in industries not related to transportation. These firms were not successful in the new industries. If firms spend decades in one industry, it is very difficult to achieve advantage in others. Resources in unrelated industries differ from those in a firm's core industry. The new resources that were made available as a result of the unrelated acquisitions could not be productively utilized because they cannot be integrated within the acquiring firm's core business.


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Basically, if an acquisition cannot be totally integrated into the business or does not provide added value to existing or potential customers, then making the acquisition may not be a wise decision. Remember from Chapter 1 that time is important: Acquisitions should be utilized to accelerate the firm's growth. Unrelated acquisitions may impede or delay the growth process. This book has shown that firms grew by first fully developing their existing resource base and then developing related resource positions. The managerial resources that were acquired provided significant value added as the acquiring firms moved into these related industries. The acquired managers provided knowledge to assist carriers from servicing specific markets to emerging as full-service, multi-modal transportation carriers. Because multi-modal carriers were developed in response to changing consumer needs, a firm's growth pattern must be linked to its customer base. This point leads to the fifth lesson learned. Fundamentally, a firm mus grow with its customer base over time. This principle was discussed in Chapter 1 with respect to McDonald's, Microsoft, and Toyota. In the industries studied, carriers grew with their customers. As customers began to require additional transportation services, the firms that grew began to offer such services. It is of critical importance that the firm stay close to the customer. This is becoming increasingly difficult as email and fax become routine modes of communication. To fully understand the evolutionary need of its customer base, the firm must keep in close, personal contact with them. If it does not, its competitors may. The focus group concept, discussed in Chapter 2, can be very effective at staying close to the customer base over time. The sixth lesson learned is that resource positions need to be built so that they provide a vehicle for meeting the evolutionary needs of the customer base. What the firm needs to do is utilize resources to meet the current customer needs while building resource positions that have the capacity to meet future customer needs. In the industries studied, the development of a hub-and-spoke operating network is utilized to support trucking, air freight, airlines, and rail modes. Building resources that can be expanded to meet the evolving needs of the customer base will provide the firm with growth opportunities within its core business and also provide a vehicle to grow into related businesses. The role of technology is important from a growth perspective. Technology should be developed to meet existing customer needs and be able to be expanded to meet evolutionary customer needs. For example, package tracking was originally designed to meet the needs of the U.S. market. However, many carriers realized that tracking of international packages would provide a differentiation advantage over their com-

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petitors. This advantage was implemented initially by the air freight carriers that wished to develop a competitive advantage over other modes of transportation in addition to speed. Technology was utilized not to achieve growth but to facilitate growth by making existing or related resources more productive or to provide better service to customers. A seventh lesson learned is linked to the firm's competition: Take advantage of the strategic errors of competitors. The crux of strategy is to gain a position of advantage and then sustain that position over time (Rumelt, Schendel, and Teece 1991). Many firms in the industries studied attempted to move into related industries before they had fully developed their operational infrastructure; all these firms failed. If the infrastructure is not fully developed, it is difficult to meet the needs of the customer. A fully developed infrastructure was a prerequisite for growth in the industries studied. In many cases, the network is what the customers are paying for. For example, if a customer wishes to ship a package from Portland, Maine, to El Paso, Texas, the firm needs to develop a national network. This same customer may have rail, air freight, and trucking needs, but the firm will not have access to these other types of shipments unless the complete distribution network already exists. By developing this network first, the firm puts its competitors at a disadvantage. Additional industry segments cannot be developed until this infrastructure is in place. The key is to develop resource positions that meet existing customer needs and have the flexibility to address the evolutionary needs of the customer. The competition may only be viewing the industry from a static (current period) perspective. Building resource positions that can be modified and enhanced as the existing customer base changes and as the firm acquires new types of customers will accelerate firm growth over time. An eighth lesson learned is that acquisitions need to provide the acquiring firm with dual benefits. Acquisitions play a critical role in the growth of the firm. However, they are costly and their implementation takes considerable time. Each acquisition should provide both a scale and a scope advantage. A fundamental reason why the rail carriers became multi-modal, global transportation firms was that their acquisition decisions achieved these dual benefits. The railroads that grew in the deregulated environment realized that their scale of operations was constrained to their rail infrastructures. However, customers wanted door-to-door service. To provide for this service, the rail carriers began to acquire trucking firms, which had a much more extensive infrastructure and provided door-to-door service. The railroads were able to develop integrated rail-truck, huband-spoke networks that provided a competitive advantage over those railroads that did not develop the more extensive networks.


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In addition, the railroads acquired ocean shipping firms to gain access to international markets. In this manner, railroads were able to expand internationally by using the existing network of the ocean carriers. Risk of failure was much lower because the international infrastructure had already been developed by the target firm. In addition, an existing customer base was already in place in order to further expand into international markets. As such, additional acquisitions may not be necessary. The railroads utilized strategic alliances to obtain domestic and international market coverage without engaging in additional costly acquisitions. Many of the U.S. air freight players that have grown in the deregulated environment have established strategic alliance networks that provide for global coverage. These alliances permit an increase in market positions without significant incremental costs being incurred by alliance members. International alliances may provide a differentiation advantage over carriers that have not engaged in international alliances. The role of alliances may become increasingly important in the twenty-first century. In the global future, we may see alliances among airlines, trucking firms, ocean shipping firms, and rail carriers. The benefit to including airlines in these alliances is that they provide a time advantage (see Chapter 1) over other modes of transportation. The benefit to the airlines is that they have two sources of revenue: passenger and freight. Many of the European and Asian airlines are major freight players. The U.S. airlines generate little revenue from air freight. The next step in the resource development path of a few of the surviving U.S. airlines may well be development of air freight through their existing global, airline alliances. One benefit of freight, during current times, is that it is less sensitive from a safety perspective. Airline passengers still have concerns regarding safety. This concern keeps load factors on U.S. airlines at significantly lower levels than before the events of September 11,2001. The second Gulf War has not helped the situation. A ninth lesson learned is that a reactionary approach to deregulation does not work. The "bloodbath" that Rakowski (1988, 1994, 2000) refers to resulted from trucking firms not reacting to deregulation. From Chapter 5, we learned that many firms continued to operate as they had in the deregulated period. These firms did not develop the resources that were critical for success. The unsuccessful firms did not develop their resource base to meet the current and future needs of an evolving customer base. These firms were unable to meet the key success factors that resulted from deregulation and, therefore, were at a disadvantage as the key success factors in the industry changed. The role of environmental scanning (Chapter 2) is of crucial importance in identifying key success

