British Airways will ground part of its fleet over rising fuel cost

Yo people,

This article demonstrates how British Airways, a major airline especially in the European market, seeks to minimise losses when facing increasing costs.

BA has previously reported earning supernormal profits in the past year, even giving out up to 35million in bonuses to its employees. However, this is changing very soon as fuel prices rise to $120 a barrel. Industry analysts warn that this will "wipe out BA's profits" in the next two years.

In a diagram, this corresponds to an upwards shift in a MC and AC curves.

To maximise profits (or alternately, minimise costs), we predict that the company will reduce output. This is consistent with BA's announcement to ground part of its fleet, especially the older and less fuel-efficient aircraft.

From the diagram, we see that due to rising costs (from red to blue), BA has gone from experiencing supernormal profits of P1abc to subnormal profits of P2def. Profit-maximising output has decreased and prices has also gone up.

However, the article instead reports BA slashing its prices, especially in transatlantic flights. We might conjecture that this is a promotional tactic in an effort to increase demand in the short run as the airline currently faces "sluggish demand".

Besides the above strategies, BA has gone one step further in seeking a long-term solution to the rising costs. It is currently taking the lead in undertaking negotiations to create a transatlantic airline alliance with American Airlines and Continental Airlines of the USA.

While such an alliance would not be equivalent to an outright merger, it is likely to nevertheless result in mutual benefit. Reference to previous airline alliances (Air France-KLM and Delta Air Lines, the Star Alliance, Wikipedia) suggest that the proposed partnership will entail greater choice in flights available, sharing of facilities such as operational staff and combined investments and purchases. This means that the benefits enjoyed by airlines participating in an airline alliance are similar to economies of scale - by purchasing airplane fleets together, for example, they might be able to enjoy a bulk discount. This is precisely an example of marketing economies of scale.

Hence, BA's strategy to negotiate for a transatlantic alliance is easily explained by how such alliances will defray costs and hopefully even increase demand (as more choices and improved service is available to the consumer).

- yongquan (: