AirTran Airways 1

AirTran AirwaysCase Study

BAM 479February 27, 2007

AirTran Airways 2

Mission StatementInnovative people dedicated to delivering the best flying experience to smart travelers. Every day.

Although simple and straightforward, AirTran’s mission statement is too broad and doesn’t address some key areas.

Revised Mission StatementInnovative people dedicated to delivering and growing (growth) the best domestic (markets) flying (product) and working experience, in terms of safety and service (self-concept & philosophy), to our employees and smart travelers (customer). Striving everyday to keep our promise of, not only safety and service (self-concept), but also leaving a small footprint in the environment (public image) through advances in mechanical technology (technology). Every day.

Case StatementAirTran’s major challenge is to remain profitable against the rise in competition from Delta Air Lines.

Critical Milestones

1996 ValuJet plane crashes in Florida Everglades halting company service

1997 AirTran formed through merger of AirWays Corp. and ValuJet.

1999 AirTran leaves Richmond, Virginia

1999 Joe Leonard joins AirTran as CEO and Chairman

1999 AirTran’s fleet becomes youngest in industry

2004 Awarded “Best Airline Website”

2004 Ranked second in Airline Quality Report

2004 AirTran remains profitable compared to industry

2005 AirTran returns service to Richmond, Virginia and receives subsidies from Richmond

2005 Adds service to 9 US locations and to Cancun (International)

Trend StatementAirTran Holdings, Inc. growth can be attributed to its low-cost strategy, commitment to safety and service, and high utilization of planes and service routes.

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Internal Factor Evaluation Matrix

Weight Rating Weighted ScoreStrengths1. Remaining Profitable .18 4 .722. High Service Quality .14 4 .563. High Plane Utilization .11 4 .444. Large Airport Presence .07 3 .215. Young Airline Fleet .03 3 .09

Weaknesses1. High Operating Cost per ASM .18 1 .182. Concentrated to East US .10 2 .203. Small International Presence .09 2 .184. Low Ratings in Select AQR Categories .06 2 .125. Highly Dependent on Fuel .04 2 .08

1.00 2.78

ExplanationsStrengths

1. AirTran needs to remain profitable, both to survive but more importantly to keep investor interest and confidence.

2. High service quality is key for AirTran to keep a recurring customer-base healthy.3. Especially important in AirTran’s low-cost strategy, utilizing planes to their fullest potential

is key.4. AirTran has a high airport presence throughout eastern United States.5. AirTran benefits from a young airplane fleet through cost savings, quality and marketing

efforts.

Weaknesses1. A major weakness of AirTran is its high operating cost per available seat mile compared

to other low-cost providers like Southwest and JetBlue.2. Through increased competition, especially Delta, AirTran is only available mainly in the

eastern United States. Customers needing to travel to the western US probably will choose another airline that could create brand loyalty for another airline.

3. AirTran is highly dependent on domestic travel. Diversifying to other markets will help ease “all eggs in one basket” effect.

4. Even though AirTran received a number two position in airline quality rating (AQR) there are still areas that AirTran lags in, like on-time performance and denied boardings performance.

5. Although mainly out of AirTran’s control, their income and costs are highly associated to the cost of fuel.

AirTran is doing fine overall with respect to its internal strengths and weakness. Key areas to improve are its high operating cost per available seat mile (ASM), domestic and internal presences and other minor areas.

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External Factor Evaluation Matrix

Weight Rating Weighted ScoreOpportunities1. Decrease Operating Cost per ASM .18 2 .362. Increase US Presence .15 3 .453. Increase International Presence .11 1 .114. Increase Select AQR Ratings .05 2 .105. Add Consumer Technologies to Fleet .03 2 .06

Threats1. Increased Competition .2 3 .62. High Fuel Costs .14 3 .423. Increasing Labor Costs .06 2 .124. Political Policies .04 4 .165. Labor Strikes .04 4 .16

1.00 2.54

Explanations

Opportunities1. A major opportunity for AirTran to drastically increase income would be to decrease their

operating cost per available seat mile (ASM). 2. AirTran has a major opportunity to expand drastically its US presence by moving airport

terminals westward.3. As noted in the milestones, AirTran is beginning service to Cancun, a popular vacation

destination, but with increased competition AirTran needs to diversify its offerings.4. One major opportunity to gain and keep loyal customer is to continue to improve its

airline quality rating (AQR). Even though AirTran is currently rated number 2 there are still areas that could use improvements.

