What's Virgin America's Problem?

The airline business is tough. As many investors have discovered, even the best airlines sometimes struggle just to survive, never mind generating a profit.

Further complicating the situation, it often seems like the normal rules of business and economics don't apply to commercial aviation.

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As discussed in a recent blog post, Delta is simultaneously squeezing its best customers and generating enough cash to resume dividend payments to its shareholders after a decade. Business 101 warns that mistreating your best customers is not a recipe for financial success. And yet, Delta is doing just that.

Spirit is another confounding example. The airline's business model is based on charging ultra-low fares, and then nickel-and-diming travelers for everything beyond basic airfare. It's an approach that most flyers find infuriating. But that lack of love doesn't seem to have dampened the traveling public's appetite for Spirit tickets. In 2012, the carrier flew 20.7 percent more passengers than the previous year and chalked up a hefty profit of $108.5 million.

Even as some carriers manage to prosper while treating their customers shabbily, other carriers do the opposite, treating their customers well but flagging financially.

A prime example is Virgin America.

At just six years old, the airline has the advantages of a late entrant, including a younger fleet and lower labor costs.  And it was clearly an airline designed from the ground up to deliver a superior travel experience, with leather seats, mood lighting, food-on-demand, and an industry-leading inflight entertainment system.

There's a lot of happy talk, with references to solid on-time performance and industry-best baggage handling, as well as the number-one ranking in the 2013 Airline Quality Rating survey.

But there's no disguising the lackluster financials. For the full year, the airline lost $145.4 million. And for the first quarter of this year, the loss was $46.4 million. Although there's some year-over-year improvement, sustained profitability is still more dream than imminent reality.

Virgin America president and CEO David Cush remains wedded to the proposition that great service will drive great performance: "We've always said that once people fly us, they stick with us—and show a preference for our service."

But he's assuming what has to be proved.  The examples of Delta, Spirit, and Virgin America certainly seem to undermine the key assumption underlying traditional theories of business success, namely that consumers are rational actors.

The evidence, at least in the airline business, suggests we're not.

Reader Reality Check

What do you make of Virgin America's failure to realize its potential?

Are travelers hypocrites, demanding service but buying on price?

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