MANAGERIAL ECONOMIC ANALYSIS OF SOCIAL COMMERCE Re.docx

MANAGERIAL ECONOMIC ANALYSIS OF SOCIAL
COMMERCE
Research Paper
Managerial Economic Analysis of the Impact of Social
Commerce on E-commerce
Submitted by
Student
Prepared for
Professor Thomas C. Makemson
BUSN 6120, Managerial Economics
Spring 1, 20XX
Section: XX
Webster University
March 2, 20xx

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author. I have cited all sources from which I used data, ideas,
or words, either quoted directly or paraphrased. I also certify
that this paper was prepared by me specifically for this course.
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Today, Facebook, Linkedin, Twitter, MySpace are well-known
social networking brand names that many of us have grown
accustomed to making part of our daily routine, whether it be
for staying in touch with friends, networking, or micro-
blogging. Social networking tools have the potential to
revolutionize e-commerce as we know it today through “social
commerce” platforms. A 2011 study by Booz & Co estimates
that social commerce is currently a $5 billion market with the
potential to grow to $30 billion in five years. Social
commerce's transformational power lies in its personalization of
the internet experience, connectivity with an individual’s
network, and the dynamic customer data collection that can
drive current and future marketing and sales efforts. In this
paper, the author will introduce the social commerce concept,
examine the social commerce market, explore the effect of
social commerce on consumer behavior, discuss social
commerce pricing strategies and valuation of social commerce
networks, evaluate the industry concentration and look at the
future of the social commerce.
What is Social Commerce?
Even though today we equate social networking with Facebook
and Twitter, social networking itself is not a brand new concept.
“Early forms of social networks include the guilds in medieval
Europe, trade groups, and unions, which can be traced back to
the early 18th century, and more modern venues like the
Chamber of Commerce and Rotary Clubs, which have emerged

over the last 10 decades as accepted forums for professionals in
similar industries and business communities to meet and further
commerce, business relationships, and advocate for changes in
business practices”. These early systems evolved into the social
networks of today and more recently integrated with modern e-
commerce capabilities to develop a new marketing and sales
channel known as social commerce.
Because it is a nascent field, the term “social commerce” has
many definitions depending on consumer and provider
viewpoints. However, the author has chosen to use this
definition throughout this paper: social commerce is a “subset
of electronic commerce that involves using social media, online
media that supports social interaction and user contributions, to
assist in the online buying and selling of products and
services”.
Today, social commerce is a field that allows firms to harness
existing social networking platforms to personalize sales and
advertising experiences based on reviews, ratings,
recommendations, networks, personalized groups, and location.
Vendors are able to provide individualized platforms and
encounters driven by data provided through external social
networking sites or internal data collection.
Groupon is an example of a social commerce firm that uses
internal and external data collection to provide users with
coupons for businesses local to a user. Groupon allows users to
submit gender, biographical data, residence location
information, favorite industries (e.g. health and beauty, food
and drink, or retail and services stores), educational
background, employment status, income range, home ownership,
marriage status, and children status. Combined with analysis of
past purchases through Groupon, this sociographic data provides
the firm with a wealth of knowledge to predict a user’s spending
habits. Therefore, this information allows Groupon to present
coupons/deals based on predicative analysis, which is analogous
to the “Customers Who Bought the Item You Added Also
Bought” feature on Amazon. Groupon customers can also easily

share coupons by email or social networking sites (i.e. Twitter,
Facebook) by clicking on the share feature located on each
potential coupon page (See Figure 1).
(
The Facebook “Like” button
)
Figure 1: Screenshot of Groupon.com based on selection of
Baltimore, Maryland as a home location.
Firms like Resource Interactive have developed end-to-end
marketing solutions for companies looking to take advantage of
social commerce platforms. Through their “Resource
Distributed Commerce Platform”, Resource Interactive provides
their customers with a vehicle to engage in Facebook Commerce
(also known as “F-Commerce”), where firms can sell their
merchandise through Facebook status updates and tab stores.
Resource Interactive manages over 18 million of their clients’
fans on Facebook and use this data to drive develop fan
engagement, brand loyalty, and social commerce strategies.
Figure 1 above shows the “Like” button seen on many websites
today and with the over half a billion Facebook members
worldwide, the market potential of firms that engage in F-
commerce is tremendous.
Social Commerce Market Analysis
In this section, we will conduct a social commerce market
analysis, specifically decomposing the supply and demand
potential for this marketing and sales platform. According to
Social Commerce Today, currently, there are more than 2
billion internet users worldwide and this figure presents a
tremendous market opportunity as people on average spend 30%
of leisure time online.
Many demographic groups also present opportunities to exploit
their social networking habits for social commerce revenues.
For example, among 11-14 year olds, high-use social networkers

(defined as accessing social networking sites three times a day
or more) are “50% more likely to be asked for advice by their
school friends about toiletries and cosmetics, 40% more likely
to be asked about mobile phones or fashion, and 20% more
likely to be asked about new music.”
According to Facebook, more than 250 million people engage
with Facebook on external websites every month. Moreover, an
average of 10,000 new websites integrate with Facebook every
day and more than 2.5 million websites have already integrated
with Facebook. Furthermore, the “Like” button feature for
websites unveiled by Facebook in 2010 has presented higher
website traffic and increased sales after websites installed the
tool. This tool lets users signal their affinity for a brand, item
or product and broadcast that back to the social networking site.
As an example of the power of the Like button tool, a film
database website saw its traffic double since it installed the
Like button throughout the site. Separately, Facebook is tasking
its members to use the Like button in an effort to compile smart
search engine using “likes” to determine what is most relevant
on the web, which is in direct competition to Google’s
algorithm search method.
Social commerce is also attracting additional share of overall
marketing budgets. A recent American Marketing Association
and Duke University’s Fuqua School of Business survey
predicted that social media advertising will account for over
18% of total marketing budgets in the next five years (See
Figure 2). In addition, this survey indicated that service
companies (See Figure 3) are planning the biggest social media
advertising increases, “as both B2B and B2C service companies
have a higher percentage of their budgets set aside for social
media than their product-focused counterparts” (eMarketer,
2011).
(
Figure 3: Source
(eMarketer, 2011)
) (

Figure 2: Source:
(eMarketer, 2011)
)As mentioned previously, a 2011 Booz & Co study indicated
that the social commerce market is estimated to grow to $30
billion by 2015 (See Figure 4). The $30 billion estimate
scratches the surface for social commerce’s market potential as
it only estimates hard goods sold through this platform. The
services industry has a great deal of potential in the social
commerce space, especially in cases where existing
technologies can be integrated as in the case of mobile phone
internet and social media advertising. Booz & Company also
conducted a separate survey in 2010 focusing on consumers who
spend at least one hour a month on social networking sites and
who had bought at least one product online in the last year.
This survey indicated that 27 percent of respondents said they
would be willing to purchase physical goods through social
networking sites.
Figure 4: Source is Booz & Co. (2011, Jan 19). Turning “Like”
to “Buy” Social Media Emerges as a Commerce Channel.
When compared to Booz & Co’s estimated social commerce
current and future market levels, U.S. consumer aggregate
spending in 2009 provides an indication as to the growing
importance of social commerce across discretionary spending
categories. Table 1 illustrates a hypothetical situation where
social commerce could have the potential to account for over
35% of the Apparel and Services (Girls, 2 to 15) market today
and 1.54% of the entertainment market. Table 1 also shows
2015 estimated social commerce market figures compared to
2009 consumer expenditures to illustrate the growth potential of
social commerce based on current consumer expenditures.
Item
U.S. Consumer Aggregate Spending in 2009
U.S. Social Commerce Market as % of 2009 Aggregate

