The TRUTH! - Capacity not Cost The Problem.

RV4

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By Michael Kinsman
UNION-TRIBUNE STAFF WRITER
March 15, 2003
The chairman and chief executive of Continental Airlines said yesterday that the friendly skies might be a little friendlier with fewer competitors.
Right now, our industry has an overcapacity of seats, Gordon Bethune told a meeting of business leaders sponsored by the University of San Diego''s School of Business Administration. I don''t think the consumer would be inconvenienced by the failure of an airline today.
Bethune said his own airline and others stand ready to fill in the gaps should United Airlines fail to climb out of bankruptcy or American Airlines or others have trouble surviving.
Earlier this week, the Air Transport Association, a trade group for major airlines, predicted that an economic slowdown, rising fuel prices and potential fallout from a war in Iraq might cause domestic airlines to lose as much as $10.7 billion this year. The group also predicted that 10 percent of daily flights would be cut and up to 70,000 airline jobs eliminated.
UAL Corp., parent company of the nation''s second-largest airline United, sought Chapter 11 bankruptcy in December, and No. 1 American Airlines has suggested it may soon have to seek bankruptcy protection as well.
If United disappears, I''m sure Continental, Delta, Northwest or others will be ready, Bethune said. Don''t forget we''ve got laid-off workers just waiting for this to happen and planes sitting idle in the desert.
Michael Boyd, an airline analyst in Evergreen, Colo., said he agreed with Bethune''s assessment.
His logic is impeccable, Boyd said. Since 9/11, air travel is down about 15 percent nationally, which is about the market share that United has. And, certainly, other airlines will be quick to pick up that slack if United goes out of business.
But Boyd is concerned that smaller markets such as Redding, Calif., and Bend, Ore., that depend only on United will be the real victims.
That''s where people will be hurt, Boyd said. We''ll have to depend on other airlines moving into those cities.
Reint Reinders, president and chief executive of the San Diego Convention & Visitors Bureau, said the airline industry is simply adjusting to a period of fast growth.
In ''98, ''99 and 2000, the airlines were ramping up, he said. It was going crazy. I fly a lot, and when I flew then all of the planes were full. The airlines were all trying to get a share of that.
Yet, he said when the business downturn of 2001 met up with the fallout from the Sept. 11 terrorist attacks, the industry began crumbling.
Bethune said the airline industry now has 15 to 18 percent more capacity than it needs, which means that almost all carriers are losing money. Continental lost $451 million in 2002.
If an airline were to fail today, he said, others are ready to fill the void with a minimum of route adjustments.
I don''t think we would miss an airline today any more than Eastern, Braniff, Pan Am or TWA, he said. Nobody was inconvenienced when those went away.
 

Bob Owens

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Is the problem capacity or yield?
How much different is the load factor now compared to two years ago? We have to remember that the industry cut capacity shortly after 9-11.
I remember looking at figures on load factors a while ago and noticing that it did not vary as much as profits did. I'll have to see if I can locate those figures again. I dont think the problem is too many seats but rather too little money for the seat. While excess capacity may affect yield if the load factors today are comparable to those during profitable times that means there are other reasons for the lack of yield.
 
Saying cost is not the problem is like saying Saddam's chemical weapons are the problem, not his track record of torturing his own people, or aggression towards his neighbors...

Capacity, yield and cost are all problems.

Yields are trashed for a lot of reasons, and UAL is a pretty good contributor. They account for about half the seats on the opaque market (Priceline, Hotwire, Orbitz). LCC's are the other. Customers won't pay a lot for their travel, and that's not going to changes.

Having one of the bankrupt carriers shut its doors will eliminate some of the excess capacity that's out there today, but it won't change the fact that profit margins with the current cost structure are too slim even in the best of times.

20 years ago, PeopleExpress was flying people transcon for about $199 round trip. Today, prices in that same range still exist, except that the costs associated with a transcon are probably 20% higher if not more.

If we didn't have a cost problem, crappy yields, and too much excess capacity on all sides, maybe our margins would be on the order of JetBlue, who is posting 17% margins.

But we do have a cost problem, we do have crappy yields, and there is too much capacity. We could probably fix any two of the three, but I don't see all three being fixed without eliminating a lot of excess capacity across the board, a shift in the economy, or a change in how much it costs to produce what we sell. AMR only controls one of those.
 

kirkpatrick

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[blockquote]
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On 3/17/2003 8:49:19 PM Bob Owens wrote:

Is the problem capacity or yield?----------------
[/blockquote]

I agree with you. In the 31 years I've been in this business load factors have remained about the same; upper 60's to about 70%. The reason is simple: any higher and the passenger has trouble finding a seat at the time he wants, any lower and you obviously have too many seats in the sky, so schedules are cut.

SW and JB don't really carry any higher loads than we do, they just do it more cheaply.

Costs and yields are the problem.

MK
 

kirkpatrick

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[blockquote]
----------------
On 3/17/2003 10:10:46 PM eolesen wrote:


Having one of the bankrupt carriers shut its doors will eliminate some of the excess capacity that's out there today, but it won't change the fact that profit margins with the current cost structure are too slim even in the best of times.

