Economies of Scale are important, at least in the minds of many managers and investors. Often, we can see these Economies of Scale at work in powerful ways. Sometimes, they seem to disappear.
Within an industry, Economies of Scale tend to be greater from one competitor to another when the industry has high growth. As an example, consider software companies. Oracle Corporation has found that software companies with annual sales of $250 million to $1 billion have operating margins of about 10%. This means that these companies spend 90% of their revenues on costs of People, Purchases and the Capital costs of depreciation. When the size of the companies increases to $1 billion to $5 billion in sales, operating margins go up to 16%. These companies spend only 84% of their revenues for People, Purchases and the Capital costs of depreciation. The largest companies, those with more than $5 billion in revenue, include Oracle, SAP, Microsoft and IBM, a group in rarified atmosphere. These companies have average operating margins of 30%, spending only 70% of their revenues on People, Purchases and Depreciation. Economies of Scale are quite high in this fast-growing industry. (See Steps 27 thru 29 of the Basic Strategy Guide on StrategyStreet.com.)
Now consider an industry that is actually shrinking in physical units sold. Here we will measure Economies of Scale by the number of employees required to produce and deliver one thousand shipments. The leading company in the industry requires 4.5 employees to produce these one thousand shipments. Another major competitor in the industry is less than one quarter the size of the leader, but this company can provide a thousand shipments using about 5 employees per thousand. The smaller firm requires about 11% more employees per thousand shipments than does the much larger company. This contrasts with the roughly 30% more people required by the smaller companies than the largest companies in the software business.
You can also see Economies of Scale at work in an industry over time. You can see it as the industry grows and reduces its costs and consequent prices. A good example is the U.S. cellular service market. In 1997, cellular service cost about 42 cents per minute and customers bought 105 monthly minutes per subscriber on average. By 2004, after much growth and consolidation in the industry, a minute of cellular service cost about 13 cents and the average customer purchased 280 minutes per month. Costs dropped substantially due to Economies of Scale.
Economies of Scale are not a sure thing in many markets. In fact, the leading company in an industry, more often than not, has a Return on Investment lower than that of a smaller competitor. (See the Perspective, “Is Bigger Really Better” on StrategyStreet.com/Tools/Perspectives.) Economies of Scale are the result of strenuous management efforts, not the gift of size alone.
Thursday, July 31, 2008
Wednesday, July 30, 2008
The Fate of Price Point Specialists in Hostility
As a market works its way through overcapacity and Hostility, the industry’s Price Point specialists come under extreme pressure.
Often, the low-end competitors, we call them Price Leaders, are squeezed out by the industry leaders, whom we call Standard Leaders, introducing low-end products to their product line. This pattern explains the demise of low-end automobile manufacturers, such as Yugo and American Motors. The high-end Price Point specialists, whom we call Performance Leaders, also tend to suffer. The industry Standard Leaders introduce more high-end products and pull enough volume from the Performance Leaders to cause them economic hardship.
Many of the Performance Leader companies are purchased by Standard Leaders over time. An example is Ford’s purchase of Volvo and Jaguar when Ford was still a strong Standard Leader. Today, the Japanese automobile manufacturers set the standards for the auto industry. They offer products at most price points, from Price Leader to Performance Leader, and present a strong challenge both to other Standard Leaders and to the remaining independent Performance Leaders in the automobile industry. (See “Why Do Leaders Lead?” in StrategyStreet.com/Tools/Perspectives.)
Even the airline industry is starting to see pressure on the Price Leaders caused by Standard Leader cost-cutting. Until recently, the Price Leaders in the industry, such as Jet Blue, Virgin America, Air Tran and even Southwest, had been protected by the onerous work rules that the unionized workforce imposed on the legacy carriers. But bankruptcy, or its threat, enabled the legacy carriers to reduce some of their cost disadvantages. Now even the best of the Price Leaders in the industry feel the sting of intense competition. At the other end of the price spectrum, no Performance Leader airline in the industry has survived more than a very few years during hostility. All are now gone.
Often, the low-end competitors, we call them Price Leaders, are squeezed out by the industry leaders, whom we call Standard Leaders, introducing low-end products to their product line. This pattern explains the demise of low-end automobile manufacturers, such as Yugo and American Motors. The high-end Price Point specialists, whom we call Performance Leaders, also tend to suffer. The industry Standard Leaders introduce more high-end products and pull enough volume from the Performance Leaders to cause them economic hardship.
