Tuesday, January 25, 2005

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The battle over airline regulation

Two stories have come out this past week on the costs and benefits of deregulation in air travel. In the Sunday New York Times, Micheline Maynard examines the debate in the United States over airline deregulation. Some groups don't like it:

[R]epresentatives of labor unions and some consumer groups, long for the stability of the time, before 1978, when the government decided fares and determined where airlines would fly. Labor unions in particular are looking for an alternative to the current situation, having been hit this decade by five airline bankruptcies, the elimination of more than 120,000 jobs and cuts of as much as 50 percent in pay and benefits.

These groups say it is time to consider reregulating airlines, or at least to start a debate about how to stabilize an industry that may be so vital to the nation's fabric that government intervention is warranted....

"Are we willing to accept the results of a free marketplace, or do we think the role of commercial aviation is such a part of our economy that we have to have government influence?" asked Patricia A. Friend, president of the Association of Flight Attendants, a labor union that represents about 75,000 airline employees. "It's a conversation I'd like to have before everyone wakes up and asks, 'What the hell happened?' "

So what are the results of that free marketplace? Read on:

Since federal restrictions on routes and fares were removed, consumers have been saving $20 billion a year on air fares, when adjusted for inflation, according to Brookings. Fares have dropped by more than 30 percent, on average, and as much as 70 percent when tickets are bought in advance, the group concluded.

At the same time, airlines have vastly expanded their networks, bringing air travel - a relatively infrequent experience [several decades ago] - to people all over the country. For example, American, the biggest airline, flew to just 50 cities in 1975; it now serves more than three times that number. Southwest, which started in 1971 with a single route in Texas, now flies to 61 cities, not counting those it serves through a code-sharing arrangement with ATA.

Read the whole thing -- the major airlines are facing a serious financial squeeze, to be sure -- but the 2001 post-9/11 government bailout worsened rather than aided their situation.

Meanwhile, Matt Welch has a great piece in Reason that looks at the travel revolution that low-cost airlines have brought to Europe. The effect has transcended the airline industry:

In less than a decade, the Southwest Airlines revolution has swept through sclerotic Europe like a capitalist hurricane, leaving a fundamentally altered continent in its wake. Low-cost airlines have grown from zero to 60 since 1994 by taking Southwest’s no-frills, short-haul business model and grafting on infinitely variable pricing, aggressive savings from the contemporaneous Internet revolution, and the ripe, Wild West opportunities of a rapidly deregulating and expanding market. Europeans, fed up with costly train tickets, annoying motorway tolls, and Concorde-style prices from national “flag carriers” such as Air France and Lufthansa, have defected to the short-hoppers in droves—200 million, nearly 45 percent of the entire E.U. population, took a low-cost flight in 2003 alone.

These airline upstarts are run by swaggering young CEOs whom the European press treat like rock stars, living up (or down) to the billing by issuing manly predictions of price war “bloodbaths” and pulling off daring publicity stunts, such as Irish carrier RyanAir’s post–September 11 sale of 1 million tickets for “free” (before taxes). Their companies have been rewarded with dot-com-bubble-like stock valuations—and the volatility that comes with them—while their long-haul counterparts dodder toward cutbacks, bankruptcy, and worse. (Switzerland became the first European country to lose its national airline when Swiss Air and Sabena folded in 2001.) In less than a generation, one of the Western world’s most notoriously regulated and distorted markets has become a poster child for unified Europe’s 21st century élan.

In the process, Europeans have changed not only their travel choices but the way they behave. “We aren’t just teaching our customers about our brand,” says Stanislav Saling, the twentysomething Slovak public relations director of SkyEurope, a new Bratislava-based low-cost carrier. “We’re selling tickets to people who have never flown before, and showing them how to use the Internet.” Brits, who have led the low-cost charge with RyanAir and easyJet, are now the world’s biggest owners of foreign second homes as a percentage of population. Across the 25-country, 458-million-resident European Union, marriage between different nationalities is at an all-time high. Residents of post-communist countries, who not long ago were more than happy to take any handouts from their far richer Western neighbors, are now leveraging the low-cost revolution to compete with them instead. Old Europe’s postwar business culture, in which CEOs of highly regulated “National Champions” were virtually interchangeable with their schoolboy pals in government, has been battered by entrepreneurial mavericks of hard-to-define provenance, such as easyJet’s 37-year-old founder Stelios Haji-Ioannou, who was born in Greece, owns houses in four countries, and (as The New York Times put it in April) “feels Greek when he is in London, English when he is in Greece, and European when he is in America.”

