Why Prices Have Been High and Awards Tough to Get — And Why That Will Change

Yesterday joe said,

Is domestic capacity ever going to increase, even a little?

The economy is relatively strong, certainly compared to the past several years. More people are flying. But the number of seats in the air hasn’t kept pace.

  • This means planes are full.
  • That drives up the price of tickets
  • And makes award tickets harder to come by.

“Capacity discipline” began with the Great Recession. With airlines losing billions of dollars they faced extreme crisis. Passenger counts were shrinking and so airlines managed to shrink seats.

At the same time there were fewer passengers, their costs were higher, fuel was at historic highs and that represents one of the three major expenses of an airline (aircraft and labor being the two other largest).

Airlines haven’t made money historically over long periods of time. It’s a capital intensive, highly regulated, and heavily unionized industry. There are few barriers to entry (for domestic competitors) except at a handful or airports. And it’s highly cyclical.

The old Warren Buffet line rings true: the quickest way to become a millionaire, historically, was to start out with a billion dollars and invest in an airline.

  • The appetite to invest in airlines seemed limitless, despite the historically poor returns.
  • There’s always been a group of investors who believed what was really needed was a new airline, usually based in the city in which they happened to live.
  • Existing carriers seemed to think they were in battle rather than business, they’d throw capacity into markets to drive each other out regardless of the financial consequences.

And yet somehow the historical pattern hasn’t held in recent years. Some people will blame it on mergers, but in many ways it’s the capacity discipline that has helped to drive the mergers as much as the other way around.

The biggest exception has been Virgin America, which since inception has lit money on fire entering markets and driving down prices. But its route network is limited, and in most recent times even it has done better and priced closer to pre-existing market.

So, is domestic capacity ever going to increase?

According to my crystal ball, if fuel prices remain low then yes — at least one airline will experiment growing capacity believing that new routes and extra flights can be profitable with a lower cost structure in place.

And if one airline does, others will follow. That will drive down prices.

What points to this is:

  • Decent economic environment
  • Lower costs
  • Historical behavior in the industry

The airline industry has always been cyclical, it would be unwise to bet that these patterns have changed, that we’ve reached ‘the end of history’ in commercial aviation in the United States.

About Gary Leff

Gary Leff is one of the foremost experts in the field of miles, points, and frequent business travel - a topic he has covered since 2002. Co-founder of frequent flyer community InsideFlyer.com, emcee of the Freddie Awards, and named one of the "World's Top Travel Experts" by Conde' Nast Traveler (2010-Present) Gary has been a guest on most major news media, profiled in several top print publications, and published broadly on the topic of consumer loyalty. More About Gary »

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Comments

  1. Sigh…just more excuses and euphemisms for reduced competition and all of the problems (some of which you bemoan in other posts) that go with it.

  2. Just playing DA, but we certainly have fewer and more powerful domestic carriers than ever before…

    FWIW, I agree with your conclusion, but think it will take a shock to get there: another financial crisis, major competitive disruption, etc

  3. Barriers to entry are huge. Try getting the capital access needed to start an airline of sufficient scale to have the network and frequency of service to have even a fair chance to sell to large MNCs all what DL, AA and UA offer.

  4. Not to mention that many airports are slot controlled. Airlines have dialed aircraft size to the load they believe they can fill on that route. Routes that need price competition (LGA/JFK to most places, ORD to places) are served by 2 or 3 carriers who are MORE than happy to share the wealth. We have seen carriers like B6 and WN become less independent, and MORE like their big brothers (B6 eliminates free bag, charges for other services, WN changes their FF program to be like DL). I’m sorry, I just don’t see pricing going down in any substantial manner without government intervention.

  5. Gary, totally disagree with your assertion that there are “few barriers to entry.” The airline industry has one of the highest barriers to entry of any industry in existence.

    Huge capital requirements, years of regulatory hoops to jump through before even making a first flight, etc…it’s very very difficult for a new competitor to ever break in and get up and running.

  6. @Guwonder there is pretty much no barrier to entry into a particular market for existing airlines. The number of companies in the US with sufficient capital is gargantuan, the only barrier is an FAA certificate, but you can buy a small airline and get that…

  7. @gary are you actually suggesting that a company like Google or Apple may decide that running an airline is a great way to get a return on their capital? I think the fact that Virgin America BARELY made it should be proof enough that the existing airline cartels would make things VERY hard for anyone trying to enter the market…not to mention the slot control that exists, an airline today could not just decide to start 10x day JFK-LAX to disrupt the market.

  8. Gleff,

    You should know as well as I do that it’s not easy to raise enough capital to start an airline in the US with the scale needed to have the network and frequency of service to have a timely chance to swallow whole the largest MNC or TMC contracts that AA, DL or UA currently have.

  9. @Gary Leff, saying “there is pretty much no barrier to entry into a particular market for existing airlines” is a VASTLY different statement than saying there is no barrier to entry for a new competitor trying to start up a brand new airline, which is what your statement in the original post implied. Huge barriers to entry there.

  10. @GUWonder any constraints on raising capital are due to just how unlikely it is to make a profit, which proves my point, if industry consolidation was driving monopoly profits the capital would be flowing in.

  11. @Gary thats a ridiculous thought. Consolidation has taken the inventory that is available, in terms of slots at major airports, and spread it among fewer airlines. The fact Virgin America and Southwest even have slots at airports like LGA is due to government intervention in mergers forcing slots to be given away or sold. To say that the barriers to entry are not a MAJOR factor in why people aren’t rushing to open up airlines…is just walking around with blinders on to the real problems.

  12. @Gary, I think you’re missing one important thing: computer systems (databases) became so big and fast, internet connection became so reliable and available — so it became possible to sell every single seat at the airplane and do it in real time at any moment. Airlines don’t need extra capacity simply because they exercise full control over every single seat.

    I’m actually surprised about things like “upgrade lists” still going — in my opinion, they should be able to finalize seat assignments as soon as check-in is over.

  13. Gleff, what you are saying si akin to saying that the barriers to entry in the US car manufacturing industry are also low, so low that it’s easy for start-ups to compete against the major US and European and Asian manufacturers and succeed to get substantial marketshare and grab major contracts necessary for success and hitting the economies of scale necessary to succeed. I just don’t buy it that the barrier to entry in the car manufacturing and scheduled commercial passenger air service Imdustry is so low.

    For industries with a low barrier to entry, look at something like blogging, award travel booking services or running a lemonade stand. Not much financial capital needed, nor even a lot of expensive human capital investment required. And economies of scale is reached rather cheaply compared to the capital intensive industries mentioned in my prior paragraph.

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