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Identifying strategic groups in the U.S. airline industry: an application of the Porter model.

Since deregulation in 1978, the U.S. airline industry has undergone significant and often surprising change. Well-established airlines including Pan Am, Eastern, Western, and Piedmont have disappeared. Other airlines such as People Express and Midway became highly publicized success stories and then took a financial nosedive into oblivion. As documented by Rakowski and Bejou (1992), of the fifteen largest U.S. airline firms in 1985, six didn't make it to 1989, and in the following two years another three ceased operations.(1) In contrast, since 1991, the industry seems to have found at least a temporary equilibrium; the nine largest airlines in 1991 were the same as those that began 1994.(2) While future change in the industry is likely, the comparative stability during recent years provides an opportunity to take a snapshot of the relative competitive positions of the nine major U.S. passenger airlines. Specifically, this article seeks to identify strategic groups within the U.S. airline industry using the well-established competitive strategy model of Michael Porter.(3) According to Porter, a strategic group consists of rival firms with similar competitive approaches and positions within the market.(4) BACKGROUND - AIRLINE INDUSTRY GROUPINGS Identifying strategic groups within an industry is highly desirable from both a qualitative and quantitative perspective. It is easier psychologically to understand the competitive dynamics of an industry if we can identify three or four similar groups rather than having to characterize each firm separately. Furthermore, by dividing the airline industry into meaningful groups, performance and operating statistics can be separated and analyzed more effectively. Informally, we know of U.S. airlines grouped as the "big three" - United, American, and Delta as well as "majors," "nationals," and "regionals" based on government revenue classifications.(5) The so-called "Chapter 11 Carriers" - America West, TWA, and Continental - were in bankruptcy during the early 1990s and have been controlled for in research models and studied separately as a group; an example is the work of Golaszewski and Sanders (1992).(6) The Transportation Research Board, in its special report Winds of Change (1991), divided the industry into "strong" and "weak" carriers to illuminate financial performance.(7) Researchers in the past have also singled out "new entrant carriers" that have emerged since deregulation and "non-union" firms for distinct treatment in analysis.(8) The size and historical groupings discussed above have proven useful and interesting. To complement these groupings, and for a better understanding of the competitive structure of the industry, it is valuable to classify airlines based on their competitive strategies. This type of identification can shed light on successful market positions and suggest future strategic directions for airline managers to target or avoid.

In this article, therefore, we first group the nine major U.S. passenger airlines by competitive strategy, using Porter's typology of generic strategies. We then assess the financial performance of each airline to validate the appropriateness of the initial strategic groupings. Finally, we discuss the implications for competition within the airline industry given its competitive structure. PORTER'S GENERIC STRATEGIES Since deregulation in 1978, the U.S. airline industry has undergone significant and often surprising change. Well-established airlines including Pan Am, Eastern, Western, and Piedmont have disappeared. Other airlines such as People Express and Midway became highly publicized success stories and then took a financial nosedive into oblivion. As documented by Rakowski and Bejou (1992), of the fifteen largest U.S. airline firms in 1985, six didn't make it to 1989, and in the following two years another three ceased operations.(1) In contrast, since 1991, the industry seems to have found at least a temporary equilibrium; the nine largest airlines in 1991 were the same as those that began 1994.(2) While future change in the industry is likely, the comparative stability during recent years provides an opportunity to take a snapshot of the relative competitive positions of the nine major U.S. passenger airlines. Specifically, this article seeks to identify strategic groups within the U.S. airline industry using the well-established competitive strategy model of Michael Porter.(3) According to Porter, a strategic group consists of rival firms with similar competitive approaches and positions within the market.(4) BACKGROUND - AIRLINE INDUSTRY GROUPINGS Identifying strategic groups within an industry is highly desirable from both a qualitative and quantitative perspective. It is easier psychologically to understand the competitive dynamics of an industry if we can identify three or four similar groups rather than having to characterize each firm separately. Furthermore, by dividing the airline industry into meaningful groups, performance and operating statistics can be separated and analyzed more effectively. Informally, we know of U.S. airlines grouped as the "big three" - United, American, and Delta as well as "majors," "nationals," and "regionals" based on government revenue classifications.(5) The so-called "Chapter 11 Carriers" - America West, TWA, and Continental - were in bankruptcy during the early 1990s and have been controlled for in research models and studied separately as a group; an example is the work of Golaszewski and Sanders (1992).(6) The Transportation Research Board, in its special report Winds of Change (1991), divided the industry into "strong" and "weak" carriers to illuminate financial performance.(7) Researchers in the past have also singled out "new entrant carriers" that have emerged since deregulation and "non-union" firms for distinct treatment in analysis.(8) The size and historical groupings discussed above have proven useful and interesting. To complement these groupings, and for a better understanding of the competitive structure of the industry, it is valuable to classify airlines based on their competitive strategies. This type of identification can shed light on successful market positions and suggest future strategic directions for airline managers to target or avoid.

In this article, therefore, we first group the nine major U.S. passenger airlines by competitive strategy, using Porter's typology of generic strategies. We then assess the financial performance of each airline to validate the appropriateness of the initial strategic groupings. Finally, we discuss the implications for competition within the airline industry given its competitive structure. PORTER'S GENERIC STRATEGIES Within any industry, companies seek to gain a competitive advantage that allows them to outperform rivals and achieve above-average profitability. Porter has suggested that the path to competitive advantage is the successful implementation of an internally consistent competitive strategy. Porter identified three "generic" competitive strategies, which have been widely studied.(9) These are cost leadership, differentiation, and focus.(10) Cost Leadership Companies pursuing a strategy of cost leadership seek to outperform rivals by producing goods or services at a lower cost. There are two potential advantages of this strategy. First, due to its lower cost structure, the cost leader can either charge a lower price than competitors and still make the same profit, or charge the same price as competitors and make a higher profit. Second, should price wars develop, the cost leader will be in a better position to withstand price-driven competition. Achieving a low-cost position often requires a high market share so that economies of scale are achieved. Emphasis is placed on reducing costs at every possible point. Hence, it may require designing products or services for ease of manufacture or delivery. Once a low-cost position is achieved, profits must often be reinvested in improved processes and technologies that further reduce costs so that cost leadership can be sustained. Differentiation Since deregulation in 1978, the U.S. airline industry has undergone significant and often surprising change. Well-established airlines including Pan Am, Eastern, Western, and Piedmont have disappeared. Other airlines such as People Express and Midway became highly publicized success stories and then took a financial nosedive into oblivion. As documented by Rakowski and Bejou (1992), of the fifteen largest U.S. airline firms in 1985, six didn't make it to 1989, and in the following two years another three ceased operations.(1) In contrast, since 1991, the industry seems to have found at least a temporary equilibrium; the nine largest airlines in 1991 were the same as those that began 1994.(2) While future change in the industry is likely, the comparative stability during recent years provides an opportunity to take a snapshot of the relative competitive positions of the nine major U.S. passenger airlines. Specifically, this article seeks to identify strategic groups within the U.S. airline industry using the well-established competitive strategy model of Michael Porter.(3) According to Porter, a strategic group consists of rival firms with similar competitive approaches and positions within the market.(4)

BACKGROUND - AIRLINE INDUSTRY GROUPINGS Identifying strategic groups within an industry is highly desirable from both a qualitative and quantitative perspective. It is easier psychologically to understand the competitive dynamics of an industry if we can identify three or four similar groups rather than having to characterize each firm separately. Furthermore, by dividing the airline industry into meaningful groups, performance and operating statistics can be separated and analyzed more effectively. Informally, we know of U.S. airlines grouped as the "big three" - United, American, and Delta as well as "majors," "nationals," and "regionals" based on government revenue classifications.(5) The so-called "Chapter 11 Carriers" - America West, TWA, and Continental - were in bankruptcy during the early 1990s and have been controlled for in research models and studied separately as a group; an example is the work of Golaszewski and Sanders (1992).(6) The Transportation Research Board, in its special report Winds of Change (1991), divided the industry into "strong" and "weak" carriers to illuminate financial performance.(7) Researchers in the past have also singled out "new entrant carriers" that have emerged since deregulation and "non-union" firms for distinct treatment in analysis.(8) The size and historical groupings discussed above have proven useful and interesting. To complement these groupings, and for a better understanding of the competitive structure of the industry, it is valuable to classify airlines based on their competitive strategies. This type of identification can shed light on successful market positions and suggest future strategic directions for airline managers to target or avoid. In this article, therefore, we first group the nine major U.S. passenger airlines by competitive strategy, using Porter's typology of generic strategies. We then assess the financial performance of each airline to validate the appropriateness of the initial strategic groupings. Finally, we discuss the implications for competition within the airline industry given its competitive structure. PORTER'S GENERIC STRATEGIES Within any industry, companies seek to gain a competitive advantage that allows them to outperform rivals and achieve above-average profitability. Porter has suggested that the path to competitive advantage is the successful implementation of an internally consistent competitive strategy. Porter identified three "generic" competitive strategies, which have been widely studied.(9) These are cost leadership, differentiation, and focus.(10) Cost Leadership Companies pursuing a strategy of cost leadership seek to outperform rivals by producing goods or services at a lower cost. There are two potential advantages of this strategy. First, due to its lower cost structure, the cost leader can either charge a lower price than competitors and still make the same profit, or charge the same price as competitors and make a higher profit. Second,

should price wars develop, the cost leader will be in a better position to withstand price-driven competition. Achieving a low-cost position often requires a high market share so that economies of scale are achieved. Emphasis is placed on reducing costs at every possible point. Hence, it may require designing products or services for ease of manufacture or delivery. Once a low-cost position is achieved, profits must often be reinvested in improved processes and technologies that further reduce costs so that cost leadership can be sustained. Differentiation Companies pursuing differentiation strategies seek competitive advantage by creating products or services that are perceived by customers as being unique and for which buyers are willing to pay a premium price. Successful differentiation provides the company with two primary advantages that flow from the perceived uniqueness of its products. First, the company is able to charge a higher price for its products or services, often with an accompanying higher margin. Second, customers willing to pay more for a unique product are often more loyal because their purchase decision is based more on perceived quality than on price. Achieving successful differentiation requires clear understanding of customer needs and investments in the capabilities necessary to meet those needs. Typically, achieving differentiation requires a trade-off with cost position, especially if the activities required to create uniqueness - such as market research, quality materials, and customer service - are themselves costly. Focus The focus strategy differs from the other two generic strategies in that it is directed toward serving the needs of a limited customer group or market segment. Companies pursuing focus strategies concentrate on serving a particular market niche, which may be defined geographically, by segment of product line, or by type of customer. Having chosen its "focus," however, the company may choose to compete within its niche either on the basis of low cost or differentiation. It gains competitive advantage by better serving the needs of the chosen segment, whether those needs be lower cost or differentiating quality. Since deregulation in 1978, the U.S. airline industry has undergone significant and often surprising change. Well-established airlines including Pan Am, Eastern, Western, and Piedmont have disappeared. Other airlines such as People Express and Midway became highly publicized success stories and then took a financial nosedive into oblivion. As documented by Rakowski and Bejou (1992), of the fifteen largest U.S. airline firms in 1985, six didn't make it to 1989, and in the following two years another three ceased operations.(1) In contrast, since 1991, the industry seems to have found at least a temporary equilibrium; the nine largest airlines in 1991 were the same as those that began 1994.(2) While future change in the industry is likely, the comparative stability during recent years provides an opportunity to take a snapshot of the relative competitive positions of the nine major U.S. passenger airlines. Specifically, this article seeks to identify strategic groups within the U.S. airline industry using the well-established

competitive strategy model of Michael Porter.(3) According to Porter, a strategic group consists of rival firms with similar competitive approaches and positions within the market.(4) BACKGROUND - AIRLINE INDUSTRY GROUPINGS Identifying strategic groups within an industry is highly desirable from both a qualitative and quantitative perspective. It is easier psychologically to understand the competitive dynamics of an industry if we can identify three or four similar groups rather than having to characterize each firm separately. Furthermore, by dividing the airline industry into meaningful groups, performance and operating statistics can be separated and analyzed more effectively. Informally, we know of U.S. airlines grouped as the "big three" - United, American, and Delta as well as "majors," "nationals," and "regionals" based on government revenue classifications.(5) The so-called "Chapter 11 Carriers" - America West, TWA, and Continental - were in bankruptcy during the early 1990s and have been controlled for in research models and studied separately as a group; an example is the work of Golaszewski and Sanders (1992).(6) The Transportation Research Board, in its special report Winds of Change (1991), divided the industry into "strong" and "weak" carriers to illuminate financial performance.(7) Researchers in the past have also singled out "new entrant carriers" that have emerged since deregulation and "non-union" firms for distinct treatment in analysis.(8) The size and historical groupings discussed above have proven useful and interesting. To complement these groupings, and for a better understanding of the competitive structure of the industry, it is valuable to classify airlines based on their competitive strategies. This type of identification can shed light on successful market positions and suggest future strategic directions for airline managers to target or avoid. In this article, therefore, we first group the nine major U.S. passenger airlines by competitive strategy, using Porter's typology of generic strategies. We then assess the financial performance of each airline to validate the appropriateness of the initial strategic groupings. Finally, we discuss the implications for competition within the airline industry given its competitive structure. PORTER'S GENERIC STRATEGIES Within any industry, companies seek to gain a competitive advantage that allows them to outperform rivals and achieve above-average profitability. Porter has suggested that the path to competitive advantage is the successful implementation of an internally consistent competitive strategy. Porter identified three "generic" competitive strategies, which have been widely studied.(9) These are cost leadership, differentiation, and focus.(10) Cost Leadership Companies pursuing a strategy of cost leadership seek to outperform rivals by producing goods or services at a lower cost. There are two potential advantages of this strategy. First, due to its

lower cost structure, the cost leader can either charge a lower price than competitors and still make the same profit, or charge the same price as competitors and make a higher profit. Second, should price wars develop, the cost leader will be in a better position to withstand price-driven competition. Achieving a low-cost position often requires a high market share so that economies of scale are achieved. Emphasis is placed on reducing costs at every possible point. Hence, it may require designing products or services for ease of manufacture or delivery. Once a low-cost position is achieved, profits must often be reinvested in improved processes and technologies that further reduce costs so that cost leadership can be sustained. Differentiation Companies pursuing differentiation strategies seek competitive advantage by creating products or services that are perceived by customers as being unique and for which buyers are willing to pay a premium price. Successful differentiation provides the company with two primary advantages that flow from the perceived uniqueness of its products. First, the company is able to charge a higher price for its products or services, often with an accompanying higher margin. Second, customers willing to pay more for a unique product are often more loyal because their purchase decision is based more on perceived quality than on price. Achieving successful differentiation requires clear understanding of customer needs and investments in the capabilities necessary to meet those needs. Typically, achieving differentiation requires a trade-off with cost position, especially if the activities required to create uniqueness - such as market research, quality materials, and customer service - are themselves costly. Focus The focus strategy differs from the other two generic strategies in that it is directed toward serving the needs of a limited customer group or market segment. Companies pursuing focus strategies concentrate on serving a particular market niche, which may be defined geographically, by segment of product line, or by type of customer. Having chosen its "focus," however, the company may choose to compete within its niche either on the basis of low cost or differentiation. It gains competitive advantage by better serving the needs of the chosen segment, whether those needs be lower cost or differentiating quality. The advantages of successful focus strategies derive from the fact that the firm is able to concentrate its efforts. Its ability to better meet the needs of its chosen customers means that it may be able to charge a higher price for its unique products or services. Alternately, it may be able to undercut the cost of the industry-wide cost leader through technologies and processes that are not cost-effective at larger scales (such as the steel foundry technology in use by the new mini-mills). Finally, concentration within a protected niche may buffer the firm from broader competition within the industry as a whole. Stuck in the Middle

