Tuesday, May 1, 2012

Focus and Leverage Part 105

As I’m typing this, I’m flying from Atlanta, Georgia to Salt Lake City, Utah by way of Denver, Colorado.  I could have chosen a more direct route directly from Atlanta to Salt Lake City, but declined to do so because of a policy constraint.  Allow me to explain.
Several weeks ago I was searching for flight options on my “favorite” airline web site, Delta Airlines.  I always check them first because I live near Atlanta and Delta occupies the entire South terminal.  What I found was an airfare that was listed at $1,270 which I thought was a bit pricey.  I checked again and the same price popped up.  I’m a cost conscious person when someone else is paying for my ticket and in this case, my company was paying, so I decided to see what other options might be available.  What I found actually made me angry.

I looked at two other carriers and their price was about 50 % less than Delta’s.  “How could this be?”  I thought.  It would seem to me that because Delta dominates the Atlanta market that their prices should at least be competitive.  I logged on again and the price was now $1,370…..up an additional $100!  As I said, I was now angry with Delta and made a decision to fly on a different carrier.  In fact I went to Expedia and was able to get a round trip ticket for under $450.  Yes, it was not a direct flight and yes, it would take longer, but in the interests of holding down costs for my company, I chose the latter of the two routes.
As I pondered what had happened, two things struck me as being true.  First and foremost, Delta uses traditional cost accounting which tells them to raise prices to be profitable.  In my world, the Theory of Constraints world, that’s my last option.  I’ve covered Throughput Accounting on my blog several times and I’ve told you that the key to profitability is by doing things to make money.  Do you think if Delta’s ticket price would have been reasonably priced that I would have chosen them as my carrier?  The answer is yes.
So think about this for a minute.  Because Delta obviously believes that the key to profitability is through excessive ticket prices, they lost my sale and probably many others.  Plus, you really never want someone to purchase a competitor’s product because they may not come back.  Did Delta have to be the lowest ticket price for me to purchase from them? No, but they did need to be competitive and they weren’t.  So the thing is, Delta lost throughput dollars and customers because they didn’t know the difference between saving money and making money to achieve profitability…..and this was the second thing that struck me.  My point is this.  No matter what your business is…no matter whether you make a product or deliver a service, the key to profitability is by increasing your throughput, not by using outdated cost accounting metrics and the mindset of saving money.  And remember, throughput is revenue minus totally variable costs.
So here I am, sitting in a Denver, Colorado airport, waiting for my connecting flight.  I really do wish I could have flown directly to Salt Lake City on Delta, but because of their policy constraint it wasn’t meant to be.  Maybe next time….but I doubt it.

Bob Sproull


Jim Bowles said...

Bob - I was going to let this pass but a nagging thought in my mind keeps telling me I shouldn't do that. In Focus and Leverage Part 105 you refer to a "policy constraint" - Delta airlines practice of charging high fares probably based on their perception of value (cost plus margin) rather than that of the customers (who provides the best value?) Perhaps you might add a footnote as to whose version of TOC you follow? Dr Goldratt told a conference in Miami in 2004 that the idea of a "policy constraint" was the biggest mistake of his life. He replaced it with the term "subordination failure" - Delta clearly haven't recognised that their inability to generate more money is due to their own actions or stubbornness. Which takes us straight to Dr Goldratt's latest view (before his death) that management attention is the number one constraint that has to be addressed, Clearly in Delta's case they haven't made the link between what they charge and the number of seats they fill. Perhaps they don't want to - we don't know what their goals is do we?

Bob Sproull said...

Hi Jim, sorry I didn't see your comment earlier. My version of TOC that I follow is Goldratt's and I don't agree that the idea of a policy constraint was his biggest mistake for one simple reason. People relate very well to the concept of "Policy Constraint." And although I agree with Dr. Goldratt's comment, I still cling to what I believe most people new to TOC understand more. Hence, I continue to use the term Poilcy Constraint. To me, the policy in the case of Delta is their continued use of traditional cost accounting. I can only assume that their goal is to make money, just like other for-profit companies. But in reality, you're correct....we really don't know what their goal truly is.