Spending (Est. 2011 Levels of the Social Commerce Market)
U.S. Social Commerce Market as % of 2009 Aggregate
Spending (Est. 2015 Levels of the Social Commerce Market)
Average annual expenditures
$5,929,795
0.08%
0.24%
Apparel and services Total
$208,496
2.40%
6.71%
Apparel and services (Girls, 2 to 15)
$14,219
35.16%
98.46%
Apparel and services (Boys, 2 to 15)
$9,499
52.64%
147.38%
Entertainment
$325,412
1.54%
4.30%
(Aggregates in millions of dollars)
Table 1: Source: 2009 Consumer Expenditure Survey, BLS.gov
Demographics of social media users also plays an important role
for retailers and marketing staff as they aim to harness the
power of social commerce. A recent Gallup poll found that both
Google and Facebook pages tend to attract young, affluent, and
educated Americans disproportionately (See Figure 5). The
study found men and women are about equally likely to have a
Facebook page. Gallup also highlighted the overlap of new

services between Google and Facebook as a source of increased
competition for the two internet innovators. Gallup cites
Google’s recent announcement that “will more prominently
display ‘social search’ results akin to Facebook's ‘like’ and
‘share’ features, and it also has its own social networking
feature, Buzz.” Facebook is following suit by including in-site
chat and e-mail options to meet Google on its own turf. This
survey sheds interesting light on social media users and could
be followed up with a study focusing on non-U.S. users of
Facebook and other social media sites considering that 70% of
Facebook’s users live outside the United States .
Figure 5: Source: Gallup.com; “Google and Facebook Users
Skew Young, Affluent, and Educated” (Morales, 2011).
Effect of Social Commerce on Consumer Behavior
Consumers operate in a world with imperfect information and
must make purchase decisions based on that imperfect
information. As such, these transactions involve risk on the
part of the consumer, especially for new products. Attitudes
toward risk vary among consumers with some consumers acting
as risk loving, risk neutral, or risk averse. Most individuals are
risk averse in situations with nontrivial outcomes. Therefore,
the author will consider that most consumers in the U.S. are risk
averse as they consider most of their nontrivial purchases of
discretionary and non-discretionary goods.
Given the risk averse nature of U.S. consumers, social
commerce provides a mechanism to reduce consumer
uncertainty by exploiting their social networks as they consider
factors like product quality. As an example of the power of
networks on purchasing decision, a 2010 study was conducted
by Varsity and published by eMarketer.com (See Figure 6). It
showed that when purchasing clothing or footwear, 81 percent
of girls, ages 13 to 18, use their friends and peers as a source of
trend information and 45 percent list this group as “very

influential”. Therefore, the girls surveyed appear to relying on
their social networks to lower their uncertainty prior to making
purchases.
Figure 6: Source: How to Influence Teen Girls Online;
www.eMarketer.com
Social buying sites like Kaboodle, take advantage of these risk
averse and imperfect information considerations that consumers
face. Kaboodle is a social shopping site where networks can
recommend, share products, discover new products from people
with a similar style. Members of Kaboodle also “create and
join groups, share advice, feedback and product suggestions and
personalize their profiles with polls and other widgets”. As of
February 2011, Kaboodle had over 14 million monthly visitors
and had over 900,000 registered users that have added 10
million products to the site.
Another retailer, Wet Seal, harnessed the power of social
commerce by developing a social buying experience through a
“virtual runway where site visitors can put together outfits to
share with their friends or to present to the community to be
voted on. A pair of friends shopping at Wet Seal can use a
service powered by Sesh.com to view the same product pages,
chat in real time, and use a drawing tool to notate or highlight
products they are considering”.
In summary, social commerce sites can help minimize consumer
perceived risk and lower consumer search costs. Going beyond
traditional price comparison sites, social buying sites can
further reduce the reservation price for consumers, who can now
also take their friend’s advice on searching for a particular good
when deciding whether to purchase from a particular store at a
certain price or continuing to searching for a lower price.
Pricing Strategies used by E-commerce and Social Commerce
Firms
Amazon, one of the major pioneers of e-commerce, has
continued to innovate the online retail space through the

integration of social commerce into its sales and marketing mix.
Amazon recently invested $175 million in and partnered with
the social commerce firm, LivingSocial to draw customers to
the Amazon.com site. LivingSocial is similar to Groupon in
that they provide users with coupons based on their location.
Unlike Groupon, LivingSocial does not offer users to provide
deeper demographic information as part of their customer
intelligence system. Instead, LivingSocial provides one deal in
a user’s area per day. The site encourages users to share the
deal to their contacts by offering users the “deal of the day” for
free if three additional contacts purchase the deal through a
unique link that a user shares with them. To generate buzz, in
late January 2011, LivingSocial partnered with Amazon to
provide shoppers with a $20 Amazon.com gift card for just $10.
LivingSocial sold 1.3 million Amazon gift cards in this
promotion.
Social commerce firms are still in their infancy even compared
to the e-commerce giants that arose following the internet
evolution in the mid-1990s. However, by joining forces with
existing e-commerce sites, social networking/commerce firms
have developed pricing strategies that indicate that they have
market power. Social commerce companies are also able to use
that market power to charge higher and vary markups among
groups through mechanism such as price-discrimination.
A 2006 study looked at the price-discrimination question as it
relates to the e-commerce sites and specifically, choices that
Amazon makes in an effort to “empirically assess the optimality
of their [price-discrimination] choices” (Ghose & Sundararajan,
2006). To conduct the price discrimination evaluation, the team
converted the “sales ranks” reported by Amazon.com into actual
demand levels by estimating how the variation in prices was
associated with variation in demand. They then took random
“samples” of data by checking prices at random times over a set
time period. They specifically looked at software packages for
sale on Amazon. One of the examples presented in the paper
was their study of the sale of the Microsoft Office suites

(Professional and Standard suites). The study found that that
the sign of the own-price elasticity of the difference suites were
positive while the signs of the cross-price elasticities were
negative. The study also found that the sales of products
decrease over time. The group discovered that the “cross-price
elasticity of the Professional version of Microsoft Office with
respect to the low-quality [Standard] version (p-standard), was
actually higher than the own-price elasticity” (Ghose &
Sundararajan, 2006). This result highlighted that in the Amazon
case, Microsoft Office Professional was very sensitive to the
price of Microsoft Office Standard. Furthermore, to
demonstrate their test model for the optimality of pricing, the
team used estimates for own- and cross-price elasticities
derived for both the Professional and Standard versions of
Microsoft Office. The estimated derivative of profits of each
version were negative, which suggested that they were both
overpriced, “since they are priced at a point where the slope of
the
profit function is negative” (Ghose & Sundararajan, 2006). This
study shows that it is possible to analyze price discrimination
and price elasticity models for e-commerce sites and should be
followed up with further research on the effects of social
networking/commerce firms on price discrimination and price
elasticity of e-retailing. This could help firms develop better
pricing models and increase revenues.
Because they have market power, e-commerce firms like
Amazon can partner with social commerce companies to
introduce additional third-degree price discrimination strategies
into their sales mix. For example, some social commerce sites
use a “group buying” technique where a specific set of
consumers must “buy-in” to a particular deal to get a particular
discount and occasionally, the higher amounts of deal-takers
result in higher discounts. Through the use of “group” buying,
social commerce firms are able to give discounts to users that
have ready-made networks of contacts that can be exploited to
generate additional revenue. For example, it is less economical

for a retailer to discount a product by 10% (thereby reducing
profit margins by 10%) to just one consumer, but the same firm
could benefit from economies of scale if the one consumer
resulted in bringing in an additional 50 buyers, all with a 10%
discount. While profit margins have shrunk on individual sales
in this scenario, the increase volume from “group” sales to 50
buyers can more than make up for the decreased margins.
Moreover, e-commerce sites can “reward” social commerce
users with deals based on how much detailed information they
provide as part of their customer profile, the amount of “Likes”
used on Facebook, and through mobile internet positioning. In
summary, price discrimination is a powerful tool that can be
used to increase revenues for both product and service
companies that partner with social commerce firms.
Deriving value from Social Commerce Networks
A mid-2010 study in the Journal of Marketing Research (JMR)
examined the question of how firms can derive value from
social commerce networks. The study considered the following
questions: Does allowing sellers to connect to each other create
economic value (i.e., increase sales)? What are the mechanisms
through which this value is created? How is this value
distributed across sellers in the network, and how does the
position of a seller in the network (e.g., centrality) influence
how much the seller benefits or suffers from the network?
The study found that by allowing sellers to connect generates
considerable economic value and that the value primarily is
linked to making stores more accessible to customers browsing
the marketplace (i.e. a “virtual shopping mall”). Interestingly,
the study also found that “sellers that benefit the most from the
network are not necessarily those that are central to the network
but rather those whose accessibility is most enhanced by the
network”.

