The Ultimate Unintended Consequence: Government Proposals Will Kill Small Community Air Service

Ten Reasons Why

I’ve been on the road for six weeks, traveling to communities large and small to discuss the grim future of small community air service in the face of economic pressures on regional airlines.

Those pressures only begin with jet fuel at a price equivalent of $120 per barrel, but the factors are many. They include the reality that: 

2) There are no aircraft of 50 seats or less in the production pipeline

3) All regional flying contracts will come up for bid between now and 2017 and likely will not be renewed by the mainline carriers

4) Low Cost Carriers in a regional market’s catchment area are drawing traffic to larger airports at the expense of smaller airports

5)  A growing pilot shortage will hurt the regional carriers first as regional pilots will find work on the mainline

6) Proposed FAA flight time/duty time regulations that put new limits on pilot flying hours will force regional carriers to hire more pilots to do the same amount of flying the sector is doing today

7) Congress, in a questionable response to the Colgan crash, passed a law requiring 1500 hours of training time for a commercial pilot

8) Most manufacturers won’t produce commercial airplanes smaller than 100-seats as most airlines can’t afford to sustain many routes with smaller planes

9) Negotiations between mainline pilots and management over new scope language is as emotional and contentious as it has ever been.

10) Proposed tax increases certain to punish the smallest of markets.

The Administration’s 2012 budget proposal already levies a $100 fee for every airplane departure in controlled airspace, costing passengers and the industry more than a billion dollars a year.  It also seeks to double the “security tax” paid by passengers to $5 per one-way trip, and triple the tax to $7.50 by 2017.  The total price tag for that proposal: $25 billion – $15 billion of which would be diverted for deficit reduction. The proposals together will cost passengers and the industry $36 billion over the next 10 years.

Air Transport Association of America CEO Nicholas Calio said it best when he said Washington is treating the airline industry like it treats  alcohol and cigarettes – taxing the hell out of it  as it does with “sin taxes” as if Congress actually wanted to discourage flying.  While I assume that’s not the government’s intent, it may well be the result.”

I do find it ironic that the government is seeking to tax an industry an incremental $36 billion over the next ten years after it lost $65 billion over the past ten years.  But I digress.

Let’s not forget that the airline industry ranks as the third greatest producer of economic activity in the US.  In my view, there is no way the industry can absorb these financial and regulatory pressures imposed by Congress without negatively impacting airlines and their role in driving economic activity. And the industry’s first response would be to remove marginal capacity from the system of production.  Where will they look to trim capacity even further – San Francisco to New York or Cincinnati to Des Moines?

Of course, airlines might try to pass new costs onto passengers, just as most industries do when faced with higher costs and limited opportunities for expansion. In this market, however, it is hard enough to simply add a few bucks to the price of a ticket to cover the rising cost of oil.  Imagine the impact of trying to pass on costs that will total billions at a time business and leisure travelers are counting pennies.

Typically, excise taxes like sin taxes work best in industries that have more control over the pricing. That is not the case in the airline industry.  Sin taxes are most successful on industries that produce products with price inelastic attributes.  The airline industry can hardly be termed an industry that produces a product with inelastic characteristics.

The ATA estimates the proposed taxes would lead to a 2.3 percent reduction in capacity at a possible cost of 9,700 airline and related jobs – and that’s just the impact from a tax increase.  Still unknown is the cost of the other factors outlined above, which alone would inevitably lead to fewer flights and fewer routes flown.

The mainline will hurt some. With fewer regional jets feeding the big carriers, how many larger aircraft do we need?  Some traffic will be captured at airports that continue to receive service within the catchment area of an airport losing service - but not all.  Some traffic may find its way onto competitor aircraft. And some demand may fall out of the system entirely.  In any instance, overall demand will suffer over the long term as marginal supply is removed from the system.

But the brunt of the damage will be felt in the small communities that rely heavily on regional carriers.

One of the things that bothers me most about Washington’s view of the airline industry is the clear bias in favor of the so called low cost carriers.  These airlines have been brilliant in cherry-picking profitable routes and creating networks designed for profitable flying. But it was the legacy carriers, not the LCCs, who invested in the assets to serve the nation’s smallest airport markets and sustained routes that, were subsidized by other flying.  It is the network carriers that keep small markets connected to the global air transportation grid. 

Unfortunately, the economics serving all these small cities are fast eroding because of factors the airlines don’t control, oil costs at the top of the list. But the lawmakers and regulators should step back and fast and realize how their well-meaning proposals could result in a loss of service to small markets across the nation.  The politicians will probably find a way to blame the airlines for cutting service while the real blame falls with those proposing “easy” fixes now that will do far-reaching economic damage  in the future.