According to Porter, any firm that fails to develop a viable competitive strategy - whether it be low cost, differentiation, or focus - may be termed "stuck in the middle" with no basis for competitive advantage. Such firms cannot compete on the basis of price because their cost structure is too high. Nor are they able to charge premium prices because they have failed to differentiate their products or services in the minds of potential customers. Nor are they protected by a niche that buffers them from broader industry competition. As a result, firms stuck in the middle are almost guaranteed low profitability and, when there is a shake-out in the industry, they are the first to exit. DATA AND METHODOLOGY As will be explained in more detail at the end of this section, the use of a scatter-plot of airlines' cost and quality positions represents the primary methodology used to identify strategic groups. Given the varied resources and capabilities required to pursue the different generic strategies detailed above, not all firms in a given business environment will compete on the same basis. Therefore, an analysis of appropriate firm-level data should distinguish between firms opting to pursue low-cost strategies, those pursuing differentiation strategies, and those that might be focusing on particular market segments. By default, firms that are not pursuing one of these strategies will be considered to be lacking in strategic direction, or "stuck in the middle." Data This analysis focuses on the nine major U.S. passenger air carriers during the time period 1991 to 1993. A "major" airline is one having revenues of at least $1 billion annually, and these airlines account for 90 percent of all U.S. passenger traffic.(11) To standardize comparisons, cost, quality, and financial data will cover only the domestic operations of these nine carriers. The evaluation of firms' cost structures is fairly simple because good cost data are readily available for the U.S. airline industry. The statistic "cents per available seat mile (ASM)" is well accepted as a measure of airline costs. This figure takes an airline's operating costs and divides it by the number of seat miles flown; the resulting cost per ASM represents the cost to fly one seat one mile. The source of these data, along with revenue and profitability figures, is the U.S. Department of Transportation.(12) However, cost per ASM is subject to interpretation because costs vary inversely with average flight distance - an established relationship discussed and documented well by Bailey, Graham, and Kaplan (1985).(13) This complication will be addressed after firms' initial cost positions are established. Important in this type of strategic analysis is the definition and measurement of differentiation within an industry. In the airline industry, firms attempt to differentiate themselves through service quality. Fortunately, a validated measure of comparative service quality is available. The Airline Quality Rating (AQR) computed annually by the National Institute for Aviation Research at Wichita State University was established in 1991 as an objective method of comparing quality factors between airlines and across time.(14) The AQR is a weighted average of nineteen factors that have been determined to be important to consumers when they assess airline quality. This measure is predominantly domestic in nature, and includes factors such as on-time performance, safety, frequent flier program assessments, financial stability, age of aircraft, lost baggage rates,

and other customer service attributes.(15) A recent survey of airline passengers conducted by Consumer Reports corroborates the general integrity of the AQR; of the nine major airlines, both rankings agree on the best and worst airlines.(16) METHODOLOGY Strategic groups have been identified using a variety of means, from competitor mapping to statistical cluster analysis. We develop our strategic groups using a scatter-plot diagram, the dimensions of which relate to cost and quality. This approach is similar to the competitor mapping described by Porter and is more appropriate than cluster analysis given the relatively few number of companies in the industry.(17) Cost per seat mile will be the X-axis variable with the industry cost average separating low and high cost firms. On the Y-axis, the Airline Quality Rating (AQR) index calculated by the National Institute for Aviation Research is used as the differentiating factor. The scatter-plot will initially divide the industry into four quadrants. The high cost, high quality quadrant will initially identify firms pursuing differentiation. Firms in the low cost, low quality sector may well be seeking cost leadership. A firm which is able to obtain both low costs and high quality may be following the focus strategy. Firms in the high cost, low quality quadrant will likely be without a clear strategy, or "stuck in the middle."
Table 1. Domestic Sector Financial and Operating Data for U.S. Major Airlines, 1993 Overall Quality Length Airline Revenue Rating (AQR) Cost/ASM of Haul American $10.8 bil. .231 8.89 cents 848 mi. Delta 9.7 .076 9.32 627 United 8.8 .176 8.88 835 USAir 6.4 -.003 11.56 621 Northwest 4.9 -.247 8.85 703 Continental 4.1 -.336 8.40 779 TWA 2.3 -.286 9.50 692 Southwest 2.1 .252 7.16 376 America West 1.3 -.294 7.03 642 Average $5.6 bil. -.048 8.84 680 Sources: Cols. 1,3,4: U.S. Department of Transportation, Air Carrier Financial and Traffic Statistics Summaries, Office of Airline Statistics. Col. 2: The Airline Quality Report 1994, National Institute for Aviation Research. The AQR includes nineteen weighted rating factors including on-time performance, safety, age of aircraft, frequent flyer plans, and various other customer service variables. For more information on the AQR measure the reader should see endnotes #14 and #15.

After firms are placed in one of these four quadrants, some interpretation may be necessary to confirm them as strategic groups. Ideally, firms in a strategic group will have their quality/cost plots close together. Also, a careful look at each airline's flight stage length will be necessary to establish that firms with widely divergent flight lengths are not misidentified as having similar cost positions.

Since deregulation in 1978, the U.S. airline industry has undergone significant and often surprising change. Well-established airlines including Pan Am, Eastern, Western, and Piedmont have disappeared. Other airlines such as People Express and Midway became highly publicized success stories and then took a financial nosedive into oblivion. As documented by Rakowski and Bejou (1992), of the fifteen largest U.S. airline firms in 1985, six didn't make it to 1989, and in the following two years another three ceased operations.(1) In contrast, since 1991, the industry seems to have found at least a temporary equilibrium; the nine largest airlines in 1991 were the same as those that began 1994.(2) While future change in the industry is likely, the comparative stability during recent years provides an opportunity to take a snapshot of the relative competitive positions of the nine major U.S. passenger airlines. Specifically, this article seeks to identify strategic groups within the U.S. airline industry using the well-established competitive strategy model of Michael Porter.(3) According to Porter, a strategic group consists of rival firms with similar competitive approaches and positions within the market.(4) BACKGROUND - AIRLINE INDUSTRY GROUPINGS Identifying strategic groups within an industry is highly desirable from both a qualitative and quantitative perspective. It is easier psychologically to understand the competitive dynamics of an industry if we can identify three or four similar groups rather than having to characterize each firm separately. Furthermore, by dividing the airline industry into meaningful groups, performance and operating statistics can be separated and analyzed more effectively. Informally, we know of U.S. airlines grouped as the "big three" - United, American, and Delta as well as "majors," "nationals," and "regionals" based on government revenue classifications.(5) The so-called "Chapter 11 Carriers" - America West, TWA, and Continental - were in bankruptcy during the early 1990s and have been controlled for in research models and studied separately as a group; an example is the work of Golaszewski and Sanders (1992).(6) The Transportation Research Board, in its special report Winds of Change (1991), divided the industry into "strong" and "weak" carriers to illuminate financial performance.(7) Researchers in the past have also singled out "new entrant carriers" that have emerged since deregulation and "non-union" firms for distinct treatment in analysis.(8) The size and historical groupings discussed above have proven useful and interesting. To complement these groupings, and for a better understanding of the competitive structure of the industry, it is valuable to classify airlines based on their competitive strategies. This type of identification can shed light on successful market positions and suggest future strategic directions for airline managers to target or avoid. In this article, therefore, we first group the nine major U.S. passenger airlines by competitive strategy, using Porter's typology of generic strategies. We then assess the financial performance of each airline to validate the appropriateness of the initial strategic groupings. Finally, we discuss the implications for competition within the airline industry given its competitive structure. PORTER'S GENERIC STRATEGIES

Within any industry, companies seek to gain a competitive advantage that allows them to outperform rivals and achieve above-average profitability. Porter has suggested that the path to competitive advantage is the successful implementation of an internally consistent competitive strategy. Porter identified three "generic" competitive strategies, which have been widely studied.(9) These are cost leadership, differentiation, and focus.(10) Cost Leadership Companies pursuing a strategy of cost leadership seek to outperform rivals by producing goods or services at a lower cost. There are two potential advantages of this strategy. First, due to its lower cost structure, the cost leader can either charge a lower price than competitors and still make the same profit, or charge the same price as competitors and make a higher profit. Second, should price wars develop, the cost leader will be in a better position to withstand price-driven competition. Achieving a low-cost position often requires a high market share so that economies of scale are achieved. Emphasis is placed on reducing costs at every possible point. Hence, it may require designing products or services for ease of manufacture or delivery. Once a low-cost position is achieved, profits must often be reinvested in improved processes and technologies that further reduce costs so that cost leadership can be sustained. Differentiation Companies pursuing differentiation strategies seek competitive advantage by creating products or services that are perceived by customers as being unique and for which buyers are willing to pay a premium price. Successful differentiation provides the company with two primary advantages that flow from the perceived uniqueness of its products. First, the company is able to charge a higher price for its products or services, often with an accompanying higher margin. Second, customers willing to pay more for a unique product are often more loyal because their purchase decision is based more on perceived quality than on price. Achieving successful differentiation requires clear understanding of customer needs and investments in the capabilities necessary to meet those needs. Typically, achieving differentiation requires a trade-off with cost position, especially if the activities required to create uniqueness - such as market research, quality materials, and customer service - are themselves costly. Focus The focus strategy differs from the other two generic strategies in that it is directed toward serving the needs of a limited customer group or market segment. Companies pursuing focus strategies concentrate on serving a particular market niche, which may be defined geographically, by segment of product line, or by type of customer. Having chosen its "focus," however, the company may choose to compete within its niche either on the basis of low cost or differentiation. It gains competitive advantage by better serving the needs of the chosen segment, whether those needs be lower cost or differentiating quality.

The advantages of successful focus strategies derive from the fact that the firm is able to concentrate its efforts. Its ability to better meet the needs of its chosen customers means that it may be able to charge a higher price for its unique products or services. Alternately, it may be able to undercut the cost of the industry-wide cost leader through technologies and processes that are not cost-effective at larger scales (such as the steel foundry technology in use by the new mini-mills). Finally, concentration within a protected niche may buffer the firm from broader competition within the industry as a whole. Stuck in the Middle According to Porter, any firm that fails to develop a viable competitive strategy - whether it be low cost, differentiation, or focus - may be termed "stuck in the middle" with no basis for competitive advantage. Such firms cannot compete on the basis of price because their cost structure is too high. Nor are they able to charge premium prices because they have failed to differentiate their products or services in the minds of potential customers. Nor are they protected by a niche that buffers them from broader industry competition. As a result, firms stuck in the middle are almost guaranteed low profitability and, when there is a shake-out in the industry, they are the first to exit. DATA AND METHODOLOGY As will be explained in more detail at the end of this section, the use of a scatter-plot of airlines' cost and quality positions represents the primary methodology used to identify strategic groups. Given the varied resources and capabilities required to pursue the different generic strategies detailed above, not all firms in a given business environment will compete on the same basis. Therefore, an analysis of appropriate firm-level data should distinguish between firms opting to pursue low-cost strategies, those pursuing differentiation strategies, and those that might be focusing on particular market segments. By default, firms that are not pursuing one of these strategies will be considered to be lacking in strategic direction, or "stuck in the middle." Data This analysis focuses on the nine major U.S. passenger air carriers during the time period 1991 to 1993. A "major" airline is one having revenues of at least $1 billion annually, and these airlines account for 90 percent of all U.S. passenger traffic.(11) To standardize comparisons, cost, quality, and financial data will cover only the domestic operations of these nine carriers. The evaluation of firms' cost structures is fairly simple because good cost data are readily available for the U.S. airline industry. The statistic "cents per available seat mile (ASM)" is well accepted as a measure of airline costs. This figure takes an airline's operating costs and divides it by the number of seat miles flown; the resulting cost per ASM represents the cost to fly one seat one mile. The source of these data, along with revenue and profitability figures, is the U.S. Department of Transportation.(12) However, cost per ASM is subject to interpretation because costs vary inversely with average flight distance - an established relationship discussed and documented well by Bailey, Graham, and Kaplan (1985).(13) This complication will be addressed after firms' initial cost positions are established.

