Why Don't The Airlines Just Raise Fares?

[Bob Owens]

mweiss,Jan 8 2005, 06:52 PM]
But so what? What matters in determining the marginal passenger cost is what the specific addition of that one passenger will cost the company to serve. And, yes, there is a degree of variability there as well (e.g., how many times that passenger calls CS). So you take an average of the costs of many passengers, and you get as close as you can.

Even though the formulae are precise, there is inherently some error in them. The better you are in reducing that error, the better your ability to manage profits. Again, that's a big part of what YM does.

So there you go again. You admit that there is inherent error. Would you agree that YM is as much art as it is science?

It doesn't exist in the real world. Just like absolute elasticity doesn't exist in the real world. And just as absolute zero can be precisely defined, so can absolute elasticity.
Um...you did.
Why is that even necessary? Or is it your allegation that nobody has a YM department that could figure anything out, and instead they just throw darts at a board?

Well those that are not trying to break labors back seem to have a YM that is functioning correctly. Its been common belief that the longer the trip the more profitable it is, admittedly a general statement, I'm sure that you have a curve for that too. So why is it that an Airline like SWA, whose greatest competitor is the Auto, is doing fine while paying their employees more than carriers like AA and UA that have all these money maker trips with little competition?

It is, but not broken in the way that you seem to think it is.
The desire to gain market share is fine. It's a departure from optimal pricing.

So is demand setting the price or is the desire for market share setting the price? My arguement is that we have departed from optimal pricing. You claim that we have not, that demand has determined the price therefore we can not raise them. I claim thats not the case. So far you have not given us any reason to support your claim. Do you deny that the obsession for market share has been a significant factor in airline management and ticket pricing for a long, long time?

Likewise with predatory pricing. However, lowering prices to gain market share has been shown not to work in nearly all instances, as the competition simply matches the pricing and nothing changes.

Exactly, so is demand driving ticket prices down in this situation? Isnt that what we have been going through these last three years?

Predatory pricing, besides being illegal, also is pretty tough to make work now, given the current financial picture.

Its also pretty tough to prove.

There are few other instances where it pays to lose money as a matter of practice. Are you insinuating that the legacies are losing money on purpose?

Sure, to eliminate some competition and to reset labor costs.

Not if they don't change much more than those contracts.

Agreed, they have to raise prices.

 

[Wretched Wrench]

Point taken...*sigh* it's just that I'm beginning to feel like I'm typing to a brick wall. :unsure:

Well, I am almost a brick wall here, myself. My calculus and economics are long behind me, and I aced neither in college. Sometimes I have to bounce some of this off my CPA or engineer sons to fully grasp it. But I am learning from this, and hate to see good discussion degraded.

 

[Bob Owens]

Well, I am almost a brick wall here, myself. My calculus and economics are long behind me, and I aced neither in college. Sometimes I have to bounce some of this off my CPA or engineer sons to fully grasp it. But I am learning from this, and hate to see good discussion degraded.

[post="236974"][/post]​

Well actually its only starting to get good now.

 

[Wretched Wrench]

Sounds like we should just let the free market work, rather than delaying the inevitable with these lingering chapter 11 operations. Chapter 11 has become a refuge for looters and union-busters.

It is ironic how the Bush administration does not like the free market if it hurts his robber baron cronies. I can remember when the Republican party was the party of the free market.

The other day Assistant Treasury Secretary for Financial Institutions Wayne Abernathy said the problem of individuals who abuse U.S. bankruptcy laws to avoid paying bills is tantamount to predatory borrowing, in a speech to a conference of state bank supervisors.

He seemed to care not a whit about corporations using Chapter 11 to stiff their employees on wages and benefits, break their union contracts, and steal their pensions.

 

[mweiss]

Like I said, give us your answer and we can go back from there.

There's nothing to discusss until the foundation is laid. Otherwise, I'll be saying things that will have no meaning to you.

Then why spend all that money on marketing?Isnt the sole purpose of marketing to stimluate demand?

In the parlance of pricing theory, the purpose of marketing is to affect the shape of the demand curve. And, yes, marketing does have an effect, albeit rather limited. This is why I said that the airlines have little, not no, contol over the demand curve.

I said:

If the price of airline tickets were cut by 50% tomorrow, wouldn't there be a greater quantity of seats demanded?

to which you responded

I dont know, would there?

If you can't follow the most basic concepts, how on earth can you draw conclusions about pricing?

Dont you agree that no matter how cheap we make airtravel there are other factors that would limit the demand?

Of course. So what? That just means that the price of airline tickets isn't the only factor impacting demand.

