NCPA - National Center for Policy Analysis

Airlines Face Unique Business Challenges

October 11, 2001

Even in the best of times, airlines must engage in a supply/demand balancing act unlike business challenges facing almost all other industries, experts point out. While the industry is not exceptionally profitable, it can make reasonable returns.

But the terrorist hijackings of Sept. 11 have turned the past month into a complete disaster. In the words of Pablo Spiller, an economist at the University of California at Berkeley: "You have not seen a reduction in demand like this ever. This is a cataclysm."

Of course, the airlines had already been struggling to overcome the effects of the economic downturn of the past year. Here are some of the considerations commercial carriers confront in order to cope in lean times:

  • The essential problem is matching capacity with demand -- which is a more difficult problem for airlines than for manufacturers in general.
  • That's because seats are their inventory and when a seat flies empty, the revenue is lost forever -- unlike manufactured products which can be stored on shelves and sold when demand picks up later.
  • For a given flight, the costs of fuel, labor and the aircraft itself are essentially fixed -- regardless of how many passengers the plane is carrying.
  • When their load factors drop, airlines tend to get into fare wars in order to fill up planes and cover those fixed costs.

Economists report that since 1978, when federal price and route controls were removed, airlines have endured several business cycles and have gradually learned to cope and survive down cycles.

But the past month has been unlike anything they have ever seen.

Source: Virginia Postrel (Reason magazine), "Economic Scene: Even in Good Times, Airlines Depend on a Hairline Balancing of Supply and Demand," New York Times, October 11, 2001.

 

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