Date
23 August 2017
Despite public outcry against United Airlines for dragging an Asian passenger (inset) off a plane due to overbooking, the airline is unlikely to change its policy. Photo: Reuters
Despite public outcry against United Airlines for dragging an Asian passenger (inset) off a plane due to overbooking, the airline is unlikely to change its policy. Photo: Reuters

How United Airlines makes more money by offering poorer service

United Airlines is suffering from a public relations crisis after an online video showing a passenger being violently dragged off a plane went viral.

The Asian passenger with a bloody face in the viral video has sparked public outcry against United.

In fact, the airline was frequently ranked one of the world’s worst airlines for in-flight service by Travel and Leisure magazine.

But the truth is, the airline has been very successful in boosting its profit despite poor customer service in recent years, leading to a surge in its share price.

United carried 143 million passengers last year. The airline has posted an annual growth rate of 3 percent in past five years.

As one of the top four airlines in the US, United far exceeds the number of passengers of its smaller rivals such as Alaska Airlines (41.94 million) and JetBlue (38.26 million).

Why do passengers fly United when there are so many other options?

The answer is that United has an unmatchable network that most budget airlines can’t compete with. For example, United offered flights to 342 destinations in North America last year, while the biggest budget airline, JetBlue, flew to 97 destinations.

Also, United offers far more competitive prices than others which offer premium services.

Simply speaking, passengers don’t have too many choices if they want convenience as well as affordable prices.

The US airline industry used to be dominated by two to three airlines. Each of them could easily make good profit. However, regulatory easing led to an influx of new entrants. As a result, the US airline industry has become far more crowded.

The airline business requires enormous upfront investment and has extremely high exit costs. Many operators hence are forced to stay in business despite multi-year losses.

Also, airline operators face fairly high fixed costs, along with almost negligible variable costs. It’s a usual practice for airlines to slash the price of tickets to fill seats, especially when take-off time is approaching.

For years, Warren Buffett stayed away from the sector but the billionaire investor changed his mind suddenly and invested heavily in four airline firms last year, including United Airlines.

As of the end of last year, Berkshire Hathaway owned a 9.12 percent of United shares with a market value of about US$2 billion.

The airline operator has managed to reverse the losing streak since 2012 and posted a combined net profit of nearly US$10 billion in the past two years. Its share price grew two times in the past five years.

While lower oil prices are a key factor behind the turnaround, United’s new “business model” also makes a big difference.

Realizing passengers are often far more price-sensitive than service-sensitive, United compresses the cost as much as possible in order to offer cheaper tickets.

By reducing the size of the cabin crew, offering lower quality in-flight meals and installing more seats, UA gets to increase its revenue.

Here, overbooking also plays an important role. By selling more seats than available and boosting the number of flights that can fully utilize all the seats, United achieves improved bottomline.

Perhaps Cathay Pacific can take a page from United Airlines.

This article appeared in the Hong Kong Economic Journal on Apr. 12

Translation by Julie Zhu

[Chinese version 中文版]

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RT/RA

Hong Kong Economic Journal columnist

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