2. What is the nature of costs in the airline industry? How does this affect pricing decisions?
3. How do the nature of the airline market and the demand for airline service affect Southwest’s decisions?
4. What general pricing approaches have airlines pursued?
5. What pricing and other marketing recommendations would you make to Southwest as it enters the Philadelphia market?
The nature of costs in the airline industry include costs relative to internal airline factors and costs relative to external factors.
Internal factors include skilled and professional labor, fuel, airport gate bidding, airplane technology, cargo limits and aircraft leasing or purchase costs.
External factors include competitor pricing, weather and natural disaster interruptions to flight schedules, terrorist and airplane accident disruptions, airport capacity, rising or falling passenger demand and traffic, increase or shrinkage in airline industry, safety and security, environmental regulation compliance, changes in consumer demographics or travel and preference spending patterns.
Airline pricing decisions are made according to specific formulations and in accord with some federal regulations, although the airline industry is extensively deregulated.
According to Investopedia.com, some relevant calculations for airline ticket pricing include considerations of available seats and projected number of passengers according to the following formulations:
Available Seat Mile = (total No. of seats available for transporting passengers) x (No. of miles flown during period)
Revenue Passenger Mile = (No. of revenue-paying passengers) x (No. of mile flown during the period)
Revenue Per Available Seat Mile = (Revenue) x (No. of seats available)
Changes in the internal and/or external factors affecting airline industry pricing affect pricing decisions by spurring a rise in prices, such as that which occurred in 2008 when the airline industry suffered a shrinkage, or by spurring a drop in prices, such as occurs when a new entrant attempts to challenge the established route of a larger airline.
Southwest operates under a different model from many other airlines. Nonetheless, since many airline costs are essentially unchanging even when the demand market does change, for example airport operations charges, Southwest's pricing decisions reflect the same problems, in some regards, that all airlines' pricing decisions reflect. According to the Federal Reserve Bank of San Francisco Economic Research Letter, "Competition and Regulation in the Airline Industry," Southwest does not use a "hub-and-spoke system" as other airlines do. Consequently, it doesn't drop routes like the other airlines when there is a downturn in passenger demand. In addition to having a homogenous fleet (therefore with uniform maintenance and repair crew and cost needs) and a shorter turnaround time, Southwest does not serve meals.
Therefore, while the nature of the airline market and the demand for airline service affects Southwest’s decisions in the same way as it affects other airlines' decisions, there are elements of the Southwest model that allow it to respond differently from other airlines in the industry when making pricing decisions as is reflected in the fact that their fares are usually lower than others on the same route.