----------------
[/blockquote]

I agree with the second half of the above statement, and with the first only temporarily.

If UA goes Chapter 7, the remaining carriers will quickly fill the gap, getting a windfall for a few short months. Any market with high load factors will get more flights, and a year later the loads will be the same. You'll have one fewer contender out there and the rest will be slightly bigger.

MK
 

JS

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Bethune could volunteer and shut down Continental. Why wait?
 

WXGuesser

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[blockquote]
----------------
On 3/18/2003 8:38:59 AM Bob Owens wrote:


Then they need to simply change the prices because for $20 someone is not going to cancell their trip or take the red eye, they may fly someone else but then again they may not. $20 is less than the cab fare or long term parking. Lets get real here, what is the number to break even and if we start charging it are our planes going to be empty and everyone elses full? What about the routes where we have the best slots or better facilities? Hey if everyone was only willing to pay the lowest fares then why do we have business and first class seats at all? Less crowded planes are a selling point in theselves.If they are running at 70% or more of a load factor they cant take everyone.How many would really switch for $20? Assuming of course that its even that much?

----------------
[/blockquote]

Yes, they would switch.

Lesson in basic economics: People will not pay more than they have to. It is the fundamental fact behind supply and demand.

I prefer to fly AA not just because I used to work there but also because of MRTC; I get to my destination feeling better than trying to wedge myself into the sardine cans other airlines call seats. But, if the price difference is $20, I might think twice.

$20 is a lot of money. I can make lunches for myself for a week on $20. I can buy enough gas to get back and forth to work for a week and a half. $20 makes the difference between paying a bill and not paying a bill sometimes. You have to remember that for the vast majority of the American Public, $20 is significant.

Yes, a goodly chunk of the airlines' revenue problems would be greatly improved if everybody raised prices across the board by $20. But everybody's not going to do that, and they can't even try to make an agreement to do that (Ask Bob Crandall about that one). If only some did that, and others didn't, you would see those 70% LFs go up for the ones that didn't.

It's really very simple.

TANSTAAFL
 

Hopeful

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I rememeber Frank Borman dismissing the threat of People's Express saying that passengers would pay the extra $$$$ to fly Eastern and other "Brand Name" carriers. Another great miscalculation on Airline Management's part. Eastern's management holds the all time record for bad decisions starting with Eddie Rickenbacker passing on entering the jet age claiming it was a passing fad!
 

Bob Owens

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Sep 9, 2002
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[blockquote]
----------------
On 3/17/2003 10:10:46 PM eolesen wrote:

Saying cost is not the problem is like saying Saddam's chemical weapons are the problem, not his track record of torturing his own people, or aggression towards his neighbors...

Capacity, yield and cost are all problems.

Yields are trashed for a lot of reasons, and UAL is a pretty good contributor. They account for about half the seats on the opaque market (Priceline, Hotwire, Orbitz). LCC's are the other. Customers won't pay a lot for their travel, and that's not going to changes.

Having one of the bankrupt carriers shut its doors will eliminate some of the excess capacity that's out there today, but it won't change the fact that profit margins with the current cost structure are too slim even in the best of times.

20 years ago, PeopleExpress was flying people transcon for about $199 round trip. Today, prices in that same range still exist, except that the costs associated with a transcon are probably 20% higher if not more.

If we didn't have a cost problem, crappy yields, and too much excess capacity on all sides, maybe our margins would be on the order of JetBlue, who is posting 17% margins.

But we do have a cost problem, we do have crappy yields, and there is too much capacity. We could probably fix any two of the three, but I don't see all three being fixed without eliminating a lot of excess capacity across the board, a shift in the economy, or a change in how much it costs to produce what we sell. AMR only controls one of those.
----------------
[/blockquote]

Nice little flag waving. I dont see the connection.

The fact is that we are giving away our services. Customers wont pay more if they dont have to but if people have to go somewhere they will pay. Lets face it air travel has been on an overall increase for 50 years. Prices had dropped at a steady rate all through the deregulated era as more and more people flew. The rate at which people flew did not rise precipitously after deregulation, however ticket prices varied greatly, even on the same flight. I beleive this was called "Yield management". Some enjoyed extremely low fares while others were raped. The fact is that costs per ASM have also continued to decline but sometimes not as fast as ticket prices. When the airlines talk about increased costs , increased by what measure? Instead of all the focus on costs we should also be looking to see exactly how much ticket prices must go up to break even. What is the number? Is it $1000 per seat? Well then obviuosly we need to cut costs. Is it $20 per seat? Then they need to simply change the prices because for $20 someone is not going to cancell their trip or take the red eye, they may fly someone else but then again they may not. $20 is less than the cab fare or long term parking. Lets get real here, what is the number to break even and if we start charging it are our planes going to be empty and everyone elses full? What about the routes where we have the best slots or better facilities? Hey if everyone was only willing to pay the lowest fares then why do we have business and first class seats at all? Less crowded planes are a selling point in theselves.If they are running at 70% or more of a load factor they cant take everyone.How many would really switch for $20? Assuming of course that its even that much?
 