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factors in the current period and as they change over time. The successful firms did develop their resource base along similar lines regardless of industry. Based upon the results of the industries studied, the sequencing of a firm's base may be the tenth—and most important lesson learned. The most successful companies are those that have grown by adding new capabilities sequentially over extended periods (Collis and Montgomery 1995). This sequential development of resources and capabilities makes them unique and rare. Competitors cannot simply buy the resources and capabilities because they are built over time in a pathdependent process that is difficult for competitors to imitate (Dierickx and Cool 1989). Sequencing Principles for Firm Growth

The general sequencing path within the industries we have studied is illustrated in Figure 10.1. The matrix provides us with four sequencing steps for growth. Step 1: First, fully develop your existing resource base. Your existing base has excess capacity (Penrose 1959). Extract the maximum benefit that your existing resource base can provide. In the industries that we studied, it was important to develop the resource base internally or by acquisition. The complete development of your existing base will provide your firm a competitive cost advantage and provide a foundation for future expansion. In the industries studied, firms that did not fully develop their existing resource base either were acquired by firms that did or went out of business because they could not compete. Firms can more fully develop their existing resources base by acquisition or internal development. Growth by acquisition or internal development results in different benefits. Growth by acquisition may be quicker, whereas growth by internal development may result in greater learning. Steps 2 and 3: Once your existing resource base is fully developed, utilize acquisitions to provide your firm with both international positions and related resources. The successful firms that grew in the industries studied acquired firms in the same industry or in related businesses. In either case, these acquisitions had existing international operations. In this manner, your firm can gain international positions that are existing as opposed to developing your own international positions independently. Direct entering of international markets can be costly and has a significant risk component. Reduce both the cost and the risk by acquiring domestic firms that have established international operations and an existing international customer base. Related acquisitions also provided significant benefits. Acquisitions into related businesses can provide complementary resources that can


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Figure 10.1 General Sequencing Pattern

be utilized to increase scale and scope of operation. For example, the high-growth rail carriers acquired trucking firms to more fully develop their national infrastructure and ocean shipping firms to gain access to international markets. Related businesses can be integrated into an acquiring firm's resource base because acquiring firms have built flexibility into their initial resource positions. One benefit of related acquisitions is managerial resources that have new sources of knowledge. One of the primary assumptions of the theory of the growth of the firm is that "history matters"; growth is essentially an evolutionary process that is based on the growth of collective knowledge (Nelson and Winter 1982; Mahoney 1995; Penrose 1995). Penrose (1995, xiii) states that "the growing experience of management, their knowledge of other resources of the firm and of the potential for using them in different ways, create incentives for further expansion as the firm searched for ways of using the services of its resources more profitably." Therefore, retain the management of your related acquisitions: They will make implementations much more easily, and the acquiring firm will obtain the benefits of the combined firms much more quickly.

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The integration of new managers from related industries may provide a platform for growth, which would not be available for firms not possessing related industry managerial resources. These related managerial resources provide the opportunity for new learning to facilitate the growth process. The related industry managers may be able to develop greater creativity from the firm's total resource base. In fact, the growth in logistics resulted from managerial resources creating new ways to utilize a transportation firm's infrastructure. Having these managerial resources, in place in related industries and in international markets, reduces the necessity for further acquisitions in favor of strategic alliances. Because only additional scale resources are needed for future expansion, additional acquisitions may be an inefficient and a relatively expensive way to obtain such resources. Further acquisitions may entail greater sunk costs and rigidity relative to collaborative linkages (Ahuja 2000). By not engaging in additional acquisitions, the funds that would have been allocated to purchase targets can be utilized for other growth purposes. Strategic alliances may be a much preferred mode of expansion once initial positions are established. Step 4: Utilize strategic alliances to more fully develop your existing and related businesses domestically and internationally. The smaller LTL carriers utilized alliances to build a national network. The air freight carriers utilized strategic alliances to establish worldwide distribution networks. The TL carriers and rail carriers utilized strategic alliances to develop into global, multi-modal carriers. In this way, growth came from utilizing strategic alliances to more fully develop additional domestic and international markets. Carriers were then in a position to provide their customers with a complete line of domestic and international products and services. Strategic alliances are important for firm growth because no one business can create all resources needed to prosper and grow. Instead, collaboration among businesses that posses complementary resources is necessary for survival and growth (Ahuja 2000). In addition, alliances provide a means of combining resources held by different firms in order to more fully exploit existing positions and new business opportunities (Dussauge, Garrette, and Mitchell 2000). The firm should be viewed not just as a set of productive resources, but also in the context of its relationships with its partners (Chung, Singh, and Lee 2000). A relational perspective of the firm focuses not only on its unique capabilities but also on its use of alliances to leverage its capabilities and gain access to the complementary capabilities of its partners (Dyer and Singh 1998). In this manner, growth is further accelerated.


