The key to success is to find the sweet spot of hours flown, cashflow, staff and the right number and type of aircraft for your unique market, be adaptable, rather than try to be the biggest and trample or undercut your colleagues.
This is the biggest problem. Unfortunately most flying schools I've been involved with have no idea how to compete without undercutting or pushing students through to somehow prove they will do it for x cost. This comes from the fact many flying school owners have been dreamers that see the price per hour and think that schools are making some sort of huge profit. When you break it down for somebody looking at investing and show them that at best your money can break even over time they are shocked and wonder why anyone does it. I've found the most important person in a small operation is the CP/CFI, they set the whole tone for the operation, set the standard and to some extent control the marketability of the operation. Owners look at them as just a regulatory requirement, but don't understand that the whole operations viability revolves around that position.
The second biggest problem is that flying schools have no idea how to market themselves, how to make flying a pastime that's fun and rewarding. Mostly they do the bare minimum website, some highlighted ads in a phone book (what's that?) and maybe an odd trip to a school for careers day. This mostly leads the clientele to consist of those who have already decided to be a pilot and have made the decision to actively search for where to do it, not a lot of people do that on a daily basis.
Another big issue that kicked a lot of schools 20 years ago was allowing TAFEs to offer cheap aviation theory. Before that schools could supplement their income fairly well by running courses at regular intervals. This probably also led to instructors having a much better handle on the theory as they were also teaching it regularly.
When it comes to large flying schools you must start with a guaranteed partner airline or such that will push students through your doors. Then you need to be set up to handle such flow, which is not easy. Yes it requires management and extra staff, however it is entirely possible to run a successful large flying college without stooping to poor pay and low standards. CSWAFC was an example of a reasonably well run outfit until it was taken over by CAE who insisted on minimum pay or go away. It was killed by horrendous management that is akin to how Rex killed the golden goose by having no idea how to look after your core business.
This all has nothing to do with how well you pay your pilots. Paying poorly because you can't afford it means that your business model is a failure. It is just treading water until it folds at some future point, as you will either not have the cash just to run operations or you won't have the staff. Either way paying poorly completes the cycle in that you will not get the staff you need to be successful, so the business will just bumble along until the wheels finally collapse. Pay peanuts, get monkeys, monkeys **** on everything, your company and its assets, and cost you more in the long run, as well as not being smart enough to improve the business and make it more profitable. Can't afford to pay staff well enough to ensure good staff, sell up, retire or buy assets that don't require staff, as you don't have the acumen to run a people oriented business.