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Airline industry newcomers benefit from herd mentality of the old timers

28-Jan-2010

When discussing airlines we often put them into geographic categories; for instance the European airlines, or the US carriers. For much of the industry’s history these were useful designations, and in some cases they still are. But especially in the US, there are now two almost distinct industries, both doing the same thing but in quite different ways, making blanket declarations far more difficult. The first group is the shrinking cadre of legacy carriers, now down to five and likely to find further consolidation in their future. The other group is composed of all the new generation carriers that operate in the region, including the largest US carrier, Southwest.

The effects of the latter group on the former have been picked and parceled for decades and it is clear that the legacy group has been battered by the newcomers. While lessons have been learned, we also know, from all the failed attempts to create low-cost companies of their own, that the legacy group has generally been unsuccessful at redefining its business model in ways that make them truly competitive in the domestic market.

A familiar and ineffective process

The other thing that continues to distinguish the legacy group is their ongoing tendency to march in lockstep with each of the five keeping a close eye on the other four. This past week we had yet another example of that mindset when they instigated and then abandoned a small fare increase of only USD16 on round trip fares.

The news releases told a familiar story—floated by one carrier, adopted by others, but not all, and then backing off one by one as they realized that there would be no unanimity. It is a pattern we have observed repeatedly since deregulation in 1978 when pricing became an internal rather than externally regulated function.

We have seen similar behaviour in the area of ancillary fees with bag fee increases, for instance, where any change is matched almost immediately; resulting in essentially identical policies. And when a single carrier tries to implement a policy without broader support by its peers, the backlash can be swift—remember the US Airways attempt to charge for soft drinks?

It is interesting that even after decades of hard knocks and bitter rivalry, this 'group-think' phenomenon persists.

The reality

The chart below displays the one way fares charged on three quite different US sectors by the carriers that operate non-stop services. In each case, the lowest fare on each airline is presented and the bag charges represent the cost for the first bag when checked at the airport. There are reductions (the same for all legacy carriers, of course) if done in advance, online.

One way US fares sample

O/W Feb 10

Carrier

Fare

Bag Cost

SFO

UA

59.70

25

LAX

AA

59.70

25

 

VX

59.70

20

 

WN

59.70

0

LAS

UA

86.70

25

DEN

F9

86.70

20

 

YX

86.70

20

 

WN

86.70

0

MCO

AA

94.70

25

NYC

B6

94.70

0

 

FL

94.70

15

 

CO

99.70

25

 

DL

94.70

25

There are a few interesting observations that can be derived from the information presented in the chart. First, there is no price competition. With the exception of Continental on one route, the base fares are identical. Furthermore, given the fact that Southwest and AirTran have once again moved into the black, one assumes that they have minimal interest in raising those fares.

Consequently, any increase, even last week's USD8 one way proposed increase, would still leave the legacy group at a disadvantage since the herd mentality has never infected the new generation group, making it unlikely that they would follow suit.

Second, if the passenger has a bag to check, there is an immediate total trip cost disadvantage in using any of the legacy group. For two of the new generation carriers, there is no additional cost and for the remaining members of this group, the bag fee is less than with a legacy carrier.

For instance a skier traveling LAS/DEN with a bag and skis would incur a USD60 additional charge, increasing the trip cost by 70%. Thus, adding any amount to the fare, even if adopted by all in the legacy group, would simply serve to make them even less price competitive with the others. The lingering mindset is that if at least they all play by the same rules, they will remain competitive with each other. But does that really matter any longer, given the alternatives available on most major routes?

Let’s keep doing it and hope for a different result…

There are two conclusions here.

One, the legacy group has yet to absorb the fact that even if they operate in concert, it no longer really affects the overall market, as there are too many external variables.

Two, the legacy group seems to have abandoned any attempt to gain a competitive advantage vis-à-vis each other. There is no pricing or service initiative amongst the remaining five that provides discernable differentiation. Oddly, the carriers themselves have been most instrumental in creating the customer perception that amongst that crowd, there is complete interchangeability. If there remains any real choice, it is between two business models, rather than between individual carriers.

The difference between choosing AA or UA between SFO and LAX consists solely of different gates for departure and arrival and, if applicable, the mileage program credited. Perhaps this is why US carrier mergers have entailed consolidation, but without the meaningful change that will ensure long-term viability


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