To a large degree, recent airline woes are plain bad luck and bad timing. For years airlines have operated with an overburdened infrastructure. But stringent FAA inspections kicked in just as oil prices soared to record highs (fuel costs airlines as much as labor does these days), and as the mortgage crisis hit, the economy tumbled into a recession. A perfect storm.
Similar shakeouts took place in 2001 as the economy slowed after the dot-com boom, triggering layoffs, bankruptcies and aircraft fire sales. Airlines are acutely sensitive to economic downturns. Many consumers and businesses eliminate air travel when times are hard, yet airlines cannot shed costs quickly enough to keep pace because they have large capital commitments and fixed costs, such as airplanes, labor contracts, gate space and landing slots. The result: an inherently boom-and-bust industry.
In hard times, airlines do all they can to survive. Some file for bankruptcy protection; others restructure and merge. Mergers, like Delta and Northwest’s, can create more routes for customers, feed traffic into airlines’ hubs and spread overhead costs. But it’s a gamble. As Continental’s recent rejection of a merger deal with United shows, no clear consensus exists on whether consolidation will ultimately help reduce costs and increase profits. Continental is scaling back where it can, and it recently announced groundings of domestic flights and told staff to expect layoffs. Long term, it is betting that international diversification will offset a weakening U.S. economy and dollar-denominated oil.
Paradoxically, these woes can be viewed as beneficial. Lower fares (at least by historical standards), packed planes, airlines racing to offer new routes and services — all of these reflect fierce, efficiency-wringing competition.
In a sense, travelers are getting exactly what they want: cheap, basic service, judging by how they vote with their wallets. Bob Crandall, former CEO at American Airlines, once said whenever American offered customers more legroom for an additional $5, it lost out to competitors over price.
Another by-product of a competitive industry is innovation. Bad business models fail and are replaced by new ones. Entrepreneurs continually strive to reinvent the industry. Take Eos Airlines. It thought a market existed for an all-business-class service to Europe with seats that recline to fully flat beds, champagne and gourmet meals. A novel idea, but one that Eos’s recent bankruptcy proved wasn’t viable.
On-demand air-taxi service is another notable high-end trend. Small regional jets are relatively cheap to operate, fly out of less congested regional airports and have sufficient range to compete with mainline carriers. The service is targeted at business people who want to avoid the hassles of commercial-airline travel. Good idea? Bob Crandall thinks so; he is leading a new venture called POGO to provide exactly this kind of service, which starts in 2009. Time will tell if he’s right.
As the industry absorbs shocks and innovates, disruption follows. Cost cutting brings pain, and rapid change triggers a sense of chaos. Yes, flying today is often miserable and airlines have trimmed services, but the fine-tuning has its benefits. While air travel was more glamorous in the past, it was also prohibitively expensive and available in only a limited number of cities. Now consumers can fly almost anywhere at a relatively low cost.
The question is: How much austerity and disarray will customers tolerate before they stop flying? If flying becomes so frustrating that customers prefer to stay put or drive, the industry will have real worries.
Garrett van Ryzin is the Paul M. Montrone Professor of Private Enterprise in the Decision, Risk and Operations Division at Columbia Business School.
An earlier version of this piece originally appeared on Public Offering, the Columbia Business School blog. To comment on this piece or read other posts, visit Public Offering.
