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Raise the #@!$% Fares: Part II

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Just as I was thinking the plight of the airlines couldn't get any worse, it devolves from ridiculous to pathetic. The latest chapter unfolded this week as a dozen of the CEOs of the major airlines sent a mass letter to their customers asking them to pressure Congress to enact legislation to curb oil speculators.

"This pain can be alleviated, and that is why we are taking the extraordinary step of writing this joint letter to our customers," the letter states, arguing that some $30 to $60 of today's record oil prices are due to speculators bidding up the price with futures contracts. The airlines want their customers to ask Congress to limit speculation in the oil markets, especially by stopping the practice of shifting contracts overseas, where they can't be monitored.

Coming from an industry that has now raised bait-and-switch to a high art, this is disingenuous at best, laughable at worst. Blaming speculators for the economic ill du jour has a long and colorful history. When you just can't face the music that supply and demand drive costs and you refuse to adjust your prices accordingly, heaving a dead fish at the closest speculator is as good a response as any.

And these CEOs ought to know better, given the fact that they have the intellectual wherewithal to analyze economic trends. There's little reliable agreement that speculation in oil contracts drives actual prices to a measurable degree. Just you go and try to find some data linking the two that isn't anecdotal or, well, speculative. There are very strong indications that it's the physical market--the actual buying and selling of the commodity at hand--that really determines what people will pay for a product.

Speculators are simply buying contracts that amount to bets on what the price of a commodity will be at some point in the future and for everyone who goes short, another goes long. Further, the amount of money in play on futures expressed as a percentage of the total physical market is so small that it's not credible to claim this can move the markets as much as some people think. Here's a nice explanation of the theory by James Surowiecki. If the airlines are whining that speculation amounts to market mismanagement, they should muck the manure out of their own stalls first. Specifically, they continue to send the wrong signals to customers by quoting fares that are below cost then trying to recover their costs with an ever growing list of hidden charges--for baggage, for curbside check in, for agent-assisted booking, for aisle seats and so on. On Friday, ABC ran a story analyzing the economics of two Continental flights, one from Houston to Richmond, a second from Newark to Los Angeles. Read it here.

On the first flight, ABC found that the average fare for the 49 seats was $152, for a total of revenue of $8,450. But it cost the airline $8,600 to conduct the flight, resulting in a net loss of $150. The California flight lost even more--$500. This is suicidal economics. It attempts to deny the underlying cost of goods with layers of irrelevant and irritating charges unrelated to the cost of delivering the basic service. What should those fares have been? How about $225 from Houston to Richmond? That's still a good value and it sends the right signal to the customer about what it really costs to provide the service on a sustainable, profitable basis.

If there is demand for these services--and there most assuredly is--there ought to be companies who can price them correctly and fairly and make a profit at it. If the fares are set correctly, customers will receive accurate signals about cost/value and they can then decide if they want to pay that fare. Or not. The market will then find its natural, unimpeded balance. One reason the airlines are reluctant to raise fares meaningfully is that there's still too much capacity for the demand, thus, too many seats are flying around below cost. In the end, if the majors do survive this crisis, there are going to be a lot of airplanes parked in the desert in United and American livery.

Just after this asinine e-mail arrived from the airlines, I got a couple of invoices from FedEx for overnight letters. The last time I used FedEx, I seem to recall the tariff was about $15 for standard overnight letters. These were $25 each for the same service. Digging into this, I discovered that FedEx is--surprise!--tacking on a fuel surcharge. But they don't charge me extra to use the corner drop box or to call with a question. In other words, FedEx is sending unambiguous signals to its customers: the service now costs more and here's how much more. They aren't blaming it on speculators or burying me in hidden charges. And guess what? I'll use FedEx less because for me, the cost/value relationship is now out of balance. I will find another, cheaper means of doing the thing that FedEx does. So may others, so FedEx may park a few airplanes, too. But want to bet that it'll survive?

That's how supply and demand works. The airlines that hope to survive will figure this out sooner or later because the people who run them really aren't that dumb. But the wisdom won't come from writing pathetic letters to their customers asking for help.

What they need to ask for is more money.

