Dinosaurs Fight Back - Futilely?
The world has changed
since the glory days of aviation. But the major
airlines - those that remain - have been slow to respond to
it now too late for them to provide modern competitive
solutions for today's flying public?
The market dominance of the
major traditional airlines is no longer guaranteed.
New low cost competitors not
only offer lower fares, but also, in many cases, better service.
And with massively lower operating costs, these new airlines can
withstand the price slashing tactics the major airlines have
used in the past to bully small airline startups out of
The traditional response of
major airlines to new startups - to slash prices and increase
flights on competitive routes - may, this time, do more harm
than good to the dinosaur airlines.
Strengthening business means
time to fight back
An interesting thing is
happening at present. The dinosaurs, all of which cut back
massively on their flights post 9/11, are now awakening from
their slumbers, feeling the resurgence of revenues flowing
through their veins as business conditions improve and air
travel numbers pick up. They are turning their attention to
combating the growth of competing lower cost carriers (LCCs)
that occurred while the dinosaurs were desperately pre-occupied
with simply struggling to survive.
You can't teach an old
dinosaur new tricks, and so, in the largest part, their response
is the same well worn response that used to work so well. They
simply flood any route on which a lower cost carrier has dared
to start service with plenty more of their dinosaur flights, and
match the LCC's fares.
This was formerly
successful, when one dinosaur would be battling only one LCC at
a time, and on a small portion of a generally profitable route
system. While the new upstart was being bled dry, the dinosaur
was suffering only a relative pinprick, on a small part of their
system. Eventually, the new carrier would be killed off, and
then the dinosaur would cut back flights and return fares to
their previous high levels.
Old tactics no longer valid
This tactic may not work
this time, because the dinosaurs are finding not just one new
upstart carrier, but a whole bunch of them, and covering not
just one or two competing routes, but 70% of their entire route
system. And, the LCCs aren't underfunded new startups, but are
well funded and already established profitable operations. One
more point of difference. The LCCs are indeed that - lower cost
carriers. The lowest operating cost of the new airlines is
enjoyed by JetBlue with a 5.9¢ a mile cost, compared to the
dinosaurs - for example, American Airlines with a cost of 9.5¢ a
This huge cost differential
enables the LCC's to operate routes with low fares and still
make a profit, but when the major airlines attempt to match or
drive the fares down further, the LCCs remain profitable long
past the point where the dinosaurs are hemorrhaging money. A
dinosaur has to sell a flight for almost 50% more than a LCC to
earn the same level of profit.
How much extra would you pay to fly on, eg, Delta or United,
compared to flying on eg JetBlue or AirTran? Few of us would pay
even a single penny more, and surely no-one would pay 50% more.
Astonishingly, for the
longest time, the dinosaurs pretended to anyone who would listen
they could charge 30% or more than the fares offered by LCCs and
that the traveling public would gladly pay this extra cost for
the benefit of the 'full service' airline with an extensive
Dinosaurs shooting themselves
in the foot
This is now being proven
incorrect, and the dinosaurs' attempts to squeeze out the new
LCCs seem to be harming the dinosaurs more than their
competitors. Partially as a result, several market analysts are
now lowering their forecasts for the 2004 profit of major
airlines, notably Credit Suisse First Boston, who this week
revised their earlier projection for AA of a slim profit of $120
million to a loss of $316 million for 2004. UBS revised their
estimate down from a $166 million profit to a $190 million loss,
also this week.
The lower yields caused by
the impact of LCCs and the dinosaur response represented 60% of
CSFB's changed projection, the other 40% being due to the
steadily increasing cost of jet fuel. The LCCs seem here to
stay, and so too do much higher fuel costs.
What can the major airlines do
What can the major airlines
do? They have allowed their costs to escalate beyond any
sustainable level of good sense, while degrading their product
so that it is perceived by passengers as a generic product best
selected on price alone. Add into this ugly reality the
surprising fact that many times the LCCs actually offer a
superior product, at a lower price and with a lower underlying
cost, and it is difficult to see how the dinosaurs can survive.
The predicament of the
dinosaurs is totally self-made. In this article, after
accurately explaining that thrift was never essential to the big
airlines, which covered costs by raising ticket prices, new AA
CEO Gerard Arpey explains
It wasn't because we were
stupid. That kind of thinking just drove us in the 1980's
That kind of thinking (ie
'cost plus') probably existed long before then, and if not
stupid, was certainly venal. Such thinking is a hold over from
the earlier days of regulated airlines and air fares.
Shame on the dinosaurs for
being slow to respond to the new opportunities and challenges
offered by deregulation. Their passive non-response not only
drove our fares way high, but also now imperil their existence,
the livelihoods of present employees and the pensions of former
These criticisms should not
exempt the labor forces of the dinosaur carriers, but who
deserves the greater share of blame - a pilot for demanding
$300,000 a year plus massive benefits to fly planes for less
than half normal working hours, or the airlines for acceding to
The dinosaurs have two
things in their favor. Size and time. Their size remains such
that they still dominate the aviation marketplace, and have
genuine opportunities to use their size (eg international
routes, partnerships with other airlines, etc) to translate into
true travel benefits for customers and economy of scale savings
As for time, part of the LCC
advantage is that they typically are recently formed companies,
flying nearly new planes, and with relatively junior and still
freshly enthusiastic work forces. Their planes will never have
the same low cost as they currently offer (especially the ones
still under warranty), and as their staff become more senior and
- potentially - disillusioned and avaricious - there is a danger
that both their operating and labor costs might increase closer
to those of the dinosaurs.
The airline industry - an
In a 2002 interview,
Warren Buffett famously said, in reply to the question 'Do
you still regard USAir as your worst investment?'
I made the comment that
if a capitalist had been present at Kittyhawk back in the
early 1900s, he should have shot Orville Wright. He would
have saved his progeny money.
But seriously, the
airline business has been extraordinary. It has eaten up
capital over the past century like almost no other business
because people seem to keep coming back to it and putting
fresh money in.
You've got huge fixed
costs, you've got strong labor unions and you've got
commodity pricing. That is not a great recipe for success.
I have an 800 number now
that I call if I get the urge to buy an airline stock. I
call at two in the morning and I say: "My name is Warren and
I'm an aeroholic." And then they talk me down.
For those of us who have the
choice, we might be well advised to do as he says.
We, the traveling public, may
finally be the winners
In the past, 'airline
competition' has primarily meant a cozy style of
'non-competition' between dinosaur airlines, all offering very
similar services on similar airplanes and at similar prices.
Occasionally a startup
carrier would appear on some routes, and those major airlines
that felt their routes threatened by the startup would slash
their fares and add flights in an attempt to squeeze the new
startup out of the market.
The general public was
usually euphoric about this, seeing airfares halve and flights
double. But this was, sadly, always a short term blip, and
as soon as the major carrier had successfully killed off its new
competitor, flights would reduce and airfares would increase
But now, it seems that many
of the low cost carriers have enough diversity of routes,
financial strength, and low underlying costs, as to be able to
withstand such tactics, meaning that lowered fares - and truly
competing airlines - might just possibly be here to stay.
Your best strategy to ensure
this is so? Reward good behavior. Whenever you have
a convenient choice, buy your travel on the new low cost
airlines like AirTran, Spirit, JetBlue, America West and
Southwest. Help keep them and their low fares in business.
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26 Mar 2004, last update
28 Nov 2012
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