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SeQuential Advantage

Many of the "new" resources that were developed in the industries studied were actually technological resources that provided greater value to existing or related resources. In the industries studied, new resources were integrated with existing resources to provide a temporary advantage. When the competition caught up, additional new resources were developed that created another temporary advantage. The continuous coupling of new resources into a firm's existing resource base created sustained advantage through a sequence of temporary advantages. A continuous influx of new industry managers was of critical importance in the development of these new resources. The firms we studied that attempted to internally develop new resources went out of business. Firms may not have the necessary managerial resources to make internal development of new resources prudent. A movement to internally develop new resource positions may move the firm too far away from its core competencies. Combine resources so that your firm builds synergistic capabilities that can develop both a sequential advantage and a barrier to entry. The hub-and-spoke operating system is a capability that many transportation segments have developed. When a ground hub-and-spoke operating system is integrated with an air hub-and-spoke operating system (e.g., air freight carriers), the integrated capabilities provide a source of long-term growth. Just as important, because these capabilities are integrated the combined air-ground network provides a significant barrier to entry. New entries must build two distinct networks and link them together if they are to be viable competitors. In addition, a potential new entrant would need acquire a fleet of aircraft and delivery vehicles: Thus, the fixed costs to gain entry into this industry would be substantial. New entrants could enter other industries with much less capital expenditures. GENERALIZING TO OTHER INDUSTRIES

Perhaps the sequencing that has been developed has application to other industries that have not undergone deregulation. The regulated environment is one in which controls are highly restrictive (see Table 4.1 in Chapter 4). However, the sequencing that has been discussed begins with the utilization of excess capacity. Because most resources are not totally utilized seven days a week, twenty-four hours a day, the concept of starting with obtaining greater utilization of existing resources may not be constrained to industries that have been deregulated.

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Initially, a firm's growth is driven by excess capacity (Penrose 1959). The utilization of the excess capacity of a firm's resource base provides for economies of scale. Utilizing excess capacity to generate economies of scale is not industry specific. In the industries studied, resources were combined via either internal development or acquisition to create capabilities that could be further leveraged to achieve economies of scale. Such capabilities permitted firms to combine resources scattered throughout the firm into an integrated framework. Acquisitions provide for rapid firm growth (Penrose 1959). Internal development, on the other hand, may result in greater learning because firms must build capabilities through their own internal integration processes. In either case, it is normally better to fully develop a resource set in one market before expanding into other markets. In this manner, firms can enter other markets from a position of strength (Wernerfelt 1984). Once a firm's existing resource base has been fully developed, the growth of the firm can be accelerated by making certain types of domestic acquisitions. The role of related acquisitions is of critical importance if your firm is to grow at a faster rate than your competitors. If acquisitions are utilized to generate economies of scale, a cost advantage may be realized. Related acquisitions can also provide economies of scope because the firm may be able to further leverage its resource base in the related industry. This scope advantage may provide your firm with a differentiation advantage over competitors. If the related acquisitions provide both a scope advantage and existing international positions, the growth of your firm will be further accelerated. The utilization of related acquisitions to achieve these dual benefits is not specific to deregulated industries. Acquisitions are a successful mode of growth in most industries. If made wisely, acquisitions can be utilized to generate both economies of scale and scope. The role of acquisitions may be of critical importance in terms of international expansion. Expansion by acquisition can be a quick way of generating growth in a firm's core market. A quicker way to generate international expansion is to acquire domestic firms that have international positions. In this manner, acquisitions can also provide firms with economies of scale both domestically and internationally. Further, if the acquired firm has an international market position, it provides the acquiring firm with an existing customer base. In the industries studied, firms fully developed resources within their core markets and then utilized related acquisitions to establish economies of both scale and scope. In addition, because the targets had international operations, the acquiring firms also grew into international markets. These acquisitions were utilized as "stepping stones"


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(Wernerfelt 1984) for expansion. Further expansion does not need to incur the costs and time of additional international acquisitions or implementation costs. It may be more prudent to engage in international strategic alliances rather than additional international acquisitions. Strategic alliances are neither costly nor do they usually require substantial implementation time. The opportunity to utilize strategic alliances to generate domestic and international growth is of critical importance and is not industry specific. First, alliances provide firms access to markets and resources at relatively minimal cost. Second, in some countries, growth by acquisition or direct entry may not be permitted. Strategic alliances may be the only opportunity for growth in these markets. Strategic alliances also permit the sharing of costs, which reduces the variable expenses of each alliance member. Alliances can also be utilized to develop multiple resource positions in multiple markets. Alliances of this nature are not constrained to industries that have been deregulated. Strategic alliances also provide many of the same benefits as related acquisition at much lower cost. Strategic alliances enable the firm to access key resources from its environments—such as information, access, capital, goods, and services—at minimal cost (Gulati, Nohria, and Zaheer 2000). Therefore, the firm has the potential to generate further growth. "Do you really believe the patterns that have been developed are generalizable to other industries?" the CEO asked. "Yes, deregulation is an environmental shock: It is not much different, in terms of impact, than the 1987 stock market crash, the Gulf War, or September 11 attacks. Firms are confronted with basically different environments in all cases. From a growth perspective the shock serves as a starting point. As we have seen in this book, some firms flourished while other firms went out of business or into Chapter 11. The environment does not constrain growth; how a firm chooses to sequentially develop its resource base is the most important factor in terms of determining how successful a firm is with growth over time," I stated. "It would seem to me that how a firm manages the transition from one stage of resource development to the next is of critical importance," the CEO said. "Managing the transitions from one stage to the next is of crucial importance: Most firms do not do this well," I stated. "Explain to me how this process is successfully managed and implemented over time," the CEO said. "O.K., but this will require a series of discussions," I said. "Fine with me; I would just as soon get it right the first time," the CEO said.

