 The
U.S. airline industry has been experiencing an enormous
amount of collective and individual financial distress. But
what impact does an airline’s financial woes have on its
pricing strategies? Does a firm in distress slash prices in
hopes of gaining market share and boosting sales? Or does it
circle the wagons and adopt a more conservative approach?
According to recent award-winning research by PhD
candidate Christian Hofer, the answer may be ‘a little of
both.’ Hofer collected quarterly data on the top 1,000
domestic routes from 1992 to 2002. He found that an
airline’s financial condition does have an effect on its
prices, but the magnitude of the effect depended on other
factors, such as the firm’s operating costs, its market
power, the market concentration, and the firm’s financial
position compared to its competitors.
The study showed that the poorer financial condition an
airline was in, the lower its airfares were. The more
concentrated the market, the more likely a financially
distressed airline was to lower airfaires. But an airline
was less likely to lower its fares if it had high operating
costs, if it had strong market power, or if its competitor
airlines were also in financial trouble.
“Managers and policy makers often complain about the
anti-competitive effect of Chapter 11 bankruptcy
protection,” says Hofer. “They feel that Chapter 11 keeps
distressed firms alive and even conveys these firms
competitive cost advantages. This contention, however, is
based on the assumption that bankrupt firms do in fact price
more aggressively than healthy firms. This is one of the
first studies to provide sound empirical evidence for that
contention.”
This makes Hofer wonder if price cutting is actually an
economically viable turnaround strategy for distressed
firms. Do distressed firms that cut prices have a greater
chance of survival than firms that don’t cut prices? Hofer
plans to tackle some of these questions in future research.
For more information, contact
chofer@rhsmith.umd.edu. |