Comments (26)

Sadly, the Airline Industry isn't unique in having executive management who devote all of whatever intelligence they might have for personal gain to the exclusion of good, effective business operation. Misdirection (propaganda) such as attacks on private General Aviation, speculators, surcharges and writing books about "How Non of it Was My Fault" is a typical method for deceiving the public and stockholders. Worse, is the fact that most of the really bad ones have managed to fortify their 'golden' positions to where it's virtually impossible to rectify the problem by removing them before the companies go under. Airlines appear to almost all fall in this category, however so does a large portion of American industry and we need to correct the situation soon before we have total economic collapse.

Posted by: Paul Bannister | July 14, 2008 9:21 AM    Report this comment

Here in western Europe we have some "low-cost" airlines whose ticket prices now bear ZERO relation to what the passenger finally pays. They are masters at generating add-ons and turning costs into revenue streams, many of which cannot be avoided by the majority of travellers.

I have just looked at a booking for an October 80-mile trip (across a stretch of sea, so no driving options) where my return fare is quoted as GBPounds 2.58, roughly $5. Any fool knows this can't be the end of it. When I go to complete my booking the (unavoidable) "taxes and charges" now bring the price to GBP48 - closer to $100.

Taking a suitcase (15 kg allowance, $25 per KILO for excess) costs another $32 return and DOUBLE that if I don't pre-book it. If I have a suitcase, I need to hand it to a check-in clerk and that's another $8 each way. Needless to say I will avoid the on-board eatables eg ham roll at $8. Electronic payment for my booking (there is no other way) costs $8 PER passenger PER sector. Pre-boarding costs $8 PER passenger PER sector. That 20-minute flight is getting very expensive...

The bigger carriers eg British Airways simply advertise a separate fuel surcharge figure which seems somewhat more honest but in BA's case this can be as much as $500 on a return first-class, long-haul ticket.

We all know the true costs have to be paid so why won't the airlines stop trying to pull the wool over passengers' eyes and commit to total transparency in pricing from the outset?

Posted by: Charles Thompson | July 14, 2008 10:42 AM    Report this comment

Americans should stop all flying on all airlines, regardless of pricing. Why should anyone willingly pay any amount of good money to subject themselves to an unconstitutional search (body cavity) and seizure (of liquids) and allow themselves to be treated as an enemy combatant - all this even before they get on the plane? After push-back, the pax are taxied out to a far corner of the field to sit and wait up to eight hours for better weather, with "Dirty Harriet" going up-and-down the aisle enforcing the no-electronics regulation like she is defending her own baby from a child molester. All the pax are deprived of food or drink or freedom, and forced to endure overflowing toilets and/or sit in their own excrement. How much depravity should it take to turn one's stomach against the airlines? What will airlines think of next? Waterboarding?

Golly, I love flying as much as anyone, and more than most, but for now, if I can't fly GA, then I drive, or I just don't go, period. Yes, if job-related, I'd rather be fired than have to fly an airline on company business. The ugly truth is: I'd sooner take a stroll though a spinning propeller than to take an airliner anywhere for any reason.

Posted by: Bruce Liddel | July 14, 2008 1:36 PM    Report this comment

Good one, Paul. I was surprised to see that AOPA, who ought to be very wary of anything the airlines say or print, jump aboard this ship. I looked up speculation in Thomas Sowell's "Basic Economics," and learned enough in 15 minutes to realize that this was just another page in the "mis-information" chapter of the airline's weighty--and never-ending--tome on mismanagement.

Posted by: Steven Ells | July 14, 2008 2:52 PM    Report this comment

If the airlines spent less time looking for a scapegoat, and spent more time on their mismanagement, things would finally get done.

Posted by: David Barth | July 14, 2008 4:10 PM    Report this comment

I've spent a lot of time on aircraft, mostly enjoying the flights, when I wasn't able to fly myself prior to the "recent indignities"!

I then promptly bought a motorhome to supplant my Cirrus and haven't had to fly the airlines since. (for goodness sakes, how many terrorists have we captured or identified by making people take their shoes off.)

I don't think I'll ever go back to commercial flights unless my owned transportation can't make some exotic destination.

Airline management is only concerned with feathering it's own nest to the tune of $millions, and to the detriment of both it's passengers and employees.