One common theme in both of these pieces is that deregulation is not without its costs -- there's more uncertainty about the financial viability of some airlines, greater stress on airline employees as these firms are pressured to improve their productivity, and as the case of RyanAir demonstrates, a few airlines that appear to delight in irritiating their customers.

The other common theme is that these costs are dwarfed by the massive benefits that consumers have accrued in the form of lower air fares and a greater variety of travel options.

Be sure to read the Welch piece on how deregulation could go further.

posted by Dan on 01.25.05 at 12:00 PM


Much like Southwest, RyanAir went out of their way not to fly from congested and costly airports, opting for sort-of-out-of-the-way hubs. This is just one way they're passing the saving onto the consumers. This is NOT an option for the National Airlines. They must fly from the capitals and to the busy financial cities. Pride indeed cost money.

posted by: BigFire on 01.25.05 at 12:00 PM [permalink]

I thought that story and its headline were quite strange. Deregulation of the airline industry was intended to do exactly what has happened, and the consequences were foreseen at the time by many in the industry. It is one of the few deregulation plans which has succeeded, and done so quite handsomely.

Admittedly, the days of airline CEO being a very comfortable $2 million/year sinecure are gone, as are the days of leg room and crab salad for anyone lucky enough to travel on business - but again, that was an intended effect.


posted by: Cranky Observer on 01.25.05 at 12:00 PM [permalink]

Its true. We had to balance whether airline employees deserve jobs for life versus whether affordable travel for nearly all Americans is more desireable.

posted by: Mark Buehner on 01.25.05 at 12:00 PM [permalink]

Low cost carriers can succeed but only up to a point. They pick out-of-the way locations with little competition but if you notice that means that the only market they really serve well is the leisure traveler just looking to go somewhere, anywhere simply because the airfare if cheap. Nothing wrong with this but at this point much of the routes the discount carriers fly and services they provide only serve a specific traveler. That leaves the business traveler and other segments of the leisure travel market underserved. From personal experience I travel discount carriers for leisure travel when I can but I would never use one for business travel - they don't give me the level of service and convenience I need. At some point discount carriers will probably start focusing on serving the business traveler and other types of leisure travelers but to do so the cost benefits of the low-cost business model start to break down.

The reason the US national carriers are in trouble can be broken down into two components:

1) Astronomical labor costs. For all the complaining airline employees do they are significantly overcompensated vs. the rest of the country. Airline pilots are the second highest paid profession in the US after doctors but only have to work 22 hours a week. Mechanics in the airline industry make on average half again as much as mechanics outside the industry. Labor unions in the airline industry are protected by the Railway Labor Act of 1926 that puts negotiating power squarely to the side of the unions making it very difficult for the companies to control labor costs. So essentially the airline industry was deregulated in terms of being able to control pricing but was not allowed to deregulate in terms of being able to control costs. For comparison sake, Singapore Airlines is a full service airline - its labor costs to sales are around 23% vs. US carriers at between 35-40% of sales.

2) To operate as a national carrier you need to operate a hub and spoke network. You just can't do point to point for the entire country. The economics just don't work. The problem with this is demand forecast. Demand is much more consistent on a point to point basis and more variable for a hub and spoke network. Since operating a route means you have to commit significant upfront fixed costs the more variable demand becomes the greater the potential for profit loss - variable demand and fixed costs are a dangerous combination. Also since a hub and spoke network requires airplanes of various sizes you don’t get the benefit of streamlining maintenance.

