Delta gets another lesson in the cost of competition in commodity markets. In a story titled “Delta Airlines Bought an Oil Refinery. It Didn’t Go as Planned“, published on Monday, August 10, 2020 by the New York Times, Clifford Kraus and Niraj Choksi recount the history of Delta’s entry into the oil refining business through the acquisition of Monroe Energy back in 2012. Kraus and Choksi depict Delta’s experience over the last 8 years as something only marginally profitable.
But are they missing something? Does it make sense to assume Delta purchased this oil refinery to make money in the fuel distribution business? Or does it make more sense to conclude Delta bought the refinery to lower its own cost of goods sold (COGS). Business management best practices for operators in commodity markets like airline travel include making every effort to lower COGS. Therefore, products like branded credit cards exist to help airlines cut out the financing middlemen (banks) and thereby shave 3pts or more off the cost of selling an airline ticket purchase.
The same goes for sourcing jet fuel. Planes can’t fly without fuel. Buying Monroe Energy provided Delta with an opportunity to pocket $4.142 per gallon of jet fuel back in February of 2014 (data obtained from the U.S. Energy Adminstration website). The savings Delta captured by refining its own jet fuel combined with the lower costs of selling airline tickets bought with Delta branded credit cards add perhaps as much as 10% margin pre COVID-19. But in 2020 with the COVID-19 pandemic throwing a gut punch to the travel business owning an oil refinery makes little sense for Delta.
Too bad business schools fail to note there is often a time limit on the usefulness of buying something otherwise unrelated to your core business to lower COGS. They should also note successful businesses selling commodities more often than not find a way to differentiate themselves from competitors. Enhanced margins can and do evaporate when the fundamentals supporting commodity markets change as is the case in 2020. Therefore, the better way to allocate resources is to convince consumers a trip on Delta is a wholly different experience from a trip on American or United or even Lufthansa.
Seen from the perspective of competition in commodity markets Kraus and Choksi’s story for today’s Times would be a lot more useful if it reframed the history of Delta’s purchase of Monroe Engineer as I have attempted to do, above.
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