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Theme 2: Industry Structure and Competition

There are many reasons for the recent poor financial performance of traditional airlines, including the effects of 9/11, the steady growth of low cost carriers (LCCs) that operate under a different business model, and the recent surge in jet fuel prices. Our research efforts to better understand the impact of various recent trends, and their implications for the viability of the current industry structure and for the business models of the traditional network carriers. We have combined input from dozens of site visits, conferences, and industry contacts to define three main research priorities for our work on industry structure and competition. These are:

  • Networks and market structure
  • Pricing strategies
  • Productivity and Performance

Networks and Market Structure

As described below, several simultaneous factors are at work in transforming the US airline industry. The growth of low-cost carriers: The rapid growth of the market share of low-cost, low-fare carriers (LCCs) during the last few years is one of the most significant trends in the industry, and has presented a considerable threat to the viability of network carriers. The response of the traditional network carriers to the growing low-fare challenge will be critical to determining the future structure of the airline industry, both in the United States and in Europe. Of particular interest in this study are the pricing strategies and capacity reactions of incumbent carriers to market entry (both successful and failed) by low-fare carriers.
Implications of hub operations: The economic viability of hub operations has been questioned in recent years. Such carriers as American have changed their hub schedules, putting less emphasis on quick connections for transfer passengers and more on high utilization of employees and aircraft. The proliferation of regional jets and low fare point-to-point services increases the need for a clear understanding of the proper role of hubs in a changing environment.

Robust schedule planning: Current optimization approaches for airline crew scheduling, fleet assignment and aircraft maintenance routing do not account for the fact that optimized solutions are rarely executed as planned. Disruptions due to mechanical failures and adverse weather conditions result in necessary "real time" changes, often leading to significantly increased costs. Moreover, a finely tuned, optimized solutions typically achieve increased utilization through the removal of slack time, allowing crews less time to connect between flights and aircraft less time on the ground between flying. This can translate into a less robust schedule, requiring frequent adjustments and potentially expensive changes. Schedule disruption can also have disproportionate impact on flights that serve high revenue passengers.

Impact of changes in air transportation service availability: The expected restructuring of the airline industry may result in significant changes in air transportation services. The pricing structures, networks, and levels of service will change if some of the major airlines either fail or reinvent themselves, and as the low-fare carriers evolve. Over the past three decades the economy and social structure of the US has developed under the implicit assumption that inexpensive, high quality air service would be available throughout the nation. If several major airlines fail at the same time then significant service disruptions will occur. Even if this is avoided, the level of service to some of the smaller communities in the nation will either be reduced or will become more expensive. This effort seeks to understand and, when possible, quantify the national dependence on air transportation to help guide airline strategy and national policy decisions.

Pricing Strategies

Airline pricing strategies are critical determinants of their profitability and financial viability. Price responses to entry by LCCs can have dramatic implications for short-term profits and market shares of incumbents, and for long-term viability of new entrants. We continue data-intensive analysis in the closely interrelated areas of pricing and revenue management, which we consider more vital than ever in the current industry environment.

Revenue management: Led by Dr. Belobaba, a recognized expert in the development and use of airline revenue management tools, we have been active in this research area. We have developed enhanced tools to forecast current demand patterns and to suggest the airline responses that could maximize revenue. The tools are used to provide both MIT students and airline managers with deeper insights into optimal responses to the challenges raised by strategic alliances, competition from low-fare carriers, and changing price-sensitivity on the part of travelers. The revenue management research completed within the PODS (Passenger Origin-Destination Simulation) research consortium at MIT has had major impacts on the revenue management development operations of its seven airline members, in addition to other airlines from around the world that have attended the more than a dozen conferences at which our PODS research findings were presented.

Productivity and Performance

The cyclical nature of the economy, and the strong correlation between the strength of the economy and the demand for air travel, result in an airline industry that can best be described as a "very dynamic" system. Understanding these dynamics is therefore critical to understanding the reasons for the long-term survival or failure of carriers. In our research, we are identifying the characteristics or strategies that are associated with financially successful airlines by investigating topics such as the relationship between labor costs and productivity, the impacts of changing airline fleets (for example, the use of regional jets) on financial performance, and the differences in financial performance between hub-and-spoke and new low-cost carriers with point-to-point operations.

Impacts of productivity on survival: Productivity plays a vital role in the profitability and long-term viability of airlines. Our work suggests that labor productivity is far more strongly correlated with airline profitability than might be expected and, moreover, that changes in compensation do not produce consistent changes in productivity. Rather, there is considerable variation in the effects of pay changes both within and across airlines.
Network structure and productivity: As noted, airlines are rethinking their hub operations. The questioning of traditional hub operations - with their characteristic "banks", or "waves", of flights - raises numerous questions and opportunities for significant research contributions. The past economic difficulties associated with hub operations may diminish if hubs are operated somewhat differently in the future. We hope to quantify what productivity gains and cost reductions can realistically be anticipated.

Links to the various themes:

  1. Safety and Security
  2. Industry Structure and Competition
  3. Labor Relations & Human Resources
  4. Infrastructure
  5. Alternative Business Models


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