Wednesday, July 23, 2014

Irrationality in the Airline Business

This Wall Street Journal headline did not shock me today, even though it speaks to an incredibly irrational set of behaviors:  "New Startup Airlines Crowd the Skies."   The article describes how a number of new players ("a flock of startups") are entering the airline industry, including a firm that has brought the People's Express brand back to life.  

Why do I say that the headline describes irrational behavior?  Consider the following important fact: for over one hundred years, the airline industry has been one of the least profitable markets on earth.  Richard Branson once joked that it was actually quite easy to become a millionaire; all you had to do was begin as a billionaire and then enter the airline industry!   Look back at the leading players in the industry in the 1970s and 1980s.   Most of them either no longer exist, or they have experienced a Chapter 11 reorganization at one point or another.  For those familiar with Michael Porter's five forces framework, a quick analysis shows that the industry is terrible along each dimension.   In short, the industry structure is incredibly unattractive.   

Why, then, are firms continuing to enter this industry?  Yes, the barriers to entry are quite low, but why enter if the likelihood of success is so low?   I think it comes down to the fact flying has always had a special allure.  Succeed, even for just a brief time, and you can become a celebrity.  Think about the famous names throughout the industry's history:  Howard Hughes, Juan Trippe, Richard Branson, Herb Kelleher, Michael O'Leary, Freddie Lake, and Don Burr.  Just take a look at the quote that ends the Wall Street Journal article today: 

"It's a high-profile, sexy business," says Henry Harteveldt of Atmosphere Research Group, a travel research firm. "And if you keep a lid on costs, have the right strategy, aircraft and managers, you can make money." What's more, the U.S. needs more airline competition, he says. The problem is: "the best markets are spoken for." 

There you have it.  It's sexy.  It's high-profile.  You can become a celebrity CEO if you succeed, or you can hob nob with CEOs who already are celebrities.  Unfortunately, many entrepreneurs in this industry forget one key lesson that I always teach my students when we study industry structure:  sexy industries are not always very profitable. 

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