The problem as I see in the US is not deregulation but rather that deregulation has not gone far enough. As usual special interest groups hobble the industry. I say either let the big national carriers die or fully deregulate the industry.

posted by: asiequana on 01.25.05 at 12:00 PM [permalink]

> They pick out-of-the way locations with little
> competition but if you notice that means that the
> only market they really serve well is the leisure
> traveler just looking to go somewhere, anywhere
> simply because the airfare if cheap.

Don't know if you have been on a Southwest flight recently but on Sunday evening, Monday morning, and Friday afternoon it is 80% business travellers just as on American or United.

But the one point about the non-traditional carriers (it isn't really correct to call them "low cost" anymore as not all of them are) that everyone seems to miss is that they all have a reasonable spread between highest and lowest ticket price on a given route. Yes, Robert Crandell was right that there is a time value to a ticket and possibly a genius for noticing it. But that value isn't 2000% between a 28-day and 1-day fare. People HATE being ripped off, and by the summer of 2000 pretty much every business traveller I met had concluded the high-fare carriers were doing nothing but.

On the route I take most often with Soutwest the 28-day fare is 129, the standard fare 179 and the walkup fare 224. That is a reasonable spread and both my company and I are willing to pay the 224 if circumstances dictate. But American would charge 1799 for the walkup fare and laugh in your face if you complained. Which is why my company now uses Southwest 85% of the time and shops the hell out of the rest.


posted by: Cranky Observer on 01.25.05 at 12:00 PM [permalink]

> Airline pilots are the second highest paid
> profession in the US after doctors but only
> have to work 22 hours a week.

The reasons why pilot pay structures are as they are are complex and obscure, and do not lend themselves to discussion in blog comments.

But I will offer two data points: (1) current starting salaries for turboprop commuter pilots are around 17k, which is not enough to make a payment on the loans needed for flight school. Regional jet captains can look for 30k-40k. (2) Southwest's pilots are close to the top of the industry in compensation, yet their company seems to be doing OK ;-)


posted by: Cranky Observer on 01.25.05 at 12:00 PM [permalink]

> They pick out-of-the way locations with little
> competition but if you notice that means that the
> only market they really serve well is the leisure
> traveler just looking to go somewhere, anywhere
> simply because the airfare if cheap.

Yeah that JetBlue direct flight from Dulles to Long Beach (or Oakland) for under $200 is really only for leisure travelers....

posted by: Ian on 01.25.05 at 12:00 PM [permalink]

Crankys got it exactly right I think. The big airlines are among those industries that just dont get it, the recording industry being case and point two. These companies seem to be just trying to weather the storm in the back of their minds believing the salad days will be back again. Not going to happen. Technology has changed too many things, and more importantly too many people. Not many companies will drop two grand to fly somebody around when they can have a video conference for free. For small companies, its very simple. If you can find a reasonable fair you make the trip. If not, forget it. Besides that, as a business traveler i actually prefer Southwest because i like the little things, like showing up on time with my luggage. Or Airtrans where i can drop 30 bucks and get upgraded to business class (and drop 30 bucks worth of free cocktails). The two extra inches of legroom and prestige of flying United just isnt very alluring.

posted by: Mark Buehner on 01.25.05 at 12:00 PM [permalink]

Notice I qualified my statement with the terms "only serve well" and "underserved." I did not say business travelers were not served at all. Of course there are certain routes that discount carriers operate that serve business travelers. That is because they specifically cherry pick only the most profitable point to point routes. If you only need to go to a few specific locations in which discount carriers cover then I'm sure that works for your company but it doesn't help me or a lot of other business travelers. I haven't used Southwest because it doesn't operate in the areas I travel and I doubt they ever will. Like I said discount carriers will eventually start to focus more and more on other areas of demand but my point was only that the cost structure will change. They have a different cost structure from the national carriers in large part because they only serve specific point to point routes.

I is not just the pilot's wages that are a problem. I only brought it up as one example. It is the entire labor cost structure which includes not just wages but benefits, prohibitive work rules and too many employees – United has 173 employees per aircraft vs. Southwest has 86 employees per aircraft.