5. One way to gain customer loyalty through increased competition is to offer more consumer technologies and luxuries. AirTran is already incorporating XM Satellite radio into each plane, but other technologies could include iPod hookups for each seat and even in-cabin internet access (wired or wireless) for laptops.

Threats1. The largest threat to AirTran is the increased competition with the low-cost sector and the

industry itself.2. AirTran is highly dependent on the fluctuations of fuel costs. Since fuel is one of the

largest costs to AirTran a slight adjustment can mean the difference between a loss and a profit.

3. Along of fuel, labor costs are one of the largest costs to AirTran and a slight adjust can mean the difference between a loss and a profit.

4. Political policies enforced by the US and other countries in which AirTran operates can have a huge impact on the company as a whole. With terrorism a top priority of the government, new policies can cause a huge burden on AirTran for new technologies or more labor costs (security, maintenance).

5. As with any business labor strikes can halt a company’s operations causing the company to loose millions in revenue.

AirTran is performing average in their external environment. Most of AirTran’s opportunities and threats need to be addressed more aggressively, such as decreasing operating costs, expanding internationally, and increased competition.

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Industry Analysis

Porter’s Five Forces

CompetitionAirTranDeltaJetBlueSouthWest

Substitute ProductsBus ServiceTrain ServiceCharter PlanesTaxis

SuppliersFuel ProvidersPilotsMechanicsFlight AttendantsAirports

ConsumersBusiness TravelersRegular Travelers

Potential Entry of New CompetitorsGovernment Regulations (FAA)Brand Loyalty and IdentificationAirport ContractsCosts

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Industry Analysis Continued

Rivalry Among Competing Firms HIGHCompetition among major competitors is extremely intense in many aspects. Since most competitors directly competing with AirTran emphasize a low-cost strategy many consumer look only to cost as a determining factor in a purchase, this indeed creates an intense environment. Switching costs are generally low, even though companies have tried to increase switching costs with the use of “frequent flyer” programs.

Potential Entry of New Competitors HIGHEntry in to the airline industry is very hard, due to many factors. Some included are government regulations and licensing from the Federal Aviation Association, brand loyalty and identification of major airlines, contracts between airlines and airports for use of runways and terminals, and the substantial costs associated with forming an airline (airplanes purchases, labor costs, fuel costs, maintenance, etc.).

Potential Development of Substitute Products LOWSubstitute products are of little threat to the airline industry. No other product domestically competes directly with airlines in terms of cost and speed of travel. Bus services may cost less but travel speed extremely slow and tedious with many stops before your destination. Train service is generally much more expensive than airplane and only have select stations/ stops. Generally charter planes are much more expensive than commercial airlines. Taxis are tremendously expensive for long distance and are constricted to speed limits and road layouts.

Bargaining Power of Suppliers HIGHAll suppliers have tremendous bargaining power with the airline industry. There are few fuel providers and no reliable alternative to fuel. There are only so many pilots in the job market and planes cannot be flown without pilots. Mechanics for airplanes are in short supply and planes cannot be flown without being serviced. Flight attendants provide services that cannot easily be replaced and customer satisfaction without flight attendant would be detrimental. Finally airports are in limited supply and you need airport to land planes and board passengers.

Bargaining Power of Consumers LOWGenerally speaking consumers, business or regular travelers, have little bargaining power with airlines. Either they buy the ticket or not, one traveler does not hurt the airline. Also there are only a select few airline to choose from and even less at an individual airport. Either the consumer wants to fly or they don’t.