230

Growth from Chaos

REFERENCES

Ahuja, G. 2000. "The Duality of Collaboration: Inducements and Opportunities in the Formation of Interfirm Linkages." Strategic Management Journal 21: 317-344. Chung, D., H. Singh, and K. Lee. 2000. "Complementarity, Status Similarity and Social Capital as Drivers of Alliance Formation." Strategic Management Journal 21:1-22. Collis, D., and C. Montgomery. 1995. "Competing on Resources: Strategy in the 1990s." Harvard Business Review (July-August): 118-128. Dierickx, I., and K. Cool. 1989. "Asset Stock Accumulation and Sustainability of Competitive Advantage." Management Science 35:1504-1511. Dussauge, P., B. Garrette, and W. Mitchell. 2000. "Learning from Competing Partners: Outcomes and Duration of Scale and Link Alliances in Europe, North America, and Asia." Strategic Management Journal 21: 99126. Dyer, J., and H. Singh. 1998. "The Relational View: Cooperative Strategies and Sources of Interorganizational Competitive Advantage." Academy of Management Review 23 (4): 660-679. Gulati, R., N. Nohria, and A. Zaheer. 2000. "Strategic Networks." Strategic Management Journal 21:199-202. Mahoney, J. T. 1995. "The Management of Resources and the Resource of Management." Journal of Business Research 33: 91-101. Nelson, R., and G. Winter. 1982. An Evolutionary Theory of Economic Change. Cambridge, MA: Belknap Press. Penrose, E. 1959. The Theory of the Growth of the Firm. New York: John Wiley & Sons. . 1995. "Foreword." 3d ed. The Theory of the Growth of the Firm: TwentyFive Years After. Oxford: Blackwell. Pettigrew, A., R. Woodman, and K. Cameron. 2001. "Studying Organizational Change and Development: Challenges for Future Research." Academy of Management Journal 44: 697-714. Rakowski, J. 1988. "Marketing Economies and the Results of Trucking Deregulation in the LTL Sector." Transportation Journal (Spring): 11-22. . 1994. "The Continuing Structural Transformation of the U.S. Less-ThanTruckload Motor Carrier Industry." Transportation Journal (Fall): 5-14. . 2000. "The Changing Face of U.S. Transportation: The Motor Carrier Industry." Journal of Transportation Law, Logistics, and Policy (Winter): 47-62. Rumelt, R., D. Schendel, and D. Teece. 1991. "Strategic Management and Economics." Strategic Management Journal 12 (Winter): 5-29. Seth, A. 1990a. "A Reexamination of Performance Issues." Strategic Management Journal 11: 99-115. . 1990b. "An Empirical Investigation." Strategic Management Journal 11: 431-446. Wernerfelt, B. 1984. "A Resource-Based View of the Firm." Strategic Management Journal 5:171-180.

Index AAA Cooper, 116,117-118 Acquisitions, 37,51,52,222-223,228; existing resources (same-industry), 42-43; international, 49-50, 224; new resources, 43-44; related resources/industry, 43,44,121, 224,228; unrelated, 44-45, 84,9596,220-221 Acquisitions, airlines/air freight, 168,169; AEI, 160,161; Danzas, 160,161; UPS and FedEx, 155 Acquisitions, railroads, 188,189,190, 194; Conrail, 176; CSX, 182,183; Kansas City Southern, 185-186; Norfolk Southern, 184; Union Pacific, 186,187 Acquisitions, trucking, 84,87-90, 100,101,121-122,125,127,128129,130 Adams, John W., 209 Additional resources, 43 Aero car, 6 Age, manager's, 9 Airborne Express, 157-158 Aircraft (airplanes), 49-50; airlines and air freight, 164; delays, 200; future of U.S. airlines, 213; FedEx, 155; orders, 199; Southwest, 147, 148; U.S. Airways, 206

Air express, 38 Air Express International (AEI), 160161 Air freight (carriers, industry), 3,1012,68,153-161,163; and airlines, 161,162; domestic and international growth, 51-52, 53; future of U.S. airlines, 213; growth options, 164-168; key success factors, 2228; lessons learned, 168-169; new resources, 218; strategic alliances, 223 Airlines (airline industry), 3,12-13, 32; deregulation, 67-71; new resources, 217-218; SAS (Scandinavian), 16-17; strategic alliances, international markets, 47, 223; and trucking firms, 41; utilizing resources, 36. See also U.S. airline industry, future of; U.S. airline industry, restructuring of Airports, 199 Air Transportation Safety and System Stabilization Act, 199 Alaska Airlines, 148-149,210-211 Alliances, intermodal, 110-111. See also Strategic alliances; Intermodal American Airlines, 41,139-141,207208; global positioning, 145-146

232

American Commercial Lines (ACL), 183 American Trans Air (ATA), 150-151 America West Airlines, 151-153,209 Amit, R., 17, 22 Arkansas Best Freight (ABF), 87, 126-128 Asia, 155-156,164,165 A u t o industry (manufacturers), 5-6, 45 Aviation services, Ryder, 112 Bagchi, P., 64 Bankruptcies (bankruptcy, bankrupt), Chapter 11, airlines, 68, 69, 135-136,162,205-210; America West, 152; American Airlines, 140141; Continental, 149; future of U.S. airlines, 197-198; United and U.S. Air, 142-145 Bardi, E., 64 Barney, Jay, 2 Belzer, M., 79 Big 3 LTL carriers, evolution of, 119, 121-129 Boeing, 32,49-50 Brincko, John, 93 Britain (British), 179,180,192 British Airways (BA), 144 British Post, 167 Building, utilization of, 35-36 Burlington Northern, Inc., 178 Burlington Northern Santa Fe Railroad (BNSF), 173,174,175, 178,187; future of, 193 Bush, George W., 169,199 Business travel (travelers), airlines, 16-17,200 Caliber System, Inc., 124 Camry, 12 Canadian National Railway (CN), 174,178-181; future of, 193 Canadian Pacific Limited (CP), 1 8 1 182 Canadian Pacific Railway (CPR), 176,181-184 Capital intensity, freight railroads, 73-74

Index

Carlzon, Jan, 16-17 Carpenter, Alvin, 192 Carriers, 53,63,64-67,68; LTL deregulation, patterns of growth, 114-129,130-131; intermodal, 190191; LTL and TL, trucking deregulation, 79-83, 84-95; rail industry, 72, 75; rail and trucking, 110-111; TL deregulation, patterns of growth, 102-114,129-130; trucking deregulation, patterns of growth, 100-102 Carriers, airlines: in Chapter 11 in 2003,142-145; global positioning, 146-147; surviving deregulation, 139-142,147-153; that went out of business, 138 Carter, Jimmy, 71 Carty, Donald, 140-141,208 Casey, Jim, 1, 2, 8 Cat strip technology, 48,49 Chandler, A., 51 Change: environmental, 5, 7, 83-84, 95; environmental, dictating, 30; strategic, deregulation, 60; strategic, implementation, 29-30 Chapter 11 airlines, 205-210. See also Bankruptcies Chessie System, 174,182 Class I railroads, 173-174,192-193; major unifications, 177 CNF. See Consolidated Freightways (CNF) Inc. Code-sharing (agreements), 70,153; Northwest Airlines, 209 Competitive strategic actions and reactions, 57,58,59 Competitors: international, air freight, 169; strategic errors, 130, 222; universities, key success factors, 19-20 Computer reservation systems, airlines, 70 Conrail (Consolidated Rail Corporation), 176-178,184 Consolidated Freightways (CNF) Inc., 92-93,128,129; evolution of, 119,121-122

