Link This | Email this | Blog This | Comments (0)

Once Again, Prices Are Set by the Market
January 26, 2008

NPR: Airline Prices Depend on Airport

I haven't harped on this theme for a while, but I was reminded of it from this NPR story on airline prices. The report expressed such confusion (and almost outrage) that airline flight prices are set by the market instead of being based on what the flight costs.

Imagine that -- 2 different flights of 600 miles each might actually have different prices depending on where you're flying from/to. Of course, that's the free market (or what passes for it in aviation) at work. If you have a discount airline in your city, you're likely blessed with lower prices. If you're at a major hub city without a discount airline (say, Cincinnati), you'll have really high airfares (or you can drive to Dayton).

What the flight actually costs is pretty irrelevant, except for when the airline is calculating their profit/loss statement. It's irrelevant to the price offered to the customer.

It's the old mindset at work -- that I should be able to set my own price as "Price = Cost + Desired Profit Margin." That's just not how most of the world works. This idea that something "shouldn't" cost so much or that a company should be able to "pass along" increased costs to their customers isn't very helpful or realistic.

Prices are set by the market. That's the best lesson I learned in business school. A corollary to that is the Toyota lesson that you can't arbitrarily raise prices -- to reach a desired profit margin you have to reduce your costs (or, as my friend Jamie Flinchbaugh has pointed out, you can change the product so it is valued more by your customers. Arbitrary price increases, above what the market will bear, might eventually drive customers to competitors.

So, I can't believe I'm defending airlines (I rarely do)... but why do they charge $X for a certain flight? Because they can. Because people are willing to pay $X.

How do you see this concept relating to your business? Do you try to pass along increased supplier costs to your customers, instead of finding ways to reduce other costs to maintain your profit level? Has your company adopted more of the Toyota type mindset of Profit = Price - Cost instead of Price = Cost + Profit?

Posted by Mark Graban on January 26, 2008 | Comments (0)