Southwest is significantly more profitable in large part due to the lack of legacy union problems and the fact that they do not have national coverage. The customer service factor obviously helps on the demand side but it is not the only contributing factor to Soutwest's profitability.

posted by: asiequana on 01.25.05 at 12:00 PM [permalink]

The 22 hour work week for pilots should read that they get paid for 22 hours a week, depending on the work rules the actual time spent working could be up to 96 hours. For most of the big name airlines about half of the time at work is unpaid(all of the preflight and flight planning etc is unpaid). For the smaller ones the ratio is much closer to 3 hours at work for 1 hour of pay. The biggest problem right now with airline competition is it isn't really competition until you are willing to let somebody lose.

posted by: tommy on 01.25.05 at 12:00 PM [permalink]

As I pointed out at Matt's blog, the "disregulation" nonsense is an outrage.

It is impossible to sort through issues like this when the language means nothing.

posted by: Billy Beck on 01.25.05 at 12:00 PM [permalink]

My dad was a pilot for many years. This is an overly simplification of his explanation of the primary problem:

The problem is that government fears of an airline being too-big-to-fail creates the perceived need for a bailout. The bailouts of the weak carriers means that supply and demand are no longer a function of the market. Supply is now a function of the government. Because the weaklings never die the death that they should, their supply of seats never goes away. The result is that once-healthy Continental, American and Delta have to compete with competitors (like USAir and United) that shouldn't even be in existence. With the demise of those airlines, and the decline in supply of seats, prices would have rebounded and the once healthy carriers would still be healthy.

Instead, Congress bailed out the weaklings in order to save the jobs of airline employees and the jobs of supplier companies. Creditors continue to get paid, which means that airlines can continue to get loans to buy new aircraft, which exacerbates the supply problem even further. The result is that the oversupply of seats gets even larger, which creates additional downward pressure on air fares.

Bottom line is that I am an air traveler and a taxpayer. As an air traveler, I benefit that my taxes go towards bailing out the airlines because the never-ending supply pushes air fares lower. I benefit at other taxpayer's expense. But if you are a taxpayer who doesn't fly, you are getting the short end of the stick. Your tax dollars are perpetuating the oversupply of seats that keeps travel costs low. If you don't travel, you don't get the benefit of the low travel costs.

If the government would let just one of the legacy carriers fail, it would wake up the capital markets and the employees of the other carriers that capitalism allows for competition and that businesses have to adapt to that competition. Supply would stop growing, demand would catch up to supply, and the airlines would return to health.

But that's not going to happen. That's because the airline business is a deregulated business where the government intervention prevents the weak from ever failing!

posted by: Don Fishback on 01.25.05 at 12:00 PM [permalink]

> If the government would let just one of the
> legacy carriers fail,

Eastern, PanAm, and TWA not counting I guess?


posted by: Cranky Observer on 01.25.05 at 12:00 PM [permalink]

To say it's a complex situation is an understatement, but a few things to consider:

Oversupply of seats is a myth - most US airlines are running load factors of between 70% and 75% - at or near all time highs. More people are flying today than in the period before 9/11. However fares remain at or near all time lows (when corrected for inflation).

It's ironic - people will shop endlessly to save $10 on airfare, then unthinkingly drop $40 on the taxi ride to or from the airport.

I have friends that work at United, and it pains me to say it, but Don is right. The best possible thing that could happen to the US airline industry would be for United to go belly up. If United failed, there would be a massive scramble in the short term, but it would help the survivors get healthy.

I saw a comparison a while back - United and Southwest went head to head. Same route, same airports, similar airplane, similar frequency, similar fares. Difference was, Southwest could fly 50% full and break even, more than 50% and they made money. United lost money even with the plane 100% full. Talk about a looser of a business model....

The Southwest business model is excellent, but what if you want to fly international? How many "discount" airlines fly across the Atlantic (few) or Pacific (almost none). Somehow we still need those "full service" airlines.