Many of the Performance Leader companies are purchased by Standard Leaders over time. An example is Ford’s purchase of Volvo and Jaguar when Ford was still a strong Standard Leader. Today, the Japanese automobile manufacturers set the standards for the auto industry. They offer products at most price points, from Price Leader to Performance Leader, and present a strong challenge both to other Standard Leaders and to the remaining independent Performance Leaders in the automobile industry. (See “Why Do Leaders Lead?” in StrategyStreet.com/Tools/Perspectives.)
Even the airline industry is starting to see pressure on the Price Leaders caused by Standard Leader cost-cutting. Until recently, the Price Leaders in the industry, such as Jet Blue, Virgin America, Air Tran and even Southwest, had been protected by the onerous work rules that the unionized workforce imposed on the legacy carriers. But bankruptcy, or its threat, enabled the legacy carriers to reduce some of their cost disadvantages. Now even the best of the Price Leaders in the industry feel the sting of intense competition. At the other end of the price spectrum, no Performance Leader airline in the industry has survived more than a very few years during hostility. All are now gone.
Thursday, July 17, 2008
International vs. U.S. Growth
Recently, CIBC World Markets’ Jeff Rubin, who is Chief Economist, and Avery Shenfeld, a Managing Director, produced a slide show called “The Age of Scarcity.” To see the slideshow in full, click here.
This slideshow helps me understand why my domestic and Europe investments are off so much more this year than my investments in emerging markets. Among the surprising findings are the following:
- The U.S. is responsible for only 10% or so of global GDP growth, the Euro zone for about 8%. But the emerging markets, including Brazil, Russia, India, China and the mid-East oil producers are responsible for 37%.
- All the major regions, including the Euro zone, Latin America and emerging Asia are much less dependent on the U.S. market for exports than they were in 2000. For example, in 2000 the Euro zone depended on the U.S. for 17% of its exports. Now it is something just north of 13%. As a result, a two percentage point decline in U.S. GDP growth would produce declines of half a percent, or less, in many of our trading partners.
- While U.S. demand for aluminum, nickel, copper, zinc and oil has declined during the period of 2005 to 2007, the demand in China has increased substantially. In aluminum, its demand has grown by 30% over that period of time.
- While U.S. and Europe are seeing minimal growth or shrinkage in their rate of automobile ownership, Russia and China are growing at rates over 50% and 20% respectively.
Of course, domestic and European companies with a high proportion of their businesses in growing markets can do well despite slow conditions in their home markets. For example, in the U.S., Celanese Corporation is operating at record rates, with high profits, due to its strong positions in fast-growing Asian markets.
Overall, these developing markets are a growing force in the growth of larger companies. To be a successful long-term player, you have to sell where the growth is. See Basic Strategy Guide Step 6 in StrategyStreet.com.
Monday, July 14, 2008
Cost in Two Hostile Industries
Again, we look at the two domestic industries in overcapacity: the automobile and the airline industries. We call these industries Hostile markets, because returns for most of the players in the industry are low and price competition is intense.
Over the last twenty years, we have studied and worked in many of these Hostile markets. In about three-quarters of the cases, market hostility is caused by the expansion of industry competition, especially expansion by low-cost competitors. Hostility in both the airline and automobile industry is the result of expansion by competitors. In autos, the expansion of Asian competitors, in particular the Japanese, has gradually put a strangle-hold on the three domestic manufacturers, GM, Ford and Chrysler. In the airline industry, the expansion of low-cost carriers, including Southwest Airlines, Jet Blue and their ilk, have done the same thing with the legacy carriers.
Few of us would volunteer to be in a Hostile market. It’s painful on the best of days. But if you had the choice of working in and managing a company in one of these two industries, which would you choose? In which industry would you be more likely to succeed as an industry leader? Would you rather be a GM, Ford and Chrysler, or any American, United, Delta and Northwest? The answer depends on your view of the relative strength of each set of companies against their expanding competition. In this and the preceding blog, we look at each industry’s domestic competitors compared to their expanding rivals on the basis of Value and Cost.
On the second dimension, that of Cost, both the domestic automobile manufacturers and the legacy airlines face a problem of age. But the legacy airlines can do more about it. Both the domestic auto manufacturers and the legacy airlines have well-seasoned work forces who have been with the companies far longer than most of their lower-cost, expanding competitors. These experienced employees are at the top of their compensation ranges and are often protected by work rules that render them somewhat less productive than their younger, and less-restricted, competitors.
