2013: Are the airline industry's improved economics likely to persist?

BECKY QUICK: This question comes from Bill Miller of Legg Mason. He writes, “The U.S. airline industry has been plagued with terrible economics for over 100 years. With the pending merger of USAir and American, the industry will have consolidated to the point where the top four carriers will control almost 90 percent of the traffic.

“As a result, the industry has been consistently profitable this past several years, with many of the airlines now earning double-digit returns on invested capital and generating substantial free cash flow. Do you think the industry’s much improved economics are likely to persist? And would there be any economic benefits if Berkshire were to own a domestic airline and pair it with NetJets?”

WARREN BUFFETT: Yeah. Well, the answer to the second is no. But the question about the industry is really interesting, because it is true that it has consolidated very significantly. And in some businesses, you can have only two competitors and they’re still terrible businesses, they beat each other’s brains out. And sometimes they end up competing to do very stupid things. You can argue that that’s what happened with Freddie Mac and Fannie Mae. I mean, enormous companies that had a huge advantage over everybody else, but they still, in their battle to both report higher earnings every quarter and to beat the other guy out, you know, drove prices for insuring loans down to the improper levels, and did a lot of other stupid things, too.

So you see — you do see certain industries where once they get down to very — a very few companies, do extremely well. And you see other industries where, even when they get to be two of them, they don’t do that that well. I mean, you can take Coke and Pepsi in the United States. I mean, they’re the only two colas that people can name, and 50 percent or so of the soft drinks are colas. But if you go into a supermarket on the weekend, you will see them pricing their product at ridiculously low prices and competing very vigorously.

So it’s very industry specific. The airline industry, you know, has this situation where they have very, very, very low incremental costs per seat, you know, with enormous fixed costs, and the temptation to sell that last seat at a very low price is very high and it’s very — and sometimes it can be very difficult to distinguish between the last seat and other seats. So it’s a labor-intensive, capital-intensive, largely commodity-type business, and it’s been — as Bill Miller points out in that question, it’s been, you know, a death trap for investors ever since Orville [Wright] took off. I mean, as I’ve said, if there had been a capitalist at Kitty Hawk he should have shot down Orville and done us all a favor. (Laughter)

But the — but having neglected to do that, investors have poured money into airline companies, and aircraft manufacturing companies, now for 100 years-plus, with terrible results. And if it ever gets down to where there’s one airline and there’s no regulation, it will be a wonderful business. And then the question is whether, having gotten down, now, through a lot of bankruptcies, to a relatively few that are doing a high percentage of the seat miles, whether it’s a good business yet. I don’t know the answer, but I’m skeptical. Charlie?

CHARLIE MUNGER: Well, the last time we were presented with a similar opportunity was when the railroads did exactly what Bill Miller suggests. The railroads got down and consolidated and got better control of their labor costs and it turned into a wonderful business. And what did we do? We missed it. We stumbled in very late to the party, right?

WARREN BUFFETT: Right.

CHARLIE MUNGER: So we’ve proven ourselves to be slow learners in this field, and it’s conceivable, isn’t it, that Bill Miller is right in what he suggests?

WARREN BUFFETT: Which way do you bet?

CHARLIE MUNGER: It goes into my too hard pile. (Scattered laughter)

WARREN BUFFETT: Mine, too.

CHARLIE MUNGER: But he could be right.

WARREN BUFFETT: Yeah, sure he could. And it will be fun to watch. But we like things we have stronger feelings about. We do not think that things will change dramatically in — well, with See’s Candy, you know, it’s — we’ve got — even there, you know, the real profitability is limited to the West Coast, but we do not see some competitor coming along and taking away business.

CHARLIE MUNGER: You really couldn’t create another railroad and —

WARREN BUFFETT: I hope not.

CHARLIE MUNGER: — and you — and you can create another airline.

WARREN BUFFETT: Very easily, and you have people that like to do it.

CHARLIE MUNGER: That’s what we don’t like about it.

WARREN BUFFETT: And people love doing it. It’s exciting to people. And you can sell the idea. I’ve had, probably, a dozen proposals over the last 25 or 30 years from people that want to get into the airline business one way or the — and a number of them have. It’s sexy, for some reason. I mean, it — you know, if you go to the office of some Mr. Big CEO and say, “I want to talk to you about this new airplane,” you get in the door. You know, I mean, if you want to talk to him about hauling coal or something, it’s a little different.

So it is a business that attracts people. And you can go out and raise money for a new airline, and the record is — it’s really been something. I don’t know how many bankruptcies there have been in the airline field, but it’s an enormous number. And, of course, some have done it more than once. We bought USAir. I bought that. I was at Gorat’s with [CEO] Ed Colodny, and he explained to me how wonderful the airline was — he’s a good guy, incidentally — and I wrote a check. And by the time the check was cashed, they were having troubles. I mean, it did not take long.

CHARLIE MUNGER: No.

WARREN BUFFETT: And then they went bankrupt twice. We were very lucky on — we actually made quite a bit of money on it, as it turned out, because there was a little blip at one point. But I think it went bankrupt twice after we bought it. And Charlie and I were on the board, and we would look at these projections, you know, and they were just ridiculous. I mean, they never came true, did they, Charlie?

CHARLIE MUNGER: No, no, no. It was —

WARREN BUFFETT: We were very popular because we actually pointed that out a few times. (Laughter)