The Business Model of US Airlines is Broken

The business model of US airlines is broken. That may sound strange since US airlines made nearly $8 billion in the first half of 2017. But they’re stagnating. They aren’t earning their profit by innovating or delivering more value to customers. And profits are down substantially from two years ago.

When American announced that full fare customers would no longer receive ‘premium’ seat assignments (most seats on the plane) without an extra charge, that seemed strange. Customers spending the most money are the ones they claim to want to ‘reward’ and incentivize and at a minimum compete for.

The message from American’s corporate communications was “this change makes our offering similar to other airlines, which generally already require customers on full Y tickets to pay for premium coach seats.”

They seem to be offering the following theory of business:

The airline industry is different from most businesses, because it’s protected from competition. Foreigners aren’t allowed to serve the domestic market. Samsung makes phones, Sony and LG sell us televisions, but neither Singapore Airlines nor Ryanair can fly from New York to Miami.

And even if they could, governments own and manage airports and are frequently captured by their largest airline tenant. Alaska Airlines bought Virgin America because it couldn’t break into or get more gates at the airports they wanted to serve on their own.

Even in the regulated era the point of regulation (under the Civil Aeronautics Board) was to prevent ‘ruinous’ competition and set prices high enough that airlines earned profit.

The only way to upend this business model is to legalize competition.

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. @Gary
    Gary, and now drumroll!!!!! for stupid comments by IAHPHX and JoshG about how you don’t know anything and you just want to eat pork while flying with foreign carriers…..

  2. “… And even if they could, governments own and manage airports and are frequently captured by their largest airline tenant. Alaska Airlines bought Virgin America because it couldn’t break into or get more gates at the airports they wanted to serve on their own.”

    I agree with this assessment and with your conclusion, but only if it applies to localized airport market share.

    FWIW I don’t see any differences between this issue and cable and telecom companies in terms of how they have segregated the market geographically.

  3. @ADP Infrastructure in the cable business is expensive, and you can’t take it with you. Airplanes, welll…fly. You can use them in whatever market you want.

    It’s the same in practice between industries, but only b/c the airlines don’t want to invade each others’ hubs with the fixed asset that they could use anywhere. Cable companies would have to spend massive amounts of cap ex on right of way, burying lines and maintaining equipment that is (literally) sunk in a market.

    That said, cable is increasingly getting disintermediated by wireless; hard to see a 3rd choice competitor creeping on airlines right now.

  4. In a free market, you fight to appease customers. In protected market you fight to appease regulator. Customers, like it or not have no other choice. Either follow the rules or take a bus.

    The idea of opening a competition would be very very hard to swallow.

    1. American (its people and government) are paranoid to terrorist attack. Decisions regarding safety is not always in line with logic (laptop ban – potential batteries caught fire in cargo). Opening domestic route to foreign airline or even allowing more competition higher the propability of terror attack, according to american.

    2. Airlines invested so much in appeasing regulator. They wouldn’t want to lose the investment and to re-invest in customer experience.

    3. Regulator wouldn’t want to lose extra income and benefits.

    4. This is hardly a matter in the eyes of citizens. There are more pressing concern like white supremacist, etc.

    In short, general american satisfied with how things going. Only frequent flyer who is not. Maybe because they’ve tasted flying with non US airlines.

  5. You only have to “defend” a policy by saying “BUT THEY DO THE SAME THING!!” if that policy sucks. If you have a fair policy or an innovative one, you don’t have to worry about the haters. For example, if Delta published an award chart they wouldn’t get beat up for it. If United served Michelin-rated-quality food (or my steaks) onboard on domestic flights, they get insane props. But it seems a race to the bottom is in play.

    Oh, and I would love for foreign airlines to be able to compete, but there’s no way I could do that and not upset my base. Very unfair!!

  6. Oligopolies that treat their customers as the enemy do eventually get regulated and managements that are convinced that this will never happen are deluding themselves. It may take a long time but if the Big 3 continue down their current path, a critical mass will develop to punish them.

  7. Which is it? They don’t want to offer a product better than their competitors or they have no competition?

  8. The issue with AA – is that the number of MCE seats has been reduced. When the 738 was reconfigured, AA went to only three rows of MCE.