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Competitive Strategies

Competitive strategies for AirTran include the following:

Market PenetrationAirTran is seeking to increase market share in its current markets through increased marketing efforts and capacity. AirTran was voted the “Best Airline Website” in 2004 that showcases AirTran’s efforts to increase its market share. Along with marketing efforts, AirTran is expanding its capacity by replacing airplane galleys with seating. Adding extra seats per flight increase the amount of revenue per flight and also decreases cost per passenger per flight.

Market DevelopmentAirTran is trying to expand from its eastern US concentration into western US and international to popular vacation spots like Cancun, Mexico.

Product DevelopmentAirTran is improving its present airplanes with consumer technologies like XM Satellite Radio for each passenger free of charge.

RetrenchmentIn an industry of decreasing profits and increases costs, AirTran is trying to find ways to cut its “fat” by outsourcing mechanic work.

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Financial Analysis

Ratios derived from 2004 dataAAI Industry (RMA, SIC 4512)

L M HCurrent Ratio 2.04 .60 1.1 1.6For every dollar of current debt (liability), AirTran has $2.04 of current assets to pay for that debt. This number is above the industry average of 1.1, meaning that AirTran is doing a great job of managing its assets.

Quick Ratio 1.9 .40 .70 1.1For every dollar of current debt (liability), AirTran has $1.90 of current assets, not counting inventory, to pay for that debt. Again this number is above the industry’s average of .7 meaning that AirTran is doing a great job of managing its very liquid assets.

Debt-to-Assets 0.63For every dollar of assets, AirTran has $.63 of debt issued.

Debt-to-Equity 1.71 -4.6 .90 1.8For every dollar of equity, AirTran has $1.71 in debt. Compared to the industry average of $.90 AirTran is doing very good.

Long-term Debt-to-Equity 1.11For every dollar of equity, AirTran has $1.11 of long-term debt issued. Compared to the previous ratio, this shows that most of AirTran’s debt is long-term.

Times-Covered Ratio 1.69 2.2 4.5 10.6For every dollar of interest, AirTran has $1.69 to pay for those interest charges. Compared to the industry, AirTran is far below the industry. Note: The number, 1.69, may be artificially deflated since there is income earned from interest.

Activity Ratios

Inventory Turnover 36.79For every dollar in inventory, AirTran generates $36.79 in sales. This number is artificially inflated and contains little value since AirTran is primarily a service company and little inventory is stocked.

Fixed Asset Turnover 2.71 1.4 3.6 8.9For every dollar of fixed assets, AirTran is able to generate $2.71 in sales. This is average compared with the industry average of $3.60. This number for AirTran may be low due to the high costs/ worth associated with their young airplane fleet.

Total Asset Turnover 1.15 1.0 2.1 3.0For every dollar of assets, AirTran is able to generate $1.15 in sales. This below average compared to the industry average of $2.10. Compared to the previous ratio, AirTran must have a greater amount of current assets (cash and non-fixed assets).

Capital Intensity Ratio .87 1.0 .48 .33AirTran needs $.87 in assets to generate a dollar in sales. This is quite high compared to the industry average of $.48. This ratio confirms that AirTran needs to reduce its operating costs, which is one of its weaknesses. Reducing this number will greatly improve AirTran’s profitability.

Profitability Ratios

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Gross Profit Margin 3.15%For every dollar of sales, 3.15% of the sale goes into AirTran’s gross profits. This number seems extremely low, but it is confirmed by AirTran’s high operating costs.

This number was determined by (Sales Revenue-Operating Expenses)/ Sales Revenue. “Cost of Goods Sold” was not used because AirTran’s costs are mainly operation related (fuel, labor). Therefore, using cost of goods sold would artificially inflate AirTran’s gross profit.

Net Profit Margin 1.18%For every dollar of sales, 1.18% of the sale goes into AirTran’s net profit, profits after taxes and interest. This is directly related and could be increased by decreasing AirTran’s overly high operating costs.

Return on Total Assets .01For every dollar of assets, AirTran is able to generate $.01 of net income. This number is horrible; AirTran needs to more efficiently utilize its assets.

Return on Shareholder’s Equity .04For every dollar of equity, AirTran is able to generate $.04 of net income. Again this number is horrible; AirTran need to better utilize its equity.

