Airline Industry Economic considerations

Historically, air travel has survived largely through state support, whether in the form of equity or subsidies. The airline industry as a whole has made a cumulative loss during its 120-year history, once the costs include subsidies for aircraft development and airport construction.

One argument is that positive externalities, such as higher growth due to global mobility, outweigh the microeconomic losses and justify continuing government intervention. A historically high level of government intervention in the airline industry can be seen as part of a wider political consensus on strategic forms of transport, such as highways and railways, both of which receive public funding in most parts of the world. Profitability is likely to improve in the future as privatization continues and more competitive low-cost carriers proliferate.

Although many countries continue to operate state-owned or parastatal airlines, many large airlines today are privately owned and are therefore governed by microeconomic principles in order to maximize shareholder profit.

Ticket revenue

Airlines assign prices to their services in an attempt to maximize profitability. The pricing of airline tickets has become increasingly complicated over the years and is now largely determined by computerized yield management systems.

Because of the complications in scheduling flights and maintaining profitability, airlines have many loopholes that can be used by the knowledgeable traveler. Many of these airfare secrets are becoming more and more known to the general public, so airlines are forced to make constant adjustments.

Most airlines use differentiated pricing, a form of price discrimination, in order to sell air services at varying prices simultaneously to different segments. Factors influencing the price include the days remaining until departure, the booked load factor, the forecast of total demand by price point, competitive pricing in force, and variations by day of week of departure and by time of day. Carriers often accomplish this by dividing each cabin of the aircraft (first, business and economy) into a number of travel classes for pricing purposes.

A complicating factor is that of origin-destination control ("O&D control"). Someone purchasing a ticket from Melbourne to Sydney (as an example) for AU$200 is competing with someone else who wants to fly Melbourne to Los Angeles through Sydney on the same flight, and who is willing to pay AU$1400. Should the airline prefer the $1400 passenger, or the $200 passenger plus a possible Sydney-Los Angeles passenger willing to pay $1300? Airlines have to make hundreds of thousands of similar pricing decisions daily.

The advent of advanced computerized reservations systems in the late 1970s, most notably Sabre, allowed airlines to easily perform cost-benefit analyses on different pricing structures, leading to almost perfect price discrimination in some cases (that is, filling each seat on an aircraft at the highest price that can be charged without driving the consumer elsewhere).

The intense nature of airfare pricing has led to the term "fare war" to describe efforts by airlines to undercut other airlines on competitive routes. Through computers, new airfares can be published quickly and efficiently to the airlines' sales channels. For this purpose the airlines use the Airline Tariff Publishing Company (ATPCO), who distribute latest fares for more than 500 airlines to Computer Reservation Systems across the world.

The extent of these pricing phenomena is strongest in "legacy" carriers. In contrast, low fare carriers usually offer preannounced and simplified price structure, and sometimes quote prices for each leg of a trip separately.

Computers also allow airlines to predict, with some accuracy, how many passengers will actually fly after making a reservation to fly. This allows airlines to overbook their flights enough to fill the aircraft while accounting for "no-shows," but not enough (in most cases) to force paying passengers off the aircraft for lack of seats. Since an average of ⅓ of all seats are flown empty, stimulative pricing for low demand flights coupled with overbooking on high demand flights can help reduce this figure.