Consumer surplus, or consumers’ surplus, is the monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest price that they would be willing to pay.
Producer surplus, or producers’ surplus, is the amount that producers benefit by selling at a market price that is higher than the least that they would be willing to sell for; this is roughly equal to profit (since producers are not normally willing to sell at a loss and are normally indifferent to selling at a break-even price).[1][2]
Price discrimination, known also by several other names, is a microeconomic pricing strategy whereby identical or largely similar goods or services are sold at different prices by the same provider to different buyers, based on which market segment they are perceived to be part of.[1][2][3] Price discrimination is distinguished from product differentiation by the difference in production cost for the differently priced products involved in the latter strategy.[3] Price discrimination essentially relies on the variation in customers’ willingness to pay[2][3][4] and in the elasticity of their demand. For price discrimination to succeed, a seller must have market power, such as a dominant market share, product uniqueness, sole pricing power, etc.[5]
But in a competitive market, normally, that won’t work, because you require monopoly power to make it work.
A monopoly (from Greek μόνος, mónos, ‘single, alone’ and πωλεῖν, pōleîn, ‘to sell’) is a market in which one person or company is the only supplier of a particular good or service.[1] A monopoly is characterized by a lack of economic competition to produce a particular thing, a lack of viable substitute goods, and the possibility of a high monopoly price well above the seller’s marginal cost that leads to a high monopoly profit.[2]
Price discrimination: A monopolist can change the price or quantity of the product. They sell higher quantities at a lower price in a very elastic market, and sell lower quantities at a higher price in a less elastic market.
And the airline industry—at least in the US, and not saying that that is the case everywhere in the world—is a competitive one.
Warren Buffet has been a pretty prominent voice critical of airlines in the US as an industry; they aren’t very profitable.
For decades, Warren Buffett’s distaste for airline stocks has puzzled many investors.
How could a business so essential to global commerce, tourism, and modern life be so unattractive to one of the world’s most celebrated capital allocators?
The airline industry is, unfortunately, a textbook example of a structurally unattractive sector:
Rivalry Among Existing Competitors: Intense. Price wars are common. Differentiation is minimal. Customers view seats as commodities, and loyalty programs offer diminishing returns.
Threat of New Entrants: Moderate to high. While aircraft procurement and regulatory hurdles present barriers, the proliferation of low-cost carriers has shown that entry is possible - often with disruptive effects.
Bargaining Power of Suppliers: High. Aircraft and engine manufacturers (Airbus, Boeing, GE, Rolls-Royce) operate as oligopolies. Airports and labor unions also exert significant leverage.
Bargaining Power of Buyers: High. With near-zero switching costs, passengers chase the lowest fare. Online aggregators have further commoditized the booking process.
Threat of Substitutes: Medium. Alternatives like high-speed rail (Europe, China) or videoconferencing (post-COVID) are becoming more viable.
Each of these forces squeezes margins. Together, they form a gauntlet that makes sustainable value creation exceedingly rare.
The airline industry has a long and notorious history of earning ROICs at or below WACC.
In other words, despite growing revenues and essential services, the industry has historically destroyed shareholder value. From 1963 to 2023, U.S. airlines rarely posted positive ROIC-WACC spreads. This isn’t just a cyclical issue - it’s structural.
Buffett never bet against airplanes - he bet against the economics of the airline business.
And over the long run, he was right.
Delta might say “okay, Person X has the ability and willingness to pay more for a product that I offer, so I’ll charge more”.
The problem is that that makes it very easy for the airline down the street to take their business by simply not charging that much.
And while there is some overhead associated with comparing prices, and customers will place some value on the time they spend comparing prices, there are a number of well-established existing services to do price comparisons between airlines, like Travelocity and Orbitz, which make this pretty quick and easy.
Like, I don’t think that the limiting factor on an airline doing personalized pricing is likely a lack of having a model that can sufficiently-accurately predict the price an individual is willing to pay, which is what AI or other computer modeling would provide. Rather, it’s the presence of a competitive market.
Sure. Everyone would prefer to have a monopoly that they control, given the option (though to avoid monopolies everywhere other than that). One generally doesn’t get the option to exclude other parties from competing with themselves, though.
If Delta or any other airline had the option, they’d rather be the only airline. But…here we are.
The problem here is that it’s also going to make your pricing uncompetitive.
You can convert consumer surplus to supplier surplus by using price discrimination.
https://en.wikipedia.org/wiki/Economic_surplus
https://en.wikipedia.org/wiki/Price_discrimination
But in a competitive market, normally, that won’t work, because you require monopoly power to make it work.
https://en.wikipedia.org/wiki/Monopoly
And the airline industry—at least in the US, and not saying that that is the case everywhere in the world—is a competitive one.
Warren Buffet has been a pretty prominent voice critical of airlines in the US as an industry; they aren’t very profitable.
searches
https://jimmysjournal.substack.com/p/why-buffett-hates-airlines-a-case
Delta might say “okay, Person X has the ability and willingness to pay more for a product that I offer, so I’ll charge more”.
The problem is that that makes it very easy for the airline down the street to take their business by simply not charging that much.
And while there is some overhead associated with comparing prices, and customers will place some value on the time they spend comparing prices, there are a number of well-established existing services to do price comparisons between airlines, like Travelocity and Orbitz, which make this pretty quick and easy.
Like, I don’t think that the limiting factor on an airline doing personalized pricing is likely a lack of having a model that can sufficiently-accurately predict the price an individual is willing to pay, which is what AI or other computer modeling would provide. Rather, it’s the presence of a competitive market.
Competitive markets are hated by private business owners
Sure. Everyone would prefer to have a monopoly that they control, given the option (though to avoid monopolies everywhere other than that). One generally doesn’t get the option to exclude other parties from competing with themselves, though.
If Delta or any other airline had the option, they’d rather be the only airline. But…here we are.