Print view (PDF)
By Patrick Lefler
Think price wars are winnable? Think again. It doesn’t matter whether you are the one starting the war or simply responding to an aggressive price move with a retaliatory one of your own—price wars are a fool’s game. A perfect example of this can be seen in the myriad price wars that individual players inflicted upon the domestic airline industry in their quest to fill airplanes and gain market share.
On April 9, 1992, American Airlines—hoping to stem the decline in air traffic that US carriers had been experiencing since before the first Gulf War—introduced a simplified pricing structure called “value pricing.” The intent was twofold: First, it was designed to radically simplify fares. More and more passengers (including some of American’s highest-paying customers) were being turned off by the growing complexity of airline pricing models. Second, it was also designed to reduce prices on most of American’s routes. While the new price strategy did more to simplify than reduce, American’s competitors interpreted the move as the first shot in a new pricing war.1
This interpretation was fueled in part by American Airlines CEO Robert Crandall’s remarks that he fully expected—even insisted—that the rest of the industry follow American’s lead in simplifying prices. Unfortunately, in the same remarks, he also added that should anyone undercut American’s fares, American would match them—and its entire new fare structure would be proportionally reduced. He further warned that anyone seeking to undercut these prices would be “stomped on by the world’s biggest airline [American Airlines] with the full weight of its fare structure.” 2
A month and half later, Northwest Airlines retaliated by introducing a promotion called “Grown-Ups With Kids Fly Free.” While the promotion was intended to both reduce and simplify, it actually made Northwest’s fare system more complicated—exactly the opposite reaction of what Robert Crandall had anticipated from his competitors. Where Crandall wanted simplicity, Northwest responded with another confusing promotion. And to make matters worse, the “Kids Fly Free” portion was a direct shot at America’s lower prices. It only took American Airlines a day to counterattack, slashing its prices 50 percent on every seat of every airplane that American flew. Within 24 hours, every major US airline matched American’s price cuts.3 The mother of all prices war had begun!
The events in May were unprecedented and the effects impressive. According to industry observers, it was “an electronic passenger riot—the telecommunications equivalent of shoppers tearing through goods in a sales bin.” AT&T was said to have been overwhelmed with long-distance phone volume on calls to the airlines immediately after as consumers jumped at the chance to take advantage of the lower fares. Some were so determined to purchase tickets that when they couldn’t get through by phone, they got into their cars and drove to the airport to buy tickets before the sale ended.4
Paying passengers, along with hotels and the rental car companies as travelers hit the skies in the spring and summer of 1992, made out like bandits. The airlines, however, experienced different results. Despite record capacity over the next three months, record losses followed; some estimates pegged airline industry losses over that same three-month period at $1.5 billion—losses that the already weakened domestic airline industry could scarcely afford.5
This was just one of many price wars that the airlines self-inflicted on itself over a 20-year period beginning in the 1980s, debilitating the entire industry. The toll over that time period is noteworthy. Hundreds of airlines declared bankruptcy, tens of thousands of employees were laid off or fired, and losses exceeded $15 billion—erasing every dollar in profit that the airline industry had made from its inception.
Again, don’t kid yourself. Price wars—aggressive and retaliatory cuts in prices to win customers and gain market share—are a fool's game.
__________
1 David Besanko, “The Mother of all (Pricing) Battles: The 1992 Airline Price War”, Kellogg School of Management Case Study, (2004).
2 Thomas Petzinger, Hard Landing: The Epic Contest for Power and Profits That Plunged the Airlines Into Chaos (New York: Times Business, 1995), Kindle Edition.
3 Bensako, "The Mother of all (Pricing Battles): The 1992 Airline Price War."
4 Bensako, "The Mother of all (Pricing Battles): The 1992 Airline Price War."
5 Thomas Petzinger, Hard Landing: The Epic Contest for Power and Profits That Plunged the Airlines Into Chaos.
 |
Patrick Lefler is the founder of The Spruance Group; a management consulting firm that helps growing companies grow dramatically faster. He is a former Marine Corps officer and a graduate of both Annapolis and The Wharton School. The Spruance Group acts as a trusted partner by offering unbiased advice and providing unique solutions to help clients solve their most pressing strategy needs. For more information, visit www.spruancegroup.com or contact Patrick at: plefler@spruancegroup.com |