Jumbo Airlines operates out of three main “hub” airports in the United States. Recently, Econo Airlines began operating a flight from Reno, Nevada, into Jumbo’s Metropolis hub for $190. Jumbo Airlines offers a price of $425 for the same route. The management of Jumbo is not happy about Econo invading its turf. In fact, Jumbo has driven off nearly every other competing airline from its hub, so that today 90% of flights into and out of Metropolis are Jumbo Airline flights. Econo is able to offer a lower fare because its pilots are paid less, it uses older planes, and it has lower overhead costs. Econo has been in business for only 6 months, and it services only two other cities. It expects the Metropolis route to be its most profitable.
Jumbo estimates that it would have to charge $210 just to break even on this flight. It estimates that Econo can break even at a price of $160. Within one day of Econo’s entry into the market, Jumbo dropped its price to $140, whereupon Econo matched its price. They both maintained this fare for a period of 9 months, until Econo went out of business. As soon as Econo went out of business, Jumbo raised its fare back to $425.
Instructions
Answer each of the following questions.
Who are the stakeholders in this case?
What are some of the reasons why Econo’s break-even point is lower than that of Jumbo?
What are the likely reasons why Jumbo was able to offer this price for this period of time, while Econo could not?
What are some of the possible courses of action available to Econo in this situation?
Do you think that this kind of pricing activity is ethical? What are the implications for the stakeholders in this situation?
Post by classmate 1
The stakeholders in this case are each of the two companies, any customers or potential customers looking for a flight from this hub.
Econo has a break even point at a low point because they offer lower wages, have limited overhead, and use older planes that are cheaper. For some period, they have been charging $425 for a flight that breakeven is $210. This profit gives them flexibility in the future.
There are a few reasons that Jumbo Airlines can offer this price for the 9 months. The first is that they are a bigger company with more capital. They have 90 percent of the flights out of into and out of Metropolis. This enables then to control the market in this hub. They can and almost have to do this to get rid of the competition. If they don’t then they risk of going out of or losing business themselves.
It seems like Econo needed to do better market research. The “big fish” always tries to eat the “little fish”. It is easier to take competition out while they are small. Econo “may even want to enter into a partnership with a brand that already exists in that market (Brandfolder, 2023), like Jumbo. An established brand with other hub potential may have been a good idea to get involve with.
I think the pricing for this strategy is ethical. For the consumers it may rub them the wrong way if they found out a company is charging more than double its breakeven point, has a high markup value. It may come off as a monopoly and being greedy. However, people need to fly to places so they would be willing to pay the price. Both companies are doing the same thing to each other. Econo tried to get the customer base by offering a cheaper price, so Jumbo counters by offering an even cheaper price. Econo could of just came into the market at a rate like Jumbo. This way the companies would have the same profit rate and maybe find a way to coincide in this market.
Reference:
Brandfolder. “4 Steps to Enter a New Market and Expand Your Business through New Market Development.” Brandfolder, brandfolder.com/resources/entering-new-markets-through-business-development/. Accessed 23 Aug. 2023.
Post by classmate 2
Who are the stakeholders in this case?
The stakeholders are the employees and management of Econo Airlines, the employees and management of Jumbo Airlines, the stockholders of both companies, the customers, and the Metropolis airport.
What are some of the reasons why Econo’s break-even point is lower than that of Jumbo?
The break-even point for Econo is less than that of Jumbo because their overhead is lower due to lower salaries for pilots, less cost for the aircrafts they are using, and Econo operates out of less hubs than Jumbo. All of these result in Econo’s ability to break even at a lower amount than Jumbo.
What are the likely reasons why Jumbo was able to offer this price for this period of time, while Econo could not?
Jumbo likely can offer the price at a loss for this period of time as they have established a larger asset base because they’ve been in operations longer, have more sources of income, have been producing more profit because of higher markup, and can afford to take the loss without bankrupting their company. Econo, on the other hand, does not likely have as large of a cash flow. Having operated for only 6 months combined with taking a loss on their services, becomes detrimental to the sustainability of Econo.
What are some of the possible courses of action available to Econo in this situation?
Econo has a few options—change their prices to lower than Jumbo and operate at a loss (this is not sustainable for business), keep their prices at its current amount and attempt to wait out the time that Jumbo can endure pricing below costs, and file a complaint with the Federal Trade Commission against Jumbo for violating antitrust laws.
Do you think that this kind of pricing activity is ethical? What are the implications for the stakeholders in this situation?
This kind of pricing activity is not only unethical, but also illegal. It violates the antitrust laws that state that businesses cannot act in ways that monopolize or attempt to monopolize trade through unreasonable methods (FTC, 2023). According to the Federal Trade Commission, “Pricing below your own costs is also not a violation of the law unless it is part of a strategy to eliminate competitors, and when that strategy has a dangerous probability of creating a monopoly for the discounting firm so that it can raise prices far into the future and recoup its losses” (FTC, 2023). In this situation, it is clear that Jumbo is trying to eliminate its competition through undercutting its prices for long enough to bankrupt the Econo company.
The stakeholders for Jumbo should be concerned that these unethical business practices may lead to the downfall of the company. Additionally, this type of behavior should be an indication that other unethical behaviors may be occurring within the business, opening up the Jumbo company to investigations and legal concerns. The stakeholders for Econo should also be concerned with how the Econo management is handling their business. It should be very clear to their financial teams that operating at a loss with very little assets is not sustainable. As a stakeholder in the Econo company, they should push for a different approach that does not inevitably lead to the bankruptcy of the company.
References
Federal Trade Commission. (2023). Predatory or below-cost pricing. Federal Trade Commission. https://www.ftc.gov/advice-guidance/competition-guidance/guide-antitrust-laws/single-firm-conduct/predatory-or-below-cost-pricing
Reply to Thread