Despite these disadvantages, both sets of industry leaders have proven to be more cost effective competitors in the last few years. The domestic auto industry can now produce an automobile using total labor hours that are close to those of its Japanese competition. Bankruptcy and other means of cost reduction have enabled the legacy airlines to reduce their costs drastically over the last five years. They are still more costly than their low-cost competitors, but the difference has narrowed enough so that, in these strapped times, even the low-cost carriers feel the pressure of low prices.
The legacy airlines still face daunting cost challenges. They are still not as cost-competitive as their low-cost, and low-priced, rivals, such as Southwest. The cost difference does not lie with the rate of pay for the workforce. Southwest pays its employees more on an annual basis than do the legacy airline competitors. Southwest continues to expand in the marketplace, even in the face of fully priced fuel on its marginal expansion. Southwest clearly can produce cash on routes that the legacy airlines can not. The explanation for these differences in cost lies in the relative productivity of the employees of these lower cost airlines.
The relative performance of the two domestic industries clearly gives the legacy airlines more hope. The age issue, in the form of retiree benefits, hits both sets of industry leaders hard. But the cost for the auto industry is nearly unbearable because the domestic producers have shrunk. The domestic auto industry has lost so many jobs over the last twenty years that its dwindling domestic employee base must support an ever-growing set of retirees. The legacy airlines face much less of a problem here. They have expanded their capacity over time by opening up new markets, especially international markets. Their problem of handling retiree benefits is much less than that of the domestic automobile manufacturers.
Overall, the airline industry’s legacy carriers are in a much stronger position than are the domestic automobile manufacturers. The automobile manufacturers are weakest in the aspect of Performance where it is most critical to be strong in a Hostile marketplace, Reliability. They have a fixed cost problem in the form of retiree benefits that will continue to get worse until they are able to expand their presence in the marketplace, an unlikely outcome as long as Reliability issues remain. You can’t reduce costs without customers. (See “Achieving The Low Cost Position” in StrategyStreet.com/Tools/Perspectives.) Still, the legacy airlines have yet to prove they can continue their leadership in the marketplace. As they cut back on their capacity, their Function advantages inevitably ebb. As they cut costs in customer service, their Reliability performance is likely to fade. And, within five years, they have to have a cost structure that will enable them to confront, and price to a standstill, low-cost carriers such as Southwest, and probably others, who will be seeking to enter their lucrative international markets to carry their large numbers of domestic passengers further on their way. Both these sets of industry leaders face enormous problems, but the domestic automobile manufacturers face the worst. Neither one will have much fun.
Over the last twenty years, we have studied and worked in many of these Hostile markets. In about three-quarters of the cases, market hostility is caused by the expansion of industry competition, especially expansion by low-cost competitors. Hostility in both the airline and automobile industry is the result of expansion by competitors. In autos, the expansion of Asian competitors, in particular the Japanese, has gradually put a strangle-hold on the three domestic manufacturers, GM, Ford and Chrysler. In the airline industry, the expansion of low-cost carriers, including Southwest Airlines, Jet Blue and their ilk, have done the same thing with the legacy carriers.
Few of us would volunteer to be in a Hostile market. It’s painful on the best of days. But if you had the choice of working in and managing a company in one of these two industries, which would you choose? In which industry would you be more likely to succeed as an industry leader? Would you rather be a GM, Ford and Chrysler, or any American, United, Delta and Northwest? The answer depends on your view of the relative strength of each set of companies against their expanding competition. In this and the preceding blog, we look at each industry’s domestic competitors compared to their expanding rivals on the basis of Value and Cost.
On the second dimension, that of Cost, both the domestic automobile manufacturers and the legacy airlines face a problem of age. But the legacy airlines can do more about it. Both the domestic auto manufacturers and the legacy airlines have well-seasoned work forces who have been with the companies far longer than most of their lower-cost, expanding competitors. These experienced employees are at the top of their compensation ranges and are often protected by work rules that render them somewhat less productive than their younger, and less-restricted, competitors.
Despite these disadvantages, both sets of industry leaders have proven to be more cost effective competitors in the last few years. The domestic auto industry can now produce an automobile using total labor hours that are close to those of its Japanese competition. Bankruptcy and other means of cost reduction have enabled the legacy airlines to reduce their costs drastically over the last five years. They are still more costly than their low-cost competitors, but the difference has narrowed enough so that, in these strapped times, even the low-cost carriers feel the pressure of low prices.
