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Oct272008

« 04. It’s Airline Deregulation Bday Week: Stakeholder Winners & Losers »

Fourth in a series on deregulation.

This month, in honor of the 30th anniversary of deregulation, I’m focusing on where deregulation got it right; wrong; backwards; and indifferent. Today we look at what is right. In the most simple of objectives, the deregulators sought to make air travel available to the masses. That was a success. But was it a market failure as well?

Deregulation of the US airline industry created a free market, right? Wrong. Because the industry operates in something far different from a from a free marktet. Government intervention -- whether through the imposition of taxes, or regulation, or interference by legislators and regulators to tinker with the market -- have created more imperfection than not.

But as we look back, the market has had it right for the most part. Not to say it hasn’t been a bumpy ride. Over the course of 30 years, we’ve seen bubbles emerge, inflate and burst as the market has worked to rein in the high costs of distribution, reduce the use of intermediaries like travel agents, and ratchet down labor costs by better balancing pay and productivity (an objective achieved mostly by those airlines who used the bankruptcy courts to wipe out debt and lower structural costs) As a result, airlines continue to find efficiencies as the model evolves, even if most of the gains have been “competed away” in the form of lower and lower ticket prices. And many of the industry’s stakeholders have generally fared well – even in turbulent times, as the market itself determines winners and losers. Which was, after all, the point of deregulation.

Examining the Stakeholders

Labor: Thirty years of boom and bust cycles have created enormous instability in terms of labor costs and labor relations– an area I believe requires a major overhaul. Union leaders may point to the loss of jobs, wages and benefits since 2000 as an example of how airline workers have been losers in a deregulated market. But neither the job number in 2000 nor the total compensation package paid in that year reflected a healthy market. A core attribute of innovative industries over the past decades is productivity growth that outpaced wage growth. That is not the case in the airline industry. Where labor in other legacy industries like autos and steel has shrunk in the face of growing competition, both in terms of the size of workforce and overall wages, airline labor has grown employment and has maintained many high paying jobs. Labor has largely won, but at the cost of productivity.

Bottom Line: Winner


Airports: Airports have largely been winners in the evolution of competition, whether through the growth of the low cost sector, new aircraft technology that promoted hub competition or the changing nature of a market’s economic and demographic underpinnings that led to increased airline service. Thirty years ago, international gateways were largely centered on the most populated centers, including New York JFK, Miami, Chicago, Los Angeles and San Francisco. We now can add Washington Dulles, Detroit, Atlanta, Dallas/Ft. Worth, Newark, Boston and others. Over the coming years, some airport markets are sure to lose service, continuing a trend that already has begun in places like Pittsburgh and the secondary markets in some of the largest US metro areas. And as in any free market, the ability of those markets to attract air carriers will depend on their success in attracting business and industry, offer appropriate facilities and sustain a healthy regional economy.

Bottom Line: Winner

Aircraft Manufacturers: For manufacturers, the US is but one consuming world region. And consume the US market did as deregulation unfolded, new carriers emerged, and hubs were built, driving demand for large numbers of narrowbody equipment. But the US is less and less an aircraft consumer today, except perhaps for the growing use of smaller planes that many airlines have added to their fleets to serve markets they couldn’t fly profitably with larger aircraft. As the US industry continues to mature, most aircraft purchases will be geared toward replacing aircraft rather than expanding fleets – an equation that only will change depending on who ultimately controls and inherits the North American markets in an era of “Open Skies” and growing consolidations. It is hard to call manufacturers a total winner, particularly given the airline bankruptcies that have significantly depressed orders, but they are certainly not losers either.

Bottom Line: Toss Up

Vendors/Service Providers: There are more winners than losers among those who serve and supply an industry that has nearly tripled in size. Along the way, we’ve also witnessed nearly 180 bankruptcies, multiple restructuring efforts, new information technology, and the outsourcing of multiple functions that were historically performed in-house -- all of which benefit the firms that operate on the periphery of the industry.

Bottom Line: Winner

Lenders/Bankers: Capital has been abundant over the past 30 years, both in funding the industry’s successes and more than a few of its bad ideas. But every time a dollar changes hand, whether as a result of mergers, restructuring, new information systems, construction, overhauls, retrofits and aircraft purchases, that capital has been made available with the lenders and bank collecting a fee. The downside for the finance folks has been the billions of dollars of capital destroyed by bankruptcy and/or bad business plans in an evolving industry that has little durability in its operating model. So far, even cash-strapped and under-capitalized legacy carriers have been able to structure deals that enhance each carrier’s respective liquidity position despite the unknowns of the economy and an unpredictable oil environment.