Index

Consolidated Freightways (CF), demise of, 92, 93,96 Consolidation (consolidate), airline industry, 201,203, 204, 205 Continental Airlines, 149-150,210 Continuous customers, 11-12 Con-Way network, 121 Con-Way Transportation, 92-93 Corning, 48 Corolla, 12 Cost reduction, 214 Costs, airlines, 144-146,163,198; American Airlines, 208; deregulation, 69; transaction, 89-90 CP Ships, 181 Crandell, Bob, 203 Creative destruction, 31 CSX Lines, ocean service, 183 CSX Transportation (CSX), 173,174, 175,178,182-184 CTI LOGISTX, 167 Customer base/needs, 37,221-222; key success factors, 18 Customer orientation, SAS, 16-17 Customers: continuous, 11-12; focus groups, 19 Customized Transportation Inc. (CTI), 183 Czech Republic, 45 Dalsey, Adrian, 158 Danzas, 160; and LTS carriers, 165; and U.S. air freight/airline industry, 164-165 Davidson, Dick, 192 Debt, 90,200-201 Decisions, sequencing of, 55, 96. See also Sequencing Delaney, Bob, 66 Delaware and Hudson (D&H) Railway, 181 Delays, aircraft, 200 Dell, 40 Delta Airlines, 138,139,211; global positioning, 145,146 Deregulation (deregulated industries, etc.), 3, 23, 26, 27, 28, 57; airline deregulation, 67-71,201,

233

202, 203; evolution of deregulated industries, 60-75; lessons learned, 75-76; other industries, 227,228; railroad deregulation, 71-75,213; reactionary approach to, 223; restrictions in regulated industries, 57-59; strategies for newly deregulated environments, 59-60; trucking deregulation, 60-67. See also Trucking deregulation, patterns of growth; Trucking deregulation, why firms fail; U.S. airline industry, restructuring of; U.S. railroad industry, radical transformation of Deutsche Post, 159-160,161,167168 Developed countries, distribution systems, 26 Developing countries, distribution systems, 26 DHL (Worldwide), 47-48,158-160; and U.S. airline/air freight industry, 163,164 Dictating environmental change, 30 Differentiation advantage, 31 Direct entry, 37; international markets, 45-46 Direction of growth, 35-37 Discount fares, 69 Distribution systems, 26 Diversification (diversifiers), 44, 84 Domestic growth, 38-45; and international growth, 51-55 Domestic resources, 53-54 Domestic steel firms, 48-49 Dual benefits, acquisitions, 222 Due-diligence process, 88-89 Earnings, airlines, 202 Ease of entry, trucking, 60 Eastern Europe, 46,166 East Texas Motor Freight Lines, Inc. (ETMF), 127 Economies of scale, 38, 60, 228 Economies of scope, 38, 60,163,228 Electronic data interchange (EDI), 66 Emerson Electric Co., 50 Emery Worldwide, 121,122,157

234

Enhanced Ground Proximity Warning System (EGPWS), 148149 Entering other industries, 90-91 Entry, ease of, 60 Environmental change, 5, 7, 83-84, 95; dictating, 30 Environmental management, 30 Environmental scanning, 28-29,8384 Environmental shocks, 2-3, 75-76, 229. See also Shocks Environment and growth over time, 15-16; air freight industry, 22-28; dictating environmental change, 30; environmental scanning, 2829; key success factors, 17-22; lessons learned, 32; SAS (Scandinavian) Airlines, 16-17; strategic change implementation, 29-30; sustainable growth, 31-32 Ericsson, 41 Estes Express, 116,118 European Express Centre (EEC), 167 Europe (European Union), 45,46; air freight, 164,165; Eastern, 46,166; TNT Post Group (TPG), 165,167; Yellow, 126 Evolutionary customer needs, 221222 Excess capacity, 51,227-228; deregulation, 60, 69, 83; airlines, 145; United Airlines, 206 Existing resources (resource base), 39,220,221,227; development of, 224; international markets, 45,49; same-industry acquisitions, 42-43; and strategic alliances, 40-41; trucking deregulation, 84; utilization of, 38 Expansion, 54,219; high-growth LTL carriers, 117; high-growth TL carriers, 109-111 Farabhod, K., 64 Fares, airlines, 69 Farris, Robert, 209 Fast food, 10-12

Index

FedEx, 1-2,10-11, 38; and DHL, 158; and Flying Tigers, 42; and UPS, 153-157; Zapmail and USPS, 40 Fenix, 188 Financial statistics, railroads, 74 Finkelstein, S., 59 Firm growth, strategic process, 1-4; confining nature of fit, 4-5; continuous customers, 11-12; fast food, air freight, and operating systems, 10-12; flexible resources, 9-10; lessons learned, 12-13; managerial resources, 8-9; organizational rigidity, 7-8; questions of resources, 4; strategic nearsightedness, 5-6; time is a strategic advantage, 10; university problem, 6-7. See also Firms Firms: changing environment, 8384; global expansion, 24; growth, framework for, 37-55; growth, sequencing principles for, 224-226; initial size, 86-87,219; and universities, 21 Fit, 10; confining nature of, 4-5 Flexible (flexibility of) resources, 910,30,213,214,218-219 Flying Tigers, 42 Focus groups, 18,19 Forwarder, air freight, 157,160 Freight. See Air freight Frequent-flying business people, 1617 Frozen Food Express (FFE), 106, 111 Fuji Heavy Industry, 48 Full-service transportation, 100-101 Galbraith, J., 30 Ghemawat, P., 17 Global expansion, 24. See also International Global intermodal carriers, 194 Globalization, 27 Global positioning, airlines, 145-147 Global Position System (GPS), 148 Global strategic alliance, 139,140,143 GM,48 Goodwin, James, 199