Social commerce industry concentration and possible vertical
and horizontal integration possible scenarios
Two of the top three social networking sites, Facebook and
Twitter, have received a great deal of attention lately as buzz
increase about possible IPO scenarios. Concerns with possible
horizontal or vertical mergers could follow closely behind as
these sites enhance their current monetization efforts. These
monetization strategies become more important as the number
of social network users continues to grow in leaps in bounds.
In early 2011, Goldman Sachs and Russian investment firm
Digital Sky Technologies invested $450 million and $50
million, respectively. Digital Sky Technologies previously
invested $500 million in Facebook and places an overall $50
billion value on Facebook. Facebook has estimated revenues of
$2 billion annually.
A separate valuation of Facebook by Seeking Alpha
contributor, Albert Babayev, states that “Goldman Sachs [is]
paying 25x-28x revenues for [Facebook], while Google and
Apple are getting 4-8x revenue [for their own companies]” (See
Figure 7). Babayev projects that Facebook’s current stock
value of $25 will grow to $111 by 2014. Babayev bases this
valuation on membership growth rates (expected to hit ~1
billion users by 2014), revenues (from advertising, gifts,
credits, etc), operating margins, tax structures, and earnings.
Babayev states that “Facebook did something no other company
has ever done. They somehow managed to take control of 600
million users, placing just about every corporation and
organization at Facebook’s behest. A minimal fee structure for
the corporations to reach these customers, increases valuations
by hundreds of millions”. Furthermore, with a current
estimated 2 billion internet users in the world, Facebook would
account for roughly 30% of all internet users today.

(
Figure 7:
Source:
How Much Is Facebook Really Worth?
(Babaye, 2011 )
.
)
As another example of the growing potential value of social
networking sites, Twitter was recently valued at $4 billion by
J.P. Morgan Chase, who is currently in talks with Twitter Inc. to
take a minority stake in that firm. Twitter is still working on
monetizing its business and is estimated to generate about $150
million in revenue in 2011, versus Facebook’s revenue
projections of $4 billion. Twitter boasts 200 million users, but
some estimates place active accounts within the U.S. at only 16
million. According to a recent WSJ article, the “best hope for
J.P. Morgan's fund may be if Twitter is acquired. Google and
Facebook may be interested. Facebook's popular status updates
are threatened by Twitter. And Google trails badly in social
media”.
A possible horizontal merger between Facebook and Twitter
could present interesting HHI implications as Facebook is the
king of social networking sites and Twitter rules the
microblogging subspace in that market. Based on estimated
user counts, a combined Facebook-Twitter firm could
potentially reach 40% of all internet users (a 33% increase over
Facebook on its own). Moreover, as discussed previously, Booz
& Co’s study on the social commerce market estimates it at $5
billion worldwide. With Facebook’s projected revenues for
2011 heading toward $4 billion, the HHI in this industry is very
high. If we consider Facebook and Twitter revenues in the HHI
equation (i.e. 10000*(4/5)^2+(.2/5)^2), the HHI value is 6416.
As such, horizontal merger activity by Facebook would likely
bring on attention from Federal Trade Commission anti-trust
regulators.
Figure 8 provides another example of Facebook’s reach and

market size, which demonstrates how any major horizontal
merger activity would likely draw regulator attention.
Developed by a Facebook intern in late 2010, the map provides
a visualization of users and connectivity around the world.
Figure 8: Source: Visualizing Friendships, Facebook.com
(Butler, 2010)
A possible vertical merger (or conglomerate depending on how
the combined firm was to be structured) could exist between
Facebook and a major smartphone (e.g. Blackberry) or wireless
cell phone provider. By combining a smartphone’s wireless
internet and geolocation capabilities and Facebook’s growing
social commerce business, a company could develop some very
interesting and potentially lucrative synergies of effort in the
social commerce space.
Mobile internet: The future of social commerce
Recently, AT&T announced the creation of a location-based
marketing service where local companies can send text
messages to cell phone users who choose to receive special
offers. This program is called ShopAlerts and relies on a
location system called a “geo-fence”. In this geo-fence,
marketers can develop ads based on user location and aim to
increase interest based on proximity. Estimates peg spending
on US mobile ads approximately $743.1 million in 2010 and are
expected to grow 48% in 2011 to $1.1 billion.
Figure 9: (Reese, 2011).
Social networking and social commerce have also integrated
their services with mobile internet capabilities. Foursquare, one

of the leading social networking/commerce, is a location-based
mobile internet application that allows friends to “check in” to a
location and share that location with friends. Once “checked
in”, users can see what friends are in the local area and can be
approached with deals by merchants in their vicinity. Users
also can receive “badges” and other discounts to award them for
return visits to business locations. As of February 2011,
foursquare had over 6.5 million users (Foursquare, 2011).
The integration of wireless internet technology and social
networking/commerce platforms provides the consumer with a
completely customized shopping experience. Advertisements
can be tailored to not only an individual’s location, but to their
patterns around town. The delivery of these proximity “deals”
offers a new stage to attract a growing “mobile” population. As
indicated in JMR study on valuation of social networks
discussed previously, sellers that benefit the most from the
network are those whose accessibility is most enhanced by the
network. The customized and targeted vehicle that social
commerce platforms like foursquare offer, serve to enhance that
accessibility. These systems also have the potential to drive
significant additional revenue for retailers and social commerce
vendors.
Conclusion
This paper provided an introduction to social commerce concept
covering an analysis of the market, the effects of social
commerce on consumer behavior, pricing strategies industry
concentration and look at the future of the social commerce as
mobile internet technologies are further integrated. Social
commerce is a nascent and evolving field with a great deal of
room to grow across all markets. Furthermore, as mobile
internet and e-commerce services penetrate deeper into
emerging markets, the growth prospects for social commerce
increase dramatically. Seventy percent of Facebook’s users
based outside of the U.S. and many developing economies have
developed regional/language-specific social networking sites.

Integrating these non-U.S. social networking sites into effective
social commerce platforms could drive unprecedented future e-
commerce sales growth in these largely unchartered waters.
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Student X
Research Paper 2
2
Student X
Research Paper:
Oil Versus the Airlines
Presented to:
Professor Thomas C. Makemson
In Partial Fulfillment of the Requirements of:
Managerial Economics
Fall 2, 2012
Section QS
ABSTRACT
For an industry whose success is based on seemingly price
alone, the airline industry faced yet another economic setback
during 2008. Since the Airline Deregulation Act of 1978, an
airline’s survival is derived from ticket price. Such a
phenomenon seems intuitive, yet it is not. From a non airline
manager’s perspective, setting the ticket price for a flight is
simple; calculate the marginal cost for the seat and apply an
appropriate markup. The result is the ticket price for a flight.
However, such price determination is not the case. Airline

managers are faced with the challenging of meeting or beating
the ticket price for each competing carrier in the markets they
compete in. For example, when setting the ticket price for a
flight between St. Louis, MO and Chicago, IL, an American
Airlines manager is most likely concerned with Southwest
Airline’s ticket price for a flight between the same two cities
rather than American’s marginal cost for the ticket.
The above example presents a problem for airline managers; the
ticket price is less a function of the cost for a flight than the
competition’s ticket price for that market. Although the same is
true for many industries, most firms outside of the airline
industry are better able to differentiate their product thus
allowing prices to be set according to cost. The traveling public
has made product differentiation nearly impossible for the
airlines by purchasing a ticket on price alone, not any particular
feature of a carrier. For example, two separate individuals, Joe
and Jill, find him and herself hungry for dinner. Joe wants
something quick and cheap while Jill would like formal dinner.
Given these distinct preferences, it is easy to see how
restaurants can differentiate their food based on more than price
alone.
A fast-food drive-through, such as McDonald’s or Burger King,
appeals to Joe but not Jill; a sit down establishment, such as
Olive Garden or Cheesecake Factory, appeals to Jill but not Joe.
As a result, McDonalds can focus on delivering its food fast
with a low price and appeal to the many “Joes” while Olive
Garden can focus on providing an eloquent evening while
charging a higher price and appealing to the many “Jills.”
While restaurants have the ability to differentiate their product
and charge different prices than the competition, airlines
cannot. Consider again Joe and Jill. Each needs to travel from
Houston, TX to Las Vegas, NV for business, leaving on

