Commercial Airlines

1. Commercial Airlines James Lannon Jacqueline Egan James Keady

2. Introduction

3. Introduction

4. Introduction

5. Industry Structure

6. Background • Industry: Travel • Product: Transportation to and from Destination • Customers: Those with disposable income and need/desire for extensive travel • Distribution: Varying levels

7. Background

8. Organization • Competitive Marketplace • Consumer Good • Extensive buyers and sellers • Perfect Information • Homogeneous product • Costs are reflected in the product price

9. Organization

10. 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

11. Competition

12. Competition

13. Major Companies American Airlines We know why you fly. • Founded 1930 • Revenue: $22.7 Billion • 5th largest airline in world • Bankruptcy

14. Major Companies United Airlines Let’s Fly Together • Founded1926 • Revenue: $37.1 Billion • One of world’s largest airlines with 2nd largest fleet- 703 planes • Merger with Continental

15. Major Companies Southwest Airlines A Symbol of Freedom • Founded 1967 • “Low Cost” Airline • Revenue: $15.7 Billion • Largest US airline with fleet of 708 planes

16. Pricing Strategies Airline Industry

17. Pricing Strategies • 2nd Degree • 3rd Degree • Bundling & Tying • Predatory Pricing

18. 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

19. 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 

20. Price Dispersion • The expected difference in fares paid is 36% • Airlines likely to have 20 or more different fares on one given flight

21. 3rd Degree Price Discrimination Dynamic Pricing • Time-based pricing Advanced Booking • High valuation vs. Low valuation Capacity Constraints • Optimal Allocation

22. 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

23. 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

24. Dynamic Pricing

25. Dynamic Pricing

26. Dynamic Pricing

27. Dynamic Pricing

28. 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

29. 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

30. 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

31. 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

32. 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

33. 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.

34. 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

35. 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.

36. 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

37. 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

38. 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

39. 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”

40. 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

41. 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.

42. 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.

43. 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.

44. 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

45. 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

46. 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

47. 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.

48. 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

49. 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

50. 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