For short haul routes, customers have the option of driving or even taking the train. There are often low switching costs associated with driving. As the hassles associated with flying have increased, switching has increased as well. While flights on longer routes are faster, there is often a price-performance tradeoff. The longer the flight, the lower the threat of substitutes.
The intensity of rivalry is high in the airline industry. There is little to differentiate airlines. Each airline has high fixed costs. Exit costs are high, as each airline has high fixed costs and only operates in the airline industry. In addition, the industry is subject to intermittent overcapacity. In addition, the service is highly perishable — an empty seat cannot be resold later. This spurs intense competition to fill airplanes. With low switching costs and a low diversity of rivals, there is a high degree of rivalry.
The airline industry is generally an unfavorable one in which to operate. Airlines have a limited degree of pricing power and therefore cannot pass along increases in factor costs to customers.
This resulted, for example, in industry-wide losses in 2008 when the price of jet fuel skyrocketed. With the constant threat of new entrants and the threat of substitutes on commuter routes, the airline industry must constantly prove itself to the consumer. For firms within the industry, it is difficult to make money under these conditions. Strict cost controls, the ability to not only attract but retain customers and the ability to fend of new entrants are all critical success factors.
FRBSF. (2002). Competition and regulation in the airline industry. Federal Reserve Bank of San Francisco. Retrieved May 1, 2010 from http://www.u.arizona.edu/~gowrisan/pdf_papers/airline_competition.pdf
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McCormick, G. (2010). U.S. airlines more cautious on 10 fuel hedges. Reuters. Retrieved May 1, 2010 from http://www.reuters.com/article/idUSTRE61O59Z20100225
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