United Airlines Passengers Should Be Paying 100% More (Source: United Airlines's President)

The president of United Airlines, Scott Kirby, thinks you probably didn’t pay enough.

Barely half of what you should have, in fact. Here’s his logic.

You want to fly from point A to point B in a certain amount of time, and at a certain level of comfort. If this were economics class, we’d simply break down what it costs to fly you, and what you’re willing to pay.

And, there should be a point on a supply and demand chart where those two variables meet. Hence, the price. At least in theory. 

But that’s not what’s happening in real life, Kirby said, at the Morgan Stanley 6th Annual Laguna Conference last week. (His talk is available here as a non-downloadable video; I had it transcribed in order to parse his comments for this article.)

Kirby is known for his insistence that much in the airline industry really comes down to math. And his evidence here is highly macroeconomic.

Take the airline industry 30 years ago, he says, and total airline revenues added up to about 1.2 percent of the entire United States gross domestic profit. Now, in 2018, it’s dropped to .6 percent.

That would mean means that the airline industry is leaving another .6 percent of the national GDP on the table.

“Another way of saying that,” Kirby said during the event, “is we are under-pricing our product by fifty percent. We are not at the point on the supply and demand curve where those two things intercept.”

Just to be clear: if they’re under-pricing by 50 percent, that means they should be able to charge twice as much, and that airline passengers are currently getting a 50 percent discount, for no good economic reason.

A side effect of that is that whenever there’s a spike in costs–fuel prices are the obvious example–airfare prices have to rise too, for the simple reason that there’s not enough margin built into pricing for airlines to absorb those higher costs.

So if Kirby is right and they’re under-pricing by 50 percent, why’s it happening? Why aren’t all the leaders of the big airlines run out of a job by investors?

Interestingly, Kirby suggests it’s because airlines have allowed air travel to become a commodity. And thus, the no-frills, low-cost economy carriers at the bottom are the ones that set prices.

As Gary Leff at View From the Wing put it, “What’s missing in this analysis is differentiating United’s product. Low cost carriers set price because consumers see them as selling largely the same thing as major airlines.”

Now, this might lead you to believe that airlines would seek to de-commoditize their industry. In other words, they’d like to develop customer perception that a flight on a low cost carrier simply isn’t the same thing as a flight on a legacy carrier like United.

One way to do that, at least to some degree, is for bigger airlines like United to add service to smaller markets. If there’s less competition from low-cost carriers, at least on those routes, the other carriers can’t drive down base fare price. 

Another option? They do what they’ve embraced: segmenting levels of service to be sure that passengers have to pay, one way or another, for every additional perk or level of service they want, from choosing their seats to being able to check bags aboard.

Yet another opportunity: Work on improving the soft experiences and brand perception that passengers hold, so customers will disassociate price from experience. The classic example in the U.S. airline industry would be Southwest.

In fairness, by my anecdotal experience, it seems like United is in fact trying to change its brand perception. But obviously they’re not there yet. Because if they were, according to this theory, you’d be paying a lot more to fly on United Airlines.

About twice as much, in fact, for the same product.

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Inc.com

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