The legacy airlines still face daunting cost challenges. They are still not as cost-competitive as their low-cost, and low-priced, rivals, such as Southwest. The cost difference does not lie with the rate of pay for the workforce. Southwest pays its employees more on an annual basis than do the legacy airline competitors. Southwest continues to expand in the marketplace, even in the face of fully priced fuel on its marginal expansion. Southwest clearly can produce cash on routes that the legacy airlines can not. The explanation for these differences in cost lies in the relative productivity of the employees of these lower cost airlines.
The relative performance of the two domestic industries clearly gives the legacy airlines more hope. The age issue, in the form of retiree benefits, hits both sets of industry leaders hard. But the cost for the auto industry is nearly unbearable because the domestic producers have shrunk. The domestic auto industry has lost so many jobs over the last twenty years that its dwindling domestic employee base must support an ever-growing set of retirees. The legacy airlines face much less of a problem here. They have expanded their capacity over time by opening up new markets, especially international markets. Their problem of handling retiree benefits is much less than that of the domestic automobile manufacturers.
Overall, the airline industry’s legacy carriers are in a much stronger position than are the domestic automobile manufacturers. The automobile manufacturers are weakest in the aspect of Performance where it is most critical to be strong in a Hostile marketplace, Reliability. They have a fixed cost problem in the form of retiree benefits that will continue to get worse until they are able to expand their presence in the marketplace, an unlikely outcome as long as Reliability issues remain. You can’t reduce costs without customers. (See “Achieving The Low Cost Position” in StrategyStreet.com/Tools/Perspectives.) Still, the legacy airlines have yet to prove they can continue their leadership in the marketplace. As they cut back on their capacity, their Function advantages inevitably ebb. As they cut costs in customer service, their Reliability performance is likely to fade. And, within five years, they have to have a cost structure that will enable them to confront, and price to a standstill, low-cost carriers such as Southwest, and probably others, who will be seeking to enter their lucrative international markets to carry their large numbers of domestic passengers further on their way. Both these sets of industry leaders face enormous problems, but the domestic automobile manufacturers face the worst. Neither one will have much fun.
Monday, July 7, 2008
Value in Two Hostile Industries
We have two domestic industries in overcapacity: the automobile and the airline industries. We call these industries Hostile markets because returns for most of the players in the industry are low and price competition is intense.
Over the last twenty years, we have studied and worked in many of these Hostile markets. In about three-quarters of the cases, market hostility is caused by the expansion of industry competition, especially expansion by low-cost competitors. Hostility in both the airline and automobile industry is the result of expansion by competitors. In autos, the expansion of Asian competitors, in particular the Japanese, has gradually put a strangle-hold on the three domestic manufacturers, GM, Ford and Chrysler. In the airline industry, the expansion of low-cost carriers, including Southwest Airlines, Jet Blue and their ilk, have done the same thing with the legacy carriers.
Few of us would volunteer to be in a Hostile market. It’s painful on the best of days. But if you had the choice of working in and managing a company in one of these two industries, which would you choose? In which industry would you be more likely to succeed as an industry leader? Would you rather be a GM, Ford and Chrysler, or any American, United, Delta and Northwest? The answer depends on your view of the relative strengths of each set of companies against their expanding competition. In this and the next blog, we look at each industry’s domestic competitors compared to their expanding rivals on the basis of Value and Cost.
First, consider Value. Value is the combination of Performance for Price. In turn, Performance is the Function, Reliability and Convenience of the product. The domestic auto industry clearly has a Value problem because it continues to lose share in the domestic market. (See “The Two Best Consultants in the World” in StrategyStreet.com/Tools/Perspectives.) So, where, in Value, is the problem, Performance or Price? It appears that the problem is one of Performance. The domestic automobile manufacturers tend to have slightly lower prices on equivalent cars than do their Japanese competitors, so it can’t be prices. That leaves Performance.
So, where might the Performance problem lie, in Function, Reliability or Convenience? Convenience might be a close call, but the edge goes to the domestic manufacturers, especially to GM and Ford, with their extensive dealer infrastructure. This is a slight nod, at best, since the vast majority of customers are well within striking range of a reputable dealer for any of the Asian and domestic producers. How about Function? Here again, if there is a nod, it goes to the domestic producers. On an equivalent car, the domestic producers tend to have more functionality for the dollar than do their Japanese competitors. No, the problem the domestic producers face more than any other is Reliability. (See “Reliability: The Hard Road to Sustainable Advantage” in StrategyStreet.com/Tools/Perspectives.) The domestic customer base has largely determined that the domestic manufacturers’ cars are not of the same quality as are their Japanese competitors. There is a particular by telling statistic that supports this conclusion. The average Japanese used car sells for a much higher fraction of its original purchase price than does its domestic counterpart.