Important in this type of strategic analysis is the definition and measurement of differentiation within an industry. In the airline industry, firms attempt to differentiate themselves through service quality. Fortunately, a validated measure of comparative service quality is available. The Airline Quality Rating (AQR) computed annually by the National Institute for Aviation Research at Wichita State University was established in 1991 as an objective method of comparing quality factors between airlines and across time.(14) The AQR is a weighted average of nineteen factors that have been determined to be important to consumers when they assess airline quality. This measure is predominantly domestic in nature, and includes factors such as on-time performance, safety, frequent flier program assessments, financial stability, age of aircraft, lost baggage rates, and other customer service attributes.(15) A recent survey of airline passengers conducted by Consumer Reports corroborates the general integrity of the AQR; of the nine major airlines, both rankings agree on the best and worst airlines.(16) METHODOLOGY Strategic groups have been identified using a variety of means, from competitor mapping to statistical cluster analysis. We develop our strategic groups using a scatter-plot diagram, the dimensions of which relate to cost and quality. This approach is similar to the competitor mapping described by Porter and is more appropriate than cluster analysis given the relatively few number of companies in the industry.(17) Cost per seat mile will be the X-axis variable with the industry cost average separating low and high cost firms. On the Y-axis, the Airline Quality Rating (AQR) index calculated by the National Institute for Aviation Research is used as the differentiating factor. The scatter-plot will initially divide the industry into four quadrants. The high cost, high quality quadrant will initially identify firms pursuing differentiation. Firms in the low cost, low quality sector may well be seeking cost leadership. A firm which is able to obtain both low costs and high quality may be following the focus strategy. Firms in the high cost, low quality quadrant will likely be without a clear strategy, or "stuck in the middle."
Table 1. Domestic Sector Financial and Operating Data for U.S. Major Airlines, 1993 Overall Quality Length Airline Revenue Rating (AQR) Cost/ASM of Haul American $10.8 bil. .231 8.89 cents 848 mi. Delta 9.7 .076 9.32 627 United 8.8 .176 8.88 835 USAir 6.4 -.003 11.56 621 Northwest 4.9 -.247 8.85 703 Continental 4.1 -.336 8.40 779 TWA 2.3 -.286 9.50 692 Southwest 2.1 .252 7.16 376 America West 1.3 -.294 7.03 642 Average $5.6 bil. -.048 8.84 680 Sources: Cols. 1,3,4: U.S. Department of Transportation, Air Carrier Financial and Traffic Statistics Summaries, Office of Airline Statistics. Col. 2: The Airline Quality Report 1994, National Institute for Aviation Research. The AQR includes nineteen weighted rating factors including on-time performance, safety, age of aircraft, frequent flyer plans, and various other customer service variables. For more information on the AQR measure the

reader should see endnotes #14 and #15.

After firms are placed in one of these four quadrants, some interpretation may be necessary to confirm them as strategic groups. Ideally, firms in a strategic group will have their quality/cost plots close together. Also, a careful look at each airline's flight stage length will be necessary to establish that firms with widely divergent flight lengths are not misidentified as having similar cost positions. Once strategic groups are established, profitability data will be used to confirm that this is an appropriate application of the Porter model. Specifically, those airlines identified as pursuing one of the three generic strategies will be compared as a group to those that are "stuck in the middle." The profitability of this latter group should be significantly lower than the group of airlines identified as pursuing a strategy within the Porter model. RESULTS: IDENTIFICATION OF STRATEGIC GROUPS The scatter diagram of airlines' relative cost and quality differentiation positions is found in Figure 1. While further interpretation is necessary, the resultant scatter plot reveals that groups can be identified that are largely consistent with the prescriptions of the Porter model. Before discussing the makeup of these groups, it is important to analyze each airline's average flight length in order to determine the accuracy of the groupings found in the scatter plot analysis. Airlines with below average flight distances have a better cost position than the scatter plot may indicate. Therefore, Southwest, Delta, USAir, and America West's competitive positions should be shifted horizontally to the left somewhat to better reflect their relative standings. On the other hand, American, United, Continental, and Northwest should see a rightward shift to compensate for their above average flight distances. TWA, near the industry average for flight length, would remain essentially in place. While the degrees of these shifts cannot be precisely determined, it is a function of the relative deviation between each carrier's flight distance and the industry mean. The impact of this analysis would bring Delta closer to American and United on a cost basis, solidifying the big three as an obvious strategic cluster of high quality, but above average cost firms. Likewise, in the high cost, low quality quadrant, USAir and Northwest would both move towards TWA, thus solidifying this grouping. Due to their shorter flight distance, America West and Southwest would move leftward into even better relative cost positions. Only Continental's position is left in doubt; with its flights averaging 100 miles above the industry average, its costs would appear to be much closer to the industry average than the original scatter plot indicates. Groupings 1. Quality Differentiation Group: American, United, and Delta From Figure 1, Quadrant I, American, United, and Delta can be identified as firms pursuing differentiation based on service quality. Excluding the much smaller Southwest for the moment, these big three airlines have higher AQR scores than the rest of the industry. Consistent with Porter's contention that cost leadership and differentiation are largely incompatible, these three also have higher costs - individually and on average - than the industry average and firms in low-

cost quadrants. These findings reflect the costs associated with the big three's approach to quality differentiation. They all provide significant amenities beyond basic flight service, and have invested heavily in the development of expansive domestic and international operations to differentiate themselves in the minds of flyers by presenting themselves as the "we fly anywhere you want to go" carriers. 2. Cost Leadership: America West From Quadrants III and IV, three firms appear to be pursuing low-cost strategies: Southwest, America West, and Continental. Consistent with Porter, Continental and America West's quality ratings are commensurately low, while Southwest's very high quality ratings demand further examination. Southwest's position does not seem to be compatible with a pure cost leadership strategy, and alternative explanations will be addressed shortly. Continental, with above average flight lengths leaving its costs close to average, is apparently not very successful at accomplishing the low-cost position it seeks. Firms which unsuccessfully pursue a strategy are considered "stuck in the middle" in the Porter model, and this seems to be a fair classification for Continental. Within the standard Porter framework, America West can be identified as successfully pursuing a classic low-cost position. 3. Focus: Southwest Since deregulation in 1978, the U.S. airline industry has undergone significant and often surprising change. Well-established airlines including Pan Am, Eastern, Western, and Piedmont have disappeared. Other airlines such as People Express and Midway became highly publicized success stories and then took a financial nosedive into oblivion. As documented by Rakowski and Bejou (1992), of the fifteen largest U.S. airline firms in 1985, six didn't make it to 1989, and in the following two years another three ceased operations.(1) In contrast, since 1991, the industry seems to have found at least a temporary equilibrium; the nine largest airlines in 1991 were the same as those that began 1994.(2) While future change in the industry is likely, the comparative stability during recent years provides an opportunity to take a snapshot of the relative competitive positions of the nine major U.S. passenger airlines. Specifically, this article seeks to identify strategic groups within the U.S. airline industry using the well-established competitive strategy model of Michael Porter.(3) According to Porter, a strategic group consists of rival firms with similar competitive approaches and positions within the market.(4) BACKGROUND - AIRLINE INDUSTRY GROUPINGS Identifying strategic groups within an industry is highly desirable from both a qualitative and quantitative perspective. It is easier psychologically to understand the competitive dynamics of an industry if we can identify three or four similar groups rather than having to characterize each firm separately. Furthermore, by dividing the airline industry into meaningful groups, performance and operating statistics can be separated and analyzed more effectively. Informally, we know of U.S. airlines grouped as the "big three" - United, American, and Delta as well as "majors," "nationals," and "regionals" based on government revenue classifications.(5) The so-called "Chapter 11 Carriers" - America West, TWA, and Continental - were in

bankruptcy during the early 1990s and have been controlled for in research models and studied separately as a group; an example is the work of Golaszewski and Sanders (1992).(6) The Transportation Research Board, in its special report Winds of Change (1991), divided the industry into "strong" and "weak" carriers to illuminate financial performance.(7) Researchers in the past have also singled out "new entrant carriers" that have emerged since deregulation and "non-union" firms for distinct treatment in analysis.(8) The size and historical groupings discussed above have proven useful and interesting. To complement these groupings, and for a better understanding of the competitive structure of the industry, it is valuable to classify airlines based on their competitive strategies. This type of identification can shed light on successful market positions and suggest future strategic directions for airline managers to target or avoid. In this article, therefore, we first group the nine major U.S. passenger airlines by competitive strategy, using Porter's typology of generic strategies. We then assess the financial performance of each airline to validate the appropriateness of the initial strategic groupings. Finally, we discuss the implications for competition within the airline industry given its competitive structure. PORTER'S GENERIC STRATEGIES Within any industry, companies seek to gain a competitive advantage that allows them to outperform rivals and achieve above-average profitability. Porter has suggested that the path to competitive advantage is the successful implementation of an internally consistent competitive strategy. Porter identified three "generic" competitive strategies, which have been widely studied.(9) These are cost leadership, differentiation, and focus.(10) Cost Leadership Companies pursuing a strategy of cost leadership seek to outperform rivals by producing goods or services at a lower cost. There are two potential advantages of this strategy. First, due to its lower cost structure, the cost leader can either charge a lower price than competitors and still make the same profit, or charge the same price as competitors and make a higher profit. Second, should price wars develop, the cost leader will be in a better position to withstand price-driven competition. Achieving a low-cost position often requires a high market share so that economies of scale are achieved. Emphasis is placed on reducing costs at every possible point. Hence, it may require designing products or services for ease of manufacture or delivery. Once a low-cost position is achieved, profits must often be reinvested in improved processes and technologies that further reduce costs so that cost leadership can be sustained. Differentiation

Companies pursuing differentiation strategies seek competitive advantage by creating products or services that are perceived by customers as being unique and for which buyers are willing to pay a premium price. Successful differentiation provides the company with two primary advantages that flow from the perceived uniqueness of its products. First, the company is able to charge a higher price for its products or services, often with an accompanying higher margin. Second, customers willing to pay more for a unique product are often more loyal because their purchase decision is based more on perceived quality than on price. Achieving successful differentiation requires clear understanding of customer needs and investments in the capabilities necessary to meet those needs. Typically, achieving differentiation requires a trade-off with cost position, especially if the activities required to create uniqueness - such as market research, quality materials, and customer service - are themselves costly. Focus The focus strategy differs from the other two generic strategies in that it is directed toward serving the needs of a limited customer group or market segment. Companies pursuing focus strategies concentrate on serving a particular market niche, which may be defined geographically, by segment of product line, or by type of customer. Having chosen its "focus," however, the company may choose to compete within its niche either on the basis of low cost or differentiation. It gains competitive advantage by better serving the needs of the chosen segment, whether those needs be lower cost or differentiating quality. The advantages of successful focus strategies derive from the fact that the firm is able to concentrate its efforts. Its ability to better meet the needs of its chosen customers means that it may be able to charge a higher price for its unique products or services. Alternately, it may be able to undercut the cost of the industry-wide cost leader through technologies and processes that are not cost-effective at larger scales (such as the steel foundry technology in use by the new mini-mills). Finally, concentration within a protected niche may buffer the firm from broader competition within the industry as a whole. Stuck in the Middle According to Porter, any firm that fails to develop a viable competitive strategy - whether it be low cost, differentiation, or focus - may be termed "stuck in the middle" with no basis for competitive advantage. Such firms cannot compete on the basis of price because their cost structure is too high. Nor are they able to charge premium prices because they have failed to differentiate their products or services in the minds of potential customers. Nor are they protected by a niche that buffers them from broader industry competition. As a result, firms stuck in the middle are almost guaranteed low profitability and, when there is a shake-out in the industry, they are the first to exit. DATA AND METHODOLOGY

As will be explained in more detail at the end of this section, the use of a scatter-plot of airlines' cost and quality positions represents the primary methodology used to identify strategic groups. Given the varied resources and capabilities required to pursue the different generic strategies detailed above, not all firms in a given business environment will compete on the same basis. Therefore, an analysis of appropriate firm-level data should distinguish between firms opting to pursue low-cost strategies, those pursuing differentiation strategies, and those that might be focusing on particular market segments. By default, firms that are not pursuing one of these strategies will be considered to be lacking in strategic direction, or "stuck in the middle." Data This analysis focuses on the nine major U.S. passenger air carriers during the time period 1991 to 1993. A "major" airline is one having revenues of at least $1 billion annually, and these airlines account for 90 percent of all U.S. passenger traffic.(11) To standardize comparisons, cost, quality, and financial data will cover only the domestic operations of these nine carriers. The evaluation of firms' cost structures is fairly simple because good cost data are readily available for the U.S. airline industry. The statistic "cents per available seat mile (ASM)" is well accepted as a measure of airline costs. This figure takes an airline's operating costs and divides it by the number of seat miles flown; the resulting cost per ASM represents the cost to fly one seat one mile. The source of these data, along with revenue and profitability figures, is the U.S. Department of Transportation.(12) However, cost per ASM is subject to interpretation because costs vary inversely with average flight distance - an established relationship discussed and documented well by Bailey, Graham, and Kaplan (1985).(13) This complication will be addressed after firms' initial cost positions are established. Important in this type of strategic analysis is the definition and measurement of differentiation within an industry. In the airline industry, firms attempt to differentiate themselves through service quality. Fortunately, a validated measure of comparative service quality is available. The Airline Quality Rating (AQR) computed annually by the National Institute for Aviation Research at Wichita State University was established in 1991 as an objective method of comparing quality factors between airlines and across time.(14) The AQR is a weighted average of nineteen factors that have been determined to be important to consumers when they assess airline quality. This measure is predominantly domestic in nature, and includes factors such as on-time performance, safety, frequent flier program assessments, financial stability, age of aircraft, lost baggage rates, and other customer service attributes.(15) A recent survey of airline passengers conducted by Consumer Reports corroborates the general integrity of the AQR; of the nine major airlines, both rankings agree on the best and worst airlines.(16) METHODOLOGY Strategic groups have been identified using a variety of means, from competitor mapping to statistical cluster analysis. We develop our strategic groups using a scatter-plot diagram, the dimensions of which relate to cost and quality. This approach is similar to the competitor mapping described by Porter and is more appropriate than cluster analysis given the relatively few number of companies in the industry.(17) Cost per seat mile will be the X-axis variable with

the industry cost average separating low and high cost firms. On the Y-axis, the Airline Quality Rating (AQR) index calculated by the National Institute for Aviation Research is used as the differentiating factor. The scatter-plot will initially divide the industry into four quadrants. The high cost, high quality quadrant will initially identify firms pursuing differentiation. Firms in the low cost, low quality sector may well be seeking cost leadership. A firm which is able to obtain both low costs and high quality may be following the focus strategy. Firms in the high cost, low quality quadrant will likely be without a clear strategy, or "stuck in the middle."
Table 1. Domestic Sector Financial and Operating Data for U.S. Major Airlines, 1993 Overall Quality Length Airline Revenue Rating (AQR) Cost/ASM of Haul American $10.8 bil. .231 8.89 cents 848 mi. Delta 9.7 .076 9.32 627 United 8.8 .176 8.88 835 USAir 6.4 -.003 11.56 621 Northwest 4.9 -.247 8.85 703 Continental 4.1 -.336 8.40 779 TWA 2.3 -.286 9.50 692 Southwest 2.1 .252 7.16 376 America West 1.3 -.294 7.03 642 Average $5.6 bil. -.048 8.84 680 Sources: Cols. 1,3,4: U.S. Department of Transportation, Air Carrier Financial and Traffic Statistics Summaries, Office of Airline Statistics. Col. 2: The Airline Quality Report 1994, National Institute for Aviation Research. The AQR includes nineteen weighted rating factors including on-time performance, safety, age of aircraft, frequent flyer plans, and various other customer service variables. For more information on the AQR measure the reader should see endnotes #14 and #15.

