For a student, a grade of 65 percent is nothing to write home about. But for the

Question

For a student, a grade of 65 percent is nothing to write home about. But for the airline . . . [industry], filling 65 percent of the seats . . . is the difference between profit and loss. The [economy] might be just strong enough to sustain all the carriers on a cash basis, but not strong enough to bring any significant profitability to the industry . . . For the airlines . . . , the emphasis will be on trying to consolidate routes and raise ticket prices. . ."

The airline industry is notorious for boom and bust cycles. Why is airline profitability very sensitive to these cycles? Do you think that during a down cycle the strategy to consolidate routes and raise ticket prices is reasonable? What would make this strategy succeed or fail? Why?

Explanation / Answer

The airline profitibility very sensitive because airlines commit large sums to equipment to create capacity for flights. The mix of customers, business people and leisure travelers, will fly less during the bust portion of the business cycle. Those planes still have to fly, and the plane must have the same size flight crew and maintenance schedules.

Airlines try to take steps when passenger volume is down, but they are often committed to their cost structure by Federal regulation, agreements with the airports and unions, etc. Having committed to so many costs, airlines have to find ways to generate more revenue per flight.

That is one strategy, but airline travel is homogeneous; a trip on one carrier is almost indistinguishable from another. The strategy is reasonable if carriers commitments to airports (flight volume commitments in their leases), unions (employee layoffs to serve less flights) and vendors (fuel purchase commitments) can be reduced with less flights, and other carriers match prices.

Discounted pricing has been tried, but other carriers would follow suit to pursue customers, who had access to competing pricing and could choose based on price. Price increases and flight consolidations are often followed by other carriers. Since there is no brand loyalty (special note to airlines' frequent flyer clubs), unless all carriers follow suit, the strategy won't succeed. Carriers with different cost structures (non-union carriers like Southwest) can respond to pricing stresses differently. By committing to lower costs across the board, but running more efficiently, they pose problems for traditional carriers who are pressured to raise prices in bust periods.

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