Italy Needs to Learn About Supply and Demand

Poor Alitalia. No seriously, I really do feel bad for them. I know they’re completely incompetent and losing millions of dollars a day, but I still feel a little sympathy. See, even if they could run a functioning airline, they wouldn’t be allowed to do it thanks to the meddling of the Italian government.

alitaliaIn last week’s episode, we were down to two bidders, but the final decision had been delayed. Then yesterday, we had big news. Um, the final decision has been delayed again. Now it’ll supposedly happen on Dec 21, but I wouldn’t put bets on it. Why?

The Italian government can’t keep their grubby hands to themselves.

We have two offers here. Air One, the Italian airline, will pay 1 euro cent per share (basically nothing) and then spend most of its money on fixing the airline and merging into it. Air France will pay 35 euro cents per share, but they won’t pour as much into the airline. They also say they’ll make Milan a regional hub and focus their efforts on Rome flying. Air One hasn’t made such claims.

The reason everything has been delayed is because the government is dragging its feet. In fact, there’s a top level meeting between the Italian and French heads of state to discuss things on Thursday, and you know this will come up in their talks. But why should it? It’s a business that should be allowed to run like a business. You know that’s not the case when you hear what some of these guys are saying.

Take yesterday’s Reuters article, for instance. On Monday, the Deputy Prime Minister Francesco Rutelli said, “Alitalia must propose the best partner, but the government also has a responsibility … It is not about necessarily choosing an Italian airline, it is not a nationalistic issue. But the interest of the country is at stake. Where will our children, our firms leave from to go to China or India? Will they have to fly from Paris, or even Frankfurt, or will they be able to leave from Milan or Rome?”

Somebody get this guy an economics text book. If there’s demand for flights between Rome and China or India, you know there will be nonstop flights there regardless of who owns the airline. If there isn’t demand? Well then there shouldn’t be a flight there, and if you force one, it will end up being an unprofitable mess. You’ll be right back where you started.

In this article talking about the delay, Rutelli was at it again. “I do not say an absolute no to a partnership with Air France or other foreign partners, but I say that if Air France wants to sit at the table, it has to act in Italy’s interests, rather than its commercial interests.”

Arrrrggggghhhhhhhh!!!!!!!!!

Look, genius, of course Air France has to act in its commercial interests. Why else would they be doing this? Do you think a single Air France shareholder is going to say, “Gee, I don’t care if we make money as long as we’re doing it for Italy.” If you do a good job of making your country a center for commerce and tourism, people will go to/from there. And if there’s demand, airlines will gladly fill it with nonstop flights. But if you have no demand, why on Earth would any airline fly it? So, spend your time furthering your country’s ability to be a desirable place for business and tourism, and then there will be enough demand for flights.

When it comes to Alitalia, just take the bid that makes the most sense from a financial perspective and get out of that mess as soon as you can.

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15 Responses to Italy Needs to Learn About Supply and Demand

  1. Oliver says:

    I am not disagreeing with anything you wrote, but of course the US government isn’t exactly hands-off when it comes to airlines. Apparently it was endangering “national security” if Fred Reid would have continued to run Virgin America. Really can’t trust those Brits and their Virgin brand, now can we? (of course, as a native of San Francisco and a graduate of Cal Berkeley Reid is almost a foreigner and can’t possibly be trusted).

  2. CF says:

    I agree, Oliver. I’ve ranted about the US government in the past as well. This is just Italy’s turn. For some reason, countries can’t get past the belief that airlines are a business. The US says it has deregulated the industry, but it keeps poking its head back in with types of regulation on and off. Either re-regulate it all or lay off completely. (Other than safety regulations, of course.)

  3. DR Gooch says:

    I agree with you general consensus wholeheartedly, however, it is not necessarily true that if there is “demand” between Rome and Beijing, that Air France would choose to operate Rome/Beijing. Airlines are constantly making choices about which routes make the most sense in the context of their particular network model. Taking into account competition and marketshare, if a carrier thinks it can get away with routing passengers over its hub and make more money that way, it often will.