After firms are placed in one of these four quadrants, some interpretation may be necessary to confirm them as strategic groups. Ideally, firms in a strategic group will have their quality/cost plots close together. Also, a careful look at each airline's flight stage length will be necessary to establish that firms with widely divergent flight lengths are not misidentified as having similar cost positions. Once strategic groups are established, profitability data will be used to confirm that this is an appropriate application of the Porter model. Specifically, those airlines identified as pursuing one of the three generic strategies will be compared as a group to those that are "stuck in the middle." The profitability of this latter group should be significantly lower than the group of airlines identified as pursuing a strategy within the Porter model. RESULTS: IDENTIFICATION OF STRATEGIC GROUPS The scatter diagram of airlines' relative cost and quality differentiation positions is found in Figure 1. While further interpretation is necessary, the resultant scatter plot reveals that groups can be identified that are largely consistent with the prescriptions of the Porter model.

Before discussing the makeup of these groups, it is important to analyze each airline's average flight length in order to determine the accuracy of the groupings found in the scatter plot analysis. Airlines with below average flight distances have a better cost position than the scatter plot may indicate. Therefore, Southwest, Delta, USAir, and America West's competitive positions should be shifted horizontally to the left somewhat to better reflect their relative standings. On the other hand, American, United, Continental, and Northwest should see a rightward shift to compensate for their above average flight distances. TWA, near the industry average for flight length, would remain essentially in place. While the degrees of these shifts cannot be precisely determined, it is a function of the relative deviation between each carrier's flight distance and the industry mean. The impact of this analysis would bring Delta closer to American and United on a cost basis, solidifying the big three as an obvious strategic cluster of high quality, but above average cost firms. Likewise, in the high cost, low quality quadrant, USAir and Northwest would both move towards TWA, thus solidifying this grouping. Due to their shorter flight distance, America West and Southwest would move leftward into even better relative cost positions. Only Continental's position is left in doubt; with its flights averaging 100 miles above the industry average, its costs would appear to be much closer to the industry average than the original scatter plot indicates. Groupings 1. Quality Differentiation Group: American, United, and Delta From Figure 1, Quadrant I, American, United, and Delta can be identified as firms pursuing differentiation based on service quality. Excluding the much smaller Southwest for the moment, these big three airlines have higher AQR scores than the rest of the industry. Consistent with Porter's contention that cost leadership and differentiation are largely incompatible, these three also have higher costs - individually and on average - than the industry average and firms in lowcost quadrants. These findings reflect the costs associated with the big three's approach to quality differentiation. They all provide significant amenities beyond basic flight service, and have invested heavily in the development of expansive domestic and international operations to differentiate themselves in the minds of flyers by presenting themselves as the "we fly anywhere you want to go" carriers. 2. Cost Leadership: America West From Quadrants III and IV, three firms appear to be pursuing low-cost strategies: Southwest, America West, and Continental. Consistent with Porter, Continental and America West's quality ratings are commensurately low, while Southwest's very high quality ratings demand further examination. Southwest's position does not seem to be compatible with a pure cost leadership strategy, and alternative explanations will be addressed shortly. Continental, with above average flight lengths leaving its costs close to average, is apparently not very successful at accomplishing the low-cost position it seeks. Firms which unsuccessfully pursue a strategy are considered "stuck in the middle" in the Porter model, and this seems to be a fair classification for Continental. Within the standard Porter framework, America West can be identified as successfully pursuing a classic low-cost position.

3. Focus: Southwest There are two possible explanations for Southwest's position in Quadrant IV. The first is that Southwest has adopted a focus strategy, the third of Porter's three generic strategies. Porter describes the focus strategy as one where a firm focuses on a given market segment and within that segment may have a low-cost position, be highly differentiated, or obtain both.(18) Southwest, unlike other airlines, does not use a hub and spoke system, and focuses on short, high-density routes. Traditionally, Southwest has been one of the smallest U.S. major airlines and has concentrated its route structure in the Southwestern U.S.; this would support the argument that it is pursuing a focus strategy. Alternately, we could argue that the Porter model does not appropriately account for firms like Southwest that achieve both low costs and positive differentiation. Southwest can no longer be considered a small niche player in the industry; in the first half of 1994 they carried more domestic passengers than Continental or Northwest, and twice as many as TWA.(19) Furthermore, this airline now serves such northern destinations as Cleveland, Columbus, Detroit, and Baltimore, and it has a major flight center in Chicago. In its recent rapid growth, it may be that Southwest is moving out of its historical focus position, and this has implications that will be discussed in a later part of the article. For the current analysis and time period, Southwest's enviable position in Quadrant IV can best be described within the Porter model as evidence of a focus strategy. Stuck in the Middle Group: TWA, NWA, USAir, and Continental Since deregulation in 1978, the U.S. airline industry has undergone significant and often surprising change. Well-established airlines including Pan Am, Eastern, Western, and Piedmont have disappeared. Other airlines such as People Express and Midway became highly publicized success stories and then took a financial nosedive into oblivion. As documented by Rakowski and Bejou (1992), of the fifteen largest U.S. airline firms in 1985, six didn't make it to 1989, and in the following two years another three ceased operations.(1) In contrast, since 1991, the industry seems to have found at least a temporary equilibrium; the nine largest airlines in 1991 were the same as those that began 1994.(2) While future change in the industry is likely, the comparative stability during recent years provides an opportunity to take a snapshot of the relative competitive positions of the nine major U.S. passenger airlines. Specifically, this article seeks to identify strategic groups within the U.S. airline industry using the well-established competitive strategy model of Michael Porter.(3) According to Porter, a strategic group consists of rival firms with similar competitive approaches and positions within the market.(4) BACKGROUND - AIRLINE INDUSTRY GROUPINGS Identifying strategic groups within an industry is highly desirable from both a qualitative and quantitative perspective. It is easier psychologically to understand the competitive dynamics of an industry if we can identify three or four similar groups rather than having to characterize each firm separately. Furthermore, by dividing the airline industry into meaningful groups, performance and operating statistics can be separated and analyzed more effectively. Informally, we know of U.S. airlines grouped as the "big three" - United, American, and Delta as well as "majors," "nationals," and "regionals" based on government revenue classifications.(5)

The so-called "Chapter 11 Carriers" - America West, TWA, and Continental - were in bankruptcy during the early 1990s and have been controlled for in research models and studied separately as a group; an example is the work of Golaszewski and Sanders (1992).(6) The Transportation Research Board, in its special report Winds of Change (1991), divided the industry into "strong" and "weak" carriers to illuminate financial performance.(7) Researchers in the past have also singled out "new entrant carriers" that have emerged since deregulation and "non-union" firms for distinct treatment in analysis.(8) The size and historical groupings discussed above have proven useful and interesting. To complement these groupings, and for a better understanding of the competitive structure of the industry, it is valuable to classify airlines based on their competitive strategies. This type of identification can shed light on successful market positions and suggest future strategic directions for airline managers to target or avoid. In this article, therefore, we first group the nine major U.S. passenger airlines by competitive strategy, using Porter's typology of generic strategies. We then assess the financial performance of each airline to validate the appropriateness of the initial strategic groupings. Finally, we discuss the implications for competition within the airline industry given its competitive structure. PORTER'S GENERIC STRATEGIES Within any industry, companies seek to gain a competitive advantage that allows them to outperform rivals and achieve above-average profitability. Porter has suggested that the path to competitive advantage is the successful implementation of an internally consistent competitive strategy. Porter identified three "generic" competitive strategies, which have been widely studied.(9) These are cost leadership, differentiation, and focus.(10) Cost Leadership Companies pursuing a strategy of cost leadership seek to outperform rivals by producing goods or services at a lower cost. There are two potential advantages of this strategy. First, due to its lower cost structure, the cost leader can either charge a lower price than competitors and still make the same profit, or charge the same price as competitors and make a higher profit. Second, should price wars develop, the cost leader will be in a better position to withstand price-driven competition. Achieving a low-cost position often requires a high market share so that economies of scale are achieved. Emphasis is placed on reducing costs at every possible point. Hence, it may require designing products or services for ease of manufacture or delivery. Once a low-cost position is achieved, profits must often be reinvested in improved processes and technologies that further reduce costs so that cost leadership can be sustained. Differentiation

Companies pursuing differentiation strategies seek competitive advantage by creating products or services that are perceived by customers as being unique and for which buyers are willing to pay a premium price. Successful differentiation provides the company with two primary advantages that flow from the perceived uniqueness of its products. First, the company is able to charge a higher price for its products or services, often with an accompanying higher margin. Second, customers willing to pay more for a unique product are often more loyal because their purchase decision is based more on perceived quality than on price. Achieving successful differentiation requires clear understanding of customer needs and investments in the capabilities necessary to meet those needs. Typically, achieving differentiation requires a trade-off with cost position, especially if the activities required to create uniqueness - such as market research, quality materials, and customer service - are themselves costly. Focus The focus strategy differs from the other two generic strategies in that it is directed toward serving the needs of a limited customer group or market segment. Companies pursuing focus strategies concentrate on serving a particular market niche, which may be defined geographically, by segment of product line, or by type of customer. Having chosen its "focus," however, the company may choose to compete within its niche either on the basis of low cost or differentiation. It gains competitive advantage by better serving the needs of the chosen segment, whether those needs be lower cost or differentiating quality. The advantages of successful focus strategies derive from the fact that the firm is able to concentrate its efforts. Its ability to better meet the needs of its chosen customers means that it may be able to charge a higher price for its unique products or services. Alternately, it may be able to undercut the cost of the industry-wide cost leader through technologies and processes that are not cost-effective at larger scales (such as the steel foundry technology in use by the new mini-mills). Finally, concentration within a protected niche may buffer the firm from broader competition within the industry as a whole. Stuck in the Middle According to Porter, any firm that fails to develop a viable competitive strategy - whether it be low cost, differentiation, or focus - may be termed "stuck in the middle" with no basis for competitive advantage. Such firms cannot compete on the basis of price because their cost structure is too high. Nor are they able to charge premium prices because they have failed to differentiate their products or services in the minds of potential customers. Nor are they protected by a niche that buffers them from broader industry competition. As a result, firms stuck in the middle are almost guaranteed low profitability and, when there is a shake-out in the industry, they are the first to exit. DATA AND METHODOLOGY