Like I said, to say it is a complex problem is a massive understatement.


posted by: Tim the Boeing guy on 01.25.05 at 12:00 PM [permalink]

Briefly - isn't comparing the post-deregulation (or post-"deregulation") situation relative to the pre-etc situation straight up a post hoc fallacy? What did tech and other productivity advances have to contribute?

posted by: rilkefan on 01.25.05 at 12:00 PM [permalink]

There may be cherry-picking going on as an airline starts up. But if you've looked at Southwest's route map recently, you'll see that they cover large parts of the country that don't fit their initial business model - clear weather to ensure reliable schedules and quick turnaround. They're now serving large portions of the northeast and its notoriously bad weather.

Also, both JetBlue and Frontier use essentially single-hub systems, not point-to-point.

Finally, while there's probably not much profit in Ted and Song and the other large airline regional carriers, there are dozens of small independent regional airlines that serve local routes.

Finally, for a while, the large airlines tried to fight back by undercutting the smaller carriers on similar or identical routes, using their larger base to subsidize predatory pricing. United in Denver drove Western(?) in Colorado Springs out of business doing that. It bought them time, but no customer love.

posted by: Joshua Sharf on 01.25.05 at 12:00 PM [permalink]

As to international air travel, isn't the allocation of those routes generally set by bilateral treaty? For instance, I don't think Southwest could offer flights to Japan, even if it wanted to, because the law expressly permits only a few carriers to fly between the US and Japan.

posted by: Tom T. on 01.25.05 at 12:00 PM [permalink]

> Airline pilots are the second highest paid
> profession in the US after doctors but only
> have to work 22 hours a week.
Wow, that statement is far out of line with reality. Starting airline pilots make around $20k per year, with student loans running around $100k. That "22 hours per week" uses the same math as "football players only work 2 hours per week." They might spend 22 hours behind the yoke, but they also spend several hours before and after each flight doing (preflight) checks.

At one job I had, we had 30+ hours per week of meetings. Did that mean I only "worked 10 hours per week" (since I was salaried, overtime was unpaid)?

Tim, here in Denver, the newspapers have been covering the United retirees who are about to get royally screwed as United tries to bail out on their pensions. When the feds bail out a pension plan, they cap pension payments at around $40k/year. Some of the retirees are looking at more than 50% cuts.

posted by: Peter on 01.25.05 at 12:00 PM [permalink]

A bit OT, but in the same spirit as the post - when is academic tenure going to be abolished? Couldn't that lead to lower college costs for students and thus make a college ed available to more people?

posted by: e-van on 01.25.05 at 12:00 PM [permalink]

"A bit OT, but in the same spirit as the post - when is academic tenure going to be abolished? Couldn't that lead to lower college costs for students and thus make a college ed available to more people?"

Never and yes. Tenure is an archaic remnant of aristocracy. In higher academia it generally means you have proven yourself adept at your job and therefore can hand it over to a grad student.

posted by: Mark Buehner on 01.25.05 at 12:00 PM [permalink]

Definitely the next step in deregulation has to be the selling of airports from municipalities to the airlines themselves. I don't see why a city has to foot the bill just so airlines can make money off of them. Example - Houston maintains two main airports - Bush (far from town, huge) and Hobby (close to town, small). Almost all the gates at Hobby are used by Southwest and other low cost carriers. Wouldn't we be better served by Southwest owning this facility? This situation is duplicated in most of the major cities in the US. Anyway, food for thought.

posted by: Don Mynack on 01.25.05 at 12:00 PM [permalink]

Partial deregulation of airlines is just like privatizing Social Security. It just makes life more of a crap shot. My 2003 summer vacation via Southwest I ended up in Portland, OR instead of Seattle. So far regulation of air safety has maintained flight standards, but with more and more of airline maintenance outsourced, can this record maintained?

posted by: VietnamVet on 01.25.05 at 12:00 PM [permalink]

Breif mention was made of the Railway Labor Act of 1926. (Interesting... pre-depression... OK, that's another thread)

Anyway, that mention makes me mindful of the deterioration of rail travel in this country. A case can be made, I think that the degree of deterioration of that industry was link directly to the degree of governmental and union involvement at the time. Oddly enough, that industry's customers went to planes... on large account as a reult of the governmental ofuling of the rail industry.