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Financial AnalysisIncome Statement- Horizontal- In Millions

2004 2003 2002

Operating Revenues

% change % change

Passenger 1,005.263 12.96% 889.950 24.69% 713.711Other 36.159 28.73% 28.090 42.89% 19.659

Total Operating Revenues 1,041.422 13.44% 918.040 25.18% 733.370

Operating ExpensesSalaries, wages and benefits 273.514 18.03% 231.728 13.91% 203.435Aircraft fuel 247.980 38.74% 178.737 15.71% 154.467Aircraft rent 150.959 21.54% 124.203 70.87% 72.690Maintenance, materials and repairs 69.514 9.30% 63.600 34.50% 47.288Distribution 50.890 12.21% 45.354 5.19% 43.115Landing fees and other rents 62.322 18.01% 52.810 24.87% 42.291Aircraft insurance and security services 22.888 16.28% 19.684 -32.87% 29.323Marketing and advertising 27.569 14.34% 24.112 15.00% 20.967Depreciation 14.628 15.84% 12.628 -26.03% 17.072Other operating expenses 88.314 11.98% 78.866 9.29% 72.159

Total Operating Expenses 1,008.578 21.26% 831.722 18.34% 702.807Operating Income 32.844 -61.95% 86.318 182.43% 30.563

Other (Income) Expense:Interest Income -5.275 57.70% -3.345 59.13% -2.102Interest Expense 19.428 -31.36% 28.303 -3.08% 29.203Other -1.332 - -Government Grant - - -0.640Payment Under the Emergency Wartime Supplemental Appropriations Act, 2003- -38.061 -Deferred Debt Discount/ Issuance Cost Ammortization - 12.257 -SFAS 133 Adjustment - - -5.857

Other (Income) Expense, Net 12.821 n/a -0.846 n/a 20.604

Income Before Income Taxes 20.023 -77.03% 87.164 775.23% 9.959Income tax expense (benefit) 7.768 n/a -13.353 1598.85% -0.786

Net Income 12.255 -87.81% 100.517 835.48% 10.745

Note: Shaded cells offer areas of interest.

AirTran’s “other” income increased drastically from 2002 to 2003. Possibly this was due to other travel revenues from package shipping.

The increase in fuel expense by 38.74% can be attributed to the high increase in the cost of fuel.

Aircraft rent increased from 2002 to 2003 possibly by a larger number of planes in AirTran’s fleet.

Aircraft insurance and security decreased from 2002-2003 may be from increased airport security, so AirTran didn’t need to hire as many and insurance rates may have decreased.

Depreciation may have decreased do to AirTran’s planes getting older and depreciating less.

An influx in income for 2003 seems to be associated with a decrease in operating costs and extra income coming from interest, income tax benefits, and government subsidies.

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Financial Analysis

Balance Sheet- Horizontal- In Millions2004 2003 2002

Assets

% change % change

Cash and Equivalents 307.49 -9.22% 338.71 225.21% 104.15Marketable Securities 26.98 n/a 0 n/a 0Receivables 19.38 11.06% 17.45 -8.73% 19.12Inventories 28.31 46.30% 19.35 109.19% 9.25Current Deferred Income Taxes 7.44 -85.71% 52.05 n/a 0Other Current Assets 22.47 -10.16% 25.01 -40.35% 41.93

Total Current Assets 412.06 -8.95% 452.57 159.43% 174.45Gross Fixed Assets (Plant, Prop. & Equip.) 447.65 37.59% 325.34 20.35% 270.33Accumulated Depreciation & Depletion 63.72 30.36% 48.88 18.07% 41.4Net Fixed Assets 383.94 38.88% 276.46 20.77% 228.92Intangibles 29.92 0.00% 29.92 -11.61% 33.85Other Non-Current Assets 79.82 61.51% 49.42 36.44% 36.22

Total Non Current Assets 493.67 38.75% 355.8 19.00% 299Total Assets 905.73 12.05% 808.36 70.74% 473.45Liabilities