As will be explained in more detail at the end of this section, the use of a scatter-plot of airlines' cost and quality positions represents the primary methodology used to identify strategic groups. Given the varied resources and capabilities required to pursue the different generic strategies detailed above, not all firms in a given business environment will compete on the same basis. Therefore, an analysis of appropriate firm-level data should distinguish between firms opting to pursue low-cost strategies, those pursuing differentiation strategies, and those that might be focusing on particular market segments. By default, firms that are not pursuing one of these strategies will be considered to be lacking in strategic direction, or "stuck in the middle." Data This analysis focuses on the nine major U.S. passenger air carriers during the time period 1991 to 1993. A "major" airline is one having revenues of at least $1 billion annually, and these airlines account for 90 percent of all U.S. passenger traffic.(11) To standardize comparisons, cost, quality, and financial data will cover only the domestic operations of these nine carriers. The evaluation of firms' cost structures is fairly simple because good cost data are readily available for the U.S. airline industry. The statistic "cents per available seat mile (ASM)" is well accepted as a measure of airline costs. This figure takes an airline's operating costs and divides it by the number of seat miles flown; the resulting cost per ASM represents the cost to fly one seat one mile. The source of these data, along with revenue and profitability figures, is the U.S. Department of Transportation.(12) However, cost per ASM is subject to interpretation because costs vary inversely with average flight distance - an established relationship discussed and documented well by Bailey, Graham, and Kaplan (1985).(13) This complication will be addressed after firms' initial cost positions are established. Important in this type of strategic analysis is the definition and measurement of differentiation within an industry. In the airline industry, firms attempt to differentiate themselves through service quality. Fortunately, a validated measure of comparative service quality is available. The Airline Quality Rating (AQR) computed annually by the National Institute for Aviation Research at Wichita State University was established in 1991 as an objective method of comparing quality factors between airlines and across time.(14) The AQR is a weighted average of nineteen factors that have been determined to be important to consumers when they assess airline quality. This measure is predominantly domestic in nature, and includes factors such as on-time performance, safety, frequent flier program assessments, financial stability, age of aircraft, lost baggage rates, and other customer service attributes.(15) A recent survey of airline passengers conducted by Consumer Reports corroborates the general integrity of the AQR; of the nine major airlines, both rankings agree on the best and worst airlines.(16) METHODOLOGY Strategic groups have been identified using a variety of means, from competitor mapping to statistical cluster analysis. We develop our strategic groups using a scatter-plot diagram, the dimensions of which relate to cost and quality. This approach is similar to the competitor mapping described by Porter and is more appropriate than cluster analysis given the relatively few number of companies in the industry.(17) Cost per seat mile will be the X-axis variable with

the industry cost average separating low and high cost firms. On the Y-axis, the Airline Quality Rating (AQR) index calculated by the National Institute for Aviation Research is used as the differentiating factor. The scatter-plot will initially divide the industry into four quadrants. The high cost, high quality quadrant will initially identify firms pursuing differentiation. Firms in the low cost, low quality sector may well be seeking cost leadership. A firm which is able to obtain both low costs and high quality may be following the focus strategy. Firms in the high cost, low quality quadrant will likely be without a clear strategy, or "stuck in the middle."
Table 1. Domestic Sector Financial and Operating Data for U.S. Major Airlines, 1993 Overall Quality Length Airline Revenue Rating (AQR) Cost/ASM of Haul American $10.8 bil. .231 8.89 cents 848 mi. Delta 9.7 .076 9.32 627 United 8.8 .176 8.88 835 USAir 6.4 -.003 11.56 621 Northwest 4.9 -.247 8.85 703 Continental 4.1 -.336 8.40 779 TWA 2.3 -.286 9.50 692 Southwest 2.1 .252 7.16 376 America West 1.3 -.294 7.03 642 Average $5.6 bil. -.048 8.84 680 Sources: Cols. 1,3,4: U.S. Department of Transportation, Air Carrier Financial and Traffic Statistics Summaries, Office of Airline Statistics. Col. 2: The Airline Quality Report 1994, National Institute for Aviation Research. The AQR includes nineteen weighted rating factors including on-time performance, safety, age of aircraft, frequent flyer plans, and various other customer service variables. For more information on the AQR measure the reader should see endnotes #14 and #15.

After firms are placed in one of these four quadrants, some interpretation may be necessary to confirm them as strategic groups. Ideally, firms in a strategic group will have their quality/cost plots close together. Also, a careful look at each airline's flight stage length will be necessary to establish that firms with widely divergent flight lengths are not misidentified as having similar cost positions. Once strategic groups are established, profitability data will be used to confirm that this is an appropriate application of the Porter model. Specifically, those airlines identified as pursuing one of the three generic strategies will be compared as a group to those that are "stuck in the middle." The profitability of this latter group should be significantly lower than the group of airlines identified as pursuing a strategy within the Porter model. RESULTS: IDENTIFICATION OF STRATEGIC GROUPS The scatter diagram of airlines' relative cost and quality differentiation positions is found in Figure 1. While further interpretation is necessary, the resultant scatter plot reveals that groups can be identified that are largely consistent with the prescriptions of the Porter model.

Before discussing the makeup of these groups, it is important to analyze each airline's average flight length in order to determine the accuracy of the groupings found in the scatter plot analysis. Airlines with below average flight distances have a better cost position than the scatter plot may indicate. Therefore, Southwest, Delta, USAir, and America West's competitive positions should be shifted horizontally to the left somewhat to better reflect their relative standings. On the other hand, American, United, Continental, and Northwest should see a rightward shift to compensate for their above average flight distances. TWA, near the industry average for flight length, would remain essentially in place. While the degrees of these shifts cannot be precisely determined, it is a function of the relative deviation between each carrier's flight distance and the industry mean. The impact of this analysis would bring Delta closer to American and United on a cost basis, solidifying the big three as an obvious strategic cluster of high quality, but above average cost firms. Likewise, in the high cost, low quality quadrant, USAir and Northwest would both move towards TWA, thus solidifying this grouping. Due to their shorter flight distance, America West and Southwest would move leftward into even better relative cost positions. Only Continental's position is left in doubt; with its flights averaging 100 miles above the industry average, its costs would appear to be much closer to the industry average than the original scatter plot indicates. Groupings 1. Quality Differentiation Group: American, United, and Delta From Figure 1, Quadrant I, American, United, and Delta can be identified as firms pursuing differentiation based on service quality. Excluding the much smaller Southwest for the moment, these big three airlines have higher AQR scores than the rest of the industry. Consistent with Porter's contention that cost leadership and differentiation are largely incompatible, these three also have higher costs - individually and on average - than the industry average and firms in lowcost quadrants. These findings reflect the costs associated with the big three's approach to quality differentiation. They all provide significant amenities beyond basic flight service, and have invested heavily in the development of expansive domestic and international operations to differentiate themselves in the minds of flyers by presenting themselves as the "we fly anywhere you want to go" carriers. 2. Cost Leadership: America West From Quadrants III and IV, three firms appear to be pursuing low-cost strategies: Southwest, America West, and Continental. Consistent with Porter, Continental and America West's quality ratings are commensurately low, while Southwest's very high quality ratings demand further examination. Southwest's position does not seem to be compatible with a pure cost leadership strategy, and alternative explanations will be addressed shortly. Continental, with above average flight lengths leaving its costs close to average, is apparently not very successful at accomplishing the low-cost position it seeks. Firms which unsuccessfully pursue a strategy are considered "stuck in the middle" in the Porter model, and this seems to be a fair classification for Continental. Within the standard Porter framework, America West can be identified as successfully pursuing a classic low-cost position.

3. Focus: Southwest There are two possible explanations for Southwest's position in Quadrant IV. The first is that Southwest has adopted a focus strategy, the third of Porter's three generic strategies. Porter describes the focus strategy as one where a firm focuses on a given market segment and within that segment may have a low-cost position, be highly differentiated, or obtain both.(18) Southwest, unlike other airlines, does not use a hub and spoke system, and focuses on short, high-density routes. Traditionally, Southwest has been one of the smallest U.S. major airlines and has concentrated its route structure in the Southwestern U.S.; this would support the argument that it is pursuing a focus strategy. Alternately, we could argue that the Porter model does not appropriately account for firms like Southwest that achieve both low costs and positive differentiation. Southwest can no longer be considered a small niche player in the industry; in the first half of 1994 they carried more domestic passengers than Continental or Northwest, and twice as many as TWA.(19) Furthermore, this airline now serves such northern destinations as Cleveland, Columbus, Detroit, and Baltimore, and it has a major flight center in Chicago. In its recent rapid growth, it may be that Southwest is moving out of its historical focus position, and this has implications that will be discussed in a later part of the article. For the current analysis and time period, Southwest's enviable position in Quadrant IV can best be described within the Porter model as evidence of a focus strategy. Stuck in the Middle Group: TWA, NWA, USAir, and Continental Quadrant II firms TWA, Northwest, and USAir are "stuck in the middle." All three suffer from costs that are above and quality ratings that are below industry averages. Continental can be added to the group if we consider its below average cost position as overstated as discussed earlier. These firms may have ended up in this undesirable position for different reasons, but they all can be classified as firms that have failed to achieve one of the three generic strategies as outlined by Porter. For example, USAir's quality rating is close to the industry average, but its costs are the highest in the industry. From this it can be inferred that USAir has pursued - but failed to achieve - a quality differentiated position. Conversely, Continental has clearly attempted a low-cost strategy, but has not obtained a cost leadership position. The positions of TWA and Northwest suggest that they are truly stuck in the middle; their strategic direction with respect to cost and differentiation is ambiguous. Validation of Results The Porter model and previous industry studies strongly suggest that firms which pursue one of the three generic strategies will have superior financial performance compared to those "stuck in the middle." Using profitability data from 1991 to 1993, as found in Table 2, we can test the validity of our strategic group identifications. The five airlines identified as pursuing one of the three generic strategies had an average 1.39 percent operating profit margin between 1991 and 1993, while the four "stuck in the middle" firms had an operating margin equal to -3.57 percent. While neither group appears particularly successful, one must keep in mind the difficult airline environment in 1991 and 1992 due to the Gulf War and recession. Using a small sample difference of means test, the 4.96 percent spread

between the two groups produced a T-statistic of 2.42, significant at the 0.25 level. Therefore, the five airlines following one of Porter's three generic strategies had statistically significant better returns than those "stuck in the middle" firms, as would be expected. On an individual airline basis, the use of the [TABULAR DATA FOR TABLE 2 OMITTED] scatter diagram and strategic groups generated from the Porter model provides useful, predictable information. The one exception appears to be Northwest, whose positive operating margin for 1991-93 stands in sharp contrast to the other three "stuck in the middle" airlines. Other than Northwest, all of the airlines following one of the three generic strategies had better operating margins than all of the "stuck in the middle" firms. It is also interesting to note that the industry roughly follows the concept of a U-shaped relationship between size and financial returns described by Porter.(20) In other words, large and small firms appear to have superior performance. The low-performing "stuck in the middle" group represents the 4th, 5th, 6th, and 7th largest firms among the nine major airlines. Contrary to Porter's expectations, it is the smallest firms that have the lowest costs and the largest firms that are able to differentiate themselves. Since deregulation in 1978, the U.S. airline industry has undergone significant and often surprising change. Well-established airlines including Pan Am, Eastern, Western, and Piedmont have disappeared. Other airlines such as People Express and Midway became highly publicized success stories and then took a financial nosedive into oblivion. As documented by Rakowski and Bejou (1992), of the fifteen largest U.S. airline firms in 1985, six didn't make it to 1989, and in the following two years another three ceased operations.(1) In contrast, since 1991, the industry seems to have found at least a temporary equilibrium; the nine largest airlines in 1991 were the same as those that began 1994.(2) While future change in the industry is likely, the comparative stability during recent years provides an opportunity to take a snapshot of the relative competitive positions of the nine major U.S. passenger airlines. Specifically, this article seeks to identify strategic groups within the U.S. airline industry using the well-established competitive strategy model of Michael Porter.(3) According to Porter, a strategic group consists of rival firms with similar competitive approaches and positions within the market.(4) BACKGROUND - AIRLINE INDUSTRY GROUPINGS Identifying strategic groups within an industry is highly desirable from both a qualitative and quantitative perspective. It is easier psychologically to understand the competitive dynamics of an industry if we can identify three or four similar groups rather than having to characterize each firm separately. Furthermore, by dividing the airline industry into meaningful groups, performance and operating statistics can be separated and analyzed more effectively. Informally, we know of U.S. airlines grouped as the "big three" - United, American, and Delta as well as "majors," "nationals," and "regionals" based on government revenue classifications.(5) The so-called "Chapter 11 Carriers" - America West, TWA, and Continental - were in bankruptcy during the early 1990s and have been controlled for in research models and studied separately as a group; an example is the work of Golaszewski and Sanders (1992).(6) The Transportation Research Board, in its special report Winds of Change (1991), divided the

industry into "strong" and "weak" carriers to illuminate financial performance.(7) Researchers in the past have also singled out "new entrant carriers" that have emerged since deregulation and "non-union" firms for distinct treatment in analysis.(8) The size and historical groupings discussed above have proven useful and interesting. To complement these groupings, and for a better understanding of the competitive structure of the industry, it is valuable to classify airlines based on their competitive strategies. This type of identification can shed light on successful market positions and suggest future strategic directions for airline managers to target or avoid. In this article, therefore, we first group the nine major U.S. passenger airlines by competitive strategy, using Porter's typology of generic strategies. We then assess the financial performance of each airline to validate the appropriateness of the initial strategic groupings. Finally, we discuss the implications for competition within the airline industry given its competitive structure. PORTER'S GENERIC STRATEGIES Within any industry, companies seek to gain a competitive advantage that allows them to outperform rivals and achieve above-average profitability. Porter has suggested that the path to competitive advantage is the successful implementation of an internally consistent competitive strategy. Porter identified three "generic" competitive strategies, which have been widely studied.(9) These are cost leadership, differentiation, and focus.(10) Cost Leadership Companies pursuing a strategy of cost leadership seek to outperform rivals by producing goods or services at a lower cost. There are two potential advantages of this strategy. First, due to its lower cost structure, the cost leader can either charge a lower price than competitors and still make the same profit, or charge the same price as competitors and make a higher profit. Second, should price wars develop, the cost leader will be in a better position to withstand price-driven competition. Achieving a low-cost position often requires a high market share so that economies of scale are achieved. Emphasis is placed on reducing costs at every possible point. Hence, it may require designing products or services for ease of manufacture or delivery. Once a low-cost position is achieved, profits must often be reinvested in improved processes and technologies that further reduce costs so that cost leadership can be sustained. Differentiation Companies pursuing differentiation strategies seek competitive advantage by creating products or services that are perceived by customers as being unique and for which buyers are willing to pay a premium price. Successful differentiation provides the company with two primary advantages that flow from the perceived uniqueness of its products. First, the company is able to

