Maintaining profitability in the airline industry

My students have been tackling this assignment this week as part of their microeconomics course.

(a) Many airlines have reported heavy losses and several have already gone into administration or filed for bankruptcy. Using cost and revenue diagrams, explain why airlines have been experiencing such losses (15)

(b) Discuss the ways in which airlines can control their losses and continue to operate profitably in an industry where costs and revenues are unpredictable (15 marks)

Answers to part (b) sort the wheat out from the chaff!

Better answers have considered:

1/ Intensive use of airline revenue (yield) management including using convertible seats so that planes are filled (high load factor) with the most profitable passengers. This argument allows students to apply concepts such as price elasticity of demand and consumer surplus to good effect when discussing price discrimination.

2/ The “urge to merge” or sign up to alliances between carriers - the attempt by BA to link up with American Airlines is a good example of this and the stronger answers developed their evaluation by considering the competition policy concerns - including Virgin Airlines’ attempt to block the move.

3/ Investment to improve fuel efficiency - FlyBe is often cited as a business that has reaped the rewards of investment in new aircraft with lower fuel consumption per kilometre flown

4/ Attempts to diversify revenue streams - including a shift towards air cargo services

5/ Shutting down destinations within hub and spoke networks (i.e. closing some loss-making routes)

6/ Reducing the volume of flights on certain routes - i.e. fewer flight departures (evaluation might consider the effect of this on the average fixed costs of airlines)

7/ Introducing greater flexibility into employment contracts - changing the balance of labour costs between fixed and variable costs (but redundancies also cost money)

8/ Departing from profit-maximisation strategies towards a mixture of pricing strategies designed to improve cash-flow and boost total revenue. In a recession and facing a barrage of demand and cost shocks, a narrow focus on profit maximisation can give way to pricing policies geared to the survival of the business in the near-term

9/ Variable fuel surcharges .... good answers looked again at the risks of collusive behaviour where fuel surcharges are concerned.

10/ More extensive use of hedging in the international crude oil markets (evaluation might stress the risks of doing this).

Any other ideas?