235

Index

Grand Trunk Western Railroad (GTW), 173-174,175 Great Britain. See Britain Growth matrix, 2, 39 Growth options, 163-164,164-168 Growth patterns, 146,188-193 Gulf War: of 1991,197,198,201; second, 205 Hambrick, D. C , 9, 59, 83 Hawaiian Airlines, 208-209 Heartland Express, 108 Hewlett-Packard, 41 Hillblom, Larry, 158 Honda, 46 Hrebiniak, L. G., 58 Hub-and-spoke operating system (network), 227; airlines, 146; LTL carriers, 121,122,124-125,128; patterns of growth, 99-100; trucking, 63, 64, 67, 87 Humpherys, David, 127 IBM, 40 Icahn, Carl, 138 Illinois Central Railroad (IC), 180181 Information, key success factors, 18 Infrastructure, 168,222 Initial firm size, 86-87,219 Integration issues, acquisitions, 90 Interlining, 61 Intermodal Surface Transportation Efficiency Act, 191 Intermodal (transportation, service, carriers, etc.), I l l ; alliances, 110111; global, 194; railways, 182,183, 190; TL carriers, 104 Internal development, 37,38; existing resource base, 224; new resources, 39-40; trucking deregulation, 91-92 International growth process, 45-50; and domestic, integrating, 51-55 International markets (developments, etc.), 24-26,27-28,45-50, 54,96; acquisitions, 224,228-229; air freight, 155,158,160,169; fut-

ure of airline industry, 213; logistics, 194; managerial resources, 219; railroads, 192,193-194,223; steel firms, 49; strategic alliances, 38, 211,223; trucking deregulation, 91-92,100-101,102. See also Global Interstate Commerce Commission (ICC), 60, 61, 62,173,187. See also Surface Transportation Board Japan, 157-158 J.B. Hunt, 102,103-104, 111 Kansas City Southern Industries (KSCI), 185-186 Kansas City Southern Railway (KCSR), 174,175,185-186; future of, 193 Key success factors, 2,16,17-22,31, 32,35; air freight industry, 22-28; deregulation, 223-224 and resources, 83-84; trucking industry, 64,66-67,83-84 Kintetsu World Express, 167 KLM Royal Dutch Airlines, 141,142 Koninklijke PTT Nederland (KPN), 166 Kraft Foods, 43-44 Labor (savings), 45 Labor unions, 204. See also Unions Learning, 51, 52 Less-than-truckload (carrier). See LTL Levitt, Theodore, 5,131, 213 Lewis, Dan, 203 Lexus, 12 Load factor, 36, 69 Lockheed Martin, 32 Locomotives (locomotive units), 72, 192 Logan, L., 64 Logistics (services, capabilities), 2526,53,65-66; international, 194; LTL carriers, 119,122,123,129; shippers, 102; TL carriers, 104,105,107108,108,110; TL carriers, Ryder, 113-114; TNT Post Group (TPG), 167

236

Long-term domestic and international growth, 1,2,35; direction of growth, 35-37; domestic growth, 38-45; framework for firm growth, 37-55; integrating domestic and international growth patterns, 5155; international growth, 45-50; lessons learned, 55 Lorenzo, Frank, 138 Losses, airlines, 197-198; American Airlines, 208; Delta, 211; September 11 crisis, 198-199,200 Low-cost carriers (providers), 207, 211,212 LTL (less-than-truckload) carriers, 62-63; and airlines, 163-164,165; deregulation, 79-83,84-95,96; deregulation, patterns of growth, 99,114-129,130-131 Lufthansa (AG), 47-48,145 Luggage, 17 Lynn, Robert, 158 Managerial resources (management team, managers), 2, 8-9,42,53, 219-220,221; acquisitions, 43,89, 90, 225; deregulation, 130; entering other industries, 90-91; environmental, 30; international markets, 46; sequential advantage, 227. See also Senior management Maquiladora, 45 Mason, P., 9 McDonald's, 10-11 McDonnell Douglas, 32 Menlo Logistics, 122 Menlo Worldwide, 122 Mergers (merged), airlines, 135,136137 Mergers, railroads, 190,193; CSX, 182; Norfolk Southern, 184; Union Pacific, 186,187 Mexico, 104,105,107,186 Microsoft, 10-11 MidSouth Corp., 185 Mikelson, George, 150-151 Miles, R. E., 59 Missouri Pacific Railroad, 186

Index

Mitsui & Company, 157-158 Motor Carrier Act, 60 Motor carriers, 190,191,194. See also Trucking Multi-modal carriers, 67 National Freight, 108-109 New resources (resource positions), 36-37,217-218,227; and acquisitions, 43-44,220; internal development, 39-40; international markets, 46-47,48,50; and managerial resources, 53; and strategic alliances, 41-42; trucking deregulation, 84 No-frill airlines, 68-69 Nonunion carriers/truckload industry, 94-95 Norfolk Southern Corporation, 176 Norfolk Southern Railroad (NS), 174,175,178,184-185 Northwest Airlines, 141-142,209210 Ocean services, 121,183 Ocean-shipping firms, 46 Old Dominion, 116 One World (global airline strategic) alliance, 47,140 Operating coverage, scope of, 87 Operating margins and ratios, rail carriers, 75 Operating network, trucking deregulation, 83. See also Huband-spoke networks Operating systems, 10-12 Organizational rigidity, 7-8,162 Other industries, 227-229 Overnight air express, 38 Pan Am, 138,139 Panama Canal Railway, 186 Parker, James F, 212 Passengers, 213,214 Pay cuts, 207 Penrose, Edith, 2,220,225 Penrose Effect, 101 Persian Gulf crisis. See Gulf War

