What does your airline ticket pay for? In order of size, these represent the expenses for a US Airways flight according to WSJ journalist Scott McCartney:
- Fuel (close to 30%)
- Salaries (maybe 20%)
- Buying and leasing planes (16%)
- Federal taxes (14%)
- Total maintenance (11%)
- Other including food, lost luggage, bumping people off flights (9%)
WSJ concludes that only 1% is left for profit–a $164 profit for every $16,400 an airline spends.
But, the cost to fly one seat one mile does vary considerably. For Southwest it is 12.96 cents while Delta, at 14.76 cents, is close to 14% more.
Or, we could look at “load factors.” Again, Southwest needs fewer people on a plane than any other airline to exceed its break even point.
This takes us to airline industry profitability:
And finally, our graph takes us to Richard Branson: ”How do you become a millionaire? Start as a billionaire and then buy an airline.”
For information on the airline industry, WSJ journalist Scott McCartney is a good columnist to follow. Here and here are McCartney articles I used for airline data while Seeking Alpha, here and here, provided a thorough analysis of the industry. My graph was from Business Insider.
Spirit Airlines is doing everything it can to charge us less for a seat on one of its planes. One gentleman paid $77 for a round trip seat between Chicago and Fort Lauderdale.
Just the seat.
How much more could he have paid? You might want to try matching each of the following Spirit Airlines fees to one of the items listed below.
- 1. $100
- 2. $4
- 3. $28-$38
- 4. $3
- 5. $30-$45
- 6. $5
- 7. $75
- 8. $6
- 9. Free
- a. check bicycle
- b. buy water
- c. first checked bag
- d. get boarding pass a airport
- e. transport dog
- f. carry-on bag for overhead bin
- g. buy bag of nuts
- h. tuck items under the seat
- i. buy a beer
(Answers at the bottom)
On the surface, it just looks like passengers pay a fee and the airline generates more revenue. But there is more. Because of the carry-on and checked luggage charges, passengers pack less. Less luggage means lighter planes. Lighter planes need less fuel–a huge cost saving for airlines.
Spirit also eliminated reclining seats on their Airbus 320s so that they could fit approximately 40 more fliers onto the plane. Think about it. Whether flights are full or empty, they still need the plane, the fuel, the pilot. And they charge for almost everything else. An extra passenger costs them very little.
An economist would say that Spirit was really good at thinking at the margin. Defined as the “extras,” the margin is where Spirit adds to revenue and saves on costs.
Thinking at the margin, Spirit probably even made money on the gentleman who paid $77 for his Chicago/Ft. Lauderdale round trip.
While my Spirit facts and the matching idea came from a WSJ.com article, I especially recommend this very clever interactive graphic that displays the shifting position of the major airlines since deregulation in 1978.
1e; 2g; 3c; 4b; 5f; 6d; 7a; 8i; 9h
You’ve probably heard the story. Fed up, a flight attendant tells passengers what he really thinks of them, grabs a beer, presses the button for the emergency chute, and leaves the plane. The overhead storage bin might have been the reason.
Overhead bins create frustration for everyone. They increase boarding delays. A cascading overflow can be dangerous when doors pop open. Attendants have to restrain impatient fliers from grabbing a bag before the plane has stopped. A cost saving fast turnaround for aircraft is delayed by passengers having to retrieve their paraphernalia. Deplaning is agonizingly slow.
An economist would disagree with a NY Times solution: “Carry-Ons and Courtesy Need to Co-Exist“. Instead, incentives have to change. Because checked baggage generates huge revenue, airlines have the incentive to charge. Responding, passengers have the incentive to take more onboard. One solution? Spirit is charging for carry-ons. Your opinion?
The Economic Lesson
Two economic concepts explain the problem:
1) The fallacy of composition states that what is good for one is bad when everyone does it. An example is fleeing from a fire in a crowded movie theater. One person, alone, can quickly leave but everyone together cannot. Similarly, one person can enjoy the plane’s overhead bin but everyone together cannot. When airlines decided to charge for checked luggage, they worsened the fallacy of composition.
2) A negative externality is a cost to a third party because of the unrelated agreement between 2 other individuals. Here, the airline agrees with you or me that it is okay to bring baggage onboard. The result, though, is a cost to other passengers and the flight staff. On an aircraft, the negative externalities multiply geometrically because everyone is creating them.
Whenever you consider doing something extra, you are thinking at the margin.
- When airlines decided to charge travelers for more than one bag, they were thinking at the margin.
- Still thinking at the margin, they realized they could generate considerable extra revenue by getting paid for extra baggage.
- Also thinking at the margin, some travelers stopped taking an extra bag.
- Still though, airlines’ extra (marginal) revenue increased by $1.5.billion.
- Then, because planes had less extra baggage, extra fuel was no longer necessary.
- Less fuel meant extra profits and larger profit margins.
- For baggage handling injuries and bag losses, there were fewer extras.
- Fewer bags meant extra room for cargo (which is more lucrative for the airlines).
- However, flight attendants are experiencing extra injuries because passengers are jamming bigger bags into the overhead racks.
- And finally, airlines have always thought about extras because one extra passenger on a plane typically costs them the price of an extra meal.
The Economic Lesson
Whenever anyone considers the cost and benefit of something extra, that person is thinking at the margin. The margin is an imaginary line that separates the current amount you are doing from the extras you might be contemplating. As you can see, airlines have been doing a lot of thinking at the margin.
Hearing that American Airlines was charging eight dollars for a blanket and pillow brought back memories of airline deregulation, Eastern Airlines, and People Express.
Does anyone remember the Eastern Shuttle? With a government given monopoly on flights between LaGuardia and Washington, D.C., Eastern guaranteed fliers a seat on every flight. You could arrive at the airport with minutes to spare and know that Eastern would roll out a new plane if the scheduled flight was full. Because fares corresponded to costs, Eastern made money.
In 1978 everything changed. With government no longer mandating interstate routes, competition surfaced and all airlines, including Eastern, had to change their behavior. Suddenly, someone else (New York Air) was charging a lower fare and advertising. They had to respond.
Charging lower fares meant consumer choice. You could fly more expensively or take the “no frills” airline (People Express) and pay extra for everything, even food.
Smiling, commentators are predicting what might be next.
The Economic Life
The market structure in which a firm competes shapes its behavior. As a monopoly, firms are price makers. They have considerable control over how to generate profits. At the other end of the competition continuum, perfectly competitive firms such as wheat farmers have their prices established through demand and supply in the marketplace. They have little power. With deregulation, the power of firms such as Eastern Airlines changed considerably.