An analysis of profit cycles in the airline industry

Abstract

The objective of this paper is to understand the financial dynamics of the airline industry by identifying profit cycle periods of the industry and their driving factors. Assuming that the industry profit cycles could be modeled as an undamped second-order system, the fundamental cycle period was identified to be 11.3 years for the U.S. airlines and 10.5 years for the world airlines. Analyses of industry profits reveal that such cycle period is endogenous, neither deregulation nor September 11 have significantly changed it. Parametric models were developed under the hypothesis that phase lag in the system caused profit oscillations; and two hypotheses, lag in capacity response and lag in cost adjustment were studied. A parametric model was developed by hypothesizing the delay in capacity response caused profit oscillations. For this model, the system stability depends on the delay between aircraft orders and deliveries and the aggressiveness in airplane ordering.