FWAAA

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Jan 5, 2003
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Apparently Bob Owens slept thru or didn't take economics 101.

If they could raise fares $20, why not raise them $50?

Wouldn't that be even better??
 

Bob Owens

Veteran
Sep 9, 2002
14,274
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[blockquote]
----------------
On 3/18/2003 9:21:07 AM WXGuesser wrote:

Yes, they would switch.

Lesson in basic economics: People will not pay more than they have to. It is the fundamental fact behind supply and demand.

I prefer to fly AA not just because I used to work there but also because of MRTC; I get to my destination feeling better than trying to wedge myself into the sardine cans other airlines call seats. But, if the price difference is $20, I might think twice.

$20 is a lot of money. I can make lunches for myself for a week on $20. I can buy enough gas to get back and forth to work for a week and a half. $20 makes the difference between paying a bill and not paying a bill sometimes. You have to remember that for the vast majority of the American Public, $20 is significant.

Yes, a goodly chunk of the airlines' revenue problems would be greatly improved if everybody raised prices across the board by $20. But everybody's not going to do that, and they can't even try to make an agreement to do that (Ask Bob Crandall about that one). If only some did that, and others didn't, you would see those 70% LFs go up for the ones that didn't.

It's really very simple.

TANSTAAFL


----------------
[/blockquote]

Ok Mr Economist;
Explain the theory behind First and Business class seats, Gucci bags, Tiffany's vs Wal Mart. Mercedes vs Volkswagon. Explain people paying money for Pet Rocks and Tickle Me Elmo toys. Sometimes demand does not follow rational thought and consumption is not always driven by need. The fact is there are many factors that determine consumption patterns. Not just price. The FACT is that the vast majority of people do pay more than they have to most of the time. While price may be a factor it is not the sole factor.
 

Hopeful

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Referring to today's news, JetBlue will start JFK to San Diego service. So AA charges $20 more per ticket than Jetblue, you don't think AA will lose passengers to JBLU?
 

WXGuesser

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Aug 20, 2002
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[blockquote]
----------------
On 3/18/2003 9:53:40 AM Bob Owens wrote:


Ok Mr Economist;
Explain the theory behind First and Business class seats, Gucci bags, Tiffany's vs Wal Mart. Mercedes vs Volkswagon. Explain people paying money for Pet Rocks and Tickle Me Elmo toys. Sometimes demand does not follow rational thought and consumption is not always driven by need. The fact is there are many factors that determine consumption patterns. Not just price. The FACT is that the vast majority of people do pay more than they have to most of the time. While price may be a factor it is not the sole factor.

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[/blockquote]

Simple idea: Quality vs. adequacy.

First and business class seats vs. Coach, Tiffany vs. Wal-mart, Mercedes vs. volkswagen, etc.. are all comparisons of Quality service vs. adequate service.

El Cheapo handbags hold things as well as Gucci, but might not last as long or look as good. I can make similar comparisons for the others, but I will simply jump right to the airplane example.

First Class or business versus coach is a quality choice. Used to be you get better meals, even more room, etc. in those areas. So people who *can* pay a premium price will do so. Plus, first class has become a way to reward those people who are loyal to your product (Frequent Flier Upgrades). But for those people who who are merely looking for adequacy (i.e. MOST of your customers) a seat on airline A isn't that much different from a seat on airline B, as long as it gets you where you want to go. So, when comparing equals, price is the most serious concern. The public sees most airlines in the "a seat is a seat" light. If people have a reason to believe they are getting quality service, they will pay more. But if they do not see a difference in service, they will go with the lower price.

Don't ask me to explain Pet Rocks and Tickle Me Elmos... That's marketing and right now we are trying to struggle through basic economics.

TANSTAAFL
 
OP
R

RV4

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Load Factors are not proof of profit or loss!

Over capacity creates strong competition for customers.

Which leads to lower yields.

Which leads to lower profits.

Which leads to cost problems.

Is it rocket science where the problem begins?
 
[blockquote]
----------------
On 3/18/2003 8:38:59 AM Bob Owens wrote:

Nice little flag waving. I dont see the connection.

[/blockquote]

Try harder. We're not in the situation we are today because of a single factor or event. There are multiple factors which have resulted in a very deep hole that we have to climb out of.

[blockquote]
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On 3/18/2003 8:38:59 AM Bob Owens wrote:

How many would really switch for $20?

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[/blockquote]

On the typical airfare today, $20 is 5 to 10% more.

I don't willingly pay 5-10% more for anything. Most people don't. I'll drive an extra mile or two to save $0.03 per gallon on gas, even if it means waiting in line.

You're out on the east coast -- how many mom and pop hardware stores are out of business because Home Depot charged a few bucks less for the same product?

How about the regional chains like Pergaments which also tried not to match HD's prices? How are they doing these days?...

More specific: how many $10 and $20 fare increases have failed in the past three years?

People simply aren't paying for quality anymore. That's why you see things like first class disappearing in long haul markets, and a growning percentage of the US market. That's why cruise lines are becoming increasingly "family friendly" rather than catering to lifestyles of the rich and crusty.
 

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