  4. CF says:

    DR Gooch – If Air France is going to take over Alitalia, they aren’t going to be buying the airline just to route everything over France. They see value in the local demand. Now, with the regional network they are bound to keep, they’ll be in the best place to be able to fly nonstop from Rome to Beijing with the possible exception of Air China and their large operation on the Chinese side.

    If they can make it work, they’ll want to have that nonstop. Otherwise, they’ll have no advantage. People could just as easily fly one stop on many other carriers with more direct routings than going back over Paris. If the demand is there, they’ll keep it.

  5. Allen says:

    I agree the government should keep it’s nose out of Alitalia’s affairs. But in this case they are a major share holder. They shouldn’t be but they are so at this point it shouldn’t be surprising that they’re involved.

    As for India and China routes, I agree that in theory that should be the case. But in with the government so insanely involved with everything Alitalia does it may be that they haven’t been able to come up with the capital to build some of those promising new routes because of all the pressure to maintain ones that are currently bleeding. Keep in mind those new routes may take a couple years to turn a profit. And with all the routes they’re already running, presumably many because of political pressure to have those specific routes, they may already be bleeding too much do worry about how to be healthy tomorrow.

  6. CF says:

    Good points, Allen. They are the major shareholder, and so they should be involved. What I’m suggesting is that they should be looking at this from a business perspective. What will be the best for Alitalia as an airline going forward? I think they need to realize that what they perceive to be the best for Italy is likely not going to be best for the airline. So they force a lot of money losing routes to be flown, and everyone is unhappy.

    That’s why the sale fell apart earlier this year. The government put so many onerous restrictions on the sale that everyone backed out. Remember, these bids are just offers and if the government picks one, they have to go into detailed negotiations. It wouldn’t surprise me at all if they fail to sell the airline once again because they put too many restrictions on it.

  7. Alex C says:

    Hey CF, you should post odds on the different possibilities and then start a pool on it.

    Seems like both airlines must be having second thoughts, though, if the gov’t is going to try to block them from cutting routes at will.

  8. Brian Lusk says:

    If you are right CF, and there is no sale this time, what happens next? How long can they last? Will the Italian government allow them to shut down? Geez
    Brian

  9. CF says:

    Who knows, Brian. I can’t believe they’re still flying now!

  10. Zack Rules says:

    Alitalia needs to just be left to die like Oedipus [though Oedipus is Greek, but the same could be said for Olympic]. Other airlines such as Ryanair, Air One, easyJet and others will pick up the slack in service if there’s demand.

  11. DR Gooch says:

    “If they can make it work, they’ll want to have that nonstop. ”

    This is not necessarily true. I am not suggesting that AF will start routing all the Italian flights through Paris. Obviously there will be nonstops, including international nonstops.

    But even if a current route is making money, the company won’t hesitate to put that metal somewhere else if a particular route is near the BOTTOM of the airline’s profitable routes and the company can make MORE money with that plane elsewhere. Airlines make choices like this all the time.

    In the case of Beijing-Rome, since we are talking about China, and since Air China is nonstop on the route, I doubt they’d cut it.

  12. CF says:

    I didn’t even realize that Air China was on the route. If that’s the case, then this is especially stupid. They have a nonstop already, so just be happy with that.

  13. PFR says:

    Jeez, remind me to never have you negotiate on my behalf! Air France is in it for the money, of course, and good luck to them. But the Italian gov’t (indeed, any gov’t) has a more complicated set of goals to balance. They have the right and responsibility to say: “if you want this opportunity, here are the elements we require, even if it makes the deal less profitable.” It seem to me that requiring the presence of key routes, even if they’re unprofitable, is in Italy’s long-term economic interest.

  14. DR Gooch says:

    “It seem to me that requiring the presence of key routes, even if they’re unprofitable, is in Italy’s long-term economic interest.”

    I disagree completely. If the market is there, a carrier will come serve it. The time for prestige routes is over.
    On the upside, I am sure Rome and Milan are perfectly capable of attracting good service.

  15. Bill says:

    Yes, the US government does get involved in US airline business but it was also the airlines that went to the government for a huge 9/11 bailout. You can’t really have it both ways. If airlines want the US out of their business then they have stop taking the handouts.

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