Originally Posted by rickair7777
The $ of tickets is driven by overcapacity and SWAs fuel hedges, in that order. Let's look at a couple of examples of businesses operating in a non-profitable market to see why:
Fixed Cost= overhead business related costs that are always there regardless of the amount of product produced (ie factory/office rental, admin staff, lights, HVAC, etc)
Variable Cost= Cost incurred ONLY while actually producing the product (factory labor, energy, raw material, shipping, equipment maint.)
Total Cost of product= Fixed + Variable (ideally you can sell your product for MORE than total cost to make a profit, but that's not what we're looking at here)
Typical Factory: Variable costs = 85%, Fixed Costs = 15%. If this factory can sell its product for 80% of total cost, it will not bother to make the product...by not making the product it can save all variable costs (80%), and only have to pay its small fixed costs. If the factory can sell the product for 90% of total cost it WILL make the product because even though it's losing money, the sale price of the product covers ALL of the variable costs plus some (5%) of the fixed costs. This means that you might be able to buy a Ford pickup for a little less than what it cost to make.
Typical Airline: Variable Costs = 20%, Fixed Costs = 80%. Notice right away the BIG difference here...the airline's fixed costs are much higher than variable costs. Their overhead, aircraft leases & maintenance, gates, and most labor costs are fixed...as long as you can cover your variable costs (fuel, peanuts, and a small % of labor) you may as well fly so that you can also make a dent in your fixed costs...an airline such as this would sell it's product for 25% of cost...covers all the variable and leaves 5% to apply to fixed costs. This is where your LA-NY $49 fares come from.
Any non-profitable business will continue in this manner until a) market conditions improve, b) it reorganizes, or c) runs out of money.
Yes, very true rickair. Very good post. Only it is more than 80/20 for fixed/variable, respectively, once you commit to fly a certain flight. Then it is probably more like 99% fixed; 1% variable cost per seat. In other words you will be better off selling those last empty seats for $10 each rather than leave them empty.
This is a well known problem in the Theory of Games. The current aggressive pricing is obviously unsustainable. The solution is to have only a handful of players competing with each other for the same business. Which, of course, is where we are headed anyway through bankruptcies and consolidations.
There's a good reason why FedEx and UPS are very profitable.