Fine. The airlines can raise fares.

Of course they can. They set them. But your previous allegation is that they can increase profits by doing so.

The load factors are at historic highs.

Which tells you about quantity demanded at the current price, not about the shape of the demand curve.

In many cases its cheaper to fly than it is to drive in travel costs alone, without even considering the value of time.

All this tells you is how flying competes against other forms of transportation to the same destination. It tells you nothing about how it competes against going to other destinations, or not going at all. Those are also substitutes.

 

[mweiss]

Despite years of increased productivity and increased efficiency the airlines are selling tickets below the cost of providing the service.

Prove to me that there are many years of increased productivity and efficiency. I've looked at RASM and CASM over time for the airlines. The evidence suggests that the focus has, until recently, been on increasing revenue, not reducing costs. The real focus on cost reduction has not occurred until this decade.

Price wars and massive losses while often coinciding with economic downturns also coincide with heightened competition for dominance and labor negotiations.

Well, duh! There's a causal relationship there. Do you see it?

There is no reason to believe that demand for airtravel is declining any more than it has in other recessions nor is there any reason to believe that demand for air travel will not continue to increase in overall demand.

Aside from the fading effects of September 11, that's true on an industry-wide basis.

The airline industry is exploiting the combined events of an economic downturn, Sept 11 and a friendly administration to reset labor costs, however even with these advantages it is still neccesary to display an economic need, real or contrived, for what these companies are doing to their employees in order to prevent huge disruptions in service(and all the economic effects of such disruptions) and allow the employees to gain public support.[/color]

[post="236945"][/post]​

You're seeing a conspiracy there, and missing the real cause.

 

[mweiss]

So there you go again. You admit that there is inherent error. Would you agree that YM is as much art as it is science?

The error is significant when looking at a single seat on a single flight. It averages out to background noise across all seats in the system. So, no, I would not agree. There is an element of art, to be sure, but it's less than the scientific component.

Well those that are not trying to break labors back seem to have a YM that is functioning correctly.

And who exactly would those be?

Its been common belief that the longer the trip the more profitable it is, admittedly a general statement, I'm sure that you have a curve for that too.

Yes, I do.

So why is it that an Airline like SWA, whose greatest competitor is the Auto, is doing fine while paying their employees more than carriers like AA and UA that have all these money maker trips with little competition?

Because WN has lower labor costs, even at the higher wages. Each WN employee serves more customers per day than the AA or UA counterpart. And, of course, WN has had the phenomenal good fortune of some of the best fuel hedging in the history of man.

So is demand setting the price or is the desire for market share setting the price?
Do you deny that the obsession for market share has been a significant factor in airline management and ticket pricing for a long, long time?

Today, it's demand. In the 1980s it was the desire for market share. Why the change? In the 1980s there were a bunch of startups, followed by a lot of consolidation and failures. The legacies had pockets deep enough to fund the market share grabs, and they had to do it because of the route instability.

When we have one or more big airline failures, we may see some more short-term grabs for market share, provided anyone has the cash to fund it.

so is demand driving ticket prices down in [predatory pricing]? Isnt that what we have been going through these last three years?

No. The last three years have been defensive, not offensive, price cuts.

 

[mweiss]

So I went ahead and said that ticket pricing today is inherently different than it was in the 1980s. Here are the factors that I believe changed the demand landscape:

• Yield management got too good. I mean it. In the business ticket world, prices shot up much faster than inflation during the 1990s, and revenues tracked it initially. This caused the business world to revolt, changing its travel policies to, in effect, "disguise" business travelers as leisure travelers (e.g., by requiring Saturday night stays).
• Technology improved. With the universality of email and much better video teleconferencing, businesses started leaning ever more heavily on using technology as a cost-effective substitute for taking trips.
• Southwest got big. Southwest has the ability to be profitable at the same airfares, on the same routes, and at the same frequencies as the legacies who would lose their shirts just matching the fares. The bigger WN grew, the more pronounced the effect became. WN is now carrying more domestic passengers than anyone else, many of them business passengers. This means that the legacies no longer have the arsenal of deep pockets to drive away other upstarts, like JetBlue, Frontier, or AirTran.

I know those first two factors to be true firsthand, having been a business traveler throughout the 1990s. The third became clear when examining the competitive landscape in the years from 1988 to 2003, in the ways that airlines responded to various threats.