charge a higher price for its products or services, often with an accompanying higher margin. Second, customers willing to pay more for a unique product are often more loyal because their purchase decision is based more on perceived quality than on price. Achieving successful differentiation requires clear understanding of customer needs and investments in the capabilities necessary to meet those needs. Typically, achieving differentiation requires a trade-off with cost position, especially if the activities required to create uniqueness - such as market research, quality materials, and customer service - are themselves costly. Focus The focus strategy differs from the other two generic strategies in that it is directed toward serving the needs of a limited customer group or market segment. Companies pursuing focus strategies concentrate on serving a particular market niche, which may be defined geographically, by segment of product line, or by type of customer. Having chosen its "focus," however, the company may choose to compete within its niche either on the basis of low cost or differentiation. It gains competitive advantage by better serving the needs of the chosen segment, whether those needs be lower cost or differentiating quality. The advantages of successful focus strategies derive from the fact that the firm is able to concentrate its efforts. Its ability to better meet the needs of its chosen customers means that it may be able to charge a higher price for its unique products or services. Alternately, it may be able to undercut the cost of the industry-wide cost leader through technologies and processes that are not cost-effective at larger scales (such as the steel foundry technology in use by the new mini-mills). Finally, concentration within a protected niche may buffer the firm from broader competition within the industry as a whole. Stuck in the Middle According to Porter, any firm that fails to develop a viable competitive strategy - whether it be low cost, differentiation, or focus - may be termed "stuck in the middle" with no basis for competitive advantage. Such firms cannot compete on the basis of price because their cost structure is too high. Nor are they able to charge premium prices because they have failed to differentiate their products or services in the minds of potential customers. Nor are they protected by a niche that buffers them from broader industry competition. As a result, firms stuck in the middle are almost guaranteed low profitability and, when there is a shake-out in the industry, they are the first to exit. DATA AND METHODOLOGY As will be explained in more detail at the end of this section, the use of a scatter-plot of airlines' cost and quality positions represents the primary methodology used to identify strategic groups. Given the varied resources and capabilities required to pursue the different generic strategies detailed above, not all firms in a given business environment will compete on the same basis. Therefore, an analysis of appropriate firm-level data should distinguish between firms opting to

pursue low-cost strategies, those pursuing differentiation strategies, and those that might be focusing on particular market segments. By default, firms that are not pursuing one of these strategies will be considered to be lacking in strategic direction, or "stuck in the middle." Data This analysis focuses on the nine major U.S. passenger air carriers during the time period 1991 to 1993. A "major" airline is one having revenues of at least $1 billion annually, and these airlines account for 90 percent of all U.S. passenger traffic.(11) To standardize comparisons, cost, quality, and financial data will cover only the domestic operations of these nine carriers. The evaluation of firms' cost structures is fairly simple because good cost data are readily available for the U.S. airline industry. The statistic "cents per available seat mile (ASM)" is well accepted as a measure of airline costs. This figure takes an airline's operating costs and divides it by the number of seat miles flown; the resulting cost per ASM represents the cost to fly one seat one mile. The source of these data, along with revenue and profitability figures, is the U.S. Department of Transportation.(12) However, cost per ASM is subject to interpretation because costs vary inversely with average flight distance - an established relationship discussed and documented well by Bailey, Graham, and Kaplan (1985).(13) This complication will be addressed after firms' initial cost positions are established. Important in this type of strategic analysis is the definition and measurement of differentiation within an industry. In the airline industry, firms attempt to differentiate themselves through service quality. Fortunately, a validated measure of comparative service quality is available. The Airline Quality Rating (AQR) computed annually by the National Institute for Aviation Research at Wichita State University was established in 1991 as an objective method of comparing quality factors between airlines and across time.(14) The AQR is a weighted average of nineteen factors that have been determined to be important to consumers when they assess airline quality. This measure is predominantly domestic in nature, and includes factors such as on-time performance, safety, frequent flier program assessments, financial stability, age of aircraft, lost baggage rates, and other customer service attributes.(15) A recent survey of airline passengers conducted by Consumer Reports corroborates the general integrity of the AQR; of the nine major airlines, both rankings agree on the best and worst airlines.(16) METHODOLOGY Strategic groups have been identified using a variety of means, from competitor mapping to statistical cluster analysis. We develop our strategic groups using a scatter-plot diagram, the dimensions of which relate to cost and quality. This approach is similar to the competitor mapping described by Porter and is more appropriate than cluster analysis given the relatively few number of companies in the industry.(17) Cost per seat mile will be the X-axis variable with the industry cost average separating low and high cost firms. On the Y-axis, the Airline Quality Rating (AQR) index calculated by the National Institute for Aviation Research is used as the differentiating factor. The scatter-plot will initially divide the industry into four quadrants. The high cost, high quality quadrant will initially identify firms pursuing differentiation. Firms in the low cost, low quality sector may well be seeking cost leadership. A firm which is able to obtain

both low costs and high quality may be following the focus strategy. Firms in the high cost, low quality quadrant will likely be without a clear strategy, or "stuck in the middle."
Table 1. Domestic Sector Financial and Operating Data for U.S. Major Airlines, 1993 Overall Quality Length Airline Revenue Rating (AQR) Cost/ASM of Haul American $10.8 bil. .231 8.89 cents 848 mi. Delta 9.7 .076 9.32 627 United 8.8 .176 8.88 835 USAir 6.4 -.003 11.56 621 Northwest 4.9 -.247 8.85 703 Continental 4.1 -.336 8.40 779 TWA 2.3 -.286 9.50 692 Southwest 2.1 .252 7.16 376 America West 1.3 -.294 7.03 642 Average $5.6 bil. -.048 8.84 680 Sources: Cols. 1,3,4: U.S. Department of Transportation, Air Carrier Financial and Traffic Statistics Summaries, Office of Airline Statistics. Col. 2: The Airline Quality Report 1994, National Institute for Aviation Research. The AQR includes nineteen weighted rating factors including on-time performance, safety, age of aircraft, frequent flyer plans, and various other customer service variables. For more information on the AQR measure the reader should see endnotes #14 and #15.

After firms are placed in one of these four quadrants, some interpretation may be necessary to confirm them as strategic groups. Ideally, firms in a strategic group will have their quality/cost plots close together. Also, a careful look at each airline's flight stage length will be necessary to establish that firms with widely divergent flight lengths are not misidentified as having similar cost positions. Once strategic groups are established, profitability data will be used to confirm that this is an appropriate application of the Porter model. Specifically, those airlines identified as pursuing one of the three generic strategies will be compared as a group to those that are "stuck in the middle." The profitability of this latter group should be significantly lower than the group of airlines identified as pursuing a strategy within the Porter model. RESULTS: IDENTIFICATION OF STRATEGIC GROUPS The scatter diagram of airlines' relative cost and quality differentiation positions is found in Figure 1. While further interpretation is necessary, the resultant scatter plot reveals that groups can be identified that are largely consistent with the prescriptions of the Porter model. Before discussing the makeup of these groups, it is important to analyze each airline's average flight length in order to determine the accuracy of the groupings found in the scatter plot analysis. Airlines with below average flight distances have a better cost position than the scatter plot may indicate. Therefore, Southwest, Delta, USAir, and America West's competitive positions should be shifted horizontally to the left somewhat to better reflect their relative

standings. On the other hand, American, United, Continental, and Northwest should see a rightward shift to compensate for their above average flight distances. TWA, near the industry average for flight length, would remain essentially in place. While the degrees of these shifts cannot be precisely determined, it is a function of the relative deviation between each carrier's flight distance and the industry mean. The impact of this analysis would bring Delta closer to American and United on a cost basis, solidifying the big three as an obvious strategic cluster of high quality, but above average cost firms. Likewise, in the high cost, low quality quadrant, USAir and Northwest would both move towards TWA, thus solidifying this grouping. Due to their shorter flight distance, America West and Southwest would move leftward into even better relative cost positions. Only Continental's position is left in doubt; with its flights averaging 100 miles above the industry average, its costs would appear to be much closer to the industry average than the original scatter plot indicates. Groupings 1. Quality Differentiation Group: American, United, and Delta From Figure 1, Quadrant I, American, United, and Delta can be identified as firms pursuing differentiation based on service quality. Excluding the much smaller Southwest for the moment, these big three airlines have higher AQR scores than the rest of the industry. Consistent with Porter's contention that cost leadership and differentiation are largely incompatible, these three also have higher costs - individually and on average - than the industry average and firms in lowcost quadrants. These findings reflect the costs associated with the big three's approach to quality differentiation. They all provide significant amenities beyond basic flight service, and have invested heavily in the development of expansive domestic and international operations to differentiate themselves in the minds of flyers by presenting themselves as the "we fly anywhere you want to go" carriers. 2. Cost Leadership: America West From Quadrants III and IV, three firms appear to be pursuing low-cost strategies: Southwest, America West, and Continental. Consistent with Porter, Continental and America West's quality ratings are commensurately low, while Southwest's very high quality ratings demand further examination. Southwest's position does not seem to be compatible with a pure cost leadership strategy, and alternative explanations will be addressed shortly. Continental, with above average flight lengths leaving its costs close to average, is apparently not very successful at accomplishing the low-cost position it seeks. Firms which unsuccessfully pursue a strategy are considered "stuck in the middle" in the Porter model, and this seems to be a fair classification for Continental. Within the standard Porter framework, America West can be identified as successfully pursuing a classic low-cost position. 3. Focus: Southwest There are two possible explanations for Southwest's position in Quadrant IV. The first is that Southwest has adopted a focus strategy, the third of Porter's three generic strategies. Porter describes the focus strategy as one where a firm focuses on a given market segment and within

that segment may have a low-cost position, be highly differentiated, or obtain both.(18) Southwest, unlike other airlines, does not use a hub and spoke system, and focuses on short, high-density routes. Traditionally, Southwest has been one of the smallest U.S. major airlines and has concentrated its route structure in the Southwestern U.S.; this would support the argument that it is pursuing a focus strategy. Alternately, we could argue that the Porter model does not appropriately account for firms like Southwest that achieve both low costs and positive differentiation. Southwest can no longer be considered a small niche player in the industry; in the first half of 1994 they carried more domestic passengers than Continental or Northwest, and twice as many as TWA.(19) Furthermore, this airline now serves such northern destinations as Cleveland, Columbus, Detroit, and Baltimore, and it has a major flight center in Chicago. In its recent rapid growth, it may be that Southwest is moving out of its historical focus position, and this has implications that will be discussed in a later part of the article. For the current analysis and time period, Southwest's enviable position in Quadrant IV can best be described within the Porter model as evidence of a focus strategy. Stuck in the Middle Group: TWA, NWA, USAir, and Continental Quadrant II firms TWA, Northwest, and USAir are "stuck in the middle." All three suffer from costs that are above and quality ratings that are below industry averages. Continental can be added to the group if we consider its below average cost position as overstated as discussed earlier. These firms may have ended up in this undesirable position for different reasons, but they all can be classified as firms that have failed to achieve one of the three generic strategies as outlined by Porter. For example, USAir's quality rating is close to the industry average, but its costs are the highest in the industry. From this it can be inferred that USAir has pursued - but failed to achieve - a quality differentiated position. Conversely, Continental has clearly attempted a low-cost strategy, but has not obtained a cost leadership position. The positions of TWA and Northwest suggest that they are truly stuck in the middle; their strategic direction with respect to cost and differentiation is ambiguous. Validation of Results The Porter model and previous industry studies strongly suggest that firms which pursue one of the three generic strategies will have superior financial performance compared to those "stuck in the middle." Using profitability data from 1991 to 1993, as found in Table 2, we can test the validity of our strategic group identifications. The five airlines identified as pursuing one of the three generic strategies had an average 1.39 percent operating profit margin between 1991 and 1993, while the four "stuck in the middle" firms had an operating margin equal to -3.57 percent. While neither group appears particularly successful, one must keep in mind the difficult airline environment in 1991 and 1992 due to the Gulf War and recession. Using a small sample difference of means test, the 4.96 percent spread between the two groups produced a T-statistic of 2.42, significant at the 0.25 level. Therefore, the five airlines following one of Porter's three generic strategies had statistically significant better returns than those "stuck in the middle" firms, as would be expected.

On an individual airline basis, the use of the [TABULAR DATA FOR TABLE 2 OMITTED] scatter diagram and strategic groups generated from the Porter model provides useful, predictable information. The one exception appears to be Northwest, whose positive operating margin for 1991-93 stands in sharp contrast to the other three "stuck in the middle" airlines. Other than Northwest, all of the airlines following one of the three generic strategies had better operating margins than all of the "stuck in the middle" firms. It is also interesting to note that the industry roughly follows the concept of a U-shaped relationship between size and financial returns described by Porter.(20) In other words, large and small firms appear to have superior performance. The low-performing "stuck in the middle" group represents the 4th, 5th, 6th, and 7th largest firms among the nine major airlines. Contrary to Porter's expectations, it is the smallest firms that have the lowest costs and the largest firms that are able to differentiate themselves. CONCLUSIONS AND IMPLICATIONS This article successfully identified strategic groups among the nine major U.S. passenger airlines utilizing the framework of Michael Porter's generic strategy typology. Standardized cost data and the use of the National Institute for Aviation Research allowed strategic groups to be accurately determined through the use of a cost/quality differentiation scatter-plot diagram. Profitability analysis largely validated the use of the Porter model to identify strategic groups in the U.S. airline industry. Five airlines appear to be successfully following one of the three generic strategies and therefore enjoy better competitive positions in the industry and superior profitability. American, Delta, and United are clustered as one group of quality differentiated airlines with costs somewhat above the industry average. It is reasonable to conclude that this is a valuable position in the airline industry, but intense competition among the three may dampen financial returns. The fact that three large and powerful airlines dominate this position would strongly imply that attempts by other carriers to stake out a high cost, high quality position would be very difficult. Southwest, which has always concentrated on short, high density routes, is identified as historically pursuing a focus strategy. As Southwest grows and finds itself in increasing competition with other airlines, its challenge will be to maintain its enviable low cost, high quality position. Higher customer expectations may accompany longer routes, and growth may create operational changes. If Southwest loses its focus strategy, it could easily forfeit its quality differentiation and end up with a traditional low cost strategy. Currently, the low cost position belongs to America West. The favorable strategic positions of these five airlines would suggest that they are in the best position to survive and prosper as the year 2000 approaches. A group of three airlines is clearly identified as lacking in strategic focus and suffers back-ofthe-pack financial performance. TWA and USAir have both failed to establish themselves as either high quality or low cost firms. They continue to suffer serious financial problems as a result, and are probably in the poorest competitive position to survive the 1990s. Furthermore, in what direction should they move? To shift in the quality direction would entail challenging the "big three," but cost leadership does not seem to be a realistic goal either. The third carrier with an obviously poor strategic position is Continental, and it too continues to suffer financially. Its

