COMMERCIAL AIRLINESJames Lannon

Jacqueline EganJames Keady

INTRODUCTION

Introduction

Introduction

INDUSTRY STRUCTURE

Background

Industry: Travel Product:

Transportation to and from Destination

Customers: Those with disposable income and need/desire for extensive travel

Distribution: Varying levels

Background

Organization

Competitive Marketplace Consumer Good Extensive buyers and sellers Perfect Information Homogeneous product

Costs are reflected in the product price

Organization

Competition

Airline Deregulation Act October 24, 1978 Removed gov’t controls 1973 Oil Crisis and stagflation- Congress feared

a repeat of the Railroads Penn Central Railroad had just collapsed in the largest

Bankruptcy in history Deregulation has created a more competitive

marketplace

Competition

Competition

Major Companies

American AirlinesWe know why you fly.

Founded 1930 Revenue: $22.7 Billion 5th largest airline in

world Bankruptcy

Major Companies

United AirlinesLet’s Fly Together

Founded1926 Revenue: $37.1 Billion One of world’s largest

airlines with 2nd largest fleet- 703 planes

Merger with Continental

Major Companies

Southwest AirlinesA Symbol of Freedom

Founded 1967 “Low Cost” Airline Revenue: $15.7

Billion Largest US airline

with fleet of 708 planes

PRICING STRATEGIES AIRLINE INDUSTRY

Pricing Strategies

2nd Degree 3rd Degree Bundling & Tying Predatory Pricing

2nd Degree Price Discrimination

Price Dispersion Variation in prices for the same item

Versioning Variations of a product or service at different

prices to different groups of customers First Class vs. Coach seating

Price Dispersion

Increases with competition Increases with variation in the population Decreases with homogeneity of the

market Increases when there are more differing

product attributes A firms responsiveness to price dispersion

decreases when their market share increases

Price Dispersion

The expected difference in fares paid is 36%

Airlines likely to have 20 or more different fares on one given flight

3rd Degree Price Discrimination

Dynamic Pricing Time-based pricingAdvanced Booking High valuation vs. Low valuationCapacity Constraints Optimal Allocation

Dynamic Pricing

Peak-Load Pricing Different demands for the same good

during different periods of the day, month, or year

Congested times vs. Off-peak times Reflects variations in opportunity cost

Results in higher price during busy period and lower price during off-peak periods

Peak-Load Pricing

Example: Flights for airline X between two

uncongested airports during off-peak periods will experience no price dispersion

Flights for airline X between one airport during a congested period and one airport during an off-peak period will experience price dispersion There is a variation in opportunity cost

Dynamic Pricing

Dynamic Pricing

Dynamic Pricing

Dynamic Pricing

Dynamic Pricing

It can be observed that: Prices increase as takeoff approaches There are season peaks over the summer

months and winter holidays There has been a general trend in

increasing airline fares over the past 15 years

Advanced Booking

Selling a good or service prior to its delivery or usage

Can increase profits when buyers are uncertain about future valuation

Allows for market segmentation Prevents loses on cancellations

Advanced Booking

Yield Management Systems Less price sensitive people are not willing

to purchase in advance Advanced purchases are made only by

low valuation people Segmentation of High-fare and Low-fare

consumers

Advanced Booking

Allows for Options Advanced contracting of a ticket with no

specified date or time Allows for maximum gain of consumer surplus

and revenues

Capacity Constraints

Optimal Allocation The most profitable allocation of High-

fare and Low-fare prices More attractive to buyers because it

guarantees services Allows for maximum consumer surplus

Predatory Pricing

There are many different Airlines who compete against each other for market share The big 6 are United, Delta, American, US Air,

Southwest, and Jet Blue The airline industry is made up for profit

by publicly owned corporations which have a fiduciary responsibility to earn profits for their investors and share holders. This is one of the reasons that Predatory Pricing

takes place in the Airline Industry.

Predatory Pricing continued..

Since there is constant competition in the airline sector, many Airlines conduct ruthless pricing campaigns to oust other airlines from their spaces. By doing this they can potentially drive them out

of the space and capture more of the market share

Drastically lowering prices from a regional airlines fare forces the smaller airline out of the market.

This forces customers to pay full boat and allows the larger airlines to earn huge margins on the flights

Predatory Pricing a Case Study

Dallas-Fort Worth is the third largest airport in the country. It serves 55 million passengers per year American Airlines flies 61% of these

passengers from this airport Complaint filed by Department of Justice

American Airlines uses its dominant position to deprive consumers of competitions benefits.

Continued..

