Overbooking, a hallmark of the airline industry. Why is this practice legal? Why do airlines continue to utilize the technique? This past Sunday April 9th, all of these questions came to the forefront of national news as United Airlines passenger David Dao was forcibly removed from his seat on United Flight 3411. As the fallout continues, United’s brand deteriorates daily, but how is their bottom line? Logic would suggest the company is in for a free fall financially, but there are several reasons why they’ll be just fine.
Short Term: It’s Going To Get Worse Before It Gets Better. Amidst the wake of the incident, Dao and his lawyers are moving quickly to take the airline giant to court. On top of all that, United is also slated to announce CEO Oscar Munoz’s annual bonus – a number in the ballpark of $13 million. The reason for the large bonus: an increase in short term profits via tendencies such as, you guessed it, overbooking. With all of this swirling, how will United remain competitive with its industry mates? Well, the good news for United is that in dragging David Dao off of their flight, they did not violate any customer agreement. When an airline ticket is purchased, the costumer agrees to the “Contract of Carriage,” which states a customer may be involuntarily removed from a flight for virtually any reason imaginable. Since this is the case, Dao’s suit will likely end in a very large cash settlement, but no criminal wrongdoing will be assigned to United or the Chicago Police. With regards to Munoz’s bonus, United should delay this announcement until their brand name recovers to a respectable level. In doing so, United will prevent any secondary and unnecessary downturn.
(Past years show the increase in profits for United as practices such as overbooking became more and more accepted and rigorous under CEO Oscar Munoz)
Industrial Scope: Airline Firms Handle Turbulence Better Than Most. When considering the short and long term financial impact on United and the airline industry as a whole, we must first examine the economics of the industry. In almost every way conceivable, all airline providers offer you the exact same product: transportation from point A to point B. With this lack of product differentiation, consumers are inclined to book the cheapest flight possible since no one choice is better or preferred over another. Thus, airlines are a great example of perfect substitutes, which forces the offered price for almost every airline to be identical. For this reason, airlines in theory should earn almost 0 profits over the long run. However, in the past 2 years, United has seen a major rise in profits. The Reason? Overbooking. Overbooking became extremely popular in the airline industry in an attempt to gain maximum revenues on each flight and try to get a leg up on the competition, so naturally every airline adopted the practice and hurts consumers in a major way. It was only a matter of time until an event like Dao’s occurred and gave every consumer the opportunity to gripe about the industry as a whole. So, consumer preferences for now will shift away from United but not in the way they would in any other product. Since flight tickets are generally purchased months in advance, United will see no immediate decrease in passengers, but should expect a slight downward tick in customers in the coming months. However, a decrease in consumer preference toward United will be short lived, as a decrease in demand for United tickets will subsequently decrease the price of their flights. Provided that consumers are self interested economic agents, they will purchase the cheapest flights they can, which will be United. If there is any doubt whatsoever of United not recovering, they’re the 3rd largest airline provider in the US: they will be more than fine. United will continue to regain brand name and slowly increase their prices while maintaining high sales until they again reach the prices of their competitors.
Long Term: Smooth Sailing For United. In the past couple of days since Dao’s removal from United Flight 3411, United’s stock (UAL) lost over $250 million in market cap. In the initial reaction, they lost as much as 4.4% per share. In short, these numbers seem distasteful and could discourage investors. However, in the course of even the past month, this slight dip is minuscule, even unnoticeable on their chart of stock prices. Compare this to the shift in consumer preference of the Chipotle E Coli outbreak and United holders shouldn’t even break a sweat. Chipotle (CMG) suffered a move than 25% decrease in stock prices over the course of several months. While it’s unclear of the future for United shares, early trading today has United essentially even on the day.
In short, it may seem like the sky is falling for United. In reality, this recent news and media scrutiny is nothing more than a minor bump in the road for one of the giants of the airline industry. As another vote of confidence for the long haul, Delta Airlines CEO Ed Bastian recently came out in support of the practice of overbooking as a very valuable business tool and reaffirmed that no greater government intervention need be done. Since every airline uses this practice, consumers simply cannot shift away from United in a boycott of overbooking. As United ticket prices fall in the short run, they will be met with a surge in sales and an eventual return to market equilibrium prices and revenues while suffering no long term financial damage.
– Corey Manley