December 23, 2008 and returning December 26, 2008. The only
selection criterion for Joe and Jill is the cheapest direct flight
between the two cities; neither is concerned with leg-room,
snacks, video-entertainment, pillows, blankets, or any other
amenities.
Armed with his and her travel dates, Joe and Jill each compare
airlines online and find two direct flight options between
Houston and Las Vegas. Continental Airlines offers non-stop
service for $704.00 while Southwest Airlines serves the same
route for only $412.50.
Which airline will be awarded Joe and Jill’s travel dollar?
Southwest Airlines will most likely be picked by each but not
because Southwest has differentiated its product from
Continental. Continental looses two potential passengers
because its ticket price is nearly $300 more than Southwest.
Given the highly competitive and price sensitive market the
airlines operate within, how do they adjust their prices when
extraordinary expenses arise? More specifically, what if a
budgeted expense nearly doubles within several months? How
do air carriers react? Do entire business models change? These
questions in response to the hypothetical cost escalation were
asked during the Summer of 2008 when the price of oil spiked
to record highs; as the cost of a barrel of oil grew exponentially
so did every airlines’ largest expense – fuel. How did each
carrier react?
Through this paper, this question will be answered.
Additionally, research will be provided to highlight the
crippling affect the oil price run-up had on the airline industry.
OIL CRISIS of the SUMMER OF 2008

Nearly every American was affected by the wildly escalating oil
prices during the Summer of 2008. Whether it was higher gas
bills to travel to work or increased shipping expenses to get
product to market, personal and business budgets were stretched
thin. Whereas the objective of this paper is not to determine the
reason for the oil crisis, a brief overview of the price run-up is
required in setting the foundation for a closer look at the
airlines’ response.
Twenty-one years of historical oil prices were analyzed; in the
early 2000s, the price found equilibrium between $20 and $30
per barrel.2 As a result of this relative price stability, only 5
years of historical data will be presented. The following graph
presents a rather shocking picture of oil from December 9, 2003
to December 9, 2008:
Graph 1: Constructed based on oil prices Dec. 9, 2003 through
Dec. 9, 2008
At the beginning of the five year period, oil was $30.27 per
barrel. The following December 9, 2004 brought $36.77 oil;
December 9, 2005 saw $57.23 oil; December 8, 2006
experienced $63.67 oil; December 10, 2007 was the start of a
slow increase in price at $87.33 per barrel; the price topped at
$143.95 on July 3, 2008; however, the price rapidly declined to
$39.77 a barrel on December 9, 2008.3 The next graph
highlights the spike in oil prices beginning one year prior to
July 3, 2008 (the date of the record price) through December 9,
2008:
Graph 2: Highlighting oil prices from one year prior of the
highest price per barrel (July 3 2008)
As previously noted, the record price of oil was on July 3, 2008

at $143.95. One year prior, on July 3, 2007, the price per barrel
was $74.26.3 This was a $69.69 jump in oil price in one year.
This 93.85% jump in price affected many companies across
many industries. However, the focus of this paper is oil’s near
doubling in price over one year and its effect on the airlines.
More importantly, how did each airline react to the price
increase and to the reaction of each competitor? Before
continuing, it should be noted that numerous airlines go in to
and out of business on a yearly basis. As a result, the top seven
airlines will be analyzed as a representation of the industry as a
whole. These airlines are American Airlines, Continental
Airlines, Delta Airlines, Northwest Airlines, United Airlines,
and Southwest Airlines.
OIL’S EFFECT on the AIRLINES
Before discussing each of the “Big Seven’s” reactions to the
skyrocketing oil prices, the bottom line effect on each carrier
will be presented. By comparing 2008 financial results to 2007
financial results, the relationship between an airline’s income or
loss and the price of oil will become evident. For the observer
who is unclear as to why oil has such a dramatic effect on
airlines, the following analogy should clear up any confusion.
An automobile burns gas to drive; an aircraft burns gas to fly.
Both automobile gas and aircraft gas (jet fuel) are a direct
byproduct of oil. However, an airplane burns substantially more
gas than a car does, thus as the price of oil skyrockets so does
one of the primary expenses of an airline. Given that
comparison, the following table presents the quarterly operating
results for the “Big Seven” for 2008 compared with 2007:
NET INCOME (LOSS) of the "BIG SEVEN"
(in millions)
Airline
1st Qtr.

2nd Qtr.
3rd Qtr.
9 Months Ended Sept. 30
Year
Year
Year
Year
2008
2007
Change
2008
2007
Change
2008
2007
Change
2007
2008
Change
American
($328)
$81
($409)
($1,448)
$317
($1,765)
$45
$175
($130)
($1,731)

$573
($2,304)
Continental
($80)
$22
($102)
($3)
$228
($231)
($236)
$241
($477)
($319)
$491
($810)
Delta
($6,390)
($130)
($6,260)
($1,000)
$1,600
($2,600)
($50)
$220
($270)
($7,440)
$1,690
($9,130)
Northwest
($4,139)
($292)
($3,847)
($377)
$2,149
($2,526)
($317)

$244
($561)
($4,833)
$2,101
($6,934)
United
($537)
($152)
($385)
($2,729)
$465
($3,194)
($779)
$334
($1,113)
($4,045)
$647
($4,692)
U.S. Airways
($236)
$66
($302)
($567)
$263
($830)
($865)
$177
($1,042)
($1,668)
$506
($2,174)
Southwest
$34
$93
($59)
$321

$278
$43
($120)
$162
($282)
$235
$533
($298)
Total
($11,676)
($312)
($11,364)
($5,803)
$5,300
($11,103)
($2,322)
$1,553
($3,875)
($19,801)
$6,541
($26,342)
Table 1: Comparison of 2008 and 2007 Financial Performance
the “Big Seven”
Although a direct correlation cannot yet be drawn between oil
price and each airline’s performance, each carrier performed
substantially worse in 2008 than in 2007. By concentrating on
the “Nine Months Ended September 30,” American Airlines
showed a $2,304,000,000 negative turn in income for 2008 than
in the same period in 2008. Continental went $810,000,000 in
the wrong direction. Delta’s earnings fell victim to the same
fate; they dropped by $9,130,000,000 in one year. Northwest,
United, and U.S. Airways fell from positive earnings by -
$6,934,000,000, -$4,692,000,000, and -$2,174,000,000,

respectfully. Southwest Airlines was the only carrier among the
“Big Seven” that showed a profit for the nine months in 2008;
however, they too showed a negative turn from 2007 earnings.
By contrast to the other six carriers, Southwest’s negative turn
of $298,000,000 signifies either better luck or better
management. That distinction is also too early to determine.
At this point, the only certain conclusion from the above graph
is that each airline performed worse, period-for-period, in 2008
than 2007. Each airline earned net income in the second and
third quarter of 2007 but quickly turned negative in 2008. In
order to better associate fuel cost with earnings, the table on the
following page presents each airline’s increase in fuel expense
for the first three quarters of 2008 over the same periods in
2007:
FUEL EXPENSE of the "BIG SEVEN"
(in millions)
Airline
1st Quarter
2nd Quarter
Year
Change
Year
Change
2008
2007
Dollar
%
2008
2007
Dollar