Posted by: J Tury | July 14, 2008 9:43 PM    Report this comment

Well Paul I like where your heart is...but your mind is not in the right place...You see....I have several thousand dollars invested in GM..I follow oil like you follow aviation...and guess what speculation.....is a major component of the cost of a barrel of light sweet crude...which can clearly be seen...by.. the last two weeks news..Iran fires some missles oil went back up seven dollars a barrel....the president lets oil companies drill off shore...oil is as of now down ten dollars a barrel...TEN dollars. I understand what your trying to say about the airlines and I agree they will blame anything and anyone...but make no mistake about it, ive been watchin oil for 5 months now...Ive watched oil surge on some minor news..then surge again because we all know oil is going to go up. Supply and demand has only a minor role in the matter...how do I know? because when the report came that demand is down and under forcast....the prices still when up

Posted by: rob haschat | July 15, 2008 11:06 AM    Report this comment

All melodrama aside, I agree with Bruce Liddel and J Tury. If I can't fly myself or drive, then I'm not going. If that means I give up vacationing in Hawaii or Europe, then so be it. The airlines have made themselves public enemy #1 for a good reason. There will be massive changes before I board another airliner.

Posted by: Greg Williams | July 15, 2008 11:27 AM    Report this comment

I wanted to book a flight to London from NYC recently and the advertised price was $648 but by the time all of the add-ons were calculated the total price was over $1000....just made me angry to waste my time. Why can't there be transparency...........seems like a great waste of time and energy.

Posted by: Noel Anderson | July 16, 2008 7:53 AM    Report this comment

There is another industry dynamic that significantly impacts the airlines ability to "Raise the #@!$% Fares". There are always people willing to start the "next great airline" or take over an established one, based upon a ridiculously flawed business model that has no hope of actually surviving. Along with those are hucksters that sell that flawed dream to investors using slight of hand, misdirection and sometimes just plain miss-information. Once done, that "airline company" jumps into the business offering unsustainable pricing. Airlines with a reasonable business model must then try to compete with those dreamers. If they don't, their occupancy rate goes down which drives up the fixed cost allocation of their operations, further increasing their costs. The "majors" can sustain that for a while until the current dreamer goes away, but in today's world, there is always another dreamer and troop of hucksters right behind. Free enterprise is a good thing as long as everyone involved takes full risk of failure. Today, that is not the case. The dreamers and hucksters are not risking their own money, they're skimming the miss-informed investor's money and there is no legal restraint to prevent them doing so.

As for the mindless security indignities at the airport, the blame for that goes directly to your Congressman for the "appearance of action" instead of measured real action. The airlines are just doing what Congress has mandated them to do.

Posted by: Unknown | July 16, 2008 8:42 AM    Report this comment

Consider this a counter point. There's a lot more to it than what you can see with the naked eye. One of the reasons an airline just can't jack up their prices overnight is because their competitor won't. That will create a mass exodus to the other guy's website, and there goes the cash flow and the end of the game comes quickly. Another "secret" in the industry is our own government. There's one half screaming at the airlines to start making a profit, then there's another "watchdog" group who analyzes fares on a daily basis to see which 2 airlines raised their fares in the same market in a 24 hour period and begins an investigation as to whether or not "racketeering" charges should be filed! I kid you not! Now throw into the mix airlines like Southwest who are masters at fuel hedging themselves and you have the basic recipe for why airlines can't and won't raise prices. What's the solution? Some would say you continue to let the free market eliminate those airlines that keep paying exec's ridiculous millions and can't get their operational costs under control. Others say you should "allow" the airlines to all get together and determine what an acceptable cost per seat mile should be and let them raise their fares without the threat of being charged with being a monopoly. You hit a one time "reset" button. While still others think it's time to regulate the industry once again. Oh Joy.

Posted by: Kim Barnes | July 16, 2008 10:27 AM    Report this comment

Paul has one thing right. The current system isn't working, and teeing off customers with deceptive gimmicks to nickel and dime them to death is only going to keep making things worse, much worse.

Posted by: Kim Barnes | July 16, 2008 10:29 AM    Report this comment

Hi Paul,

Great post. From someone who has to ride the airlines to/from work 4 times a month, I wish they would just price the ticket to cover the cost and get away from these extra charges too. Aisle seat and exit row charges? Charging for one bag? You've gotta be kidding!

Johnny

Posted by: Johnny Sewell | July 16, 2008 3:10 PM    Report this comment

How many gas stations have you seen that have NOT raised gas prices for fear that someone else is going to open another gas station and sell gas cheaper? Too bad gas stations don't follow the airline business model...