The industry-leaders in the airline industry are in better Value shape than are the automobile industry leaders. They, too, are losing share, though at a much slower rate than they did a few years ago. Most of their share loss has been due to their premium pricing in routes served by discount airlines.
The Performance of these airline industry leaders is relatively good. They have a clear Function advantage. Their hub and spoke systems allow a passenger to get from one place to another far easier than do the discount airline competitors. The legacy airlines also offer the best frequent flyer programs. Convenience also favors the legacy carriers. It’s a wash when it comes to purchasing tickets and printing boarding passes. Virtually anyone with a computer and an internet connection can purchase an airline ticket easily and print boarding passes before the flight. The legacy airlines, though, have a clear Convenience advantage in their willingness to assign seats on their flights. Reliability is another matter. The legacy airlines have a reputation for spotting Reliability. They suffer from delays and lost baggage. Some question their customer service on-board the aircraft and their abilities at handling customer problems. They are in public relations doldrums. Often, the low-cost competitors wear the industry halo, in part, due to their low prices. But there is substance there as well. Southwest Airlines, in particular, has a reputation for good Reliability with on-time arrivals, enthusiastic employees and relatively low levels of customer complaints.
In summary, the domestic auto producers have a big Value problem in Reliability. The legacy airline competitors have a big Value problem in Price, and a developing problem in Reliability. A Price problem is much easier to fix than is a Reliability problem. A slight edge on Value, then, goes to the domestic airline legacy carriers.
Over the last twenty years, we have studied and worked in many of these Hostile markets. In about three-quarters of the cases, market hostility is caused by the expansion of industry competition, especially expansion by low-cost competitors. Hostility in both the airline and automobile industry is the result of expansion by competitors. In autos, the expansion of Asian competitors, in particular the Japanese, has gradually put a strangle-hold on the three domestic manufacturers, GM, Ford and Chrysler. In the airline industry, the expansion of low-cost carriers, including Southwest Airlines, Jet Blue and their ilk, have done the same thing with the legacy carriers.
Few of us would volunteer to be in a Hostile market. It’s painful on the best of days. But if you had the choice of working in and managing a company in one of these two industries, which would you choose? In which industry would you be more likely to succeed as an industry leader? Would you rather be a GM, Ford and Chrysler, or any American, United, Delta and Northwest? The answer depends on your view of the relative strengths of each set of companies against their expanding competition. In this and the next blog, we look at each industry’s domestic competitors compared to their expanding rivals on the basis of Value and Cost.
First, consider Value. Value is the combination of Performance for Price. In turn, Performance is the Function, Reliability and Convenience of the product. The domestic auto industry clearly has a Value problem because it continues to lose share in the domestic market. (See “The Two Best Consultants in the World” in StrategyStreet.com/Tools/Perspectives.) So, where, in Value, is the problem, Performance or Price? It appears that the problem is one of Performance. The domestic automobile manufacturers tend to have slightly lower prices on equivalent cars than do their Japanese competitors, so it can’t be prices. That leaves Performance.
So, where might the Performance problem lie, in Function, Reliability or Convenience? Convenience might be a close call, but the edge goes to the domestic manufacturers, especially to GM and Ford, with their extensive dealer infrastructure. This is a slight nod, at best, since the vast majority of customers are well within striking range of a reputable dealer for any of the Asian and domestic producers. How about Function? Here again, if there is a nod, it goes to the domestic producers. On an equivalent car, the domestic producers tend to have more functionality for the dollar than do their Japanese competitors. No, the problem the domestic producers face more than any other is Reliability. (See “Reliability: The Hard Road to Sustainable Advantage” in StrategyStreet.com/Tools/Perspectives.) The domestic customer base has largely determined that the domestic manufacturers’ cars are not of the same quality as are their Japanese competitors. There is a particular by telling statistic that supports this conclusion. The average Japanese used car sells for a much higher fraction of its original purchase price than does its domestic counterpart.
