Economies of scale and excess capacity
By far, I would consider this aspect to be the key factor when we come to joining the dots to measure profitability. Put simply, it is the cost advantage an airline gains with expansion. Long run average cost of any firm is the optimal quantity/level it can produce/serve with minimum cost. This is the prime reason why, any airline firm is on aggressive path to expand, either through increase in sales or through acquiring other firm. Very often within this business space, excess capacity is created which then starts denting the profit.
Example: Consider there are 100 customers in a city who make use of domestic airline, and two players offering the service. Each serving 50 customers maintains their long run average cost to minimal. However, if third player in the market enters, it will share the market space. Two players already operating in the market, lose their share without any reduction of average fixed cost. Diseconomies of scale creep in, excess capacity is created.
[End of part 1 . . . Part 2 will be published next week]