    So my guess is that if they gave full Y passengers MCE, there would be an expectation from last minute Y passengers that they will get a MCE seat. But then what if those 3 rows are already full and there a no Elite upgrades.

    I think the reason is more related to little MCE inventory. Plus MCE international is being converted to Premium Economy – a different class.

  9. @David Gonzalez (August 22, 2017 at 6:34 pm) – as mentioned in my comment I was referring to airport infrastructure, which as Gary notes services the airline as its primary customer in its current state.

    Holding all municipal airports in a third-party industry affiliated organization combined with management of market share would probably alleviate this issue though as passengers we would be funding it directly.

  10. This is a common problem in markets where there is a race to the bottom. If the market wont solve the problem (Foreign competition would be nice, but we could end up with even MORE ULCC’s bringing levels even further down), then its up to the government to set the minimum service levels…this is what you are seeing happen now, with minimum seat pitch rules, and flyers rights organizations. When one side gets too powerful, there needs to be a correction…and most likely it will come in the form of regulation.

  11. @ADP That’s fair, at least for the 11-13 fortress hubs (depending on how you feel about LGA and JFK being fortress Delta hubs). At min or contested hubs (ORD, LAX, SEA, and non-hubs), it could be game on if airlines wanted it to be.

    Then again, with such a large % of AA flights out of their five fortresses (and ORD), hard to get them excited about BNA, etc.

  12. @joelfreak as noted this is already one of the most heavily regulated industries in the country, it’s why airlines are so protected, more regulation isn’t exactly going to make things better for consumers.

    airports, security, air traffic control are all handled by government. who can fly. their labor relations. handled by government. there’s a dedicated agency which regulates marketing and most industry practices, and at a more strenuous level than most industries (the DOT has far more authority over airlines than the FTC has over other industries).

    what you’re asking for is really less competition — a regulator that becomes a single airline, dictating how all travel happens. that’s the air travel consumer nightmare.

  13. Singapore Airlines is a high cost operator that is hemorrhaging money. Ditto Cathay. Ditto many of the carriers around the world with the ‘best’ service. if any of those even tried to enter the US market with domestic flying (and that’s after all the hurdles are cleared), they would have their lunch eaten by the US carriers as the US carriers have significantly lower costs and could trounce them. People might say they want a better service, but they’ll always go for the lowest fare. and SQ, CX and the like cannot afford that, nor would they necessarily want to enter into a market where they know the hemorrhaging will just accelerate.

  14. Another upvote for Jason’s comment. Look at the fastest growing airlines in Asia – the low cost carriers like AirAsia and Cebu Pacific are crushing the ones with good service. Its sad because many readers of this blog are willing to pay more for better service (I am willing to pay more for better service as well). But 99% of Americans will just go for the cheapest option.

    Doesn’t explain cutting service to high paying customers, however. That part baffles me.

  15. 2 articles on the same article on an issue that affects 1% of fliers. Travel topics must be slim pickings for blogging and ad revenue today.

    Does United offer Economy plus on full fare Y tickets? im curious

  16. Also another note is yes profits are high for airlines right now because of fuel. They need to come up with ways to save money and increase revenue because if they don’t we’re going to have repeat of bankruptcies circa 2000s. But by all means lets criticize a for-profit fortune 500 company for not giving away free stuff they could be earning money for.

  17. I believe your blog mentioned that airlines tend to get skimpy during the “boom” period of the business cycle. Petty policies such as this should indicate that a “bust” is due.

  18. The problem isn’t specifically seat assignments for certain full fare customers. I’m not a full fare customer, and most people aren’t either. The problem is the business model that calls for, well, read Gary’s three points. American, Delta and United are not competing now – they are effectively a cabal working together to consummate their race to the bottom in search of maximizing every nickel in temporary profits. In most markets there is competition, however, and we need to fly Southwest, JetBlue and Alaska for better service; or for those to whom price absolutely matters the most, ignore the Basic Economy scam and fly Allegiant, Spirit or Frontier.

    I’m afraid it is business travelers being loyal to American, United and Delta when they shouldn’t be that props up this model. Gary is simply using the latest announcement by American as a hook for discussing the much broader issues.

