The Failure of the 1978 Airline Deregulation Act

It has been 35-years since the Airline Deregulation Act. was signed. Those with a vested interest in its success (mostly, officials in government or with the airlines) either loudly assert that it is a ‘great success’, or meekly avoid talking about it. A few have spoken up about the failure; here are links…
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Below are copies of two outstanding news articles (with added links and mark-ups) from Forbes.com,. The original articles were both written by Houston-based investment adviser Richard Fingers. They were published in August 2012, but have become even more relevant with recent developments. Yes, the latest in a long series of bankrupt-airline mega-mergers: the marriage of American and US Airways.

Federal authorities (at DoJ and FAA) appear to be ignoring again the ‘antitrust’ implications. It seems that the regulatory fervor that ripped apart AT&T to protect consumers has, well, … maybe it just crashed and burned, but neither officials nor the media cares to report the fatalities.

Mr. Fingers paints a detailed and complete picture of how the U.S. airline industry has effectively devolved since passage of the Airline Deregulation Act in 1978. I have taken some liberty to mark up both articles with highlighting, sidenotes, links, and other minor edits. Readers are strongly encouraged to read the original articles and the many quality comments at Forbes.com (article links are at the bottom of each article below).

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(Forbes.com, 8/20/12)

Airlines: Who Can Tolerate Them

The “big bang” in the airline world was October 24, 1978. On that momentous day, the Airline Deregulation Act (the “Act”) was signed into law.

Prior to the new law, airlines were governed by the Civil Aeronautics Board (CAB). It set fares and granted (or not) licenses to airlines for new routes. The system had functioned for over four decades when, in the early 1970’s, the Arab oil embargo drastically increased fuel prices and the economy suffered from stagflation. The rate system often subsidized inefficient routes. As air fares were escalating rapidly, congressional pressure mounted  to scrap this antiquated bureaucracy. The theory was that the industry, once untethered from government shackles, would surely thrive under unfettered capitalism. Let’s see how we’ve done….

Initial Enthusiasm

Post-1978, the stampede to compete was fast and furious. The “Act” basically allowed, perhaps encouraged, any sentient being who satisfied adequate pecuniary requirements and experience to join the fray. And ,in the intervening twenty five year period, 129 enterprising souls did exactly that.

By the end of 2003 only 15 of these start-ups remained (with that number much less today). Some of the great entrepreneurial success stories were Southwest, Jet Blue, and America West (now merged into US Airways). Of the twenty-three major and regional carriers licensed before the mass ‘airline rush’, only seven survive today, and three of those are small regional airlines in Alaska and Hawaii. Bankrupt are old great names Eastern Airlines, Braniff and Pan American. Most of the others have been merged out of existence so that only United, Delta, US Airways and, with fate hanging, American remain extant. Of these remaining majors it should be noted that all have been through at least one bankruptcy.

As far as Wall Street is concerned, the airline industry is an afterthought at best. Always an enterprise mired in debt, in constant turmoil with employees, and indefinitely exposed to the vagaries of oil prices – in short, it’s a bad business to be in. The entire stock market capitalization of the top five airlines is only about $22 billion … and this represents over 70% of the industry. To put a little perspective on this, Apple (AAPL) closed on Friday with a stock market value of over $607 billion, or over twenty seven times as much as the big five combined.

These paltry market valuations rest on the industry’s stellar consistency in losing money.  During the ten years up until 2010, airlines racked up over $50 billion in cumulative losses. 9/11 (reduced demand), high fuel prices, the LCC’s … there is always some excuse. So it’s a cutthroat business. Big deal; so are computers and appliances and television manufacturing. But, we’re not talking about computers or TV’s, so we will revisit this thought shortly.

It should be noted that there were many years in the red under the regulatory regime as well. Then, miraculously, there was profitability of $2.7 billion in 2010, a smaller $396 million in 2011 and billions projected overall profitability for 2012.  Why? What changed, or was it just coincidence?

Here Is What I Think

Structural change has been inexorably shaping the airline business, most radically over the past four years. Swallow this statistic. According to Innovata, and measured by available seat kilometers (ASK’s) from August 2010 to August 2012, United, Delta, American, and US Airways reduced, that means shrunk, domestic capacity by 16.3%, 16.6%, 8.4% and 14.3% respectively.**…further evidence of the decline in commercial air traffic levels, which should reduce the demand for ATC services. See the related aiR POST 4-23-2013  OAG reports that August 2012 has the lowest level of scheduled domestic commercial airline capacity in over ten years, despite steady increase in domestic travel over this period. While international capacity continues to expand, this trend of shrinking numbers of domestic seats is expected to continue. Domestic arteries are increasingly used as connection vehicles to major hubs, to transfer to more lucrative overseas routes.

