Does the Withdrawal of Capacity Help?

As industry prices fall, and companies’ fortunes decline with the resultant squeeze on their margins, some companies, especially the leaders, seek to withdraw capacity from the market.  The leading companies expect the capacity withdrawal to do two things: redress the imbalance between capacity and demand; and raise prices to more attractive levels because of this better balance.  In practice, the withdrawal of capacity often fails to achieve either of these objectives.

Whenever a leader in an industry reduces its capacity to force price increases, it must consider how competitors will respond.  In many, if not most, cases low-cost competitors expand their capacity to make up for the withdrawal of capacity by the industry leaders.  The end result often is even more capacity available in a marketplace and the same or lower prices available for the industry leaders.

After several quarters of improving profits, the airline industry is again slipping into hostile market conditions as rising fuel prices reduce margins and force higher prices.  Higher prices limit demand growth.  In response to the margin squeeze these tougher times bring to the industry, the industry leaders are restricting the growth in their capacity and, in some cases, reducing the capacity they offer in the domestic U.S. market.  The problem is that several of the industry followers are not going along.

United Continental Holdings and AMR Corporation’s American Airlines have both posted losses for the most recent quarter.  Both of these industry leaders plan to reduce their domestic capacity as a result.  They will be reducing seats available flying into and out of selected domestic markets. 

The pattern of leaders reducing capacity and followers adding it seems to be holding in the current airline industry.  Southwest Airlines, JetBlue Airways and Alaska Air Group derive most of their revenues in the domestic U.S. market.  Each of these companies reported profits in the most recent quarter.  This profitability of the three follower airline competitors indicates that their costs are lower than are the costs of the two legacy airlines that have reported losses, United Continental and American Airlines.  Southwest plans to increase its capacity by 5% to 6% in 2011.  JetBlue plans to add 6% to 8% this year, while Alaska Air plans to grow its capacity by 9%. 

The industry followers are able to add capacity in the face of capacity withdrawal by their larger industry-leading competitors because they have these lower costs.  The lower costs enable the follower companies to make a profit while their larger competitors suffer losses.  In the long run, the only way that the industry-leading competitors will be able to stop the expansion of these follower competitors will be to match or beat their lower cost structures

Failures in Reliability Lead to Share Loss

We have written several times before about the Customer Buying Hierarchy (i.e. customers buy Function, Reliability, Convenience and Price, in that order).  We have also written, on several occasions, about companies winning and failing customers in a marketplace.  In a stable market, failure of a supplier causes more market share to move than does another competitor’s “win” of market share against its peers.  Most failures occur in Reliability. Recently, two of America’s paragon companies have failed their customers on Reliability and are now struggling to catch up.  Other leaders have had a similar problem and have recovered nicely. 

Macy’s is a clear leader in the department store market.  Over the last several years, Macy’s has purchased and integrated other large department store competitors.  For example, in 2005 Macy’s purchased May Department Stores.  As the company worked to integrate these acquisitions and obtain synergistic savings, their attention swerved from customer service.  The company’s failings were greatest in customer interactions with the company’s sales associates.  Nearly half of customer complaints focused on actions of sales associates. These are failures in Reliability.  A customer expects to be well treated by a department store that charges relatively high prices for its goods.  Macy’s failed to do that. The company’s market share began to drift lower as a result of these failures. 

Now Macys is investing a great deal more money and time into the proper training of its sales associates.  This investment is beginning to pay off.  A recent survey of customer satisfaction indicated that the company was making strides in improving its reputation.  Still, it lags the performance of some of its important rivals.  This is still a Macy’s work-in-progress.

Wal-Mart is another industry paragon who drifted from its Reliability promises.  Wal-Mart committed two notable sins.  First, it removed some products that were important to its core customers.  The company did so in an effort to improve the product mix and the margins a better product mix would bring.  Some of its core customer volume began to drift away.  The company also moved away from its aggressive pricing.  Instead of every day low prices, the company began to promote deals on some products while raising prices on others.  Customers didn’t like that either.  Recently, a survey by a retail consulting firm has found that Target Stores offered prices below those of Wal-Mart.  So, Wal-Mart has created Reliability failures in both product availability in its stores and its promise to have “always low prices, always.”  The company’s market share has also drifted lower. 

Wal-Mart now promises to return to its core values and core customers.  It is bringing back the products it once eliminated in favor of higher margin products.  It is getting more aggressive in pricing once more.  This, too, is a work-in-progress. 

Certainly, these leaders can recover from these miscues. We have seen other leading companies struggle with Reliability and yet recover nicely.  For example, several years ago McDonald’s went through a period of time where it was losing market share.  As the company examined the reasons for this market share loss, it noted that customers began to see its prices as high in the quick service restaurant industry.  In addition, its products in stores had developed a reputation as being about the same as or, in some cases, lower in quality than some of its big competition.  Under the leadership of a CEO well versed in operations, the company returned to its roots by emphasizing its core quality values and aggressive pricing.  Today, McDonald’s is the unquestioned leader in the quick service restaurant industry.  Many of its competitors struggle to keep up with McDonald’s. Most fail to do so.  McDonald’s again has gained share in the industry over the last several years.  McDonald’s success in reversing its Reliability failures suggests that the pathway is open for both Macy’s and Wal-Mart.  They both should be able to enjoy similar success.  The odds are they will.