Index

Pfizer, 43 Pharmaceutical firms, 31,39-40 Pharmacia, 43 Philip Morris, 43-44 Pricing (freedom, strategies), 57; restrictions, 60, 61 Profitability, Southwest Airlines, 212 PTT Post, 166-167 Purolator Courier Corporation, 157 Raghunathan, T, 64 Rail(road) carriers (firms, industry; railroads), 3, 39,131,213; acquisitions, 222-223; and airlines, 163164; deregulation, 71-75; strategic alliances, 40-41; and trucking firms (carriers), 43,110-111. See also U.S. railroad industry, transformation of Rakowski, J. R, 109-110,223 Reactionary approach to deregulation, 223 Refrigeration (refrigerated services), 106 Regulation (regulated industries, period, etc.), 27; air freight/airline industry, 23,135, 203, 203-204. See also Deregulation Regulatory agencies (bodies), 57-59 Related acquisitions (businesses, expansion), 44,121,162,164, 214, 224-226,228 Related resources (resource positions), 36, 39, 220,221; international markets, 46,47-48,49-50; and strategic alliances, 41 Re-regulating (re-regulation), 203304 Resources (resource base/positions), 3-4,10,217,227-228; additional, 43; air freight industry, 23, 27,168; and customer base/needs, 221222; deregulation, 59; domestic, 53-54; existing, 40-41,42-43,220, 221,224,227; flexible/flexibility of, 9-10,30,213,214,218-219; new, 36-37,39-40,41-42,43-44, 217-218,220,221,227; questions

237

of, 4; related, 36,39,41,43, 220, 221; trucking deregulation, 83-84, 90-91; utilization of, 35-36,38, 213,221. See also Managerial resources Resources (resource base/positions), international market: existing, 45, 49; managerial, 46; new, 46-47,48, 50; related, 46,47-48 Restrictions, trucking, 60, 61 Revenue, railroads, 173,175 Rigidity, organizational, 7-8,162 Ritchie, Jim, 126 Roadway, 114,115,116,119,122-124, 128-129 Roadway Package Systems (RPS), 31 Roberts Express, 123 Ryder, 112-114 Ryder Integrated Logistics, Inc., 113 Safety, railroads, 73 Sales force, key success factors, 18 Same-industry acquisitions, 42-43 Santa Fe (Southern) Pacific Corporation (SFP), 178 SAS (Scandinavian) Airlines, 16-17 Satellite technology, trucking, 107 Scanning environment, 83-84 Schneider Transportation, 106-108, 111 School, 35-36 Schumpeter, J. A., 31 Scope of operating coverage, 87 Seaboard Coast Lines, 174,182 Sea-Land Corporation, 182 Sea-Land Service Inc., 182 Second Gulf War. See Gulf War, second Security, 204 Segmenting, trucking industry, 62-64 Senior management (managers), 2; acquisitions, 101,121-122; key success factors, 18; LTL carriers, 121-122. See also Managerial resources September 11 crisis, 198-203; views of Congress, 203-205 Sequencing of decisions, 55,96,129130

238

Sequencing principles, firm growth, 224-226 Sequential advantage, 227 Shippers, 25,53, 65-66; trucking deregulation, patterns of growth, 100-102 Shipping companies and railroads, 190 Shocks (catastrophe), 2-3, 75-76,201, 212-213,229. See also September 11 crisis Shoemaker, P., 17,22 Siemens, 48 Simple business model, 204 Singapore Post, 167 Sky Team alliance, 139,211 Small-package express service, 123 Smith, Fred, 1-2 Snow, C. C , 59, 58 Soo Line Railroad (Soo), 174,175 , 181 Southeastern Freight, 116,116-117 Southern Pacific Rail, 187-188 Southwest Airlines, 68-69,147-148, 211-212 Spiral down syndrome, 15, 96 Staggers Rail Act, 71 Star global alliance, 47,143 Steel firms, 48-49 Strategic: actions and reactions, competitive, 57, 58, 59; advantage, time, 10; change, 29-30, 60; decision making, 214; errors, competitor's, 130,222; nearsightedness, 5-6; weaknesses, airline industry, 161-162. See also Firm growth Strategic alliances, 3,37,38,223,226, 229; domestic and international, 53,54; international, 38,47-48, 211; LTL carriers, 116-118,125-126; and resources, 40-42; TL carriers, 111 Strategic alliances, airlines/air freight, 70,163-164,168,213,223; American Airlines, 207; Continental, 150; Delta, 139,211; global, 139,140,143; Northwest, 141,142; UPS and FedEx, 155-156

Index

Strategic alliances, railroads, 189, 190,192; future of, 193,194-195; Norfolk Southern, 185 Strategy (strategies): newly deregulated environment, 59-60; in regulated environments, 57-59 Students, 6-7; key success factors, 20-21 Subsidizing (subsidization), airlines, 203 Superior Connection, 180 Surface Transportation Board (STB), 187. See also Interstate Commerce Comission Sustainable growth, 31-32 Swift Transportation, 102,104-105, 111 Synergy through acquisitions, 89-90 Teamsters Union, 94,94-95 Technology (technological innovations/improvements), 221-222; acquisitions, 50; airlines, 148-149; railroads, 72,73,191-192,192-193; trucking, 101,102; trucking, satellite, 107 Texas Air Corporation, 138,149 Third World countries, 45 Throckmorton, John, 64-65 Time, 12; and key success factors, 22; strategic advantage, 10 TL (truckload) carriers, 62; deregulation, 79-83,95; deregulation, patterns of growth, 99,102-114, 129-130 TNT Freightways Corporation (USF Subsidiaries), 116,118-119,120 TNT Limited, 50 TNT Post Group (TPG), 165-168 Tobacco industry, 43-44 Tonami Transportation Co., 157-158 Toyota, 11-12,39,113-114 Tracking resources (package), 25,31,66 Training, new resources, 40 Transaction costs, 89-90 Transitions, 229 Transplace.com, (TPC), 104,105 Transportation Management Center (TMC), 114