Now, to the the law of unintended consequence. The spawn of Airline Deregulation Act of 1978 has been oligopoly.**…in other words, Airline Deregulation failed entirely. Actual competition was reduced, and now the airlines have virtual monopoly pricing powers, which they are starting to use. The industry is now so entrenched and concentrated that the top five airlines have substantially more market power than in the Jurassic period before deregulation.

Consider a few basics.

Thirty-five years ago, the top five airlines controlled under 70% domestic market share but now, with recent mergers of United/Continental and Delta/Northwest, the biggest five (UAL, DAL, LCC, LUV and American) represent over 72%. .  When you add in their international routes it can rocket up way over 80%.  And ,with American Airlines muddling through bankruptcy proceedings, US Airways (LCC) circles like a frenzied great white shark to consolidate yet another competitor.

But the landscape is actually worse, a whole lot worse. When you drill down to specific markets you see that in many large airports, just a single airline controls 75% to over 85% of all domestic flights* – UAL dominates Houston Intercontinental Airport, Dallas/Fort Worth International Airport is controlled by American Airlines, and Hartsfied-Jackson Atlanta International Airport and Delta are just an old married couple. So much for the intended increased competition.*…a few other examples: UAL at Newark, O’Hare, Denver & SFO; DAL at Minneapolis & Salt Lake City; LLC at Boston, Charlotte & St. Louis; LUV at Baltimore, Midway and Dallas-Love. In fact, nearly every major U.S. airport is strongly dominated by either one or two major airlines; the potential for price-collusion is outstanding.

The Result

When you stir in the ingredients of continued shrinking domestic capacity with near monopoly at many airports, the stew yields pricing power, lots of it and much more to come.

Price of the average US domestic itinerary’s rose combined over 15% in 2009 and 2010 and an additional 8.3% in 2011. Three more successful price hikes were pushed through in the first quarter of 2012, the latest data I could find. And all those bag charges and cancellation fees you’ve been hit up for, … well, the jargon for those is “ancillary charges”. As of last September, they now comprise a whopping 29% of airline revenue and climbing. So taking those into consideration fares have headed into the stratosphere. Next: look for having to pay for assigned seating and expedited airport check-in.

By whatever measure, airline travel, adjusted for inflation, is significantly cheaper today than in 1978. A couple of statistical groups suggest what cost $2.22 back in the regulated world would have cost $1.00 in 2009. Add in recent price hikes (and adjust for the now ubiquitous “ancillaries”) and you are probably getting close to $1.50 in 2012. Even using this higher figure, prices are down by about a third on apples to apples comparison.

Has it been worth it? Planes don’t go any faster today than in 1978. There is a lot less legroom today, but for an extra fifty bucks or so you can fix that issue. There’s a bunch more gadgets on today’s planes, but I don’t use them, so I don’t know what their price tag is. All the food you want is for sale. Conveniently, you can avail yourself of the luxury of phone service for two dollars a minute. Creature comforts are of tertiary concern, if they are a bother at all.

One of the clearly stated goals of the “Act” is “the avoidance of unreasonable industry concentration which would tend to allow one or more air carriers to unreasonably increase prices, reduce services, or exclude competition….”  So, it’s as if we never left the starting blocks.

There are fewer major airlines today than pre-deregulation, and through the elaborate hub and spoke systems, a single airline may exercise near absolute control of many airports. It’s as if the industry has subdivided the country into certain fiefs and there are tacit boundaries that must not be crossed. The system we contend with today is the result of dozens of bankruptcies, reorganizations, liquidations, and mergers distilled down to a remaining few powerhouse airlines that now have more pricing power than ever before, which they exercise by rapidly reducing system wide capacity.

For me and you (the passenger), it’s one thing for fares to increase, it’s quite another to suffer higher prices with less and less choice and ever greater inconvenience. Airplane travel has devolved into a truly undignified affair.

So, at the end of the day, has deregulation been a net positive or negative, and what does the future hold? I will explore in my next post.

Original article by Richard Finger; aiREFORM has added
highlighting, side-notes, links and other minor edits.
Here is a link to the original article at Forbes.com: 8-20-2012
(Forbes.com, 8/23/12)

Protect Your Wallet: Regulate The Airlines

It has taken nearly thirty five years, but finally the airlines are in such a dominant market position that the consumer is rendered helpless. After multiple trips through bankruptcy court, abrogation and renegotiating for favorable labor contracts, and subsequent mergers, the major airlines are in their strongest position in history.  And it’s the government that is largely responsible for the situation we find ourselves in today.

The Justice Department evaluates all airline mergers and acquisitions on competitive grounds, with the Transportation Department and FAA chirping in background advice. Congress, which has the discretion to intervene, has opted out of the major recent mergers between United/Continental (UAL) and Delta/Northwest (DAL). Each mega-merger effectively grants near monopoly at many airports and for many routes. Justice denies ATT the right to merge with T-Mobile, yet blesses a United/Continental union that has limited or no competition on many routes. Either doing proper diligence is neglected or it is fair game to call Justice Department competence into question.

