Recently, The Wall Street Journal reported that both Delta Air Lines and Continental Airlines were reporting gargantuan losses for the fourth quarter of 2004. By gargantuan, I mean some really big numbers. Delta lost $2.2 billion for the quarter while Continental’s loss was $206 million.
Both airlines cited high fuel costs and brutal fare competition. While these factors certainly are important and offer an easily understood explanation for the losses, are they really the core problem?
Strategies for improving operations include further slashing of fares and salary reductions for employees — 32% for Delta pilots. Obviously, the theory is that cutting prices will increase demand and, thereby, raise total revenue. In addition to salary cuts, the airlines are squeezing suppliers to further cut operating costs. So, they’re cutting prices as an anecdote for increasing costs.
Does this really make sense?
Whether this strategy is sound or not depends on whether air travel possesses the characteristics of elastic or inelastic demand. If demand is inelastic, they are wasting their efforts to increase air travel by slashing prices because there’s only so much demand for air travel and pricing will not change demand. Alternatively, if it is elastic in nature, they have some reason to hope for success. If fact, it is a combination of both elastic and inelastic.
This is where I think the airline industry is making a mistake. They have segmented the market into the regular, recurring customers at whom they throw the fare book and nonrecurring, recreational travelers for whom they role out the red carpet. This seems backwards to me.
Do not make the mistake of needing to be in Denver tomorrow and just go to the airport and buy a ticket unless you have a sack full of money. However, if you can plan your trip weeks in advance and arrange to leave at 5 p.m. on Thursday and not return until after Sunday, you can likely get a ticket for peanuts. Thus people who must regularly travel long distances on short notice, i.e. bread and butter customers, are beat over the head while vacationers heading for Disney World get cheap rates.
What does that have to do with the cost of operating an airline? Wouldn’t it be better to just figure out how many passengers need to fly to a given destination and how much it costs to haul them there and set prices accordingly? Then, at the last minute, if seats are available, discount the fares to fill the plane. Charge everybody a reasonable rate based on costs and make the vacationers wait until the last minute to see if they can fly on the cheap.
With all the varying rates for the same destination I wonder if the airlines actually know what a reasonable fare should be. Logically, I think that should be the starting point for setting prices. Perhaps having a reasonable idea what it will consistently cost to travel from Jackson to New York would actually increase demand by allowing people to budget with some degree of certainty. As it now stands, it could vary from $500 to upwards of $1,000, or more.
Needless to say, discount airlines, like Southwest, have rattled the traditional airlines out of their complacency toward lower fares and customer service. The discounters offer minimal fringes, on-time flights, no reservations and low fares. As these competitors drained off business from full-service airlines, the response has been to skew fares downward to compete for the casual business while jacking up the fares for the business customer. However, as with automobiles, I don’t think trying to compete in the arena of one-size-fits-all is working for the airlines. Some people want a Cadillac and are willing to pay for it while others are happy Chevy people.
One thing I do know is that if they make the seating space any smaller us big guys are going to have to fly standing up or buy two seats.
Praise for the Legislature
Changing gears for a moment, we are anxious to criticize the Legislature for everything that goes wrong in our state. However, occasionally they do something right and we ought to give them credit when it’s due.
Several weeks ago, they passed Senate Bill 2480, which created a $20- million fund to enable the community colleges to operate workforce-training programs. Additionally, they reduced the unemployment taxes on businesses by a similar amount.
In an unusual twist of bureaucracy, our unemployment taxes are sent to Washington where they are held until needed to pay unemployment benefits. We have grossly overpaid the fund and have a huge balance in our account. Senate Bill 2480 draws some of these funds down to be used for workforce training and lowering the unemployment tax on businesses. This legislation was a winner for everyone, and the Legislature should be commended for passing it.
Thought for the Moment
What can be added to the happiness of a man who is in health, out of debt, and has a clear conscience? — economist Adam Smith (1723-1790)
Joe D. Jones, CPA (retired), is publisher of the Mississippi Business Journal. Contact him at firstname.lastname@example.org.
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