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May 07, 2008

Flying the Frenzied Skies

Garrett van Ryzin
Paul M. Montrone Professor of Private Enterprise
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Flight cancellations, delays, inspection fiascos, mergers, bankruptcies. And now a second bag tax? What’s going on with the airline industry?

In part, it’s bad luck and bad timing. Airlines operated with an overburdened infrastructure to begin with, and then FAA inspections surfaced precisely as oil prices soared to record highs and the economy teetered into a housing-led recession. A perfect storm.

In 2001 there were similar shakeouts as the industry came down from a boom cycle fueled by the dot-com era, when airlines had to fire people, go into bankruptcy and jettison aircraft. Airlines are very sensitive to economic downturns. Many consumers and businesses eliminate air travel when times are hard, yet airlines cannot shed costs as quickly to keep pace because they have large commitments of capital and fixed costs such as airplanes, labor contracts, gate space and landing slots.

In hard times, airlines do what they can to survive. Some file for bankruptcy protection; others restructure and merge. Mergers, like Delta and Northwest’s, can help airlines offer more routes to customers, feed traffic into their hubs and spread overhead costs. But it’s a gamble. Continental’s recent rejection of a merger deal with United shows that industry consensus on whether or not consolidation will ultimately help reduce costs and increase profits is far from clear. Continental, for one, is betting that its international diversification will allow it to endure a weakening U.S. economy and dollar-denominated oil.

Perversely perhaps, these woes can also be viewed as a good thing. Low prices, crowded planes and gates, airlines scrambling over each other to offer new routes and services — all of these are signs of a starkly competitive industry.

In a certain way travelers have gotten what they’ve asked for too. Bob Crandall, former CEO at American Airlines, once said that every time American experimented with giving people more room on the plane and charging $5 more, they would lose out to competitors over price. Cheap, basic service is what most air travelers seem to want, judging by how they vote with their wallets.

Another byproduct of a competitive industry is that there is a lot of innovation and change. Bad business models fail and are replaced by new ones. There is no shortage of entrepreneurs trying to reinvent the industry. Eos Airlines thought there was a market for an all-business class service to Europe with fully flat bed seats, champagne and gourmet meals. An interesting idea, seemingly, but their recent bankruptcy proved it wasn’t viable.

One interesting trend happening on the high end right now is on-demand air taxi service provided by small regional jets that are relatively cheap to operate, fly out of less-congested regional airports and have sufficient range to compete with mainline carriers. They are 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. Time will tell if he’s right.

As the industry continues to absorb shocks and innovate, it’s obviously disrupting the lives of employees and travelers alike. Sure, air travel was more glamorous in years past, but it was also extremely expensive and only available to a limited number of cities. Now people can fly anywhere for relatively little. Yet air travel can be miserable and crowded; airlines have cut back on services. Cost cutting produces hardships, and rapid change can feel a lot like chaos.

The question is: how much will you tolerate before you stop flying? If it reaches the point where we all opt to stay home or drive rather than fly, then the airline industry will really have something to worry about.


by Chris | May 08, 2008 at 12:12 PM

The plural of aircraft is aircraft. Hope that helps. Nice article! Chris

by Jill Stoddard | May 08, 2008 at 3:11 PM

Hi Chris -- Thanks, we made the correction.

by George Arkedis | October 01, 2008 at 6:04 AM

Read Mr. van Ryzin comments on the airline industry. The industry is more bust than boom and the author would do well to suggest how to fix it as most are aware of how miserable flying is these days. We older flyers remember the good old days when flying was a pleasurable experience, fewer passengers, more profits for the airlines, and higher prices as they were controlled. I remember the advice long ago by an executive in railroad business who told me that one could make money moving freight but never passengers. The answer is, of course, higher prices and fewer customers as the diseconomies of scale have taken over. Do governments or IATA take over? This is clearly a case, unfortunately, where the free market doesn't work.

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