Question

Case study 7.2: The airline industry has very marked differences in structure between the United States and Europe. US airlines were deregulated in 1978, leading to intense competition on many routes, bankruptcies and mergers. In Europe the airlines have remained highly regulated, with governments protecting their own largely state-owned airlines. The deregulation in the US has led to much lower fares per passenger-mile and has caused some radical changes in structuring and therefore unit costs. Economies of scale arise if airlines can make use of a single type of plane. For example, Southwest Airlines only flies the Boeing 737, while the struggling US Airways uses a number of different aircraft. This was largely because US Airways came into existence as a result of a series of mergers. Southwest can therefore reduce its maintenance costs, crew training and scheduling costs compared with US Airways. This was reflected in the fact that in 1993 its costs were only 7 cents per available seat mile, compared with over 11 cents for US Airways.

Economies of scope are also very important in the airline industry. Clearly it is cheaper for an airline to carry passengers and freight in the same aircraft than carry them in separate aircraft. However, the most important economy of scope arose from a change in routing: instead of having a large number of point-to-point services between different cities, airlines like Southwest and Continental switched to using a hub and spoke system. This meant that customers flew from one city to a central hub, and then from there to their final destination, as shown in Figure 7.4. This gave these airlines airlines a number of advantages. They could fly a much larger number of routes, in terms of joining city-pairs, with a given number of aircraft and miles flown. This would attract more passengers. Since these passengers all landed at the hub, before being transferred to their final destination, it allowed the airlines to fill the flights more comprehensively. It also became possible to combine passengers with different characteristics more effectively; thus routes that largely carried business passengers could now attract vacation customers.

The above economies of scale and scope have not prevented many airlines from getting into serious financial difficulties recently. Although the events of 11 September 2001 did not help the industry, there were already many problems brewing in terms of overcapacity and industrial relations. Many airlines now appear likely to go out of business unless they receive government subsidies, a controversial issue discussed in more detail in Chapter 12

Questions:

2. What implications are there regarding mergers of different airlines?

3. What disadvantages might be incurred with the hub and spoke system compared with the point- to-point system?

4. Explain why the hub and spoke system relates to economies of scope rather than economies of scale.

Answer 1

ANS 2) The implications regarding the mergers of different airlines are that while the southwest airlines only flies the Boeing 737, the US airways uses a number of different aircraft because US airways came into existence as a result of series of mergers.

ANS 3) The disadvantages that might be incurred with the hub and spoke system compared with the point to point system is that there would be delays people have to go to the hub at first and then to their destination. The hub adds the travel time.

ANS 4) The hub and spoke system relates to economies of scope rather than economies of scale because the economy of scope arose from change in routing and hub and spoke system uses different routes like going to a central hub first and then to the final destination.