%
American
$2,050
$1,410
$640
45.4%
$2,423
$1,644
$779
47.4%
Continental
$1,048
$684
$364
53.2%
$1,363
$821
$542
66.0%
Delta
$1,422
$958
$464
48.4%
$1,678
$1,112
$566
50.9%
Northwest
$1,114
$704
$410
58.2%
$1,207
$855
$352

41.2%
United
$1,575
$1,041
$534
51.3%
$1,848
$1,206
$642
53.2%
U.S. Airways
$823
$550
$273
49.6%
$1,086
$658
$428
65.0%
Southwest
$753
$564
$189
33.5%
$894
$607
$287
47.3%
Total
$8,785
$5,911
$2,874
48.6%
$10,499
$6,903
$3,596

52.1%
Airline
3rd Quarter
Year
Change
Year
Change
2008
2007
Dollar
%
2008
2007
Dollar
%
American
$2,722
$1,743
$979
56.2%
$7,195
$4,797
$2,398
50.0%

Continental
$1,501
$895
$606
67.7%
$3,912
$2,400
$1,512
63.0%
Delta
$1,952
$1,270
$682
53.7%
$5,052
$3,340
$1,712
51.3%
Northwest
$1,912
$882
$1,030
116.8%
$4,233
$2,441
$1,792
73.4%
United
$2,461
$1,324
$1,137
85.9%
$5,884
$3,571
$2,313
64.8%

U.S. Airways
$1,110
$692
$418
60.4%
$3,019
$1,900
$1,119
58.9%
Southwest
$1,000
$660
$340
51.5%
$2,647
$1,831
$816
44.6%
Total
$12,658
$7,466
$5,192
69.5%
$31,942
$20,280
$11,662
57.5%
Table 2: Comparison of 2008 vs. 2007 Fuel
Expense of the “Big Seven”
The relationship between oil price and airline earnings is
beginning to develop considering the staggering percentages
that each airline’s fuel expense rose in 2008 over the previous
period in 2007. Northwest Airlines suffered the most, with a
73.4% increase in fuel for the first three quarters in 2008 over
2007; although, all but Southwest Airlines suffered at least a

50% increase in fuel expense for the same period. Recall the
day of the record high price per barrel, July 3, 2008. The high
began the third quarter 2008, with oil remaining above $100 per
barrel until two days prior to the end of the third quarter; this
time period was the worst in 2008 for the airlines. Northwest
saw the highest fuel expense increase of 116.8%; United
followed with a 85.9% increase; Continental’s 67.7% increase
was third; U.S. Airways increase of 60.4% ranked it fourth;
American saw its fuel expense increase 56.2%; Delta
experienced a close 53.7% increase; the best performer was
Southwest. Although, its fuel expense increase still exceeded
50% of the previous year. Some carriers were affected worse
than others.
For the observer who is familiar with operating data, the
question arises, “what about the remaining expenses? Airlines
have other expenses other than fuel.” This observer is correct in
his remark regarding additional expenses the airlines incur;
such is why there is yet one missing link directly proving oil
price as the culprit behind 2008’s airline plight. The following
chart ties fuel expense together with each airline’s total
expenses for 2008 over 2007:
INCREASE in OPERATING EXPENSES of the "BIG SEVEN"
ATTRIBUTABLE to INCREASE in FUEL EXPENSE
2008 vs. 2007
(in millions)
Airline
1st Quarter
2nd Quarter
3rd Quarter
Increase
%

Increase
%
Increase
%
Increase
%
Total
Fuel
Due to
Total
Fuel
Due to
Total
Fuel
Due to
Total
Fuel
Due to
Expense
Expense
Fuel
Expense
Expense
Fuel
Expense
Expense
Fuel
Expense
Expense
Fuel
American
$705
$640
90.8%

$2,057
$779
37.9%
$1,010
$979
96.9%
$3,772
$2,398
63.6%
Continental
$521
$364
69.9%
$668
$542
81.1%
$768
$606
78.9%
$1,957
$1,512
77.3%
Delta
$6,941
$464
6.7%
$2,073
$566
27.3%
$814
$682
83.8%
$9,828
$1,712
17.4%
Northwest

$4,508
$410
9.1%
$1,052
$352
33.5%
$1,095
$1,030
94.1%
$6,655
$1,792
26.9%
United
$687
$534
77.7%
$3,389
$642
18.9%
$1,185
$1,137
95.9%
$5,261
$2,313
44.0%
U.S. Airways
$420
$273
65.0%
$927
$428
46.2%
$1,116
$418
37.5%
$2,463

$1,119
45.4%
Southwest
$328
$189
57.6%
$409
$287
70.2%
$468
$340
72.6%
$1,205
$816
67.7%
Total
$14,110
$2,874
20.4%
$10,575
$3,596
34.0%
$6,456
$5,192
80.4%
$31,141
$11,662
37.4%
Table 3: Percentage of operating expenses caused by increase in
oil price
Now the picture is clear: American, Continental, Delta,
Northwest, United, U.S. Airways, and Southwest’s poor
financial performance in 2008 is nearly 100% attributable to the
rapid increase in oil price. Several carriers, such as Delta and
Northwest had several non-cash expense items that increased

total expenses
; however, 70 to 95 percent increased fuel expense to total
expense increase ratios tell most of the story. Continental
suffered the worse over the entire nine month period, while
American suffered two of the worst quarters of any carrier in
the first and third quarters.
Although it is not the only objective of this paper to equate
increased oil price to decreased oil price, it is important to
present the severity of the oil versus earnings dilemma. More
critical is developing a managerial plan to combat oil prices.
Once the problem has been identified, each carrier has one of
two decisions: 1 – do nothing and hope for the best; or 2 –
implement a revised strategic plan to compensate for the
problem. The remainder of this paper addresses the strategic
plans of the “Big Seven.” Throughout the planning process,
managers have to be cognizant of economic theory and the
potential demand reaction to every decision, especially pricing
decisions.
DEMAND ELASTICITY and AIRLINE TICKET PRICES
The obvious solution to an increase in a business’ expenses is
an increase in the price of the company’s product; for the
airlines, the answer to rising fuel prices is not quite as simple.
As the opening story about Joe and Jill alluded to, the average
airline passenger is quite sensitive to ticket price. Most
travelers pick a flight based solely on price; the airline with the
lowest ticket price for a given route will win a potential
passenger’s travel dollar. Secondly, many potential travelers
are finding viable substitutes to air travel, exacerbating the
pricing problem. More specifically, leisure travelers are relying
on alternate modes of transportation, such as bus, train, or
driving, or not traveling at all. Business travelers are beginning

to rely on video-conferencing, telephone-conferencing, or less
meetings altogether.
Consumer price sensitivity is the primary factor airline
managers must take into account when implementing strategic
plans; however, how sensitive is the consumer to a price
change, and how much will quantity demanded shift when ticket
prices are increased? Consumer price sensitivity to a change in
a products price is expressed by the product’s own price
elasticity. Multiplying the own price elasticity of a product
with the percentage increase in price of a product will provide a
manger with the percentage change in quantity demanded for his
product.
For example, if a manager knows the own price elasticity for
his product is -1.5, and he must increase the products price by
12% to cover increasing expenses, quantity demanded for the
product will decrease by 18% (-1.5 x 12%).
If armed with this information, airline managers can estimate
the effect a ticket price increase will have on quantity
demanded for their airline. Since the most likely option to
combat rising fuel prices is to charge higher ticket prices,
airline managers must derive an estimate of the own price
elasticity for their airline. However, such a task is well beyond
the economics expertise of the average airline manager and the
author of this paper; an entire branch of economics is dedicated
to estimating demand functions and demand elasticities. These
econometrics pofessionals use sophisticated analysis and
computer software to develop accurate estimates of the own
price elasticity for a firms products.
As such, airline managers should not “guesstimate” such an
important variable for their company; either internal economists
or external consultants should be trusted for and accurate
estimate of the own price elasticity.

