Friday, December 10, 2004

Airline Economics I - Going Broke Flying Full

Have you been on an airliner lately? I don't care which airline, but did you notice that it was pretty full? Even on the airlines that are in bankruptcy the airplanes seem to be full. With full airplanes, how can the industry be swimming in an ocean of red ink?

Now, have you noticed what airlines are charging to take you thousands of miles in relative safety and efficiency? (Yes, Virginia, flying is safer than driving...A lot safer). The airplanes are mostly new employing state of the art technology and the airports and terminals for the most part are new or being remodeled and improved.

The answer on a per mile basis is almost nothing. Flying is dirt cheap. For short haul flying, it can easily cost more to park for a few days than a ticket to a nearby city.

Why?

Competition and the vagaries of the airline business. You see, airlines have virtually the most perishable product possible. If Safeway doesn't sell a bunch of bananas today, they can sell them tomorrow and maybe the day after until they show brown spots. An airline seat is completely lost revenue as soon as the airplane pushes back from the gate. The marginal cost of producing that seat is near zero as the airplane, fuel, crew, and ground facilities are all already paid for whether that seat is filled or not. Therefore, any revenue at all which can be made from filling that seat is gravy on top of fixed costs. That means that if the airline can sell the seat for $20.00 just before pushback, that's $20.00 of revenue with almost no additional cost.

That, then is the reason that airlines have incentives to undercut each other to fill otherwise empty seats. Unfortunately, they tend to collectively bring too many seats to market and can't make any money while fighting each other in a race to the bottom. Hence low prices, full airplanes, and broke airlines

Why do they do this? That will be the subject of a future post.


3 comments:

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  3. Actually, there is some new thinking around "marginal" passengers. The thought experiment is something like this:

    "You have filled half the seats with paying customers, but are just one more customer shy of break-even. Only marginal revenue customers remain wanting to board. Question: how many additional passengers would you need to take on to break-even as a percentage of the remaining seats?"

    More provincial thinking says 100% - anyone who wants to get on get on! In actuality, you are adding some "marginal" revenue, but your adding additional fuel burn, weight, baggage, boarding delay, etc. Plus, you must consider the flow versus local revenue. The half-plane of paying customers might be taking a connecting high-yield trip internationally. The marginal revenue customer will just clog up the system so to speak.

    Anyway, there is a lot of thinking around this, and people continue to debate. Imagine the same scenario now at Delta, Northwest, and United? If you're bankrupt, how many marginal customers do you enplane? The answer may not, be a straightforward as you think.

    ReplyDelete

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Capt Rob