How much of that history, I wonder is being considered regarding rail's replacement? I would argue that with a few exceptions, we're seeing history repeating itself.

posted by: Bithead on 01.25.05 at 12:00 PM [permalink]

> Oddly enough, that industry's customers went to
> planes... on large account as a reult of the
> governmental ofuling of the rail industry.

The airline industry most assuradly did NOT spring up out of the ground as a result of the lonely efforts of determined entrepraneurs. The Post Office, the Army, NCAA, various cities, and many federal and local government agencies spent a LOT of money and effort in the 1920s and again in the 1950s to make airline travel possible. None of this was recovered from the industry.


posted by: Cranky Observer on 01.25.05 at 12:00 PM [permalink]

Agreed... and was thereby crippled at the get-go.
Yet, that doesn't mean it needs to stay that way.

posted by: Bithead on 01.25.05 at 12:00 PM [permalink]

Regarding Pan Am and TWA, they didn't go under, they were bought. United bought Pan Am's Pacific routes, and Delta bought the mostly-European leftovers TWA was recently purchased by American. Cranky is right that Eastern did go under. But that was back in 1991! Many years prior to the government's entry into the business of bailing out the airline weakings. (It was in the business of bailing out the S&P industry back then). Bottom line is that since 2001, the government has not allowed one major airline to fail. For an unofficial list of all the basket cases, visit this web site: http://www.air-transport.org/econ/d.aspx?nid=6207

As far as capacity, the load factors are up only because the fares are low, thus causing the legacy carriers to lose billions. It's not the loads that are the problem for the legacy carriers, it's the fares!

The oversupply of seats causes downward pressure on fares. The low prices causes demand to increase. So you get good loads at horrendous prices (horrendous for the airlines, I should say) The problem is, that the legacy airlines can't make money with the fares they charge.

Let them go out of business, and let their routes get picked up by the discounters. Prices won't go up because the discounters will replace the capacity. Supply of seats will stay the same because the planes of the liquidated airlines will get sold to some discount outfit. The only folks that will suffer are the employees. I imagine most of them will get hired by the discounters, but not at the same wage level that they're at now.

posted by: Don Fishback on 01.25.05 at 12:00 PM [permalink]

> TWA was recently purchased by American.

TWA was an estimated 3 days from filing Chapter 7 when it was "bought" by American for about 5 cents on the dollar. You can call that an acquision if you wish! Basically the same with PanAm.

I forgot Braniff.

I do agree with your basic point that one of the majors needs to disappear, although I would think it should be the one that has been abusing the intent of the Chapter 11 laws for the last 7 years. I am not quite so sure that the United States can allow major segments of its economy to be destroyed by exogenous shocks that are not in any way the fault of that segment. We tried moving electric utilities from a cushioned model to a fully competitve model and the result was California (including the corruption, which had been predicted).

But more bail-outs past a year post-9/11 have no justification.


posted by: Cranky Observer on 01.25.05 at 12:00 PM [permalink]

The airline industry is not a free marketplace, as other posters have pointed out. The link has my observations.

Given the current industry-wide constraints, TWA, Eastern, PanAm, etc are not enough companies to exit the business to help.

posted by: Liberty Lover on 01.25.05 at 12:00 PM [permalink]


Most salaried professional occupations do not get paid for every hour they actually work and have similar tuition burdens.

On average investment bankers, lawyers, doctors, etc. don't make that much in terms of starting salaries either, especially when you put it in terms of hourly pay. But starting salaries are hardly an accurate comparison especially when the average salary is significantly higher. Average salaries for pilots are the second highest in the country.

Most people in this country would be more than happy to retire at age 60 with a $40k/year pension. United management was told once by the head of the pilot's union that they didn't want to kill the golden goose they just wanted to choke it until they got every last egg. Apparently they squeezed too hard.

posted by: asiequana on 01.25.05 at 12:00 PM [permalink]

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