    When Doug Parker, whose transition between employers was odd to say the least, openly states in a conference call that the reason United is losing some business with Basic Economy is that American has been a little slower to implement it (cough, wink, hint, cough, wink) – and then within weeks American announces BE will soon be in place on every domestic route plus some international ones, you don’t really need to wonder whether these people are really competing any more.

  19. Please let me know what profit margin in the airlines is acceptable? Is the 10 to 15% they make now too much?

  20. Jason is wrong-

    https://hbr.org/2010/07/the-globe-singapore-airlines-balancing-act

    Ironically, SQ is getting slammed by the other Big 3 bugaboo- the ME3 have a much more convenient hub for most international travelers. Going from the US to China or India or many other business destinations? SQ is going to be a two stop that takes you out of your way. It’s like if a US airlines operated a hub in Mexico City- its just not on your way to anywhere, except for UK – Australia.

    Back to the original thesis- I’d argue that the Big 3 are offering exactly what people want. It’s not like premium flights, free upgrades, and more valuable points have not been tried before- it’s just the airlines make more money doing what they are doing now. I think it was Pogo who said, “we have met the enemy, and it is us”…

  21. Right now, the US airline industry may be the most profitable “broken” business model in the history of the world. 🙂 They made more than $13 billion (with a “b”) last year, and will make more this year. And if the Wall St. estimates are right, they’ll make more next year, too.

    So while the airlines do things that many consumers don’t like, you’re not going to get a lot of support in the financial world by claiming their business model is “broken.” Especially since they used to have a business model that WAS truly broken: the one that caused bankruptcies, layoffs and postponed capital expenditures. You know, the model that probably made Gary Leff happy because he could get lots of perks he didn’t pay for.

    I also think it’s wrong to say that the current industry model is bad for consumers. Everyone likes to complain about the lack of competition and rising airfares, but the problem is that it’s not really true. Oh sure, there are some markets where airfares seem a bit high, but there are also plenty of markets where airfares seem low. Just look at the secretflying website any day and you’ll find crazy good airfare deals. And for those of us playing the credit card game (aka almost everyone reading this blog), the perks are amazing. Oh, sure, maybe it’s not as easy as a UA 1K to snag a free seat up front, but my air travel has never cost me less in my life (thank you Citi, Chase, BoA, Barclays and the others). And I like walking into almost any airport in the world and getting a lounge visit I don’t pay for. So the game changes, and one needs to adapt. But, objectively, I’m not really sure who’s getting “screwed” by any of this right now. Maybe the people who pay high interest rates on their credit card debts? I certainly don’t think that many of your readers are suffering.

  22. @George
    I’m not wrong, and that article is 7 years old. Maybe go reference an article that is more recent, that incorporates their recent financial performance? Yes, SIN is not the best hub location wise, and SQ will increasingly face competition from the ME 3 on many itineraries. but SQ is having trouble competing in the market now that the market has deregulated and carriers such as Tigerair, scoot, malindo, etc are growing. Cathay is getting trounced and just announced their worst performance ever.
    Either way, none of these famous “premium” carriers have the cost structure to compete in the USA market, nor could they ever really enter more than a handful of US markets if the regulations went away because they simly do not have the infrastructure (ie number of planes) to do so. Sure, maybe have a JFK-LAX flight or two. But forget service to the Clevelands, Nashvilles, Louisvilles and St Louises of the world.
    And yes, I do agree with some others – I think it’s kind of ridiculous that a full fare Y ticket on AA doesnt get you a MCE seat, just as years ago I thought it was ridiculous that somebody flying a paid F or J ticket LAS-ORD-LHR ticket on TED connecting to United didnt automatically qualify for Economy Plus. That is grating

  23. “People might say they want a better service, but they’ll always go for the lowest fare.”

    “I’d argue that the Big 3 are offering exactly what people want. It’s not like premium flights, free upgrades, and more valuable points have not been tried before- it’s just the airlines make more money doing what they are doing now.”

    I think this deserves more credit for the current situation. People seem to just want the cheapest travel experience, the carriers cut every frill, and then, when that is miserable, complain about it. It is almost always possible to pay more and get a pleasant experience. Sometimes not very much more (speaking as someone who never pays full fare, but does seek out international discount business class and upgrades.) But it is only a relatively small number of frequent business travelers who seem to value that and pay for it in miles or cash. For those people, in many ways, we are in the golden age of travel (based on experiences in BA first and AF premiere).