attempt to become a Southwest style low-cost, no-frills airline faltered during 1994.(21) In order to regain profitability, all of these carriers might consider downsizing and focusing on particular market segments that match their strengths. Northwest is the one carrier whose strategic situation is not adequately explained in this Porter model analysis. Although part of the "stuck in the middle" group, its financial performance is considerably above that of the other three firms in this group. If we maintain that our model and data are valid, then the only reasonable explanation for Northwest's good profit performance is that it is focusing on a market segment that shields it from the severe price and service competition that impacts the industry as a whole. Northwest does focus geographically in the north-central U.S., and this region has not yet seen the intense price competition characterized by Southwest Airlines in the West, CalLite in the East, or Valujet out of Atlanta. Unless Northwest holds some type of barrier to entry against this type of firm in its region, which we do not believe it does, it is likely only a matter of time before its "stuck in the middle" strategic position catches up with it. ENDNOTES 1 J.P. Rakowski and David Bejou, "Birth, Marriage, Life, and Death: A Life Cycle Approach for Examining the Deregulated U.S. Airline Industry." Transportation Journal, Vol. 32, No. 1 (Fall 1992), pp. 15-29. Pan Am, Midway, and Braniff are the three "top-fifteen" airlines to cease operations following their analysis. 2 Based on analysis of "U.S. Major Carriers System Traffic" data in Air Transport World, June 1992, p. 136, and May 1994, p. 124. 3 M. E. Porter, Competitive Strategy (New York: The Free Press, 1980). 4 Ibid., pp. 129-130. 5 A. T. Wells, Air Transportation: A Management Perspective. (Belmont, California: Wadsworth, 1994), pp. 166-168. 6 R. Golaszewski and M. Sanders, "Financial Stress in the Airline Industry," Journal of the Transportation Research Forum. Vol. XXXII, No. 2 (1992), pp. 313-320. 7 Transportation Research Board, Winds of Change: Domestic Air Transport Since Deregulation. (Washington D.C.: National Research Council, 1991) pp. 65-79. 8 S. Morrison and C. Winston, The Economic Effects of Airline Deregulation. (Washington, D.C.: The Brookings Institute, 1986), pp. 62-64. This is an example of a model that successfully isolated the impact of newly certified carriers. 9 B. T. Lamont, D. Marlin, and J. J. Hoffman, "Porter's generic strategies, discontinuous environments, and performance: A longitudinal study of changing strategies in the hospital industry." Health Services Research. Vol. 28, No. 5, (Dec 1993) pp. 623-640.

D. F. Jennings and J. R. Lumpkin, "Insights between environmental scanning activities and Porter's generic strategies: An empirical analysis." Journal of Management. Vol. 18, No. 4, (Dec 1992), pp. 791-803. 10 Porter, 1980, pp. 34-46. 11 Computed from data on 1993 RPMs (revenue passenger miles) for major, national, and commuter/regional carriers; Air Transport World, May 1994, 119-126. 12 Reporting regulations require airlines to file detailed reports of finances and operations, and these are summarized in Air Carrier Financial Statistics and Air Carrier Traffic Statistics, U.S. Department of Transportation, Office of Airline Statistics, Washington, D.C. 1992-1994. 13 E. E. Bailey, D. R. Graham, and D. P. Kaplan, Deregulating the Airlines. (Cambridge Mass: the MIT Press, 1985), pp. 51 and 92. 14 B. D. Bowen and D. E. Headley, The Airline Quality Report 1994 (NIAR Report 94-11). National Institute for Aviation Research, Wichita State University, April, 1994. Since deregulation in 1978, the U.S. airline industry has undergone significant and often surprising change. Well-established airlines including Pan Am, Eastern, Western, and Piedmont have disappeared. Other airlines such as People Express and Midway became highly publicized success stories and then took a financial nosedive into oblivion. As documented by Rakowski and Bejou (1992), of the fifteen largest U.S. airline firms in 1985, six didn't make it to 1989, and in the following two years another three ceased operations.(1) In contrast, since 1991, the industry seems to have found at least a temporary equilibrium; the nine largest airlines in 1991 were the same as those that began 1994.(2) While future change in the industry is likely, the comparative stability during recent years provides an opportunity to take a snapshot of the relative competitive positions of the nine major U.S. passenger airlines. Specifically, this article seeks to identify strategic groups within the U.S. airline industry using the well-established competitive strategy model of Michael Porter.(3) According to Porter, a strategic group consists of rival firms with similar competitive approaches and positions within the market.(4) BACKGROUND - AIRLINE INDUSTRY GROUPINGS Identifying strategic groups within an industry is highly desirable from both a qualitative and quantitative perspective. It is easier psychologically to understand the competitive dynamics of an industry if we can identify three or four similar groups rather than having to characterize each firm separately. Furthermore, by dividing the airline industry into meaningful groups, performance and operating statistics can be separated and analyzed more effectively. Informally, we know of U.S. airlines grouped as the "big three" - United, American, and Delta as well as "majors," "nationals," and "regionals" based on government revenue classifications.(5) The so-called "Chapter 11 Carriers" - America West, TWA, and Continental - were in bankruptcy during the early 1990s and have been controlled for in research models and studied separately as a group; an example is the work of Golaszewski and Sanders (1992).(6) The

Transportation Research Board, in its special report Winds of Change (1991), divided the industry into "strong" and "weak" carriers to illuminate financial performance.(7) Researchers in the past have also singled out "new entrant carriers" that have emerged since deregulation and "non-union" firms for distinct treatment in analysis.(8) The size and historical groupings discussed above have proven useful and interesting. To complement these groupings, and for a better understanding of the competitive structure of the industry, it is valuable to classify airlines based on their competitive strategies. This type of identification can shed light on successful market positions and suggest future strategic directions for airline managers to target or avoid. In this article, therefore, we first group the nine major U.S. passenger airlines by competitive strategy, using Porter's typology of generic strategies. We then assess the financial performance of each airline to validate the appropriateness of the initial strategic groupings. Finally, we discuss the implications for competition within the airline industry given its competitive structure. PORTER'S GENERIC STRATEGIES Within any industry, companies seek to gain a competitive advantage that allows them to outperform rivals and achieve above-average profitability. Porter has suggested that the path to competitive advantage is the successful implementation of an internally consistent competitive strategy. Porter identified three "generic" competitive strategies, which have been widely studied.(9) These are cost leadership, differentiation, and focus.(10) Cost Leadership Companies pursuing a strategy of cost leadership seek to outperform rivals by producing goods or services at a lower cost. There are two potential advantages of this strategy. First, due to its lower cost structure, the cost leader can either charge a lower price than competitors and still make the same profit, or charge the same price as competitors and make a higher profit. Second, should price wars develop, the cost leader will be in a better position to withstand price-driven competition. Achieving a low-cost position often requires a high market share so that economies of scale are achieved. Emphasis is placed on reducing costs at every possible point. Hence, it may require designing products or services for ease of manufacture or delivery. Once a low-cost position is achieved, profits must often be reinvested in improved processes and technologies that further reduce costs so that cost leadership can be sustained. Differentiation Companies pursuing differentiation strategies seek competitive advantage by creating products or services that are perceived by customers as being unique and for which buyers are willing to pay a premium price. Successful differentiation provides the company with two primary

advantages that flow from the perceived uniqueness of its products. First, the company is able to charge a higher price for its products or services, often with an accompanying higher margin. Second, customers willing to pay more for a unique product are often more loyal because their purchase decision is based more on perceived quality than on price. Achieving successful differentiation requires clear understanding of customer needs and investments in the capabilities necessary to meet those needs. Typically, achieving differentiation requires a trade-off with cost position, especially if the activities required to create uniqueness - such as market research, quality materials, and customer service - are themselves costly. Focus The focus strategy differs from the other two generic strategies in that it is directed toward serving the needs of a limited customer group or market segment. Companies pursuing focus strategies concentrate on serving a particular market niche, which may be defined geographically, by segment of product line, or by type of customer. Having chosen its "focus," however, the company may choose to compete within its niche either on the basis of low cost or differentiation. It gains competitive advantage by better serving the needs of the chosen segment, whether those needs be lower cost or differentiating quality. The advantages of successful focus strategies derive from the fact that the firm is able to concentrate its efforts. Its ability to better meet the needs of its chosen customers means that it may be able to charge a higher price for its unique products or services. Alternately, it may be able to undercut the cost of the industry-wide cost leader through technologies and processes that are not cost-effective at larger scales (such as the steel foundry technology in use by the new mini-mills). Finally, concentration within a protected niche may buffer the firm from broader competition within the industry as a whole. Stuck in the Middle According to Porter, any firm that fails to develop a viable competitive strategy - whether it be low cost, differentiation, or focus - may be termed "stuck in the middle" with no basis for competitive advantage. Such firms cannot compete on the basis of price because their cost structure is too high. Nor are they able to charge premium prices because they have failed to differentiate their products or services in the minds of potential customers. Nor are they protected by a niche that buffers them from broader industry competition. As a result, firms stuck in the middle are almost guaranteed low profitability and, when there is a shake-out in the industry, they are the first to exit. DATA AND METHODOLOGY As will be explained in more detail at the end of this section, the use of a scatter-plot of airlines' cost and quality positions represents the primary methodology used to identify strategic groups. Given the varied resources and capabilities required to pursue the different generic strategies detailed above, not all firms in a given business environment will compete on the same basis.

Therefore, an analysis of appropriate firm-level data should distinguish between firms opting to pursue low-cost strategies, those pursuing differentiation strategies, and those that might be focusing on particular market segments. By default, firms that are not pursuing one of these strategies will be considered to be lacking in strategic direction, or "stuck in the middle." Data This analysis focuses on the nine major U.S. passenger air carriers during the time period 1991 to 1993. A "major" airline is one having revenues of at least $1 billion annually, and these airlines account for 90 percent of all U.S. passenger traffic.(11) To standardize comparisons, cost, quality, and financial data will cover only the domestic operations of these nine carriers. The evaluation of firms' cost structures is fairly simple because good cost data are readily available for the U.S. airline industry. The statistic "cents per available seat mile (ASM)" is well accepted as a measure of airline costs. This figure takes an airline's operating costs and divides it by the number of seat miles flown; the resulting cost per ASM represents the cost to fly one seat one mile. The source of these data, along with revenue and profitability figures, is the U.S. Department of Transportation.(12) However, cost per ASM is subject to interpretation because costs vary inversely with average flight distance - an established relationship discussed and documented well by Bailey, Graham, and Kaplan (1985).(13) This complication will be addressed after firms' initial cost positions are established. Important in this type of strategic analysis is the definition and measurement of differentiation within an industry. In the airline industry, firms attempt to differentiate themselves through service quality. Fortunately, a validated measure of comparative service quality is available. The Airline Quality Rating (AQR) computed annually by the National Institute for Aviation Research at Wichita State University was established in 1991 as an objective method of comparing quality factors between airlines and across time.(14) The AQR is a weighted average of nineteen factors that have been determined to be important to consumers when they assess airline quality. This measure is predominantly domestic in nature, and includes factors such as on-time performance, safety, frequent flier program assessments, financial stability, age of aircraft, lost baggage rates, and other customer service attributes.(15) A recent survey of airline passengers conducted by Consumer Reports corroborates the general integrity of the AQR; of the nine major airlines, both rankings agree on the best and worst airlines.(16) METHODOLOGY Strategic groups have been identified using a variety of means, from competitor mapping to statistical cluster analysis. We develop our strategic groups using a scatter-plot diagram, the dimensions of which relate to cost and quality. This approach is similar to the competitor mapping described by Porter and is more appropriate than cluster analysis given the relatively few number of companies in the industry.(17) Cost per seat mile will be the X-axis variable with the industry cost average separating low and high cost firms. On the Y-axis, the Airline Quality Rating (AQR) index calculated by the National Institute for Aviation Research is used as the differentiating factor. The scatter-plot will initially divide the industry into four quadrants. The high cost, high quality quadrant will initially identify firms pursuing differentiation. Firms in the

low cost, low quality sector may well be seeking cost leadership. A firm which is able to obtain both low costs and high quality may be following the focus strategy. Firms in the high cost, low quality quadrant will likely be without a clear strategy, or "stuck in the middle."
Table 1. Domestic Sector Financial and Operating Data for U.S. Major Airlines, 1993 Overall Quality Length Airline Revenue Rating (AQR) Cost/ASM of Haul American $10.8 bil. .231 8.89 cents 848 mi. Delta 9.7 .076 9.32 627 United 8.8 .176 8.88 835 USAir 6.4 -.003 11.56 621 Northwest 4.9 -.247 8.85 703 Continental 4.1 -.336 8.40 779 TWA 2.3 -.286 9.50 692 Southwest 2.1 .252 7.16 376 America West 1.3 -.294 7.03 642 Average $5.6 bil. -.048 8.84 680 Sources: Cols. 1,3,4: U.S. Department of Transportation, Air Carrier Financial and Traffic Statistics Summaries, Office of Airline Statistics. Col. 2: The Airline Quality Report 1994, National Institute for Aviation Research. The AQR includes nineteen weighted rating factors including on-time performance, safety, age of aircraft, frequent flyer plans, and various other customer service variables. For more information on the AQR measure the reader should see endnotes #14 and #15.

