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What Killed American Airlines Could Kill You
 

Too much inventory and not enough demand can cripple a business of any size. Let this be your warning.

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When AMR, the parent of American Airlines, declared bankruptcy earlier this week, few should have been surprised. This was a fall long in coming. But it’s one that pretty much every entrepreneur should study. You might be thinking, “Yeah, but the airlines operate in another world—and one that bears little resemblance to mine.” Stay with me. Despite the obvious differences between a giant corporation and a small business, one of the basic factors that spelled financial doom for the airline could apply to you.

Planes, planes everywhere 

One of the long-standing problems of the U.S. airline industry was excess capacity. There were simply too many planes with too many empty seats. Here's the short version:

  • Airlines wanted to push each other out of the way, so they wanted to expand routes and capture market share.
  • Executives bought planes whenever they had spare cash—or financing. They wanted to make it easier to capture more market share.
  • Airplanes are immensely expensive pieces of equipment and the lifespan, and amortization period, is very long. So every day a plane costs money.
  • It was less expensive to keep planes in the air with at least a few passengers than it was to let them stay on the ground.

And so, the entire U.S. industry had massive amounts of capacity. You could fly almost anywhere for relatively little, especially if you wanted for a particularly hot deal. And that was the problem. 

Demand 1, supply 0 

When there's too much supply and not enough demand, you can predict the end: Prices sink like a jet that has suddenly run out of fuel. The airlines got into pricing wars, customers got used to cheap fares, and too many planes kept sucking money out of the companies. 

Overcapacity isn't something unique to large corporations, however. Think of it like Thanksgiving dinner. You go all out, cook a big meal, shoehorn the remainders into the fridge, and live off them for a couple of days until you can no longer stand the sight of turkey or stuffing and have to toss the rest. That's wasted capacity. 

For your business, it might be having too many salespeople on the floor or far more inventory on the shelves than you need to meet current demand for finished product. Maybe you're running an Internet-based company and you're making unconsciously lavish use of cloud computing and storage resources. Whatever capacity represents to you, it adds capital and/or operational costs whether used or not. Try to rationalize the capacity to serve customers so you have enough for peak demand, but not enough to swim in. 

Step dancing 

One time to be particularly careful is when you're adding new capacity in expectation of increasing business. The business speeds up so you add capacity to meet the demand. But whether you're getting cloud services or adding a new production line, it's like taking a step up. Suddenly you'll have excess capacity and cost per unit work done for customers will jump. 

Know that this is going to happen and market like mad to increase demand. Maybe it will be a time to run some promotions to get new customers in the door. What is vital is that you boost demand enough so that your cost per unit work comes down again to normal levels. 

When everyone else does it 

The pain for the airline industry was not that one or two airlines were profligate in their acquisition of capacity. It was that all of them were. Competition is one other area where overcapacity can blindside you. 

Not only do you need to pay attention to your own company's capacity, but to that of your competitors. When the total capacity in your particular markets rises, prices will fall. You can't necessarily stop it from happening, but you can plan around it. Look for the early signs and develop supporting and less widespread lines of business. 

Then you'll be able to suddenly drop prices, putting your competitors into a panic, while you use the additional higher-margin lines to support the business. Take a cue from the airline industry model of consolidation and buy some of those competitors for their customer lists and to take excess capacity out of the entire system. 

Manage capacity, and you can not only avoid the traps it can represent, but turn it into an advantage.

 

IMAGE: Eric Bégin via Flickr
Last updated: Nov 30, 2011

ERIK SHERMAN's work has appeared in such publications as The Wall Street Journal, The New York Times Magazine, and Fortune. He also blogs for CBS MoneyWatch.
@ErikSherman




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