Airlines must take a variety of factors into consideration when making strategic decisions related to cost-benefit analyses of flight schedules (Carbonneau, 2005). The hub-and-spoke model utilized by airlines leads to competitive advantages, such as an increased number of flights available from the hub, allowing customers more flexibility if they need to change flights at the last minute (Nannes, 2000). Burghouwt, Lieshout, & Veldhuis also point out that the hub-and-spoke model creates economies of scale for the airline (2008), spreading costs across a larger number of flights. Additionally, transcontinental airplanes could be considered specific assets (Brickley, Zimmerman, & Smith, 2009); a cost analysis must take into consideration the next available alternative—which would preclude small, local flights. Additionally, airplanes required for international or transcontinental flights out of Washington, DC, must arrive from some other location. Keeping a full schedule of flights makes the airline more attractive to potential customers and can serve as a reputational barrier to entry, keeping other airlines from entering that market (Grimm, Lee, & Smith, 2006).
As part of a cost analysis of flights flown by United Airlines from San Francisco to Washington, DC, an article in the Wall Street Journal concluded that United Airlines was losing money on each flight and recommended United Airlines cancel them. The WSJ analysis included costs of labor, fuel, and food per individual flight, as well as factoring in airport-based costs. In a complex industry like the airline industry, this simplistic form of analysis fails to consider all relevant aspects of the market environment.
The airline industry is oligopolistic, meaning there are relatively few players (Renard, 2004). It is common for these players to anticipate potential responses of competitors when making strategic decisions, in order to make allowance for those potential or likely responses. This creates a level of interdependence unknown in industries with a larger number of competitors in a more pure competitive pricing environment.
The airline industry developed the hub-and-spoke model following the deregulation of the industry in 1978. An airline builds up service at a strategic metropolitan location and offers a large number of flights from that location for local travelers as well as for those traveling through from another location. This allows the airline to offer a much larger number of flights daily from that location then would be available with a basic point-to-point model (Burghouwt, Lieshout, & Veldhuis, 2008). Offering flexibility of schedule, which includes the option for travelers to change flights if needed, gives the airline a competitive advantage (Nannes, 2000). Additionally, the airline will benefit from economies of scale, spreading fixed costs across a much greater number of flights. Airlines also offer frequent flier programs and other incentives to encourage business travelers, especially, to use only one airline (Carbonneau, 2005).
Calculating costs associated with one particular flight and comparing it with the revenue received from tickets sold on that particular flight no longer makes sense when considered within this model. An analysis of a flight must take into account the strategic advantage gained by offering a particular flight in a schedule, even if that particular flight does not fill to capacity. Many customers—business travelers, especially—will choose an airline based on the number of alternative flights from one destination to another (Carbonneau, 2005). The cancellation of that particular flight could lead to customers deciding to use a different airline, instead. Thus, some of the benefits of offering the flight cannot be tallied in a simple way. Many potential customers will actually be traveling from an international location through San Francisco to Washington, DC, or from San Francisco through Washington, DC, to international locations. Some segments of the trip might more than make up for any revenue loss on the SFO to IAD leg.
The concept of specific assets—those that are utilized for a particular purpose—must also be taken into consideration when analyzing airline strategy (Brickley, Zimmerman, & Smith, 2009). Certain airplanes are used for larger numbers of people and longer distance travel. Many of the planes used to fly from coast to coast or to international destinations cannot be substituted for those handling local routes. Added to these constraints is the necessity of ensuring the correct model of airplane arrives at another location where it is required. Put simply, a cost-analysis must consider what the next best use would be for the type of aircraft that travels from San Francisco to Washington, DC. It also must consider what flights will fly out of Washington, DC, requiring that type of aircraft. If the subsequent flight generates high revenue, this factors into the airline’s cost-analysis of the prior flight.
Reputational effects must also be taken into account. This can mean that United’s reputation for market share at the San Francisco hub as a whole serves to deter potential competitors from entering the market, raising a high entry barrier (Grimm, Lee, & Smith, 2006). In addition, reputation can influence customer choice. If an airline cancels all flights to a specific destination out of a major hub, it will limit customer choice—potentially leading customers to switch to other airlines and their frequent flier programs. It could signal weakness as well. This weakness could affect demand or it could affect whether or not other airlines attempt to enter that market.
Clearly, analyzing strategic decisions made in the airline industry is complicated and must take into account a wide variety of factors.
Brickley, J., Zimmerman, J., & Smith, C. W. (2009). Managerial economics and organizational architecture (5th ed.). McGraw Hill-Irwin. Retrieved from www.mhhe.com/brickley5e
Burghouwt, G., Lieshout, R. & Veldhuis, J. (2008). Competition between hub airports: the case of Amsterdam Schiphol Airport. Paper for Air Transport Research Society 2008 Conference. Athens, Greece. http://www.airportmediation.org/jart/prj3/armcc_airportmediation/uploads/dbcon_def-uploads/NEUBAUER/AMS/AMS_/AMS_Competition_between_hub_airports_the_case_of_Amsterdam_Airport_Schiphol.pdf
Carbonneau, S. (2005). Three essays on competition and market power in airlines’ hub-and-spoke networks. (Doctoral dissertation.) Retrieved from University of Texas Libraries Digital Repository. (Accession number 2013-08-05T21:32:47Z) http://repositories.lib.utexas.edu/handle/2152/20993?show=full
Grimm, C., Lee, H., & Smith, K. G. (2006). Strategy as action: Competitive dynamics and competitive advantage. New York, NY: Oxford University Press. Retrieved from http://books.google.com/books?id=mszfxEtxSIcC&printsec=frontcover&source=gbs_ge_summary_r&cad=0#v=onepage&q&f=false
Nannes, J. M. (2000). Statement before the Committee on the Judiciary, House of Representatives, Concerning Airline Hubs and Mergers. Washington, DC. Retrieved from http://www.justice.gov/atr/public/testimony/4956.htm
Renard, O. (2004). Modelling airline competition. Presented at the ANU/NECG Conference on the Performance of Air Transport Markets. Sydney, Australia: Network Economics Consulting Group.