Airline Woes and The Price of Incentives

Why human incentives should be taken seriously by all institutions

Over the past few years, Boeing has been under significant media scrutiny due to concerns surrounding its aircraft's safety. A series of accidents have drawn attention, including:

• Alaska Airlines Flight 1282 on January 5, 2024, over Portland, Oregon;

• United Flight 433 experiencing a lost fuselage en route from San Francisco International Airport to Rogue Valley International Medford Airport on March 15, 2024;

• Ethiopian Airlines Flight 302, a Boeing 737, which crashed in Addis Ababa on March 10, 2019;

• Lion Air Flight 610, which tragically crashed on October 29, 2018.

Picture of debris from the Ethiopian Airlines Flight 302 from Reuters

These incidents represent only a fraction of the total number of cases involving Boeing, and time will reveal the truth behind them. However, Boeing has issued a statement indicating that they are restructuring their employee bonus incentives to prioritize safety and quality.

I am curious about the specific bonus structure that will be implemented to incentivize risk management and quality. The airline industry is known for its high operating costs that include labor, fluctuating fuel prices, airport fees, and debt burdens (particularly for high capital expenditure), all of which heavily impact margins. On top of this, the industry is highly competitive, which is often reflected in their price wars (and obvious cost cutting in terms of service). They will need to devise creative strategies to incentivize risk management and quality without compromising their profitability objectives.

This reminds me of the Reward and Punishment Superresponse Tendency mentioned by Charlie Munger in 'The Psychology of Human Misjudgment.' As some of you may know, Charlie Munger was Warren Buffett's right-hand man at Berkshire Hathaway. He passed away on November 28, 2023, just a few days before his 100th birthday. His insights and philosophy profoundly influenced Buffett and shifted Berkshire’s strategy towards focusing more on wonderful companies at a fair price, as opposed to fair companies at a wonderful price. This approach also encouraged an extremely long-term perspective on investing, which Munger famously called 'sitting on your ass' investing.