175-An Update on Cutting Capacity to Raise Prices

Several months ago, we wrote a blog (See Blog Here) that noted the capacity reductions in the airline industry. In particular, the large legacy airlines were reducing their capacity in order to raise industry pricing. At the time, this effort was showing relatively little help with industry pricing.

As part of this original blog, we noted that there was a problem with the withdrawal of capacity in order to force prices up. The problem is expansion of capacity by low cost competitors. We explained that we had seen many cases in other industries where industry leaders reduced capacity to force industry prices up, only to be stymied by the addition of capacity by low-cost competitors.

Well, some new numbers have shown that the same thing is happening in the airline industry. AirFinancials.com has measured the change in domestic capacity of the airline industry between 2003 and 2009. The four largest legacy carriers, Delta, American, United and U.S. Airways, reduced their available seat miles, the best measure of domestic capacity, by 85 billion miles, a 21% average reduction. However, during the same period of time, low-cost competitors, including Southwest, JetBlue, AirTran and four other smaller carriers, added 84 billion available seat miles to their capacity. (See the Symptom & Implication, “Foreign competitors are expanding with low prices” on StrateyStreet.com.) So the legacies reduced capacity by 85 billion and the smaller, low-cost carriers, added 84 billion. The industry’s total capacity dropped by 1 billion available seat miles, far less than demand has fallen over the last year. Price competition and low industry returns continue.

The legacy carriers are shrinking away their network and scale advantages to the low-cost carriers. The low-cost carriers are more than happy to replace the capacity that the legacy carriers drop. (See the Symptom & Implication, “Some competitors are using growth to reduce their costs” on StrategyStreet.com.) Bad news for the legacy carriers.

Posted 3/15/10

Update:

By 2019, the top four domestic air carriers (American Airlines, Southwest Airlines, Delta and United Airlines controlled 65% of the total domestic market. Their market power was greater than this percentage because these carriers held even higher shares of their key hubs and spokes. In recent years, these four major airlines removed unprofitable flights, filled a higher percentage of seats on planes, and slowed capacity growth to command higher airfares. Airline capacity has grown at a slower pace than ticket prices. In addition, since 2008, the airlines have charged ancillary fees for services that were formerly free.  The four major carriers finally achieved significant pricing power in their markets.

Hostility ended in the airline industry when the four largest carriers gained control of a significant majority of flights, especially those flights to and from major airports. See HERE for more perspective.

9/22

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