A fixed cost, as defined by Bernanke and Frank in The Principles of Economics, is the sum of all payments made to the firm’s fixed factors of production. A fixed cost does not increase or decrease with output, it remains the same regardless of output. Companies, such as airlines, operating with high fixed costs are faced with many challenges in order to maximize profitability.
Airlines will incur the same costs to fly a given route regardless of whether or not the plane is at capacity, yet in the airline industry, there are many factors that affect output. Weather events, labor disputes, seasonal travel trends, as well as events that can impact the industry as a whole like a plane crash or terrorist attack all affect output. Any number of these factors can determine whether or not a scheduled flight is cancelled or whether at takeoff it is 5% full rather than 50% full.
As a result of the September 11 terrorist attacks airline travel decreased and fares were lowered in order to lure passengers back. According to an article published in the Transportation Journal in the summer of 2003, load factors for 2002 were estimated at 72 percent but the breakeven passenger load at that time was at 81 percent. Net losses in 2002 were estimated at approximately $9 billion.
Airlines have developed several strategies in order to overcome these challenges. One strategy is to reduce fares and increase capacity during slow times while increasing fares during peak months. The idea is to “to increase occupancy by decreasing price during slow times, and to increase revenue by increasing price during busy times with the overall objective of increasing operating profits” (Toh & Raven, 2003). Other strategies include inventory control such as overbooking as well as managing discount fare allocations – when and who get the discounts.
While operating a business with