Published April 2004

No-frills airlines grab
a spoke of ever-rolling ‘Wheel of Retailing’

Air travelers today have finally found something to cheer them up: lower fares. After enduring longer lines, security delays and a fare system that was anything but fair, customers are seeing the benefits of a surge in competition in the airline industry.

Some of these changes have come as a textbook example of a marketing theory called the “Wheel of Retailing.” What this theory says is that new retail businesses break into an existing market by offering lower prices along with generally lowered levels of service. In the retail sector, this is best exemplified by the “no frills” store with unadorned displays of goods in a warehouse-like ambiance. Certainly, Costco and Wal-Mart come to mind.

The theory doesn’t stop there, though. After capturing part of the market, the no-frills stores start to worry about keeping their customers, and begin to add services — credit, delivery, more in-store assistance, etc. — which puts upward pressure on their prices. Eventually, as this process advances, and prices rise to absorb the costs, the door opens to another competitor who will again offer lower prices in an austere, frill-free environment.

The classic version of this “wheel” in action does not have a happy ending.

Barneys New York began as the low-cost supplier of men’s and boys’ clothing. It was the entrepreneurial dream of a pants-maker, Barney Pressman, whose idea was to provide an alternative to the expensive department stores that dominated the market. Its “Barneys Boys Town” outfitted countless thousands of young boys with their first suits and, in a sense, their first glimpse of themselves as adults. All at the low, low prices the advertising promised.

Barney’s son, Fred, took the operation upscale, just as the “Wheel of Retailing” would suggest. He bet the company on new, European designs and fabrics, and took the business to new heights of financial prosperity and market position.

But the “Wheel of Retailing” came off the tracks for Barneys when Fred’s sons Gene and Bob took over the firm and tried to take it even further upscale. Lavishly decorated retail stores, market-limiting prices and a business plan overly dependent on borrowed money all combined to bankrupt the firm. What had taken two generations to build up took a remarkably short time, less than 10 years, to scuttle.

How will the “Wheel of Retailing” play out in the airline industry? No one can be sure, of course, but it is unlikely that we will see a rerun of Barneys’ spectacular collapse. Instead, there are some reasons to believe that the low-fare, no-frills airlines will enjoy growing market share for some time.

One reason is that the consumers’ preference for lower fares over higher service levels isn’t something that jumped up overnight. It has been evident ever since Congress deregulated airline fares in 1978.

Air travelers often decry the descent of air travel style and cachet, but consumers vote with their dollars, and the pattern of their preference has been unmistakable. While they enjoy complaining about cheese-cracker meals and time-consuming routing through Cincinnati or some other hub, most are reluctant to pay anything but the lowest fare.

The second reason is that the established airlines, including United Airlines (now in bankruptcy proceedings), are targets that don’t have a lot of maneuvering room to compete. These airlines have the higher labor costs of a unionized work force as well as the higher worker-per-airplane ratios of mature, change-resistant organizations. And their size does not give them any significant advantage in managing their fuel costs, a major factor in all airline profitability.

All in all, there is not much hope that these airlines are going to be able to turn things around any time soon — which is evidenced by the fact that each is attempting to establish new, regional airlines to generate profits.

In addition, the upstart, frill-free, union-free airlines currently enjoy a price advantage while being able to preserve a level of service that is not dramatically different from the big guys. Part of the reason for this is that the poor financial condition of the established airlines has forced service level cutbacks there, also, reducing the difference.

Another part is that so much of perceived service has to do with attitude. Fortunately for the new entries, bad attitudes and low morale generally take time, as well as indifferent management, to mature in a work force — another plus for the new airlines still filled with entrepreneurial spirit.

Whether the frill-free airlines will be able to maintain their current advantage, then, is really a question of good management more than anything else. And this is the lesson for us in the “Wheel of Retailing.” Throughout the cycle, but especially at the entry point, success is all about cost control and work-force motivation.

James McCusker, a Bothell economist, educator and small-business consultant, writes “Your Business” in The Herald each Sunday. He can be reached by sending e-mail to otisrep@aol.com.

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