Posted by: David Brown | July 17, 2008 7:40 AM    Report this comment

Paul, I completely agree with your assessment. The speculators are certainly guilty of driving the prices up via all the negative hysteria surrounding oil supply. To counter them we need positive hysteria that will drive them nuts and have them clamoring to dump their contracts before they get caught with their pants down. But I digress, I have seen numerous weekday business trips on commercial airlines sell for roughly $0.42 - $0.68/mile, now the guvmnt gives us something on the order of >$0.48/mile to drive our cars! Helloooooooo airline CEO's! You all need to go back to MBA school and take notes on the "Value Map" part of the classes in pricing. Better yet, buy: "The Price Advantage" by Marn, Roegner and Zawada. But then again, maybe I'm wrong.......an airline ride is so much more inconvenient and inhospitable these days than a ride in one's own automobile, maybe that is your value map premise?

Posted by: Michael Caban | July 17, 2008 9:18 AM    Report this comment

Hi Noel, So New York to London round trip is about 7,000 miles, give or take a few. My math makes that $1,000.00 trip about $0.14/mile, sounds like a smokin' transportation deal to me. Try driving 7,000 miles for $1,000. Your reaction is quite telling as to the state of mind of what I would call today's "Discretionary" traveler. In my view, this is the crux of the matter. The airlines in their infinite wisdom to build "Discretionary" passenger volume (to fill those seats the biz folks weren't using and on Saturday and Sunday) have gotten the flying public addicted to "fare crack" that has no basis on a fundamental value map. Now the airlines have created a monster in that they have exploded their infrastructure (and therefore their fixed overhead costs) with these discretionary travelers addicted to "fare crack" that has no relationship to the cost of providing the service. So now the airlines faced with huge fuel cost increases to provide their service and still fearing to let their discretionary travelers off the low "fare crack" they have been serving up, have been piling on the fee adders to recover some of the rising cost of their low "fare crack". And now the discretionary traveler whining and moaning begins. I really have no sympathy whatsoever for the airline company plight they have priced themselves into nor the flying public who has been duped into thinking that such prices are even remotely grounded in business profit/reality.

Rant Mode off.

Mike

Posted by: Michael Caban | July 17, 2008 9:43 AM    Report this comment

"Airlines with a reasonable business model must then try to compete with those dreamers" ... with really low fares.

Why?

Does the "dreamer" have some sort of magical unlimited capacity? When "Dream Air" fills it's single 737 with $5 fares, why does Delta also have to fill it's planes with $5 fares?

Posted by: Brett Parks | July 17, 2008 10:16 AM    Report this comment

"Does the "dreamer" have some sort of magical unlimited capacity? When "Dream Air" fills it's single 737 with $5 fares, why does Delta also have to fill it's planes with $5 fares?"

That's a good point Brett. Remember SkyBus? They were all the rage a little more than a year ago in what the rocket scientists in the media called "The Big Airlines worst nightmare" with every flight having a few seats priced at just $10!

Some threat. You had a better chance in winning the lottery before you found a seat when you wanted to go, where you wanted to go for $10.

Posted by: Kim Barnes | July 17, 2008 11:21 AM    Report this comment

Robert Hasiak has it right folks.

I've traded and followed commodities for almost a decade and like it or not, those high paid C.E.O's are not THAT stupid - the commodity markets have tremendous impact on the price of the goods they trade.

Consider this: when you research the global demand for oil and compare it to global production (the supply/demand matrix) back when oil was $55 a barrel and then look at that same supply/demand matrix today, you'll find that it hasn't changed much, it's almost flat as we are talking about a very short period of time to go from $55 to our current pricing. Actually, recently the demand is DOWN due to high prices and production is slightly up from the $55 days. Given the FACTS, there is no way to conclude that simple supply and demand factors have pushed up the price of oil.

So what has? Speculators. HUGE institutional speculators that recently (at the outset of the mortgage crisis) had the success of getting Congress to approve a moritorium on the contract limits and margin account requirements. They are currently working on just 5% margin accounts, which means they can control huge numbers of contracts with very little capital and Congress is letting them do it!

Posted by: Scott Robinson | July 17, 2008 11:30 AM    Report this comment

Mike, good point you made as well. It always makes me laugh when people expect to get on a 75 million dollar airplane, that burns $75 a minute worth of gas, with a crew cost of about $400 per hour, not to mention crew training, required aircraft inspections, aircraft insurance, parts, gate usage fee of 1 million per year per gate, an average $1,500 landing fee, the mechanics, the dispatchers, the rampers, the gate agents, the customer service agents, catering, a whole building full of office support staff, reservationists, advertising and website IT techs, and the list goes on.