Update on 10.25.2011 by swelbar

The good folks at ATR remind me that the ATR42 comes standard at 48 seats.  The company believes that it is a replacement for the 50 seat jets.

Scope Yet Again; Commenting to a Commenter

There is often some very good reading over at www.airliners.net inside their civil aviation forum with some very good commenters and very interesting threads to follow.  This week, one asked:  “United/Continental Conceding Domestic Market?”  Another speculated about the future of the Air Line Pilots Association (ALPA).  Another asked which is the next US carrier to file for bankruptcy? That speculation is rightfully focused on the regional sector of the industry.  But much of the discussion fails to recognize the tangled web called the domestic network business, which includes mainline carriers, regional carriers and the unions. The players in this web are inextricably intertwined - but too often discussed in silos. 

United-Continental Holdings’ CEO Jeff Smisek once said something I now quote in every presentation I make. Of the world’s now largest airline, he said:  “We’ll have the domestic operations sized solely to feed the international traffic.”  That quote and its derivatives are sprinkled throughout the airliners.net thread focusing on whether United/Continental is conceding the domestic market.

In my view, the US domestic business is at a crossroads.  Do iconic names like United, Delta, American and US Airways continue to make pure domestic flying a significant portion of their route portfolio, or do they continue to attrite pure domestic operations away because cost structures can no longer support mainline flying in what has become an ultra low fare market?

Some in the thread note that Smisek’s words worry some pilots, as they should. And those concerns shouldn’t be limited to the flight deck.  In a ‘be careful what you ask’ for scenario, there are forces at work that ensure the regional sector of the business as we know it today will be smaller tomorrow.

There is a virtuous circle of events at play:  with in the wing oil in excess of $100 per barrel; no 50 seat and less replacement aircraft in the pipeline; regional flying under contract that won’t be renewed because of economics; the prevalence of low cost carriers in the primary and secondary catchment areas of small and non hub airport markets; a pilot shortage that will impact the regional sector; flight time/duty time regulations that will require more regional pilots to perform the same level of flying being performed today; a new law requiring 1500 hours of flying for new pilots; and the fact that the smallest aircraft coming to market will be at least 100 seats. 

And so the circle spirals downward for the regional sector of the business.

I think scope is a cancer because it has been used as a bargaining chip.  It has been, and is, a Ponzi scheme as I wrote in US Pilot Unions’ Dirty Little Secrets.  There has been a B-Scale in place supporting the rich mainline contracts since 1984 when new hires were offered positions at lower rates of pay.  When it was deemed wrong for unions to do such a thing, regional airline code sharing relationships were formed.  This “outsourcing” was agreed to by the union in return for higher wages and benefits for incumbent mainline pilots.   

After my last two posts on scope I expected, and received a lot of interesting mail.  Much of it emotional but some as ugly as the commentator who suggested “a certain poetic irony to the image of you[Swelbar] in a smokin' hole and another Captain Renslow at the controls.  Be careful what you ask for.”

Now it is my turn to say:  Be careful what you ask for.  If no B-Scale for domestic flying is possible and a phasing out of regional jobs is the goal in this round of negotiations, then what is going to cross-subsidize the wages, benefits and work rules at the mainline? By my calculation then, there is even less money to go around to for mainline pilots to win in a new contract.  And with the loss of feed traffic from a smaller regional sector, the real question is just how many mainline narrowbody aircraft does a carrier need?  In a point-to-point world, the answer is a whole lot less. If 14,000 mainline pilot jobs were lost in a decade of downsizing then more job losses are on the way from a loss of feed.  And the effects of a pilot shortage are even less.

And so the virtuous circle spirals downward for the mainline sector of the business.

Commenting on a Commenter

I received the following private email from John, which encompasses the views of many other commenters (public and private). He writes:

I read your blog because I know management does, I’m not your biggest fan.  However, I would like to see your opinion on the consolidation of regional carriers.  To me, scope is synonymous with outsourcing, which you say allows for flexibility.  But the real advantage of outsourcing is the low cost entry into markets (and exit). 

Things have changed, wouldn’t you agree?  Cash strapped regional airline are a thing of the past because consolidation has honed the market down to three: Republic, Skywest, and Pinnacle.  With size came assets, more loan opportunities, and market dominance.  In my opinion, I believe that regional airlines have reached a size where they have serious power over code sharing agreements or have the option to go many markets alone, Skywest is already considered a major airline with a MC of $6B.

I know you love to blame labor, because your audience isn’t.  I understand you have to make a living, and the ATA may not want to hear this, but they are screwing up.  The majors better start thinking of in-sourcing or face another round of upstart airlines entering the market with low cost structure and plenty of established routes thanks to the majors giving them business.

