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Lindley Estes is a business writer for The Free Lance-Star and Fredericksburg.com. This blog is on Fredericksburg-area business. Send an e-mail to Lindley Estes.

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Just because you need it doesn’t mean it’s profitable

A RECENT article in Fortune on the struggles of airliners shows there’s not always a relationship between an industry’s usefulness to society and its profitability.

The May 12 edition of Fortune had an article on the challenges facing American Airlines, which lost $328 million in the first quarter. Analysts estimate the airline is losing $3.3 million a day.

Although the article focuses on the problems at American, it makes clear that the entire industry is suffering in the wake of soaring oil prices that this week passed $126 a barrel.

To compound the problem, airlines don’t have the ability to raise flight prices enough to make up the difference. Ample competition from other airlines prevents that, and consumers will only pay so much.

"No airplane was ever designed to make a profit with jet fuel at these prices, and no carrier has figured out a way to charge enough to make up the difference," the article states.

Fortune makes clear that the airlines have already tried to add fees wherever they can–charging more for extra or heavy luggage and adding fees for formerly complimentary onboard meals and movies.

"Airlines like American long ago chopped the low-hanging fruit and added extra fees wherever they could," the article states.

Fuel costs have increased 29 percent since last year, while the market allows fares to go up only 5 percent, Fortune says. The average cost in fuel for a Boeing 767 to fly from New York to Los Angeles has gone from $7,781 to $27,495 in the past four years.

Southwest Airlines has cleverly hedged jet fuel prices, allowing it to pay less for its biggest expense. That has enabled Southwest to charge lower fares, and has boosted its stock returns.

Other airlines haven’t been as successful at controlling fuel costs, and competition from low-cost providers such as Southwest has prevented higher fares. Many airlines have declared bankruptcy, and the stocks have tanked.

Few would dispute that airlines play a crucially important role in society, and hence one might think they’d be equally profitable. Meanwhile, seemingly mundane businesses that get little publicity rake in the dough.

Billionaire investor Warren Buffett advises people to seek out companies that have "durable competitive advantages" and can pass along expenses to consumers. (Ironically Buffett once got burned by the airlines, making an ill-fated big bet on U.S. Airways stock.)

Buffett and his partner at Berkshire Hathaway, Charlie Munger, have in the past used Wrigley chewing gum to explain durable competitive advantage, which they call a company’s "moat."

They have said consumers would gladly pay an extra nickel to buy a pack of Wrigley gum over the generic brand. Perhaps that’s one reason Berkshire recently bought a multi-billion-dollar stake in Wrigley.

Meanwhile, airlines have no such moat. Few would pay much extra money to fly one airline instead of another, assuming the flight times were roughly equal. So revenue is somewhat static while expenses soar.

Not a good time to be operating in the friendly skies, no matter how crucial the service provided.

Permalink: http://news.fredericksburg.com/businessbrowser/2008/05/11/just-because-you-need-it-doesnt-mean-its-profitable/

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