Consider Southwest Airlines

Consider Southwest Airlines. That carrier uses both dimensions of pricing to reduce costs.

First, the airline specializes in lean operations that have lower costs than all other major air carriers. This enables the company to offer lower prices for vacation travelers and others who can book flights well in advance. Such discounted prices are usually about 10 to 20 percent less than competing airlines for the same routes.

You can often fly on the airline coast-to-coast for the same price paid for a similar, discounted flight more than years earlier. Those low prices attract lots of customers, and the airline often has a higher percentage of seats filled than its competitors. That popularity drives down costs because the extra expense to add another passenger is very small. As Southwest spokespeople might say, it's just peanuts. Most of the increased revenue turns into profit contribution.

Second, like other airlines Southwest also charges more for people who buy tickets at the last minute. However, Southwest's prices differ from those of other airlines by being based on a much smaller percentage increase from the discounted fare. Thus, a business traveler may be able to buy a last minute ticket as little as 25 percent of the price of a competing airline. This strategy drives a lot of last minute travelers to Southwest at premium prices, further lowering costs while fattening margins.

How can you use lower prices to cut your costs faster than your prices drop?