Pricing is one of the hardest things to get right but fares into smaller communities in the US have not been economically viable. Tom Bacon explains why this should change and how.

Flying through hubs in the US is now taken for granted. ‘Hubbing’ was the airline revolution of the 1980s so it is now over 30 years old. In the 90s and noughties, this notion was expanded with small regional jets (mostly 50-seaters), which generally served smaller communities into the large hub airports. For many hub carriers, half of the flights now flown may be by small jets.

Pricing into these smaller communities has, however, often ignored normal economic considerations. Consider these points:

•Pricing is much less than the cost of the two non-stop flights inherent in the connect service.

•The additional cost of ‘hubbing' – bag transfer, peaking in manpower and

  facilities at the hub airport – is ignored.

•The higher seat mile cost of the small aircraft operating between the smaller

  community and the hub is ignored.

•Despite costing as much as 20% more than the sum of the two flights, connect  

 fares are generally less than 70% of the sum of fares of the two flights!

So…think about charging 70% of your normal pricing for a product that costs 20% more. Not very sensible, eh?

Two factors drove this unfortunate – and highly uneconomic -- result:

Ultra competition: As airlines entered the smaller markets with small jets, other carriers followed into the very same markets. So a small city that previously had limited or no jet service quickly had three to four carriers connecting that city to numerous hubs. All four major hub carriers (American Airlines, United Airlines, Delta and US) currently serve Chattanooga and Key West, for example.

By product pricing: Carriers often justify pricing to the small communities – and the losses – on byproduct economics. Even though hubs are designed to connect passengers, any particular connection is a ‘byproduct’ of the two direct flights. If the flights to the small cities cover their own cost of operations and also contribute marginally to the rest of the hub, they are retained. Too much byproduct thinking, however, can pull down overall hub profitability.

A costly oversight

This pricing disconnect, however, hasn’t been the major focus for US airlines. Airlines have lost money consistently for decades – overcapacity existed not just in the small communities, but throughout the system. Instead, airlines have undergone other fundamental restructuring (bankruptcy, mergers, dramatic capacity reduction) and, uncharacteristically, the industry has begun to make money. However, the pricing changes in many regional markets are largely still ahead of us.

There are now fewer airlines (Northwest, Continental, and AirTran have merged with other carriers) and fewer hubs (Cincinnati, Pittsburgh, St Louis, Las Vegas, Memphis have all been either downsized or eliminated as hubs). Nevertheless, smaller communities still often enjoy good service to multiple hubs. Fifty seat regional jets (the revolution of the 90s and noughties) facilitated this but there is now an industry move away from these jets. The reduction in 50-seat aircraft will in turn drive further changes in the industry and more rational (higher) pricing for many smaller communities.

Here are four possible solutions to the problem:

1. Demise of 50-seater With 50-seat aircraft less economic (due to higher fuel prices and rising maintenance costs), airlines are looking at replacing them with larger aircraft, mostly with 70 seats. Delta has announced that some of its’ small jets will now be replaced by 117-seat aircraft, formerly flown by AirTran.

2. Industry Capacity Discipline Despite the interest in replacing smaller regional jets with larger (lower unit cost) aircraft, airlines are not interested in adding capacity. If all 50-seat aircraft were replaced with 70 plus seat aircraft – and total seats offered in a market remained constant - the number of flights flown in the communities served by small jets would fall by at least 29% - or 1600 daily flights! That is equivalent to the total number of daily flights associated with American’s largest hub at Dallas/Fort Worth! Although not all 50-seaters will be replaced, the replacement programme will still have a dramatic change in the industry in the next 3-5 years!

3. Rationalisation of Competition Rather than have each existing carrier in a market drop its number of flights by the same percentage, service into these smaller communities will be rationalised – with service by certain carriers or to certain hubs likely eliminated completely. Rather than each of three carriers reducing flying from four to three to their hubs, a more likely result would be for one carrier to exit the market completely. The strongest carrier in the market will likely maintain its current flight schedule, putting pressure on the weaker services to be pared dramatically.

4. Rationalisation of Pricing As competition falls in these cities, pricing can become more rational. Fares will approach the sum of the locals. We have seen higher fares and improved unit revenue for carriers as capacity has been reduced across the industry; the next chapter for improved industry pricing will be focused on connect services into the smaller communities served primarily with 50-seat regional jets.

To sum up then, changes in the US airline industry (bankruptcies, consolidation, capacity discipline) have all contributed to making the industry healthier going forward. Replacement of 50-seat regional jets over the next five years will further improve industry profitability but will also result in higher airfares in these smaller communities.

This guest article was produced exlusively for EyeforTravel by Tom Bacon, former airline executive and industry consultant in revenue optimisation. Questions? Contact Tom tom.bacon@yahoo.com.