 

[Trip Confirmed]

So I went ahead and said that ticket pricing today is inherently different than it was in the 1980s. Here are the factors that I believe changed the demand landscape:

• Yield management got too good. I mean it. In the business ticket world, prices shot up much faster than inflation during the 1990s, and revenues tracked it initially. This caused the business world to revolt, changing its travel policies to, in effect, "disguise" business travelers as leisure travelers (e.g., by requiring Saturday night stays).
  
• Technology improved. With the universality of email and much better video teleconferencing, businesses started leaning ever more heavily on using technology as a cost-effective substitute for taking trips.
  
• Southwest got big. Southwest has the ability to be profitable at the same airfares, on the same routes, and at the same frequencies as the legacies who would lose their shirts just matching the fares. The bigger WN grew, the more pronounced the effect became. WN is now carrying more domestic passengers than anyone else, many of them business passengers. This means that the legacies no longer have the arsenal of deep pockets to drive away other upstarts, like JetBlue, Frontier, or AirTran.

I know those first two factors to be true firsthand, having been a business traveler throughout the 1990s. The third became clear when examining the competitive landscape in the years from 1988 to 2003, in the ways that airlines responded to various threats.

[post="237027"][/post]​

The most correct and complete explanation I've seen here in ages.

And 100% correct.

 

[Bob Owens]

Wretched Wrench,Jan 8 2005, 10:39 PM]
Sounds like we should just let the free market work, rather than delaying the inevitable with these lingering chapter 11 operations. Chapter 11 has become a refuge for looters and union-busters.


Yes, these bankrupt companies just happen to stay around long enough to get all the other airlines long term concessionary contracts, then the airlines all make a miraculous recovery, eran record profits and tell us "You agreed to the contract, a deal is a deal".

It is ironic how the Bush administration does not like the free market if it hurts his robber baron cronies. I can remember when the Republican party was the party of the free market.

Ah yes, when labor has a chance to make a little progress he accuses us of holding the nation hostage and inconveiencing the "hard working people" of the country.

The other day Assistant Treasury Secretary for Financial Institutions Wayne Abernathy said the problem of individuals who abuse U.S. bankruptcy laws to avoid paying bills is tantamount to predatory borrowing, in a speech to a conference of state bank supervisors.

He seemed to care not a whit about corporations using Chapter 11 to stiff their employees on wages and benefits, break their union contracts, and steal their pensions.

No thats just good business.

 

[Bob Owens]

mweiss,Jan 8 2005, 11:12 PM]
There's nothing to discusss until the foundation is laid. Otherwise, I'll be saying things that will have no meaning to you.

Give it a try. It could be quicker. Then I will have more time to post on the USAIR board.

If you can't follow the most basic concepts, how on earth can you draw conclusions about pricing?

I follow the concept, however you seem to be ignoring the fact that air travel is an intermediate good. You are also ignoring the fact that price cuts do not always stimulate enough demand to justify the cuts. Sometimes you need to just stop producing that specific product, no matter how much you discount pet rocks and 8-tracks it still wont be worthwhile to produce them. But then again thats not the debate here which is whether or not airline ticket prices should be raised.


So what? That just means that the price of airline tickets isn't the only factor impacting demand.

And Demand is not the only factor affecting pricing either.

 

[Bob Owens]

mweiss,Jan 8 2005, 11:15 PM]
Prove to me that there are many years of increased productivity and efficiency.

I believe I read on the ATA website about productivity, 30% since the mid eighties comes to mind, and no one can dispute the huge increases in fuel efficiency.

By the way I'm still waiting for you to prove to me that the airlines cant raise fares.


I've looked at RASM and CASM over time for the airlines. The evidence suggests that the focus has, until recently, been on increasing revenue, not reducing costs. The real focus on cost reduction has not occurred until this decade.

Well then you must be new to this industry. Back in the eighties B-scale and Lorenzos famous trip to BK court were not attempts to increase revenue but cut costs. In fact Gordon Bethune is critical of the airline industry's obsession with cost cutting, The line he used was "You can make pizza so cheap that nobody will buy it". I've been in this industry for over twenty five years, nearly all that time there has been an obsession with cutting labor costs and the airlines have been very successful at it.

Well, duh! There's a causal relationship there. Do you see it?

Sure but did you se the relationship between these lean years and the extreme booms that follow once the concessions are won from the workers?

You're seeing a conspiracy there, and missing the real cause.

And you are assuming that there is only one dimension to what is going on in this industry.

 

[Bob Owens]

mweiss,Jan 8 2005, 11:30 PM]

And who exactly would those be?

The answer to that is obvious.

Because WN has lower labor costs, even at the higher wages.

Does it have lower labor costs? Prove it. Ive seen figures to the contrary.