Accounts Payable 20.99 13.46% 18.5 311.11% 4.5Short Term Debt 13.84 175.70% 5.02 -52.01% 10.46Other Current Liabilities 167.6 13.26% 147.98 7.75% 137.34

Total Current Liabilities 202.42 18.04% 171.49 12.60% 152.3Long Term Debt 300.13 24.11% 241.82 21.09% 199.71Deferred Income Taxes 0 -100.00% 26.1 n/a 0Other Non-Current Liabilities 69.14 3.60% 66.74 -4.05% 69.56

Total Non-Current Liabilities 369.28 10.34% 334.66 24.28% 269.27Total Liabilities 571.7 12.95% 506.15 20.06% 421.57Stockholder's Equity

Common Stock Equity 334.04 10.53% 302.21 482.41% 51.89Common Par 0.09 12.50% 0.08 14.29% 0.07Additional Paid In Capital 361.06 7.09% 337.15 79.44% 187.89Retained Earnings -22.49 -35.28% -34.75 -74.31% -135.26Other Equity Adjustments -4.62 1611.11% -0.27 -66.67% -0.81

Total Equity 334.04 10.53% 302.21 482.41% 51.89Total Liabilities & Stock Equity 905.73 12.05% 808.36 70.74% 473.45

Note: Shaded cells offer areas of interest.

Cash grew substantially from 2002 to 2003 probably from AirTran’s huge profits and subsidies; this in turn increases current assets.

Inventories from 2002 to 2003 grew, maybe to include more spare parts or customer amenities.

Accounts payable increased a lot from 2002 to 2003 possibly from in credit accounts at the time the balance sheet was obtained.

Common stock from 2002 to 2003 for AirTran must have been a hot ticket item, or AirTran issued more stock.

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Financial Analysis

Income Statement- Vertical- In Millions2004 2003 2002

Operating Revenues

% of % of % of

Passenger 1,005.263 96.53% 889.950 96.94% 713.711 97.32%Other 36.159 3.47% 28.090 3.06% 19.659 2.68%

Total Operating Revenues 1,041.422 100.00% 918.040 100.00% 733.370 100.00%

Operating ExpensesSalaries, wages and benefits 273.514 26.26% 231.728 25.24% 203.435 27.74%Aircraft fuel 247.980 23.81% 178.737 19.47% 154.467 21.06%Aircraft rent 150.959 14.50% 124.203 13.53% 72.690 9.91%Maintenance, materials and repairs 69.514 6.67% 63.600 6.93% 47.288 6.45%Distribution 50.890 4.89% 45.354 4.94% 43.115 5.88%Landing fees and other rents 62.322 5.98% 52.810 5.75% 42.291 5.77%Aircraft insurance and security services 22.888 2.20% 19.684 2.14% 29.323 4.00%Marketing and advertising 27.569 2.65% 24.112 2.63% 20.967 2.86%Depreciation 14.628 1.40% 12.628 1.38% 17.072 2.33%Other operating expenses 88.314 8.48% 78.866 8.59% 72.159 9.84%

Total Operating Expenses 1,008.578 96.85% 831.722 90.60% 702.807 95.83%Operating Income 32.844 3.15% 86.318 9.40% 30.563 4.17%

Other (Income) Expense:Interest Income -5.275 -0.51% -3.345 -0.36% -2.102 -0.29%Interest Expense 19.428 1.87% 28.303 3.08% 29.203 3.98%Other -1.332 -0.13% - -Government Grant - - -0.640 -0.09%Payment Under the Emergency Wartime Supplemental Appropriations Act, 2003- -38.061 -4.15% -Deferred Debt Discount/ Issuance Cost Ammortization - 12.257 1.34% -SFAS 133 Adjustment - - -5.857 -0.80%

Other (Income) Expense, Net 12.821 1.23% -0.846 -0.09% 20.604 2.81%

Income Before Income Taxes 20.023 1.92% 87.164 9.49% 9.959 1.36%Income tax expense (benefit) 7.768 0.75% -13.353 -1.45% -0.786 -0.11%

Net Income 12.255 1.18% 100.517 10.95% 10.745 1.47%

Note: Shaded cells offer areas of interest.