Just as airline managers should rely on economics professionals
for their data, so will the author of this paper. Over the past
several years, numerous economics professionals have
researched airline pricing and consumer reaction. Kenneth J.
Button of the Center for Transportation Policy, Operations, and
Logistics compiled much of this elasticity research while
studying the effects of taxation on air transportation. His
findings show that the elasticity of demand for ticket prices
varies on many factors ranging from personal to business travel
and domestic to international travel. Additionally, length of a
particular route affects the elasticity of ticket prices.
The following table presents Button’s findings:
Table 4: Own price elasticity for airline
ticket prices12
Button’s compilation brings about another dilemma for airline
managers; elasticity can vary dramatically based on the type of
flight. Business travel has the lowest values; most business
travel elasticities presented are inelastic in that business travel
demand will not fluctuate as much as the increase or decrease in
price. However, economy, discount, or pleasure travel present
larger values and are elastic in that demand will fluctuate more
than the increase or decrease in price. For example, if
American Airlines needed to raise prices 20%, how would
demand be affected? For international business travelers, own
price elasticity is -.26, thus a 20% increase in price leads to
only a 5.2% decrease (-.36 x 20%) in business travelers.
However, for cross country leisure travelers, own price
elasticity is -1.52, thus the same 20% increase in ticket price
leads to a 30.4% decrease (-1.52 x 20%) in leisure travelers.
As can be seen, airline managers must be aware of the different

elasticities affecting each market segment; each type of
customer and type of route will react differently to price
changes. A detailed route and customer analysis is beyond the
scope of this paper, but non-the-less it is important to note the
complex demand structure an airline faces. More specifically,
American Airlines faces own price elasticities ranging from -
1.58 to -2.34.
While a 10% price increase only causes a 15.8% decrease (-
1.58 x 10%) in demand on the low end, the same price increase
causes at 23.4% decrease (-2.34 x 10%) in demand on the high
end. Considering this demand variability, combating increasing
prices presents a rather difficult dilemma. Armed with
elasticity data for the industry as a whole, the following
analysis aims to present solutions for rising oil prices.
DEMAND ELASTICITY and OIL PRICES
Considering the potential price sensitivity of airline travelers,
combating increasing oil prices is not as simple as raising ticket
prices to cover the increased price of fuel. Mangers must cover
the increasing price of oil but at the same time must be cautious
about decreasing passenger demand. As a starting point to
address the increasing losses associate with fuel, the first step is
to determine how much passenger revenue must be increased to
compensate for increased fuel. However, demand effects must
be considered before raising ticket prices by this percentage,
thus approximating an own price elasticity for each airline is
required. With these two values, the decrease in demand
associated with the increase in price can be determined. The
following table presents this information:
PRICE INCREASE REQUIRED to COMPENSATE for FUEL
(and subsequent demand decrease)
9 MONTHS ENDED SEPTEMBER 30, 2008
Airline

Passenger
Fuel
Price
Approximate
Demand
Revenue
Expense
Increase
Price
Decrease
(000,000s)
(000,000s)
Required
Elasticity
American
$14,060
$2,398
17.06%
-1.50
-25.58%
Continental
$10,633
$1,512
14.22%
-1.50
-21.33%
Delta
$13,848
$1,712
12.36%
-1.50
-18.54%
Northwest

$7,529
$1,792
23.80%
-1.50
-35.70%
United
$14,270
$2,313
16.21%
-1.50
-24.31%
U.S. Airways
$8,594
$1,119
13.02%
-1.50
-19.53%
Southwest
$7,927
$816
10.29%
-2.00
-20.59%
Table 5: Demand decrease associated with an increase in ticket
price
In calculating the demand decrease associated with each
airline’s price increase, the approximate price elasticities were
estimated as follows: American, Continental, Delta, Northwest,
United, and U.S. Airways all focus on both leisure and business
travelers on short through long distances. As a result, the price
elasticity was estimated from Sutton’s table presented earlier;
since all six operate similar structures, the best approximation
for price elasticity was a combination of the various market

segments served. As a result, the best own price elasticity
approximation is -1.50. Since Southwest focuses primarily on
leisure, budget minded traveler’s, the best approximation from
Sutton’s table is an own price elasticity of -2.00.
Given the information presented, each airline’s management
team has a problem on its hands. To cover fuel expenses with
passenger revenue, demand will fall dramatically; this scenario
would have the opposite effect, declining revenues. Several
solutions are available to counteract the associated demand
decrease; they are as follows:
-Supply can be decreased.
-Alternate forms of income can be established.
-Inefficient aircraft can be replaced with fuel efficient aircraft.
-Mitigate fuel expense through fixed contracts.
One or more of the above strategies should be used to
compensate for the estimated decrease in demand associated
with price increases. Interestingly enough, each carrier in the
“Big Seven” responded to rising oil prices with a mixed
strategy. The following sections highlight the response of each
carrier to the oil induced financial distress of 2008.
AMERICAN AIRLINES’ STRATEGY
Led by CEO Gerald Arpey, American Airlines instituted several
changes in an effort to combat rising oil prices. Fares were
increased but not at the rate shown above. Instead, additional

stream of revenue were created. For example, beginning on
June 15, 2008, they began charging $15 for the first checked
bag. Airlines have historically charged $25 for a second bag
but charging for the first bag was a rather unprecedented move.
Other additional fees include $125 to $699 for traveling with
pets and from $3 to $6 for food on-board.
Perhaps the most notable fee, a fuel surcharge will be added to
each ticket. Capacity cuts of 11 to 12 percent in the fourth
quarter of 2008 were also planned; as a result of capacity cuts,
8,000 jobs will also be shed.
The company also placed 34% of its anticipated jet fuel on
contracts for 2008. The final move by American Airlines is to
retire 85 of its inefficient aircraft.
CONTINENTAL AIRLINES’ STRATEGY
Larry Kellner, CEO of Continental Airlines, and his team
responded quite similar to American. Capacity reductions of up
to 11% by the end of the fourth quarter, 2008 were announced
during the summer of 2008. Sixty-seven older aircraft will be
retired. These old Boeing 737 aircraft will be replaced with
new, more fuel efficient 737s; however, the fleet will still be
reduced from 375 aircraft to 344 aircraft at the end of the
transition. Associated with the capacity reductions, Continental
announced layoffs of 3,000 employs.17 All of these changes
were on top of ticket price increases and fuel surcharges. Also,
Continental implemented a $15 first bag fee.16
DELTA AIRLINES’ STRATEGY
With perhaps the boldest of all moves, Delta Airlines CEO
Richard Anderson announced plans to merge with Northwest
Airlines in order to share expenses and expand global capacity;
as this paper is being written, the merger has passed.
Will the intended cost-savings emerge? Only time will tell.
Along with the merger, Delta also announced capacity cuts of

