Cultural Revolutions

Understanding the Airline Industry

United Airlines’ December 9 bankruptcy filing came as no surprise to those who understand the airline industry, in which even America’s most successful living investor, Warren E. Buffet, could not turn a profit.  Buffett once observed, “In a business selling a commodity-type product it’s impossible to be a lot smarter than your dumbest competitor.”  Mr. Buffett’s investment company, Berkshire Hathaway Inc., lost money by purchasing convertible preferred stock in U.S. Air in 1989, a decision he later termed “a mistake” in his annual letter to shareholders.  At the time of purchase, he told them, “We have no ability to forecast the economies of the investment banking business, the airline industry, or the paper industry.”  Two years later, he observed, “At the time some of you may have doubted this confession of ignorance.  Now, however, even my mother acknowledges its truth.”  U.S. Air later filed for bankruptcy, one of more than 125 carriers to do so since the 1978 federal deregulation of the industry.

The economics of the airline industry are lousy even when the economy is expanding.  Carriers face high capital costs (the purchase of new airplanes) and have difficulty making price increases stick.  Pre-deregulation airlines were protected from competition and could pass their high capital structures on to consumers in the...

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