September 11, 2004

...AND LOWER...:

Major Airlines Struggle in a Jet Stream of Change: Low-fare carriers and high fuel costs keep up the pressure three years into a post-attack slump. (James F. Peltz, September 11, 2004, LA Times)

They have been pummeled by several jarring events since 2001, including the 9/11 terrorist attacks and this year's surge in fuel prices. But beyond these shocks, many analysts and industry executives say, something even more fundamental is going on: The airlines' traditional way of doing business is failing.

Since the attacks, the carriers have lost a collective $27 billion.

The growth of smaller, discount airlines such as Southwest, JetBlue and AirTran is one big factor. Their rise has cut into the larger airlines' share of the market and has helped drive fares lower overall.

That has been good news for the nearly 650 million travelers who board domestic flights each year. But it has robbed the major carriers of their ability to raise prices to offset their enormous costs and stop the bleeding.


The inability of industries to raise prices is the clearest indication that inflation is a dead letter for the forseeable future.

Posted by Orrin Judd at September 11, 2004 10:57 AM
Comments

Well, the inability of the old-line carriers to raise prices stems from competitors supplying the same essential service at much lower prices.

Posted by: David Cohen at September 11, 2004 12:17 PM

About a year ago I read a calculation that since inception the airline industry has collectively spent more capital than it has accrued. Collectively, airlines have never been profitable. It's not just this post bubble cycle thats been hard on the airlines, it's their entire recorded history.

There has never been a prolonged period of airline profitablity. Perhaps that reflects the number of flagship national carriers that persist in providing service despite mind boggling losses and in so doing distort market forces and their atbility to effectively allocate capital.

If so, we may do best to short Boeing in its struggle against Airbus. Whatever the cause, the industry itself is a poor choice as a leading economic indicator. Not that I wouldn't like to believe your main argument that inflation has quieted.

Posted by: Ray Clutts at September 11, 2004 12:49 PM

Ray:

I've read the same thing, that since the Wright Brothers, the American airline industry has yet to show a collective profit.

However, Southwest Airlines has had 53 consecutive profitable quarters, including every one since 9/11, so obviously it's not the industry, it's the management.

Posted by: Michael Herdegen at September 11, 2004 1:24 PM

It'd be a better society without them.

Posted by: oj at September 11, 2004 1:43 PM

It was true as well of railroads in the 19th century, although some were very profitable.

The problem with transportation nets is that they are very expensive, so you really cannot afford much duplication.

Both 19th century railroads and 20th century air routes had way too much duplication.

This says little or nothing about inflation, in general.

Think of bottled water. It's worse than tap water and costs 5,000 times as much, and sales are growing. Prices are not falling.

As Paul Brewbaker, one of the world's few funny economists would say, 'What's up with that?'

Posted by: Harry Eagar at September 11, 2004 4:38 PM

Even Coke makes bottled water now and it's much cheaper than Perrier was when bottled water first came to market.

Posted by: oj at September 11, 2004 6:14 PM

You don't like airplanes, you don't like people to drive, you don't like interstates...

What's left ?
A team of mules ?

Posted by: Michael Herdegen at September 11, 2004 10:36 PM

Ans yet he expects the economy to grow like gangbusters without a transportation network.

Posted by: Robert Duquette at September 11, 2004 10:51 PM

Michael:

Why go anywhere?

Posted by: oj at September 12, 2004 12:27 AM

Very Zen, and quite profound. I agree.

However, most of us can't, (or won't), live our lives at that deep level.

Posted by: Michael Herdegen at September 12, 2004 3:56 AM

"... the inability of the old-line carriers to raise prices stems from competitors supplying the same essential service at much lower prices."

David:

You make an implicit assumption that is incorrect. The Low Cost Carriers (LCCs) and Network Carriers (NCs) do not offer the same service. The LCCs provide point to point service between high frequency city pairs, the NCs provide a hub-spoke network to virtually everywhere. If you want to go from LA to New York, there are plenty of LCCs to take you, but if you want to go from Rochester, NY to Milwaukee, NCs are the only way to go.

If all the airlines were to to follow the LCC business model, something like 70% of the US would be without airline service. And, contrary to OJ, I doubt very much they would be happy about it.

The LCCs are able to offer lower cost travel largely because they cherry-pick the routes.

Posted by: Jeff Guinn at September 12, 2004 6:28 AM

Jeff,

Then why is it I can take a major carrier non-stop from LaGuardia to Jacksonville for less than it cost last year at this time?

Posted by: Bart at September 12, 2004 7:30 AM

Bart:

A couple reasons: 1. Maintaining market share. 2. NCs bringing down costs.

But no matter what the NCs do, for various inavoidable reasons, it costs more to run a hub & spoke network than a point-point system.

Just like the phone system, or railroads, or cable, or the internet, etc would cost less if done point-point. But that only works if you are willing to exclude lots & lots of points.

Posted by: Jeff Guinn at September 12, 2004 11:25 AM

Very good, Jeff. I've been preaching this for years, but nobody gets it.

The classic example was when the courier services tried to cherrypick the Post Office, which would have destroyed it.

You might not want to send a letter of Anchorage very often, but would you be willing to pay $5,000 when you did?

Orrin, don't talk about bottled water if you don't know anything about it. Perrier wasn't first, not by a hundred years.

Posted by: Harry Eagar at September 12, 2004 6:24 PM

Harry:

Why shouldn't you pay $5,000 if that's what the service costs?

Pick your bottled water of the past--today bottled water is cheaper.

Posted by: oj at September 12, 2004 6:27 PM

I got 200,000 USLESSAir FF miles anybody want to buy them?

Posted by: Robert Schwartz at September 13, 2004 1:55 AM

$18 a liter for what we bottle here.

Having a network reduces overall costs, Orrin, so that everybody benefits, even those who never send a letter to Anchorage.

That's what's wrong (well, not the only thing) with neoclassical economics. It does not know how to value networks.

A guy who runs a blog from New Hampshire with posters on the other side of the ocean ought to get an inkling of the value of a network

Posted by: Harry Eagar at September 13, 2004 4:03 PM

Harry:

Instead he loses respect for paper mail.

Posted by: oj at September 13, 2004 4:10 PM

You're profiting from a network, all the same.

It isn't easy teaching elementary economics to classically-trained students, but I'll try a real simple example.

Before the days of packet service between Liverpool and New York, merchants in the US had to tie up capital for a year at a time to obtain manufactures that were not produced here.

Once packet service was began (right after Waterloo), the N.Y. merchants were able to order more frequently (monthly instead of every 12 or even 18 months). That freed up their capital, which, among other things, financed the Erie Canal.

No technological or other improvement was involved. It was a pure benefit of a new network.

Classical economics could never account for it, though, because the benefits and costs could not be attributed.

It's magic, see?

Posted by: Harry Eagar at September 13, 2004 9:43 PM

Yes, LCC's cherry-pick routes, but, some of that has to do with their ability, or lack thereof, to get gates at airports they might want to fly to.

Another aspect is, since so few people want to go from Rochester, NY to Milwaukee, why should the rest of us subsidize their transport ?
They could go point-to-point on a smaller airplane, they could go point to point with two or more legs, they could use a bus for some of their trip...

There are many ways to service smaller markets without anyone losing money.

As for the postal example, it wouldn't cost anything like $ 5,000 to send a letter. What it would cost is time. The Post Office, or whomever handled mail service for Alaska, would just wait until they got enough mail to make it worth the trip. A mini-van full, at say, $ 1 a letter, ought to do it. At that rate, there'd be at least three trips a week to Alaska.

Posted by: Michael Herdegen at September 14, 2004 3:28 AM
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