8% to 10% by the end of the fourth quarter, 2008. Along with
the capacity reduction comes 4,000 layoffs.17 Delta joined with
other domestic carriers in implementing a $15 first bag fee; fuel
surcharges and price increases were also put in place on many
routes.
NORTHWEST AIRLINES’ STRATEGY
As discussed above, Northwest Airlines merged with Delta
Airlines in an attempt to share expenses and expand global
capacity.
Prior to the merger, Northwest CEO Edward Bastian
announced capacity cuts up to 9.5% by the end of 2008.
However, in contrast to other carriers, he hoped to reduce the
workforce through natural attrition instead of layoffs.
The company tried to fend of rising oil prices by hedging 54%
of its anticipated 2008 fuel needs.
Along with higher fares and fuel surcharges, Northwest
implemented a $15 first bag fee, fees for food ranging from $3
for a snack to $10 for a meal, and a $5 - $35 fee for extra leg
room and seat choice for domestic flights and $15 - $75 for
international flights.20
UNITED AIRLINES’ STRATEGY
Glenn Tilton, CEO of United Airlines, announced the largest
capacity cuts of any carrier, with 17% to 18% capacity
reductions by the end of 2008 in to 2009. Whereas Northwest
Airlines hopes to trim employment through attrition, United
reduced its workforce by 1,100 employes. Other drastic
measures by United include retiring 70 older jets from its fleet
and eliminating its discount carrier, Ted.22 The company also
has a list of new fees including the $15 first bag fee, fees for
food ranging from $3 for a snack to $9 for a fresh meal,

increased fees for pets ranging from $175 to $250, and fees to
upgrade to “economy plus” of $14 to $109. These recent
charges are on top of fare increases and fuel surcharges.20
U.S. AIRWAYS’ STRATEGY
CEO Doug Parker and the entire U.S. Airways management
team have followed suit with the previous carriers. Fare
increases and fuel surcharges were the first of several revenue
generating steps. Additionally, U.S. Airways instituted the $15
first checked bag fee of its counterparts. Along with the bag
fee, U.S. Airways also charges $5 to $7 for food, $5 for choice
seats, and $100 to travel with pets in the cabin. A fee unique to
U.S. Airways is a charge for drinks, $2 for non-alcoholic drinks
and $5 to $7 for alcoholic beverages.
Capacity reductions are also underway of 2% to 4% by the end
of 2008; the company will also allow leases to run out on 28
aircraft. These will be replaced with fourteen Embraer-190s
and five Airbus-321 aircraft. Associated with the capacity
reductions will come 1,700 job losses.
SOUTHWEST AIRLINES’ STRATEGY
As the financial tables above show, Southwest Airlines survived
the fuel crisis better than any of its “Big Seven” counterparts.
Incredibly, while the other six carriers mounted huge losses for
the nine months ended September 20, 2008, Southwest earned a
profit. Initially, Southwest CEO Gary Kelley not only
announced no cut-backs but additional capacity would be added
in 2009. Although, it now appears oil prices were slow to catch
up with Southwest. As of the beginning of December, 2008,
Southwest announced a 4% to 5% reduction in flying for the
first quarter, 2009. The airline plans to keep its fleet the same
size.25 Another considerable difference between Southwest and
the other carriers is the lack of additional fees. Southwest has
increased fares but has not added fuel surcharges, bag fees,

snack fees, drink fess, or cabin upgrade fees.24
Instead of charging additional fees, Southwest attempted to
control rising costs through fuel contracts. According to Kelly,
his company saved $1.3 billion through the end of the third
quarter 2008 from its fuel hedging program. Even with the
recent decline in crude oil prices, Southwest’s program is still
in the money; as of October 15, 2008, it was valued at $550
million. The airline has such faith in its finance department
that it has fuel contracts through 2012. 85% of Southwest’s
anticipated fuel requirements of the fourth quarter of 2008 is
contracted at $62 per barrel; 75% of 2009 at $90 per barrel;
50% of 2010 at $90 per barrel; 40% of 2011 at $93 per barrel;
and 35% of 2012 at $90 per barrel.
DIFFERENCES in STRATEGIES
After reviewing each of the “Big Seven’s” survival strategies, it
becomes quite evident that one of the airlines is not like the
others. Whereas Southwest Airlines has focused on controlling
its costs through fuel contracts, the other six have focused on
increasing revenue. The better strategy is apparent after
reviewing the financial data presented in the beginning of this
paper; Southwest Airline’s strategy has resulted in positive
earnings for the first nine months of the year while the others
are all in the red. However, Southwest’s strategy has been set
for many years. American, Continental, Delta, Northwest,
United, and U.S. Airways have been on the defensive against oil
in the past year. Southwest, on the other hand, has been on the
offensive against fuel prices for nearly twenty years. Since the
time when current CEO, then CFO, Gary Kelly took office in
1989, he began locking in fuel contracts to stabilize the airlines
income statement.
Given Southwest’s huge success with its fuel hedging program,

why do other airlines not have such programs in place? If one
airline can save over one billion dollars in three quarters, the
average person would assume others would follow suit.
However, the hidden side of contracts, such as Southwest’s fuel
contracts, is the cost. For example, commodities clearing
houses require a margin of nearly 10% of the contract price to
be paid at contract signing. A contract of 100,000 barrels at
$100 per barrel is worth $10,000,000, thus to hedge at that
price, an airline would face an upfront cost of $1,000,000.
Additionally, airlines (and other such investors) incur
transaction costs for each contract; Southwest incurs one more
cost as well. What if oil prices fall below the contract price?
In a traditional contract, the airline is still responsible for the
contracted amount at the contracted price resulting in a loss on
the hedge. To protect against such an occurrence, Southwest
pays premiums offering downward price protection. If the spot
price drops below the contract price, Southwest can and will let
the option expire and not pay the higher price. While the airline
saves on fuel costs, it still loses the premium paid for the
contract. These fees are paid as an insurance policy for the
airline. As with all insurance, there is risk involved. Southwest
is willing to pay a premium to protect itself against rising fuel
costs in spite of the financial risk involved with the contacts.28
This additional information regarding contracts, such as fuel
hedging, is the underlying factor preventing every other airline
from participating in the same fuel cost saving measures as
Southwest. Given the huge upfront costs of hedging - 10%
margins, transactions costs, and potentially downward price
protection – airlines are faced with an expensive proposition,
and as any reader of the USA Today knows, the average airline
does not have much additional cash lying around to cover such
additional expenses. According to Peter Fusaro, founder of an
energy-trading information firm, “Facing higher energy prices
and billions of dollars in debt, most airlines can’t afford to

hedge.”28
Secondly, as discussed above, if the spot price of oil falls below
the contract price, the airline will face losses associated with
the hedge. As a result, many airline managers view such
financial contracts as risks and most are striving to eliminate as
many risks as possible these days. Energy consultant Stephen
Schork agrees: “I think airlines have been reluctant to hedge
because corporate culture views futures as a gambling tool.”
However, he adds, “but they’ve been reluctant to their own
detriment. If you’re an airline without a significant hedge,
you’re in a difficult spot.”
Although it would seem easy to copy Southwest’s fuel hedging
program and save over a billion dollars in fuel, many airlines
simply cannot afford to do so, or their management is reluctant
to do so based on speculative reasons. Either way, Southwest
will remain to have a significant cost advantage over nearly
every other competitor. If the other six continue to raise prices,
will additional capacity cuts be required? Only time will tell.
CONCLUSION
Two important conclusions can be drawn from this research.
First, regardless of the cause, the oil crisis of the Summer of
2008 drove the airline industry into some of the worst financial
performance in recent times. Even though the increase in oil
price heightened during the summer months of 2008, data
clearly shows that high oil prices began before 2008 began.
Second, one airline was better prepared to handle escalating oil
prices than others. Some may call it luck, others may call it
superior management, but either way, Southwest Airlines,
through long standing fuel contracts, survived the oil crisis
better than its competitors.
Whereas American, Continental, Delta, Northwest, United, and

U.S. Airways have been on the defensive for many months,
Southwest has been on the offensive for nearly twenty years.
Southwest focuses on controlling fuel costs; the other six focus
on increasing revenue. Which strategy will prevail in the long-
run? Although no manager can predict the future, it is simple to
tell which airline has prevailed thus far. Will the rapidly
declining oil prices of the Fall of 2008 bring better financial
results to the airlines? Most would assume yes, but some of the
toughest economic times in years might decide otherwise.
However, that is a topic for another paper on another day. For
now, the airlines will continue their battle against oil.
BIBLIOGRAPHY
American Airlines’ Quarterly SEC 10-Q Filings. Accessed Dec.
2, 2008. http://phx.corporate-
ir.net/phoenix.zhtml?c=117098&p=quarterlyEarnings.
Baye, Michael R. Managerial Economics and Business Strategy,
6th Ed. Copyright 2009. McGraw-Hill/Irwin. Boston, MA.
Button, Kenneth J. “The Taxation of Air Travel.” George Mason
University School of Public Policy: Center for Transportation
Policy, Operations, and Logistics. April, 2008. Accessed Dec. 3,
2008.
http://www.gmupolicy.net/transport2003/airlinetaxation.pdf.
Christopher Hinton, “Storm Clouds Gather, but Southwest CEO
Has a Plan.” MarketWatch, Dec. 4, 2008. Accessed Dec 7, 2008.
http://www.marketwatch.com/news/story/storm-clouds-gather-
airlines-southwest/story.aspx?guid=%7B0853494C-B557-43D9-
9EA1-CA346181A479%7D.
Continental Airlines’ Quarterly SEC 10-Q Filings. Accessed
Dec. 2, 2008. http://www. continental.com /web/en-
US/content/company/investor/reports.aspx.

