Sizing the advantages of incumbency

By Alex Dichter, Ekaterina Khvatova, and Corrado Sala

In many industries, depreciated fixed assets provide a cost edge that favors incumbents. Airlines are different.

Incumbents in network-based industries, such as telecommunications, usually benefit from economies of scale that set high barriers to entry for new players. Airlines are an exception to this rule. Our analysis of the performance of the top nine US airlines over the last ten years indicates that the industry’s new capacity is about 10 percent less expensive to operate than existing capacity,1 since newer planes are typically more efficient and require less maintenance than older models. Carriers with newer fleets thus enjoy operating benefits that help them to offset the capital costs of new planes and to charge less for flights than do established airlines that have older planes or may be locked into long-term leases.

Exhibit 1

This cost edge among entrants helps create the perpetual oversupply and depressed margins that characterize the airline sector. It also contrasts sharply with the situation in telecommunications, where depreciated fixed assets provide a cost edge that upstarts find hard to match. Companies in capital-intensive industries where network effects predominate should always be scanning their environment for signs that new technologies might deliver operating savings that swamp the economic advantage incumbents expect to enjoy by not incurring new capital costs.

Exhibit 2

About the authors

Alex Dichter is a director in McKinsey’s Tokyo office, Ekaterina Khvatova is an associate principal in the London office, and Corrado Sala is a consultant in the Milan office.