Each WN employee serves more customers per day than the AA or UA counterpart.

Ok, but they are not moving them to Tokyo or London, markets where passengers pay a lot more money. The total cost per passenger mile drops as the length of the trip grows, or at least it should. Are you switching from comparing rpms to numbers of passengers to suit your arguement?

And, of course, WN has had the phenomenal good fortune of some of the best fuel hedging in the history of man.

Thanks to the fact that other airlines sold them their options.

Today, it's demand.

I disagree.

In the 1980s it was the desire for market share. Why the change? In the 1980s there were a bunch of startups, followed by a lot of consolidation and failures.

We are still at the "lots of start ups stage".

When we have one or more big airline failures, we may see some more short-term grabs for market share, provided anyone has the cash to fund it.

Somehow, I believe they will find it. What is GE going to do with all those planes otherwise?

No. The last three years have been defensive, not offensive, price cuts.

Perhaps they have been taking defensive actions against other carriers while at the same time taking agressive offensive action against their own employees. Or do you feel thats impossible? Is everything either black or white in your world?

 

[Bob Owens]

mweiss,Jan 8 2005, 11:47 PM]
So I went ahead and said that ticket pricing today is inherently different than it was in the 1980s. Here are the factors that I believe changed the demand landscape:

• Yield management got too good. I mean it. In the business ticket world, prices shot up much faster than inflation during the 1990s, and revenues tracked it initially. This caused the business world to revolt, changing its travel policies to, in effect, "disguise" business travelers as leisure travelers (e.g., by requiring Saturday night stays).
• Technology improved. With the universality of email and much better video teleconferencing, businesses started leaning ever more heavily on using technology as a cost-effective substitute for taking trips.
  
  You left out that it was also a huge time saver that could allow someone to close a deal in London and Tokyo the same (long) day.
• Southwest got big. Southwest has the ability to be profitable at the same airfares, on the same routes, and at the same frequencies as the legacies who would lose their shirts just matching the fares. The bigger WN grew, the more pronounced the effect became. WN is now carrying more domestic passengers than anyone else, many of them business passengers. This means that the legacies no longer have the arsenal of deep pockets to drive away other upstarts, like JetBlue, Frontier, or AirTran.
  
  Fine. let SWA take over all the short haul domestic routes.

I know those first two factors to be true firsthand, having been a business traveler throughout the 1990s. The third became clear when examining the competitive landscape in the years from 1988 to 2003, in the ways that airlines responded to various threats.

Maybe you need to go back a few more years to get the clarity that airline workers who have been here have. Then maybe you would understand our skepticism.

We have seen these cycles before, and the same rhetoric gets spuced up and slightly altered each time. Once the airlines feel that they have bled the workers all they can we will likely see the same thing as before. The LCCS will die off or be bought off, the industry will continue to consolidate and at least one of the legacies will dissapear. Then like a pheonix from the ashes those that remain will have a miraculous recovery and boast of record profits. In the meantime the employees will be stuck with concessionary agreements that last into the next decade.

A conspiracy? Sure why not? Ever hear of the ATA or the Air Conference? (Aircon.org), there is plenty of motive and everyone other than the workers stand to gain from lower labor costs. The fact is that labor is a huge cost for the airlines, savings in labor can be diverted to several other benificiaries, those who do business with the airlines can charge more (we saw our concessions get eaten up by fuel), or pay less, and those who benifit from airline services, Hotels etc also indirectly benifit from lower labor costs when they lead to lower ticket prices even if on the surface it appears that the airlines are fighting for their own survival.

 

[mweiss]

Give it a try. It could be quicker. Then I will have more time to post on the USAIR board.

By showing your confusion between demand and quantity demanded, you've already proven that it won't work.

Leaving aside whether or not airlines are pricing at the maximum profit point, do you agree with the theory of pricing? Because if you don't, then we cannot begin to discuss the specifics of what will happen when the prices change.

you seem to be ignoring the fact that air travel is an intermediate good.

It's irrelevant when setting prices, because you cannot control external factors. As long as air travel is a paid-for element of the trip, price has an impact on demand. For leisure travelers, that impact is much higher than for business travelers, which is why leisure travelers are far more elastic.

You are also ignoring the fact that price cuts do not always stimulate enough demand to justify the cuts.

Not at all. Of course they do. And if you cannot generate profitability at any price, your best option, as you noted, is to get out of the business.

And Demand is not the only factor affecting pricing either.

It's very close to being the only factor. The supply curve cannot be shifted quickly in the airline industry.