The efficient industry hypothesis suggests that if an industry looks particularly attractive, or unattractive, then companies will enter, or leave, until the attractiveness or unattractiveness disappears. But then there are businesses which governments are keen on. The airline industry is one of them and governments fight to allow their taxpayers to pour ever more money into black holes.
Warren Buffett observed that the world airline industry has not made a dime for investors in a century of manned flight. He said this in 1991, acknowledging his mistake in buying stock in US Air (now known as US Airways). Although Mr Buffett engineered a profitable exit from his investment, matters are no better. US Air is under Chapter 11 protection, along with United Airlines and now Delta and Northwest Airlines. The bankruptcy court judge is as essential to your flight as the pilot.
The Sage of Omaha argues that industry factors generally dominate profitability: “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.” But what gives an industry a reputation for bad economics?
I have always favoured the efficient industry hypothesis, the business analogue of the efficient market hypothesis. If an industry looks particularly attractive, or unattractive, companies will enter, or leave, until that attractiveness or unattractiveness disappears. But, like the efficient market hypothesis, the efficient industry hypothesis is a tendency, not a universal truth. There is debate over whether company or industry effects are more important to persistent profitability but little doubt that some industries are persistent dogs.
Some businesses attract too many entrants because people like being part of them. Newspapers, for one. Publishing and bookselling have always attracted people who love books more than they love money. With antique shops, wine retailing and restaurants you can always sit on a Louis XV chair and eat your own cooking with choice vintages, even if customers won’t. And frequently this is what happens.
Some businesses have too much capacity because governments favour them. Politicians are convinced that steel is the product on which all economic activity ultimately depends and that the expansion of steel production is a measure of industrial success. When the Soviet Union collapsed, its gross national product was perhaps a tenth that of the US but its steelmaking capacity was greater. If steel is the totemic raw material, cars are the totemic manufactured product. Governments support more car plants than the market can justify. Good news for drivers but bad news for efficient car manufacturers and their shareholders.
The dollar bill auction is an unpleasant party game played by economists. The rule is that a dollar bill goes to the highest bidder, but both highest and second-highest bidder must pay. The game can continue until the resources of the players are exhausted. Even if you are already hopelessly in the red – you have spent more than a dollar to gain a dollar – you may go on raising the stakes. Another cent might win you a dollar: not to put up another cent involves certain loss.
The game describes wars of attrition in military strategy – and in commercial life. If the market will ultimately be profitable for those businesses that remain, companies go on spending in order to be among them. The total amount that can be lost in this process may, as in the dollar bill auction, greatly exceed the profits anyone will ever derive.
The misfortune of the airline business is that it combines all these characteristics. Being an airline executive seems to offer the company of glamorous hostesses and the allure of exotic locations, even if the reality is meetings with insolvency practitioners and visits to the commercial courts. Governments want to see an airline carry their flag: Italy and Greece fight the European Commission to allow their taxpayers to pour ever more money into black holes called Alitalia and Olympic Airlines. Few other industries could have expected the speed and scale of assistance that Congress offered America’s airlines after September 11.
Perhaps there is, ultimately, a profitable airline business for those who stay the course. That is what Northwest and Delta are telling their creditors, what Olympic is telling its sponsoring government. But as long as such claims are accepted, the day the airline industry earns a dime for investors less shrewd than Mr Buffett will never dawn.