Do Firms Pass Commodity Cost Savings to Consumers? Evidence and Impacts of Asymmetric Pricing Behavior in the U.S. Airline Industry

Abstract

We examine airlines’ pricing behavior with respect to fuel cost fluctuations. Managerial accounting “cost-plus” pricing models assume that a firm would adjust selling prices to “pass through” an increase or decrease in the costs of inputs. Using archival data, we find some evidence of airline pricing power -- managers opportunistically retain selling prices when fuel costs decrease. We also document pricing behavior that is more consistent with consumer power: airlines absorb a larger portion of commodity cost increases than they enjoy commodity costs decreases. Further, the periods of airline pricing power and consumer power correlate rationally with the changes in the economic environment within the airline industry. Managers offset margins eroded by commodity fuel cost increases by reducing employee compensation, increasing long-term debt, and by depleting cash reserves. Retained cost savings reverse some of those trends.

Keywords: pricing behavior, input costs, airline industry, opportunistic pricing