Substantial income was made in 2003 mainly due to a decrease of operating expenses as a part of total revenues. Major decreases seem to have come from wages and fuel, which happen to account for most of the company’s expenses.

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Financial Analysis

Balance Sheet- Vertical- In Millions2004 2003 2002

Assets

% of % of % of

Cash and Equivalents 307.49 33.95% 338.71 41.90% 104.15 22.00%Marketable Securities 26.98 2.98% 0 0.00% 0 0.00%Receivables 19.38 2.14% 17.45 2.16% 19.12 4.04%Inventories 28.31 3.13% 19.35 2.39% 9.25 1.95%Current Deferred Income Taxes 7.44 0.82% 52.05 6.44% 0 0.00%Other Current Assets 22.47 2.48% 25.01 3.09% 41.93 8.86%

Total Current Assets 412.06 45.49% 452.57 55.99% 174.45 36.85%Gross Fixed Assets (Plant, Prop. & Equip.) 447.65 49.42% 325.34 40.25% 270.33 57.10%Accumulated Depreciation & Depletion 63.72 7.04% 48.88 6.05% 41.4 8.74%Net Fixed Assets 383.94 42.39% 276.46 34.20% 228.92 48.35%Intangibles 29.92 3.30% 29.92 3.70% 33.85 7.15%Other Non-Current Assets 79.82 8.81% 49.42 6.11% 36.22 7.65%

Total Non Current Assets 493.67 54.51% 355.8 44.02% 299 63.15%Total Assets 905.73 100.00% 808.36 100.00% 473.45 100.00%Liabilities

Accounts Payable 20.99 2.32% 18.5 2.29% 4.5 0.95%Short Term Debt 13.84 1.53% 5.02 0.62% 10.46 2.21%Other Current Liabilities 167.6 18.50% 147.98 18.31% 137.34 29.01%

Total Current Liabilities 202.42 22.35% 171.49 21.21% 152.3 32.17%Long Term Debt 300.13 33.14% 241.82 29.91% 199.71 42.18%Deferred Income Taxes 0 0.00% 26.1 3.23% 0 0.00%Other Non-Current Liabilities 69.14 7.63% 66.74 8.26% 69.56 14.69%Minority Interest 0 0.00% 0 0.00% 0 0.00%

Total Non-Current Liabilities 369.28 40.77% 334.66 41.40% 269.27 56.87%Total Liabilities 571.7 63.12% 506.15 62.61% 421.57 89.04%Stockholder's Equity

Preferred Stock Equity 0 0.00% 0 0.00% 0 0.00%Common Stock Equity 334.04 36.88% 302.21 37.39% 51.89 10.96%Common Par 0.09 0.01% 0.08 0.01% 0.07 0.01%Additional Paid In Capital 361.06 39.86% 337.15 41.71% 187.89 39.69%Cumulative Translation Adjustment 0 0.00% 0 0.00% 0 0.00%Retained Earnings -22.49 -2.48% -34.75 -4.30% -135.26 -28.57%Treasury Stock 0 0.00% 0 0.00% 0 0.00%Other Equity Adjustments -4.62 -0.51% -0.27 -0.03% -0.81 -0.17%

Total Equity 334.04 36.88% 302.21 37.39% 51.89 10.96%Total Liabilities & Stock Equity 905.73 100.00% 808.36 100.00% 473.45 100.00%

Note: Shaded cells offer areas of interest.

The 2.98% increase in marketable securities is probably associated with stock in other companies.

Current assets increase slightly compared to previous years, but this is probably associated with AirTran’s deferred income taxes.

Fixed (Non-current) assets increased maybe from increased labor or plane purchases or maintenance.

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Recommendation

I would recommend that AirTran continue its expansion into other domestic and international markets, and to work hard to decrease is operating costs per available seat mile (ASM) to better compete with its competition, notably Delta Air Lines.

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Sources CitedAirTran Airways Corporate Website (http://www.airtran.com)

Strategic Management, Concepts and Cases, p. 202-213

CNN Money, AAI (http://money.cnn.com/quote/financials/financials.html?symb=AAI)