  24. Airlines are a capital intensive business, and therefore tend to be run by finance guys, not marketing ones.

    As such, all are trained to cut expenses and maximize ebitda that way. Parker is just running the airline he was trained to run. Luckily for him, Delta ‘innovates’, and he can just copy.

    I don’t blame Jim for doing what he’s doing. It worked for him at AW, didn’t really work for him at USAir b/ft he rest of the industry wasn’t aligned yet.

    However, the lesson he learned is that you can just copy features/bugs of competitors and financially manipulate for the win. The lesson I see (and perhaps Alaska does as well) is that the lone wolf model-wise may have more risk in the short term but much more headroom for profit in as an alternative in good times and as a differentiator in turbulent times (pardon the metaphor).

    I think all US3 are operating as if good times (cheap fuel, cheap money) will never end. Maybe hey are right. They better hope so. Turning he model in a recession is going to whiplash consumers and mystify FP&A departments.

  25. Singapore isn’t going to fly NYC to Miami. That’s hilarious. If it could, Singapore would pick up a few premium routes (e.g., LHR to LAX) and go after the true premium traveler. It has no interest in catering to self-entitled elites, Kettles, and travel hackers.

    Face it. Some of you are lucky that the US airlines still provide a product that can be accessed by laundering gift cards and churning credit cards.

  26. Competition is going to continue the race to the bottom. If you want a standard of service, it will need to be regulated. There is a reason why we have a level of safety in the air today, and its because of regulation, NOT because of competition. Food safety today is also because of regulation. Its not the end of the world if there are some simple minimum seat pitch rules, and rules for baggage, etc. Free market isn’t forcing high quality, which is usually what comes of it.

  27. Asian LLCs like Air Asia, even Lion Air, offer a much better consumer experience than the US full cost carriers, let alone US LCCs.

  28. Did you just say LEGALIZE COMPETITION?!?! In America?!?

    Doesn’t the “free enterprise” and “undo regulations” party control all three branches of government in USA?

    Isn’t it all about ….

    Whoops, sorry. My mistake.

  29. American’s “hate selling” approach has become so odious, and its inflight product so bad, that even when the headline fare using popular search engines (e.g., google flights, Kayak) or online travel agencies (orbitz, priceline, etc.) shows fares lower than its competitors, I still don’t even CONSIDER that airline as an option when booking trips for myself and the many friends and family members who ask me for advice, or for whom I book their trips — especially since the whole process itself of booking flights has become so intentionally muddled, tedious, and downright unpleasant in the name of sucking ever more money out of passengers’ pockets through the confusing array of never-ending bs fees and other add-ons.

    As someone with many years of professional experience booking flights for corporate and personal clients as a travel agent; who has written extensively about the industry in the past; and who has also provided cutting edge research that redefined significant aspects of publicly-owned passenger terminal and cargo facilties at JFK and LaGuardia Airports in NYC financed in part with NY State Industrial Development Agency (now Empire State Development) funded projects, I am able to view issues from many sides/perspectives, be it as a consumer from personal experiences; assisting others’ and their varying needs/experiences/problems that emerge during their journeys; or from within the finance department of one of the world’s premier airlines itself.

    I also worked on Wall Street for four years at one of the best known firms where I scored among the top of my training class on the Series 7 & 63 exams — so the relentless pressure to meet quarterly analysts’ expectations is certainly understood as well.

    Problem is, the pendulum has now swung too far in the other direction from where it was during my days working at an investment firm (1989-93) when two former giants within the industry failed (Eastern, Pan Am) and several others (TWA, Continental, America West) filed for Chapter 11 bankruptcy protection, to three large legacy network carriers (American, Delta, United) plus Southwest, and the resulting Oligopoly we now have.

