BUSINESS CASE: United in Pain

The airline industry is notoriously “cyclical.” That is, instead of making profits all through the business cycle, it tends to plunge into losses during recessions, only regaining profitability sometime after recovery begins. Mainly this is because airlines have large fixed costs that remain high even if ticket sales slump. The cost of operating a flight from one city to another is pretty much the same whether the flight is fully booked or two-thirds empty, so when business slumps for whatever reason, even highly profitable routes quickly become money-losers.

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It’s true that airlines can to some extent adapt to a decline in business by switching to smaller planes, consolidating flights, and so on, but this process takes time and still tends to leave costs per passenger higher than before.

But some recessions are worse for airlines than for other businesses, because operating costs rise even as demand falls. This was very much the case in early 2008. In the spring of that year, the Great Recession of 2007–2009 was still in its early stages, with unemployment just starting to rise. Yet airlines were already, as an article in the Los Angeles Times put it, in a “sea of red ink.” The article highlighted the case of United Airlines, which had suddenly plunged into large losses and was planning large layoffs.

Why was United in so much trouble? Business travel had started to slacken, but at that point leisure travel, such as flights to Disney World, was still holding up. What was hurting United and its sister airlines was the cost of fuel, which soared in late 2007 and early 2008.

Fuel prices fell back down in late 2008. But by that time United was suffering from a sharp drop in ticket sales. The airline finally returned to profitability in 2010, which was also the year it agreed to merge with Continental. But in early 2011 fuel prices rose again, putting airlines once more in a difficult position.