The industry-leaders in the airline industry are in better Value shape than are the automobile industry leaders. They, too, are losing share, though at a much slower rate than they did a few years ago. Most of their share loss has been due to their premium pricing in routes served by discount airlines.
The Performance of these airline industry leaders is relatively good. They have a clear Function advantage. Their hub and spoke systems allow a passenger to get from one place to another far easier than do the discount airline competitors. The legacy airlines also offer the best frequent flyer programs. Convenience also favors the legacy carriers. It’s a wash when it comes to purchasing tickets and printing boarding passes. Virtually anyone with a computer and an internet connection can purchase an airline ticket easily and print boarding passes before the flight. The legacy airlines, though, have a clear Convenience advantage in their willingness to assign seats on their flights. Reliability is another matter. The legacy airlines have a reputation for spotting Reliability. They suffer from delays and lost baggage. Some question their customer service on-board the aircraft and their abilities at handling customer problems. They are in public relations doldrums. Often, the low-cost competitors wear the industry halo, in part, due to their low prices. But there is substance there as well. Southwest Airlines, in particular, has a reputation for good Reliability with on-time arrivals, enthusiastic employees and relatively low levels of customer complaints.
In summary, the domestic auto producers have a big Value problem in Reliability. The legacy airline competitors have a big Value problem in Price, and a developing problem in Reliability. A Price problem is much easier to fix than is a Reliability problem. A slight edge on Value, then, goes to the domestic airline legacy carriers.
Thursday, July 3, 2008
Capacity Reduction to Raise Prices
Some analysts have estimated that the domestic airline industry needs to reduce its capacity by 20% in order to become profitable. This estimate sounds very high to me, as I’m sure it would to most of the flying public. If you miss a flight today, or if one should happen to be canceled on you, you are not necessarily going to get to your destination today. Airlines are flying with a high percentage of their seats filled.
But the airline industry seems to be taking this advice to heart. All of the legacy airlines have announced substantial capacity reductions to their current fleets. In addition, the legacy airlines have been shifting domestic capacity to their international routes, thereby reducing domestic capacity, over the last few years.
There is a broad belief that this reduction in capacity will enable the industry to raise prices. This is unlikely to be the case in this industry, as it has not been the case in other industries.
Over the last twenty years, we have analyzed many industries in overcapacity, like the current domestic airline industry. (See “The Real Reason Market Share Matters” in StrategyStreet.com/Tools/Perspectives) In several of those industries, the industry leaders reduced their capacity in order to support prices or get them to rise to more acceptable levels. In each case, this initiative failed.
Capacity reduction usually fails because lower cost competitors in the industry simply add capacity as the higher cost capacity withdraws. The industry leaders end up with lower market shares and the expanding followers end up with both higher market shares and better cost structures. These low-cost competitors become even more formidable opponents.
The same thing seems to be happening in the airline industry today. As the legacy carriers have reduced their domestic capacity over the last few years, the low-cost airlines have expanded to take their places. Already, Southwest Airlines has announced plans to continue growing its domestic route structure through 2009. Virgin America, a discount airline, also plans to take delivery of new aircraft over the next year. Sounds like the same old story playing out again.
But the airline industry seems to be taking this advice to heart. All of the legacy airlines have announced substantial capacity reductions to their current fleets. In addition, the legacy airlines have been shifting domestic capacity to their international routes, thereby reducing domestic capacity, over the last few years.
There is a broad belief that this reduction in capacity will enable the industry to raise prices. This is unlikely to be the case in this industry, as it has not been the case in other industries.
Over the last twenty years, we have analyzed many industries in overcapacity, like the current domestic airline industry. (See “The Real Reason Market Share Matters” in StrategyStreet.com/Tools/Perspectives) In several of those industries, the industry leaders reduced their capacity in order to support prices or get them to rise to more acceptable levels. In each case, this initiative failed.
Capacity reduction usually fails because lower cost competitors in the industry simply add capacity as the higher cost capacity withdraws. The industry leaders end up with lower market shares and the expanding followers end up with both higher market shares and better cost structures. These low-cost competitors become even more formidable opponents.
The same thing seems to be happening in the airline industry today. As the legacy carriers have reduced their domestic capacity over the last few years, the low-cost airlines have expanded to take their places. Already, Southwest Airlines has announced plans to continue growing its domestic route structure through 2009. Virgin America, a discount airline, also plans to take delivery of new aircraft over the next year. Sounds like the same old story playing out again.
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