    Fact is, for the predominant group of travelers, or those who fly often for business and who’s needs require the type of schedules and destinations that only the largest three airlines, American, Delta and United, offer, their options are by and large limited to these three carriers if they (or the company they work for) is based in the nation’s two largest cities, Los Angeles and New York where no single airline has a stranglehold in those markets (yet). And their options become progressively fewer from there, with Chicago offering a “choice” between American and United for companies requiring international travel, or perhaps broadens to include Southwest from Midway Airport if international destinations and cities that rely on regional jets is not required so much. Otherwise, even in a market as large — and lucrative for its concentration of corporate and other high income travelers — as Chicago, there’s just two of the three largest airlines to choose from for the vast majority of high-fare paying fliers.

    From there, more often than not, it’s a no-choice choice (aka monopoly) situation in places like Atlanta, Detroit, Miami, Minneapolis/St. Paul, Philadelphia, Salt Lake City at these fortress hubs, or a limited competition between one of the big three, and a smaller competitor that offers fewer destinations, less schedule frequency, or both, such as Dallas, Denver, Houston, Phoenix, and San Francisco.

    Sure, those seeking to deflect attention from the predominance of an oligopoly in the airline industry will hyperventilate about the Ultra Low Cost Carriers (Allegiant, Frontier, Spirit), but that’s a smokescreen.

    High-yield business travelers, and those who are affluent enough to fly more than once or twice a year, seldom fly on any of the ULCCs, and unless their travel is largely confined to routes that either Alaska Airlines (and Virgin America) or Jetblue fly that have the frequency American, Delta or United offer, by and large its just a choice among the big three airlines at best, maybe two of the three sometimes (if they’re lucky), and pretty much no choice at all in places like Atlanta, or the other fortress hub cities where one airline has a lock on the market.

    With barriers to entry exceptionally high, such as simply meeting a “fitness test” to obtain a license to operate from the government, let alone finding gates, take-off and landing slots at key airports, leasing aircraft, IT, hiring and training a workforce, just to name a few things to before the first flight gets off the ground, the big three have little incentive to compete, and instead, as most reasonable minds will agree based on both their own personal experiences, and the overall classic textbook examples of how businesses behave with limited competition, or more commonly known as oligopolies.

    How long the airlines and their well-paid armies of consultants and lobbyists can continue to successfully bluff their way through this to ward off governmental intervention is unknown.

    Personally, I would much prefer to see new entrants emerge that bring these clearly abusive and arrogant big three their well deserved comeuppance instead of having the government step in.

    And I don’t regard ANY of the ULCCs as being the ones likely, or even capable, of being the ones to bring about the desperately needed change. In fact, without naming names, there’s one airline in this group of ULCCs that is on my “no fly list” due to its extensive and years long list of widely reported safety lapses/incidents.

    Hopefully, recent published reports here in the VFW universe (and elsewhere) that David Neeleman, founder of Morris Air (which was acquired by Southwest), and perhaps better known as the founder of Jetblue (and another airline, Azul, in Brazil) filed papers and a “help wanted” ad in a trade publication for a start-up will result in a well-funded, well managed, new entrant that will inject some life into this moribund gang of three who could care less about even trying to offer anything resembling value for their passengers’ money.

    As long as planes are packed (as we all know they are), options are limited, and there’s practically no need to offer anything more than to open the door, and pack ’em into teeny-tiny seats because there’s nobody else out there competing for business…and as long as the big three can wink and nod at each other through quarterly analysts’ calls about dealing with “competitive” dynamics using words like “capacity ‘discipline'”, then the situation will not only remain as horrible as it is now for most passengers, it will likely get even worse…

  30. The right type of regulation benefits consumers.

    Airlines, as I predicted, are now victimized by their own success. Earning a profit means only that Wall Street expects airlines to earn bigger profits each quarter. How the airlines respond to those expectations is the test of a sustainable business model. So far the Big3 have shown no imagination.

  31. @john “the right type” of airline regulation is like saying ‘I would like to have a cat, provided it barked’ — we get the kind of airline regulation we do for a reason.

  32. Not entirely on point, but I just got off a call to AA Exec Plat desk trying to change a business class flight to CDG for one to Lyon to make an upscheduled meeting there, and was quoted a price of 2k! – even after offering to fly coach. The same coach flight (on BA) is currently available for $125 one way on BA’s website, but if I take that I lose my return reservation incurring who knows what penalties. This type of punitive/avaricious pricing does not endear either airline to me (the agent tried hard, checking twice with her backroom operation) . Any suggestions welcome.

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