With American Airlines (LLC) still angling to exit bankruptcy, the issue becomes will they merge with US Airways? Will Justice do their usual wink and nod and allow this combination that will create the world’s largest airline? If they do, than airline consolidation with full government blessing will be complete. Four airlines (UAL, LLC, LUV, DAL) will control the domestic skies.2-20-2013  Intra-market monopolies will predominate to the detriment of the traveler.

If an aberration occurs and the marriage is denied, pundits question whether either US Airways or American can compete solo against the giant tentacles of United, Delta, and Southwest (LUV). So we’re damned if they do and damned if they don’t.

Competition is a good thing … and many more times than not, fewer regulations allow for a fierce competitive landscape that reduces costs, encourages innovation, lowers barriers to entry, and thus ultimately benefits the consumer. It is Darwinism, and only the best survive.

From what we have seen, airlines don’t behave the same as a normal commercial enterprise. Their path to profitability – or at least sustainability – is to reduce the numbers of flights, curtail customer services, and cram more passengers into tighter and tighter spaces. The avenue to prosperity for Apple (AAPL) is to build a better product and to keep improving it and selling each subsequent generation for less and less. If a corporation doesn’t continue to innovate they perish. Research in Motion (RIMM) and Nokia (NOK) are both dying a slow death. Can they innovate in time to resuscitate themselves? Who knows? I only know that these two enterprises in some way alienated consumers who exercised their right of choice and voted AAPL or Samsung.

A fundamental difference between smart phones and airlines is that the customer has far less choice when selecting an airline. She or he is often forced to choose by default. The airline then has little incentive to make your ride pleasurable because they know you have little choice.

Does airline insolvency equate to a RIMM or NOK going out of business? Hardly. More often than not an airline bankruptcy is a result of inequality of labor costs between one carrier and another. So bankruptcy declaration is a way to either renegotiate with pilot, mechanic, and flight attendant unions or force even harsher wage reductions through a court approved reorganization plan. Since just about every airline has been through some sort of bankruptcy proceeding, industry labor wages are probably as close to parity with each other than ever before.

When American emerges either as a standalone or part of US Airways, its labor costs will be much reduced. If RIMM is liquidated it will be an issue of an inferior product or a lack of productivity vis a vis a competitor. So I don’t think it too much of a stretch to say that bankruptcy for the airline industry is analogous to a hammer in a toolbox to beat labor into submission.* Shareholders*these heavy-handed airline tactics eventually undermine safety. Pilots and other employees are demoralized; they become fatigued, indifferent, and easily distracted. Accidents happen, and lives are lost. get punished and usually lose everything or close to it. Airline investing for the long term is near the very worst investment a person can make.

My Answer To The Problem

Here is my solution. As anathema as bureaucracy is to me, maybe in the case of airlines it is the exception that proves the rule. The airlines are a public necessity that is vital to both the national security and commercial success of our country. Their relevance makes them tantamount to a utility and that is how they should be designated.

Airline insolvency can become a distant relic. Even with the heavy industry concentration, recent waves of fare increases, baggage fees, food fees, legroom fees, their still seems to always be a question of profitability. Fuel costs are roughly one third of expenses and West Texas Intermediate Crude (WTI) has climbed back up to the mid-nineties per barrel, so the spiral of fare increases and capacity reductions will continue making travel even less tolerable than it already is.

In my previous article I wrote that, adjusted for inflation, airline travel is cheaper in 2012 than in 1978.  A couple of people questioned me on this and one astute observer pointed out that certainly, when you take into account the inferior service and overall quality of the travel experience, perhaps it is more expensive today – under the theory, you may pay less but you get a lot less, too. There is no question that business travel is far more expensive today than ever before…..often five or six times or more than what a discount ticket costs. Searching for cheap flights is a national pastime and a whole subculture unto itself. There are often 10 or 12 different fare structures on the same flight. And interestingly, they all arrive at the destination at the same time.

Under a regulated utility-like structure, fares would be rationalized and capacity would be increased by mandate. Fares would be calculated to allow the airlines a return on their invested capital. Perhaps ticket prices would rise and fall with the cost of jet fuel. Yes, it would be a little more expensive than the cheapest fares today, but certainly much less onerous than what a last minute purchase costs. No longer would it be an imperative to book vacations months and months ahead. Getting a flight would be much less of an ordeal and, with a return of capital almost guaranteed, service would improve.

I will leave you with these words:

“Our airlines, once world leaders, are now laggards in every category, including fleet age, service quality and international reputation. … Airport congestion has become a staple of late-night comedy shows. … Passenger complaints have skyrocketed. … Chapter 11 bankruptcy protection filing(s) show airline deregulation was a mistake.”

Those were the words of Robert Crandall, longtime former CEO of American Airlines. I couldn’t have said it better myself.

Original article by Richard Finger; aiREFORM has added
highlighting, side-notes, links and other minor edits.
Here is a link to the original article at Forbes.com: 8-23-2012