Friday, December 10, 2004

Airline Economics I - Going Broke Flying Full

Have you been on an airliner lately? I don't care which airline, but did you notice that it was pretty full? Even on the airlines that are in bankruptcy the airplanes seem to be full. With full airplanes, how can the industry be swimming in an ocean of red ink?

Now, have you noticed what airlines are charging to take you thousands of miles in relative safety and efficiency? (Yes, Virginia, flying is safer than driving...A lot safer). The airplanes are mostly new employing state of the art technology and the airports and terminals for the most part are new or being remodeled and improved.

The answer on a per mile basis is almost nothing. Flying is dirt cheap. For short haul flying, it can easily cost more to park for a few days than a ticket to a nearby city.


Competition and the vagaries of the airline business. You see, airlines have virtually the most perishable product possible. If Safeway doesn't sell a bunch of bananas today, they can sell them tomorrow and maybe the day after until they show brown spots. An airline seat is completely lost revenue as soon as the airplane pushes back from the gate. The marginal cost of producing that seat is near zero as the airplane, fuel, crew, and ground facilities are all already paid for whether that seat is filled or not. Therefore, any revenue at all which can be made from filling that seat is gravy on top of fixed costs. That means that if the airline can sell the seat for $20.00 just before pushback, that's $20.00 of revenue with almost no additional cost.

That, then is the reason that airlines have incentives to undercut each other to fill otherwise empty seats. Unfortunately, they tend to collectively bring too many seats to market and can't make any money while fighting each other in a race to the bottom. Hence low prices, full airplanes, and broke airlines

Why do they do this? That will be the subject of a future post.

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Capt Rob