The "passenger" wants all this, steak and lobster and a tailwind for $59 (one-way)

It is truly laughable.

Posted by: Kim Barnes | July 17, 2008 11:34 AM    Report this comment

Scott, you forgot to include the unofficial, but real, inflation Washington has given us through runaway money printing to bail out large financial institutions. The whole subprime fiasco is showing up in the prices of everything, like oil, that we import. Commodity speculators are attempting to save their financial butts by outguessing inflationary effects on oil prices. They can lose those butts by overdoing the speculative run-ups.

Posted by: Paul Bannister | July 17, 2008 12:42 PM    Report this comment

Scott, you forgot to include the unofficial, but real, inflation Washington has given us through runaway money printing to bail out large financial institutions. The whole subprime fiasco is showing up in the prices of everything, like oil, that we import. Commodity speculators are attempting to save their financial butts by outguessing inflationary effects on oil prices. They can lose those butts by overdoing the speculative run-ups.

Posted by: Paul Bannister | July 17, 2008 12:43 PM    Report this comment

Yes Paul, there is simply no way to condense this huge problem down to a couple paragraph post. I was basically trying to say that speculation is at least ONE VERY REAL part of the equation and that it is erroneous to simply point to supply/demand as the culprit (which the media seems to be feeding us) when the consumption/production figures have been basically flat since $55 oil. General consensus in the oil industry is that based solely on supply/demand and production costs, etc., that oil should be in the $60 to $65 a barrel range.

To your point, there are some valid reasons for the speculation, which is why I said it is only PART of the problem. The rest of the problem lies in the REASONS for the speculation.

It's a complicated mess that our leaders are ill prepared to deal with. They dropped the ball in dealing with it earlier before we got to this point. Simply put, Washington is broken and things are going to have to get a lot worse so they American people wake up and FORCE real change (and I'm not talking about the ridiculous LIP SERVICE empty political retoric change being spouted by our current presidential front runners!)

Posted by: Scott Robinson | July 17, 2008 12:58 PM    Report this comment

Scott Robinson understands! This may seem off-topic, but there is a direct causal link, not only to the airlines and the oil fiasco, but to nearly everything else wrong with America.

"The last line of defense in support of freedom and the Constitution consists of the people themselves." Page 167 The Revolution: A Manifesto, by Ron Paul.

Unless the rest of us are at the very least willing to with-hold consent from our government when it consistently fails to follow our constitution, there is no hope that anything will ever get better.

Yes, that even means actually voting against BOTH Obama AND McCain.

Posted by: Bruce Liddel | July 17, 2008 2:19 PM    Report this comment

The reason some airlines (Delta, Continental etc, do not charge for the first checked bag) are adding fees is to attempt to get some additional revenue from relatively cheap tickets sold well before fuel prices exploded. American in particular, is trying to stay out of Chapter 11 during a period of extremely tight credit. They will file well before cash levels put obtaining debtor in possession financing at risk.

Speculation is part of any commodities that allows for a futures market.

Berto is sharp as usual, but he is a bit optimistic on GA costs. Add in the aircraft financing, pilot training, medical, weather, flight planning, parking, and the other plethora of total flight costs to come up with a realistic cost per mile.

Posted by: Harry Alger | July 24, 2008 10:53 AM    Report this comment

It's a small world after all, folks. :-)

Another factor (not the only not, and not the most important one, but another one) is the currency markets. If the dollar depreciates 50% vis-a-vis the Euro (and other currencies) in a couple of years, one of the consequences is that its purchasing power declines. Go look at oil prices in Euros and in dollars, and you'll find that oil has indeed risen... but less than you think. The USA is paying a higher price in dollars, partly because the dollar is now worth less.

Again, I am not telling you that this is the only subject. But it must be considered, too... when Scott Robinson says that oil should be at $60-$65 per barrel due to the changes in supply and demand since the days of $55 oil, add 50% to that due to foreign-exchange factors and you get $90-$100 per barrel.

That explains at least part of the variation in prices, although of course not all.

Posted by: Rodolfo Paiz | August 6, 2008 6:22 PM    Report this comment

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