Bottom Line: Toss-up

Shareholders: The Biggest Loser. The only question remains is at what point the shareholder demands that the industry create and execute an investment thesis for the long-term? I don’t believe that airline equities will continue to be mere trading vehicles for tomorrow’s industry, particularly as airline management teams sharpen their focus on building a durable industry. With little room remaining to remove much more by way of structural costs, airline executives will look to improve fortunes by ensuring that yesterday’s excesses do not find their way into tomorrow’s operating models. With fewer barriers to efficiency, there may soon be a brighter investment prospectus for airline equity holders.

Bottom Line: Loser

Consumers: The Biggest Winner. It has been a great ride for the intended beneficiary of the deregulated industry – the passengers that enjoyed unprecedented growth and choice in affordable air travel. The consumer has won on price as real airfares have declined nearly 50 percent over the past 30 years. The consumer has won on choice whether it be the airline, the airport or the routing. In fact, consumers have won on nearly every measure except for reliability. As airlines now cut back, unbundle the product and attach new fees for various services, the consumer will pay more for the privilege of flying. But the market will continue to discipline non-competitive behavior and protect consumer interests as airlines compete in the manner deregulators intended 30 years ago.

Bottom Line: Winner

Concluding Thoughts

Alfred Kahn may be the father of deregulation, but I always considered Robert Crandall, the former American Airlines CEO, the Don of deregulated competition. Now that Crandall, in his retirement years, advocates some form of re-regulation, the industry may look anew at a system that clearly is not working for all stakeholders.

I believe that today’s CEOs are different than those in the executive suite 15, 20 or 30 years ago. Many are “agents of change” not wedded to, nor overly concerned with, the industry’s legacy past.

This year’s oil price scare may turn out to be the greatest catalyst for change this industry has experienced since deregulation. Fuel could turn out to be the factor that finishes the job as the industry works to rid itself of uneconomic capacity. Excess capacity that was born under the past generations of airline CEO’s in a single-minded effort to drive market-share all the while capitulating to legacy stakeholder interests along the way.

Ultimately, the US government remains the single-most important impediment to economic success for airlines – based in part on, if and how, a new administration and Congress manage the competing demands and political war zones ahead with foreign competition, labor relations, safety, security and access to capital.

The government could begin by living up to its promise to build an infrastructure that will actually support the modern air travel system with new generation air traffic control and technology, freeing up air space that otherwise constricts the very efficiency and reliability a healthy and durable airline industry demands.

Bottom Line: The market works for most. We just have to get out of the way and let it do its job.

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Reader Comments (30)

Color me confused/baffled. I agree that deregulation has been a net "win."

What I don't understand is why you testified before the U.S. Senate on November 10, 2005 that North Texas consumers should continue to be excluded from the beneficial impacts of the Airline Deregulation Act, via the near-universally condemned Wright Amendment.

In all seriousness, how do you reconcile the two apparently opposing trains of thought?

10.30.2008 | Unregistered CommenterAnonymous

I was wondering when this question would appear. I will do my best to answer. It will have an analytic answer and an emotional one as well. It is a fair question: how could I do anything that would on its face quash competition? Many of my reasons can be found in the second dereg piece on Southwest and the LCCs.

Analytical

1. It was an opportunity to respond to what I felt was a poorly done research piece that distorted the actual benefits sponsored by Southwest. But it was their research piece that formed the assumption base used in our analysis that was tedious but transparent in its approach.

My primary complaint was twofold: 1) that the LCCs generally and Southwest specifically were getting too much share of credit for low fares (read economic benefit) that were sweeping the US at the time. Fares at DFW and at other hubs and in markets of all sizes were seeing signficant declines as network legacy carriers were adapting their respective models to the low fare environment. Southwest and the LCCs only serve a few of the markets in the US, and the legacy network carriers the most therefore I was simply tired of the LCC charade; and 2) the stimulation rates used by the Southwest-sponsored piece needed to be addressed. They were grossly overstating new demand. Demand would have been diverted from DFW and as a result the Metroplex would not have realized anywhere near the economic benefit stated in the Southwest-sponsored piece. Further, traffic to these larger markets in the Southwest-sponsored study was already accessing LUV through other points on the Southwest network and was ignored in the Southwest-sponsored analysis. Way too much double-counting of benefits for my analytical thinking regarding the evolution of the domestic market.

