9-Postponing the Real Clash

Delta recently announced that it was trimming its domestic capacity and shifting that capacity to international flights. It will cut its domestic capacity by about 5%, which will bring its capacity in August of 2008 to a level 10% below that of one year earlier. United Airlines did something similar earlier in the year.

In the short term, this will help these two legacy airlines’ margins because international passengers pay more per available seat mile than do domestic passengers. In the long term, the benefits are considerably less clear because of the encouragement these moves offer to the low-cost airlines.

By withdrawing capacity from the domestic market, Delta and United create more opportunities for the expansion of low-cost and low-priced airlines, such as Southwest and Jet Blue, among others. In most industries where the industry leaders withdraw capacity in order to shore up margins, other industry followers, especially low-cost followers, expand at least by enough to make up for the withdrawal of the leader’s capacity. Usually they expand even faster than the leaders withdraw capacity.

Then what happens? The low-cost carriers become even stronger because they expand where they can produce a cash return on their marginal investments. They then become more formidable competitors for the higher margin business as well. These low-cost people are not going away.

Further down the road, there will be an inevitable clash for higher-margin passengers, such as business travelers, between the legacy airlines like United and Delta and the low-cost airlines. When that clash comes, those low-cost airlines will be stronger. It is difficult to predict a winner in that clash.

For an example of how these things happen, consider this: Toyota and Honda began as low-cost, low-priced players in the domestic automobile industry. Early in the history of the entrance of the Japanese manufacturers into the US market, the large US auto manufacturers considered them inferior competitors and refused to introduce automobiles that would compete with them directly. The leading Japanese companies then used their profits and cash flows from their small automobile offerings to expand into the heart of the US automobile market. Today, none of the domestic automobile manufacturers can take on these companies and expect to prevail. Leaders need to stop low-cost competitors earlier, rather than later, in their evolution.

Posted 4/3/08

Update

A leader in an industry cannot successfully remove capacity and raise prices unless it can control any potential new entrant. The airline industry could not control these new entrants and low prices continued pressuring the industry. The removal of capacity did little to help the large airlines. Industry prices continued to fall throughout 2008 and 2009. Industry returns were dismal.

The two best consultants in the world have spoken. Southwest is a preferred competitor offering many flights at prices competitors apparently cannot, or will not, meet.  By 2020, Southwest was the far-and-away leader in domestic passengers, 20% to Delta’s 16%.  In revenue passenger miles American, held a slight lead over Southwest.  SWA continued to maintain a cost and all – in pricing advantage over its legacy rivals.

We have found that there are four basic Price Points in a market. You can find an explanation of each Price Point and its impact on a market HERE.

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THE SOURCES OF STRATEGYSTREET.COM: For over 30 years we observed the evolution of more than 100 industries, many hostile.  We put their facts into frameworks applicable to all industries and found patterns.  Strategystreet.com describes the inductive results of these thousands of observations and their patterns.