239

Index

Trucking deregulation, patterns of growth, 99; evolution of the industry, 99-102; lessons learned, 129-131; LTL carriers, 114-129; TL carriers, 102-114 Trucking deregulation, why firms failed, 79-83; acquisitions, 87-90; demise of Consolidated Freightways, 92-94; entering other industries, 90-91; failed responses by LTL carriers, 84-95; failed responses by TL carriers, 95; internal development, 91-92; key success factors and resources, 83-84; lessons learned, 95-96; unions, 94-95 Trucking firms (industry, carriers, companies), 3, 39; and airlines, 41; deregulation, 60-67; international markets, 45,46; new resources, 218; and rail carriers (railroads), 43,190,194; U.S. domestic and TNT Limited, 50. See also Motor carriers Truckload carriers (firms). See TL TTR Logistics, 113-114 TWA, 138,140 Union Pacific Corporation, 188 Union Pacific Railroad (UP), 174, 186-188 Unions (unionized), 204; and deregulated trucking industry, 9495,114,116 United Airlines (UAL), 142-143,145; future of airlines, 205,206-207 United States: and TNT Limited, 50; airlines, 36, 41. See also U.S. United States Railway Association (USRA), 176 Universities (university problem), 67; key success factors, 19-22 Unrelated acquisitions, 44-45,84, 95-96,220-221 UPS (United Parcel Service), 1, 8,11, 31,38,63,83; and FedEx, 153-157; and Roadway, 123 U.S. airline industry, future of, 197198, 212-213; airlines unlikely to survive consolidation, 205;

Chapter 11 airlines, 205-210; lessons learned, 214; possible surviving airlines, 210-212; second Gulf War, 206; September 11 crisis, 198-205 U.S. airline industry, restructuring of, 135-138; air freight, 153-161, 164-168,168-169; carriers in Chapter 11 in 2003,142-145; carriers surviving deregulation, 139-142; carriers that went out of business, 138; global positioning, 145-147; growth options, 163-164; growth options for air freight industry, 164-168; lessons learned, airlines and air freight, 168-169; smaller surviving carriers, 147153; strategic weaknesses, 161162 U.S. Airways (U.S. Air), 143-145, 205-206 U.S. domestic steel firms, 48-49 USF Subsidiaries (TNT), 116,118119,120 U.S. market coverage, trucking deregulation, 91,92 U.S. Postal Service (USPS), 40 U.S. railroad industry, radical transformation of, 173-176; Canadian National Railway, 178181; Canadian Pacific Railway, 181-184; Conrail, 176-178; CSX, 182-184; future of railroads, 193194; growth patterns, 188-193; Kansas City Southern, 185-186; lessons learned, 194-195; Norfolk Southern, 184-185; Union Pacific, 186-188 U.S. transportation industry, 169 Utilization of resources (resource base), 35-36,217; acquisitions, 43; airlines, 213; and customer base, 221; excess capacity, 83; existing, 38,42; related, 43,43 Warehousing services, 65-66 Watkins Motor Lines, 128 Weber, Jurgen, 203 Welty, Gus, 191

240

Werner Enterprises, 102,105-106, 111 Wernerfelt, B., 91-92 Western Pacific Railroad, 186 Wilner, F, 192-193 Wisconsin Central (WC), 179-180 Withuhn, William, 184

Index

Yellow, 87,114,115,116,119,124126,128,129 Zapmail, 40 Zeithaml, C , 30 Zeithaml, V, 30

ABOUT THE AUTHOR

Michael L. Pettus is Associate Professor at the Tabor School of Business, Millikin University, in Decatur, Illinois.

Growth from Chaos: Developing Your Firm's Resources to Achieve Profitability without Cost Cutting

Growth and Profitability

Growth and Profitability

Invented here: maximizing your organization's internal growth and profitability

From Chaos to Mission

Achieve Your Goals (WORKLIFE)

Achieve Your Goals

Achieve Your Goals (WORKLIFE)

Blueprint to a Billion: 7 Essentials to Achieve Exponential Growth

Spirals: From Theodorus to Chaos

Bangladesh: from stabilization to growth

Argentina: from insolvency to growth

Drive: 9 Ways to Motivate Your Kids to Achieve

Drive: 9 Ways to Motivate Your Kids to Achieve

Cost-Benefit Analysis And Water Resources Management

Competitive Equity: Developing a Lower Cost Alternative to Mutual Funds

Writer's Resources: From Paragraph to Essay

Microbes at Work: From Wastes to Resources

Difference Equations: From Rabbits to Chaos

Difference Equations: From Rabbits to Chaos

Children without Language: From Dysphasia to Autism

Chaos: From simple models to complex systems

Mechanics: From Newton's Laws to Deterministic Chaos

Inverse Limits: From Continua to Chaos

Inverse limits. From continua to chaos

Cutting to the Chase

Inverse Limits. From Continua to Chaos

From Crisis to Growth in Africa

Crystal Growth - From Fundamentals to Technology

Growth from Chaos: Developing Your Firm's Resources to Achieve Profitability without Cost Cutting

Growth and Profitability

Growth and Profitability

Invented here: maximizing your organization's internal growth and profitability

From Chaos to Mission

Achieve Your Goals (WORKLIFE)

Achieve Your Goals

Achieve Your Goals (WORKLIFE)

Blueprint to a Billion: 7 Essentials to Achieve Exponential Growth

Spirals: From Theodorus to Chaos

Bangladesh: from stabilization to growth

Argentina: from insolvency to growth

Drive: 9 Ways to Motivate Your Kids to Achieve

Drive: 9 Ways to Motivate Your Kids to Achieve

Cost-Benefit Analysis And Water Resources Management

Competitive Equity: Developing a Lower Cost Alternative to Mutual Funds

Writer's Resources: From Paragraph to Essay

Microbes at Work: From Wastes to Resources

Difference Equations: From Rabbits to Chaos

Difference Equations: From Rabbits to Chaos

Children without Language: From Dysphasia to Autism

Chaos: From simple models to complex systems

Mechanics: From Newton's Laws to Deterministic Chaos

Inverse Limits: From Continua to Chaos

Inverse limits. From continua to chaos

Cutting to the Chase

Inverse Limits. From Continua to Chaos

From Crisis to Growth in Africa

Crystal Growth - From Fundamentals to Technology

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