After firms are placed in one of these four quadrants, some interpretation may be necessary to confirm them as strategic groups. Ideally, firms in a strategic group will have their quality/cost plots close together. Also, a careful look at each airline's flight stage length will be necessary to establish that firms with widely divergent flight lengths are not misidentified as having similar cost positions. Once strategic groups are established, profitability data will be used to confirm that this is an appropriate application of the Porter model. Specifically, those airlines identified as pursuing one of the three generic strategies will be compared as a group to those that are "stuck in the middle." The profitability of this latter group should be significantly lower than the group of airlines identified as pursuing a strategy within the Porter model. RESULTS: IDENTIFICATION OF STRATEGIC GROUPS The scatter diagram of airlines' relative cost and quality differentiation positions is found in Figure 1. While further interpretation is necessary, the resultant scatter plot reveals that groups can be identified that are largely consistent with the prescriptions of the Porter model. Before discussing the makeup of these groups, it is important to analyze each airline's average flight length in order to determine the accuracy of the groupings found in the scatter plot analysis. Airlines with below average flight distances have a better cost position than the scatter plot may indicate. Therefore, Southwest, Delta, USAir, and America West's competitive

positions should be shifted horizontally to the left somewhat to better reflect their relative standings. On the other hand, American, United, Continental, and Northwest should see a rightward shift to compensate for their above average flight distances. TWA, near the industry average for flight length, would remain essentially in place. While the degrees of these shifts cannot be precisely determined, it is a function of the relative deviation between each carrier's flight distance and the industry mean. The impact of this analysis would bring Delta closer to American and United on a cost basis, solidifying the big three as an obvious strategic cluster of high quality, but above average cost firms. Likewise, in the high cost, low quality quadrant, USAir and Northwest would both move towards TWA, thus solidifying this grouping. Due to their shorter flight distance, America West and Southwest would move leftward into even better relative cost positions. Only Continental's position is left in doubt; with its flights averaging 100 miles above the industry average, its costs would appear to be much closer to the industry average than the original scatter plot indicates. Groupings 1. Quality Differentiation Group: American, United, and Delta From Figure 1, Quadrant I, American, United, and Delta can be identified as firms pursuing differentiation based on service quality. Excluding the much smaller Southwest for the moment, these big three airlines have higher AQR scores than the rest of the industry. Consistent with Porter's contention that cost leadership and differentiation are largely incompatible, these three also have higher costs - individually and on average - than the industry average and firms in lowcost quadrants. These findings reflect the costs associated with the big three's approach to quality differentiation. They all provide significant amenities beyond basic flight service, and have invested heavily in the development of expansive domestic and international operations to differentiate themselves in the minds of flyers by presenting themselves as the "we fly anywhere you want to go" carriers. 2. Cost Leadership: America West From Quadrants III and IV, three firms appear to be pursuing low-cost strategies: Southwest, America West, and Continental. Consistent with Porter, Continental and America West's quality ratings are commensurately low, while Southwest's very high quality ratings demand further examination. Southwest's position does not seem to be compatible with a pure cost leadership strategy, and alternative explanations will be addressed shortly. Continental, with above average flight lengths leaving its costs close to average, is apparently not very successful at accomplishing the low-cost position it seeks. Firms which unsuccessfully pursue a strategy are considered "stuck in the middle" in the Porter model, and this seems to be a fair classification for Continental. Within the standard Porter framework, America West can be identified as successfully pursuing a classic low-cost position. 3. Focus: Southwest There are two possible explanations for Southwest's position in Quadrant IV. The first is that Southwest has adopted a focus strategy, the third of Porter's three generic strategies. Porter

describes the focus strategy as one where a firm focuses on a given market segment and within that segment may have a low-cost position, be highly differentiated, or obtain both.(18) Southwest, unlike other airlines, does not use a hub and spoke system, and focuses on short, high-density routes. Traditionally, Southwest has been one of the smallest U.S. major airlines and has concentrated its route structure in the Southwestern U.S.; this would support the argument that it is pursuing a focus strategy. Alternately, we could argue that the Porter model does not appropriately account for firms like Southwest that achieve both low costs and positive differentiation. Southwest can no longer be considered a small niche player in the industry; in the first half of 1994 they carried more domestic passengers than Continental or Northwest, and twice as many as TWA.(19) Furthermore, this airline now serves such northern destinations as Cleveland, Columbus, Detroit, and Baltimore, and it has a major flight center in Chicago. In its recent rapid growth, it may be that Southwest is moving out of its historical focus position, and this has implications that will be discussed in a later part of the article. For the current analysis and time period, Southwest's enviable position in Quadrant IV can best be described within the Porter model as evidence of a focus strategy. Stuck in the Middle Group: TWA, NWA, USAir, and Continental Quadrant II firms TWA, Northwest, and USAir are "stuck in the middle." All three suffer from costs that are above and quality ratings that are below industry averages. Continental can be added to the group if we consider its below average cost position as overstated as discussed earlier. These firms may have ended up in this undesirable position for different reasons, but they all can be classified as firms that have failed to achieve one of the three generic strategies as outlined by Porter. For example, USAir's quality rating is close to the industry average, but its costs are the highest in the industry. From this it can be inferred that USAir has pursued - but failed to achieve - a quality differentiated position. Conversely, Continental has clearly attempted a low-cost strategy, but has not obtained a cost leadership position. The positions of TWA and Northwest suggest that they are truly stuck in the middle; their strategic direction with respect to cost and differentiation is ambiguous. Validation of Results The Porter model and previous industry studies strongly suggest that firms which pursue one of the three generic strategies will have superior financial performance compared to those "stuck in the middle." Using profitability data from 1991 to 1993, as found in Table 2, we can test the validity of our strategic group identifications. The five airlines identified as pursuing one of the three generic strategies had an average 1.39 percent operating profit margin between 1991 and 1993, while the four "stuck in the middle" firms had an operating margin equal to -3.57 percent. While neither group appears particularly successful, one must keep in mind the difficult airline environment in 1991 and 1992 due to the Gulf War and recession. Using a small sample difference of means test, the 4.96 percent spread between the two groups produced a T-statistic of 2.42, significant at the 0.25 level. Therefore, the five airlines following one of Porter's three generic strategies had statistically significant better returns than those "stuck in the middle" firms, as would be expected.

On an individual airline basis, the use of the [TABULAR DATA FOR TABLE 2 OMITTED] scatter diagram and strategic groups generated from the Porter model provides useful, predictable information. The one exception appears to be Northwest, whose positive operating margin for 1991-93 stands in sharp contrast to the other three "stuck in the middle" airlines. Other than Northwest, all of the airlines following one of the three generic strategies had better operating margins than all of the "stuck in the middle" firms. It is also interesting to note that the industry roughly follows the concept of a U-shaped relationship between size and financial returns described by Porter.(20) In other words, large and small firms appear to have superior performance. The low-performing "stuck in the middle" group represents the 4th, 5th, 6th, and 7th largest firms among the nine major airlines. Contrary to Porter's expectations, it is the smallest firms that have the lowest costs and the largest firms that are able to differentiate themselves. CONCLUSIONS AND IMPLICATIONS This article successfully identified strategic groups among the nine major U.S. passenger airlines utilizing the framework of Michael Porter's generic strategy typology. Standardized cost data and the use of the National Institute for Aviation Research allowed strategic groups to be accurately determined through the use of a cost/quality differentiation scatter-plot diagram. Profitability analysis largely validated the use of the Porter model to identify strategic groups in the U.S. airline industry. Five airlines appear to be successfully following one of the three generic strategies and therefore enjoy better competitive positions in the industry and superior profitability. American, Delta, and United are clustered as one group of quality differentiated airlines with costs somewhat above the industry average. It is reasonable to conclude that this is a valuable position in the airline industry, but intense competition among the three may dampen financial returns. The fact that three large and powerful airlines dominate this position would strongly imply that attempts by other carriers to stake out a high cost, high quality position would be very difficult. Southwest, which has always concentrated on short, high density routes, is identified as historically pursuing a focus strategy. As Southwest grows and finds itself in increasing competition with other airlines, its challenge will be to maintain its enviable low cost, high quality position. Higher customer expectations may accompany longer routes, and growth may create operational changes. If Southwest loses its focus strategy, it could easily forfeit its quality differentiation and end up with a traditional low cost strategy. Currently, the low cost position belongs to America West. The favorable strategic positions of these five airlines would suggest that they are in the best position to survive and prosper as the year 2000 approaches. A group of three airlines is clearly identified as lacking in strategic focus and suffers back-ofthe-pack financial performance. TWA and USAir have both failed to establish themselves as either high quality or low cost firms. They continue to suffer serious financial problems as a result, and are probably in the poorest competitive position to survive the 1990s. Furthermore, in what direction should they move? To shift in the quality direction would entail challenging the "big three," but cost leadership does not seem to be a realistic goal either. The third carrier with an obviously poor strategic position is Continental, and it too continues to suffer financially. Its

attempt to become a Southwest style low-cost, no-frills airline faltered during 1994.(21) In order to regain profitability, all of these carriers might consider downsizing and focusing on particular market segments that match their strengths. Northwest is the one carrier whose strategic situation is not adequately explained in this Porter model analysis. Although part of the "stuck in the middle" group, its financial performance is considerably above that of the other three firms in this group. If we maintain that our model and data are valid, then the only reasonable explanation for Northwest's good profit performance is that it is focusing on a market segment that shields it from the severe price and service competition that impacts the industry as a whole. Northwest does focus geographically in the north-central U.S., and this region has not yet seen the intense price competition characterized by Southwest Airlines in the West, CalLite in the East, or Valujet out of Atlanta. Unless Northwest holds some type of barrier to entry against this type of firm in its region, which we do not believe it does, it is likely only a matter of time before its "stuck in the middle" strategic position catches up with it. ENDNOTES 1 J.P. Rakowski and David Bejou, "Birth, Marriage, Life, and Death: A Life Cycle Approach for Examining the Deregulated U.S. Airline Industry." Transportation Journal, Vol. 32, No. 1 (Fall 1992), pp. 15-29. Pan Am, Midway, and Braniff are the three "top-fifteen" airlines to cease operations following their analysis. 2 Based on analysis of "U.S. Major Carriers System Traffic" data in Air Transport World, June 1992, p. 136, and May 1994, p. 124. 3 M. E. Porter, Competitive Strategy (New York: The Free Press, 1980). 4 Ibid., pp. 129-130. 5 A. T. Wells, Air Transportation: A Management Perspective. (Belmont, California: Wadsworth, 1994), pp. 166-168. 6 R. Golaszewski and M. Sanders, "Financial Stress in the Airline Industry," Journal of the Transportation Research Forum. Vol. XXXII, No. 2 (1992), pp. 313-320. 7 Transportation Research Board, Winds of Change: Domestic Air Transport Since Deregulation. (Washington D.C.: National Research Council, 1991) pp. 65-79. 8 S. Morrison and C. Winston, The Economic Effects of Airline Deregulation. (Washington, D.C.: The Brookings Institute, 1986), pp. 62-64. This is an example of a model that successfully isolated the impact of newly certified carriers. 9 B. T. Lamont, D. Marlin, and J. J. Hoffman, "Porter's generic strategies, discontinuous environments, and performance: A longitudinal study of changing strategies in the hospital industry." Health Services Research. Vol. 28, No. 5, (Dec 1993) pp. 623-640.

D. F. Jennings and J. R. Lumpkin, "Insights between environmental scanning activities and Porter's generic strategies: An empirical analysis." Journal of Management. Vol. 18, No. 4, (Dec 1992), pp. 791-803. 10 Porter, 1980, pp. 34-46. 11 Computed from data on 1993 RPMs (revenue passenger miles) for major, national, and commuter/regional carriers; Air Transport World, May 1994, 119-126. 12 Reporting regulations require airlines to file detailed reports of finances and operations, and these are summarized in Air Carrier Financial Statistics and Air Carrier Traffic Statistics, U.S. Department of Transportation, Office of Airline Statistics, Washington, D.C. 1992-1994. 13 E. E. Bailey, D. R. Graham, and D. P. Kaplan, Deregulating the Airlines. (Cambridge Mass: the MIT Press, 1985), pp. 51 and 92. 14 B. D. Bowen and D. E. Headley, The Airline Quality Report 1994 (NIAR Report 94-11). National Institute for Aviation Research, Wichita State University, April, 1994. 15 The nineteen factors in the AQR are as follows, listed from most to least important based on their respective weightings: 1) On-Time Performance, 2) Number of Accidents, 3) Flight Problems,* 4)Denied Boardings,* 5) Pilot Deviations,* 6) Mishandled Baggage,* 7) Fares,* 8) Frequent Flier Awards, 9) Other Complaints,* 10) Refunds,* 11) Customer Service,* 12) Ticketing/Boarding,* 13) Load Factor, 14) Advertising,* 15) Financial Stability, 16) Credit,* 17) Average Age of Aircraft, 18) Number of Aircraft, 19) Average Seat-Mile Cost. *Denotes an item based on consumer complaints to the D.O.T. as reported in its "Air Travel Consumer Report." For more information, interested readers should see pages 1-5 of the Airline Quality Report 1994. 16 "The Best Airlines." Consumer Reports. June 1995, pp. 381-388. 17 The study of strategic groups is a major stream in strategy research. However, the quantitative derivation of strategic groups has received criticism (e.g., J. Barney, "Strategic Groups: Untested Assertions and Research Proposals," Managerial & Decision Economics. Vol. 11, No. 3 [July 1990], pp. 187-198). Our approach seeks to confirm the existence of theoretical groups rather than find and label statistically derived groups. Importantly, using competitor mapping to identify strategic groups has precedent (e.g., Patrick McNamee & Marie McHugh, "Mapping Competitive Groups in the Clothing Industry," Long Range Planning. Vol. 22, No. 5, [Oct 1989], pp. 89-97). 18 Porter, p. 39. 19 Air Transport World, "U.S. Major Carriers" (Data Table) November, 1994, p. 136. 20 Porter, p. 43.

21 W. Zellner, "Why Continental's CEO fell to Earth." Business Week, November 7, 1994, p. 32. Mr. Kling is assistant professor of transportation and logistics, Niagara University, Niagara University, New York 14109; Mr. Smith is assistant professor of strategy, Syracuse University, Syracuse, New York 13244-2130.