Delta Airlines’ Quarterly SEC 10-Q Filings. Accessed Dec. 2,
2008. http://phx.corporate-
ir.net/phoenix.zhtml?c=71481&p=irol-sec.
Energy Information Administration, Official Energy Statistic
from the United States Government: Daily Europe Brent Spot
Price. Released Dec. 10, 2008. Accessed Dec. 11, 2008.
http://tonto.eia.doe.gov/dnav/pet/hist/rbrted.htm.
Herbst, Moira. “Hedging Against $200 Oil.” Business Week
Online. May 7, 2008. Accessed November 11, 2008.
http://www. businessweek.com /bwdaily/dnflash/
content/may2008 /db2008056_075377.htm.
Kayak Online Travel Agency: Airline Fees. Updated Dec. 16,
2008. Accessed Dec. 16, 2008. http://www.kayak.com/airline-
fees.
MSNBC: “Airlines move to make bad situation worse.” June 4,
2008. Accessed Dec. 3, 2008.
http://www.msnbc.msn.com/id/24963160/.
Northwest Airlines’ Quarterly SEC 10-Q Filings. Accessed Dec.
2, 2008. http://www. nwa.com /corpinfo/newsc/2008/.
Orbitz Online Travel Agency: Flight Search from Houston, TX
to Las Vegas, NV. Accessed December 1, 2008.
http://www.orbitz.com/.
Rubin, Rose M.,Joy, Justin N. “Where are the Airlines Headed
Now?” Journal of Consumer Affairs. July 1, 2005. Accessed
Dec. 2, 2008. http://www.allbusiness.com/sector-92-public-
administration/administration/1185414-1.html.
Seany, Rick. “Did You Know? Top Ten Largest US-Based
Airlines.” FareCompare.com. April 15, 2008. Accessed Dec. 1,

2008. http://rickseaney.com/2008/04/15/did-you-know-top-10-
largest-us-based-airlines/.
Southwest Airlines: Flight Search from Houston, TX to Las
Vegas, NV. Accessed December 1, 2008.
http://www.southwest.com/cgi-
bin/buildItinerary2?ref=bkflt_hp_wl_tt.
Southwest Airlines’ Quarterly SEC 10-Q Filings. Accessed Dec.
2, 2008. http://www.southwest.
com/investor_relations/fs_sec_filings.html.
Southwest Airlines Reports Third Quarter Financial Results.
Forbes Magazine Online. October 16, 2008. Accessed
November 11, 2008. http://www.forbes.com /prnewswire/feeds/
prnewswire/2008
/10/16/prnewswire200810160643PR_NEWS_USPR_____LATH
024A.html.
United Airlines’ Quarterly SEC 10-Q Filings. Accessed Dec. 2,
2008. http://ir.united.com/ phoenix.zhtml?c=83680&p=irol-
news&nyo=0.
U.S. Airways’ Quarterly SEC 10-Q Filings. Accessed Dec. 2,
2008. http://www.usairways.com/
awa/content/aboutus/investorrelations/secfilings.aspx.
� Airfare based on a flight search from Houston, TX to Las
Vegas, NV on Orbitz.com and Southwest.com.
� Energy Information Administration: Daily Europe Brent Spot
Price. Released Dec. 10, 2008.
� Energy Information Administration: Daily Europe Brent Spot

Price. Released Dec. 10, 2008.
� FareCompare.com: “Did You Know? Top Ten Largest US-
Based Airlines.” April 15, 2008.
� Net Income(Loss) presentation calculated based on each
airline’s quarterly SEC 10-Q filings.
� Fuel expense presentation and calculation based on each
airline’s quarterly SEC 10-Q filings.
� Total expense and fuel expense presentation and calculation
based on each airline’s quarterly SEC 10-Q filings.
� Non-cash expenses/write-offs from each airline’s quarterly
SEC-10Q filings.
� Journal of Consumer Affairs: “Where Are the Airlines
Headed?” July 1, 2005.
� Michael R. Baye, “Managerial Economics and Business
Strategy.” Pages 75 - 80. 2009.
� Michael R. Baye, “Managerial Economics and Business
Strategy.” Page 96. 2009.
� Kenneth J. Button: “The Taxation of Air Travel” April, 2005.

� Gillen, Morrison, & Stewart’s own price elasticities as
presented by Sutton.
� Oum, Zhang, and Zhang’s own price elasticities as presented
by Sutton.
� Passenger revenue and fuel expense based on each airline’s
quarterly SEC 10-Q filings.
� Kayak.com: Airline Fees. Copyright 2008.
� MSNBC.com:“Airlines Move to Make a Bad Situation
Worse.” June 4, 2008.
� American Airline’quarterly SEC 10-Q filing.
� Delta Airline’s quarterly SEC 10-Q filings.
� Delta Airline’s quarterly SEC 10-Q filings.
� MSNBC.com: “Airlines Move to Make a Bad Situation

� Northwest Airlines quarterly SEC 10-Q filings.
� MSNBC.com: “Airlines Move to Make a Bad Situation
� “Southwest Airlines Reports Third Quarter Financial
Results.” Forbes.com. October 16, 2008.
� Christopher Hinton, “Storm Clouds Gather, but Southwest
CEO Has a Plan.” MarketWatch, Dec. 4, 2008.
� Moira Herbst. “Hedging Against $200 Oil.” Business Week
Online. May 7, 2008.
� Moira Herbst. “Hedging Against $200 Oil.” Business Week
Online. May 7, 2008.
Role of the internet in the modern day employment cycle:
Abstract:
The economy, presently, is going through a lot of changes. New
economic trends have been emerging, worldwide, at a rapid
pace. Most corporations are looking to cut costs and optimize

their procedures. Amidst these drastic changes, the employment
landscape is also changing. There are newer, more innovative
programs and procedures that employers/corporations are
adopting. The extent to which organizations can optimize
depends largely upon the availability of technology. This
particular research paper will focus on the different internet
based tools and applications that have brought a revolution to
the modern day employment cycle.
The entire employment cycle consists of numerous parts:
Application, Recruitment, Training, Deployment, internal and
external organization communication, Termination, and
Retirement. The purpose of this paper is to research the
technological usage in each of these phases and to analyze the
effects, both positive and negative, of this new found
technology. The intention of this research is to thoroughly
understand the employment cycle and its dynamics. We will
also be able to evaluate how these new internet technologies
will impact cost, effectiveness, and how they will fit into the
current employment cycle. It will also touch upon the influence
that the internet based social networking phenomenon has had
on the employment cycle of an organization.
Outline:
1. Introduction
2. Human Resource: Employment cycle
3. Traditional employment cycle implementation VS
technology enabled employment cycle implementation
4. Industry trends
5. Analysis: Impact of internet on efficiency and effectiveness
6. Results

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