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Price Leaders Against Standard Leaders in Troubled Times

For once, the airline industry Standard Leaders, the legacy airlines seem to be improving their positions compared to the Price Leaders, the discount airlines. In our system of analysis, a Standard Leader is a competitor, or one of several competitors, or products that set the standard for performance and price in an industry. A Price Leader is a competitor, or product, that offers below industry-standard performance for a very low price. So far, none of the legacy airlines has gone back into bankruptcy. On the other hand, a number of Price Leader discount airlines have failed, including Frontier Airlines and Skybus Airlines. What has happened? Three things.

First, the bankruptcies of the legacy carriers helped those companies drastically reduce their high costs. Some analysts have noted that the difference in operating margins of the Price Leader discounters and the Standard Leader legacy carriers is only 2% today, down from 7% five years ago. A 5% cost advantage is not much in the way of a Price Leader’s low cost structure, which it needs in order to offer its lower prices and attract its customer segment.

In order to succeed over a long period of time, discounters always must offer a significant discount on a product that is “acceptable” in the market, if not as good as the Standard Leader product. In order to offer the substantial discounts, Price Leader competitors must have a lower cost structure. In turn, this lower cost structure is largely the result of the discounter offering fewer benefits than the Standard Leader product. We have done extensive analyses on these Price Leader companies. Our research suggests there are two separate types of Price Leaders who follow somewhat different business models (see the Perspective, “Turmoil Below: Confronting Low-End Competition” in StrategyStreet.com).

Second, the legacy carriers have begun selectively competing with the discount carriers on price. In many markets, the legacy carriers offer prices that are within reach of those of the discount airlines. (See the Symptoms and Implications, “As large competitors match low prices other competitors face difficulties” on StrategyStreet.com.) In most markets, a successful Price Leader needs to offer a discount of 25% or more on its product in order to grow significantly at the expense of a Standard Leader.

Third, the discount airlines’ natural market is shrinking during these troubled times. In fact, the airline industry in general is shrinking, as measured by revenue passenger miles flown. However, the discount airlines carry a higher proportion of price-sensitive leisure travelers. This market segment is off a good deal more than is the business traveler segment, which makes up a higher proportion of the legacy airlines’ customers.

Even though today’s airline industry is seeing the discounter product become more like the legacy airlines’ product, and vice versa, these discounters still need to offer a notably lower price than do the legacy carriers. That seems to be more difficult these days.

Posted 10/9/08

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