The Department of Justice continued by saying, “when small airlines try to compete against American, American typically responds by increasing its capacity and reducing its fares well beyond what makes business sense.” This allows American to drive smaller airlines

out of the market

Vanguard Airlines

Small airline based in Kansas Profitable flight for Vanguard was the Kansas

to Dallas route Started this route in January 1995

By April 1995 American had flooded the market Upped flights from 8 to 14 per day Matched Vanguards fare of $80 per trip

continued

American continued an all out war on Vanguard Used similar tactics against them on all routes

which flew to Dallas Wichita, Cincinnati, and Phoenix

Vanguard was forced out of Dallas-Fort Worth hub all together

Perfect Example of Predatory Pricing

Once Vanguard pulled out of the Dallas Hub American, almost immediately cancelled extra (unprofitable) flights and raised routes fares by 50 to 80 percent Bragged that Kansas city route went from

being the “worst” to the “best in the west”

Transportation Law

Paul Dempsey, director of Transportation Law program at University of Denver describes airline pricing Says it is a “homicidal mission to destroy the

low-cost airlines.” American vs. Vanguard is a perfect examply

Benefits of a Big Budget

American was able to absorb the short term costs of increasing the number of flights out of Dallas American executives concluded, “the short

term cost, or impact on revenue, of “aggressive” (predatory) pricing can be viewed as the investment necessary to achieve the desired effect on market share.”

In other words, price so low that smaller airlines can’t compete so they are forced to exit the market.

Predatory Pricing is Hard to Prove

Supreme Court established 3 criteria for proving an instance of predatory pricing. Prices must be below an appropriate measure

of cost These artificially low prices must be capable of

driving rivals from the market The perpetrator must have a reasonable

prospect of using its monopoly power to recoup its short-term losses.

Deregulation

Since 1978 when deregulation, no government regulation on price, went into effect, courts had not heard a single predatory pricing case against an airline. (2001) So hard to prove because cost of flying an

extra passenger is practically nothing How to compare ticket prices

Business-Coach, Advanced or Same Day Purchase, bonus frequent flyer miles for different routes.

Bundling and Discounts

Many Airlines give customers different types of incentives to fly with them rather than the competition. Frequent Flyer Miles Drink Coupons Flight &Hotel Discounts

Frequent Flyer Miles

Airlines often offer repeat customers “miles” for flying with them as a type of Loyalty Program Each mile on the trip represents a mile that

they can redeem at a later date for another free or discounted flight

By doing this airlines are able to increase consumer loyalty Consumers want to use same airline so that they

can accumulate miles for free trips

Continued…

Frequent Flyer miles also can be used for increased benefits Travel Upgrades Access to Airport Lounge Priority Bookings

This is an example of 2nd Degree Price Discrimination

2nd Degree Discrimination

Two-Part Tarrif Price to get on the Plane Another cost for food, movies, alcohol, etc.

Example American Charges $150 one way to Miami

If you want to watch the movie you pay $2 for headphones, and if you want to drink you pay $7 for beer.

Bundling

Many times Airlines will work with travel agencies. Allow for people to book flight and hotel at

same time Easy for the consumer, much less expensive By doing this they increase flyers because

they feel like they are getting a better deal

Continued..

Bundling also allows airlines to charge premiums at peak times of the year, while still offering discount Spring break packages are more expensive if

you do not book them in a package Successful because marginal costs of bundling

hotel and airfare are low Travel agency fee offset by more volume in sales

because of discount

Analysis and Recommendations

Airlines have fallen on tough times since the financial crisis of 2008 Many airlines struggling to survive because of

decreased travel and increased maintenance and fuel costs.

Many fleets are aging and are starting to need to be replaced Airlines will have to take on huge amounts of

debt to finance new planes

Investor Outlook

Investing in an airline would be a risky investment to take on

The amount of debt vs. revenue that an airline actually has is huge. Money made per seat sold actually is quite

low If market stays on current upswing,

airlines potentially could be more profitable. Pending low fuel costs

I would not suggest investing in Airlines at this point

Suggestions

Airlines should have better customer loyalty programs Increased loyalty means increased revenue for

every happy customer Having better miles programs will make

customers want to fly more to receive the benefits sooner. Making a trip to the Bahamas cost 20,000 miles

rather than 30,000 miles could increase loyalty Continue offering flight packages and bundling

with hotels to make travel easy and affordable.

Suggestions…

Have tighter regulations on predatory pricing Allowing more competition in the market will drive

prices down Less expensive flights will increase peoples travel

plans Smaller airlines can enter the market, and buy planes

from large aging fleets of the market leaders This way the small airlines can get business going, and

the large airlines will have capital to finance improvements on their fleet

Stop nickel and diming customers. Charging $2 for headphones, rather than giving them

out and keeping the customer happy could make a huge difference with regards to customer loyalty.