As a result of the diversion from DFW to LUV, there would have been an impact on AA's hub structure whether they scheduled service from LUV directly or not. But the simple assumption in the piece was that they would. The piece I testified to was about hub degradation and the leverage on levels of service. The analysis could have been applied to any hub.

As for the emotional part of it, I had just been part of a number of labor negotiations that resulted in a reset of rates of pay that I had not imagined. Cost structures had little choice but to be reduced in order to do battle with the Southwest's of the new economic order. And cost control remains a paramount issue as we move forward as the revenue line can only move so fast.

After all Herb had made a deal hadn't he? He agreed to the limits of Wright. Now even Southwest found itself in a domestic environment that was offering up few profitable market opportunities. The most immediate opportunities for growth could be found if he tried to go back on his agreement all in the name of competition.

Honestly, I would probably have done the same thing. But at the same time, American had made hundreds of millions of dollars of investment in DFW knowing that the Wright and Shelby Amendments were in place. There were consequences in overnight repeal for American that also needed to be considered.

So to say that somehow I stood in the way of market evolution, OK. To say that the Metroplex was not already enjoying indirectly the benefits of lower fares in markets the Southwest-sponsored study said only they could deliver - I say no.

In the end, the agreement actually came close to what I thought was "wright". The Metoplex enjoys easier access to these markets that were already being disciplined by Southwest.

Moreover, I believe the Metroplex did not get sold a bill of goods of the benefits that only Southwest could deliver all the while it has maintained the benefits the AA hub delivers each and every day.

Sorry for the long answer, there could have not been a short one.

10.30.2008 | Unregistered CommenterSwelbar

Ok.... not sure I agree, but I at the very least I appreciate your thoughtful answer.

11.2.2008 | Unregistered CommenterAnonymous

With respect, I doubt many here are buying such a biased and old school protectionist position...

1. With the exception of Charlotte and perhaps Cincinnati (both non Southwest cities), the fact remains that the Metroplex has for years suffered from some of the highest airfares in the country when the traditional Love Field WA short-haul markets are removed. To say that AA has been benevolent when it comes to low fares is quite the farce - look at the facts.

2. The Metroplex remains the ONLY major metropolitan area still adhering to such antiquated restrictions on free enterprise as is found in the WA. Los Angeles has five major airports, NY has three, Chicago two, The Bay Area three, Houston two, and the list goes on. Study after study has been done in each of these markets and the evidence is always overwhelming - more competition yields a greater economic impact.

3. My favorite point however, had to be the small town air service argument. This one is always ripe for political hostage taking because it reaches such a breath of voting constituents. If these markets are not profitable without the intervention of government - whether through direct subsidy, protectionist policies, or via political leverage, then THEY SHOULD NOT HAVE AIR SERVICE. Period. Did our government dictate to the railroad companies of yesteryear which towns they should service and which ones they should bypass? No, the market determined the future landscape. Some towns where lost, but some of our largest cities emerged out of this one industry. In a free market our airlines must be set free.

4. Finally, I think its time we all cease with the "LCC" moniker, as there is little service level differentiation left between airlines. "Low Cost" is what any company (whether airline or not) should strive for. Do we call Dell Computer or the Japanese auto makers "Low Cost Manufacturers" or LCMs? How about Google? Is Google a "Low Cost Advertiser" or LCA? No, it's crazy, it's a spin, and it confuses reality.

Southwest, Airtran, the "new" Continental and others are less "LCC"s, and more evolved models of a better mouse trap. American Airlines does not have a God given right to serve the DFW market anymore than Braniff International had years ago. The market changes, the industry changes, and AA must rely on itself and not the government to change with it.

To My Friend

I am in general agreement to each of your points as I have written of the need to rid a sense of entitlement for many in this industry.

I am particularly in tune with your comment that the LCC moniker needs to change. I have actually asked our class to come up with some ideas as to how the name must change - not that it should change.

Thanks again for the time you spent.

Swelbar

11.3.2008 | Unregistered CommenterSwelbar

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The airline industry operates like the veins of the United States by pumping precious cargo throughout the country. Most young people don’t realize how different the airlines were a few decades ago. The entire industry was regulated by the government. Regulation is usually considered a more socialistic liberal idea that is opposed by conservative capitalists.

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