After all, outsourcing worked so well on the 787 it aught to do equally well for the airlines…right?

For the record, I do not see scope as outsourcing as it was agreed by both parties that a certain number of smaller jets can be used within the domestic system carrying a certain airline code.  After all, the mainline pilots did not want to be bothered with those little jets.  As for John, the real advantage of deploying small jets under the airline code is to maintain presence in feed markets that the mainline cost structure could no longer support.  Mainline aircraft in markets like Charleston, WV is a thing of the bygone years that immediately followed deregulation, yet they unfortunately still comprise a disproportionate size of the memory bank called entitlement. 

Yes, things have changed and are changing.  There are haves and have nots within the regional industry today as there were in mainline industry of yesterday.  There is one airline, SkyWest, which stands alone in the industry because of stellar management that understands the carrier’s place in the industry and their role in building a balance sheet that ensures Skywest will be part of the discussion for years to come. While I am sure that SkyWest would love to have a market capitalization of $6 billion that you make fact – on Friday the market capitalization of SkyWest was less than $650 million.

To make a valid argument, John would need to produce economics at the mainline that allow the company to serve Ft. Wayne, Indiana with non-regional (77 seats and more) equipment.  And my guess is that he could not. How many of those 737s/A320s/MD80s are filled with traffic coming from 50 and 70 seat jets?  How could he produce the same economics on the flying without having to make wholesale changes to his existing collective bargaining agreement in order to keep the flying in house? 

I get this argument often from other commenters that look back before looking ahead. Yes you can bring the flying in house - but not until the terms of the collective bargaining agreement reflect the B-Scale terms and conditions the mainline pilots found, and find, appropriate for their regional brothers and sisters.

Many claim I am too quick to blame labor.  In this case, it is the unions that create this purported “outsourcing” to support bloated mainline salaries, benefits and work rules.

John is right in his comment that “the majors better start thinking of in-sourcing or face another round of upstart airlines entering the market with low cost structure and plenty of established routes thanks to the majors giving them business”  -- at least on one front.  Today, the use of the regional industry is a defensive weapon used by networks to curb encroachment into mainline markets.  By forcing regional carriers to fly fewer 76-seat aircraft and less as well as limit their ability to fly anything bigger (again assuming the pilot unions would not change their collective bargaining agreements to meet or exceed the terms available from the regional provider), any airline network will begin to vacate certain markets that may then become an opportunity for a start up or an inroad for an incumbent like Southwest or jetBlue. 

Scope is as much as regulator of the business as is government at a time this industry does not need any more regulation.  Regulation often results in unintended consequences, one of which will be to create market vacuums that an upstart might willingly fill. Nature abhors a vacuum.

And John and many of his fellow mainline pilots end up over-regulating the business of feeding the aircraft they fly.  No feed – assuming that airlines cannot get to the right economics to fly certain routes – will likely result in significantly less mainline narrowbody flying – perhaps just enough to support the international operation.  And that may not be the consequence that mainline pilots have intended.

Regional Airline and Small Community Air Service: It’s Time to Regionalize, Not Marginalize, the System

There are dark clouds looming around the regional airline industry that threaten small community air service and the regional airline industry as we know it.  This could be one hell of a storm.

On Wednesday I had the honor of moderating a panel at the Regional Airline Association’s 36^th Annual Convention in Nashville, TN.  The panel consisted of representatives of many diverse, yet critical, relationships to the industry’s regional sector.  Mike Ambrose of the European Regions Airline Association offered perspective and cited some of the differences/similarities between the US and European regional sectors; Greg Principato, long-time Washington aviation and political veteran and now head of the Airports Council International – North America provided the airport view of the importance of the regional carriers; and the current head of oneworld, Bruce Ashby, provided insight from the global alliance perspective as well as from his front row seat watching the US regional airline industry transform itself into what it is today.

The storm begins with fuel.  The equivalent price of a barrel of jet fuel is nearly $130 per barrel compared to $30 per barrel when the explosive growth of the US regional industry began in the late 1990s.  With regional economies around the US performing unevenly and demand down on top of soaring fuel prices and less capacity, it is no longer economically sound to fly to some markets.

As retirements of mechanics and pilots increase at the mainline carriers, talent is being plucked from the regional airlines to fill those vacancies.  Maintenance costs are escalating at rates that will test even the most optimistic and work to assure that current contracts between the mainline and the regional partners for 50-seat flying will likely not be renewed. 

All of these structural issues are compounded by the heavy hand of government regulation that will only increase costs to the regional sector.  This government intervention ensures that the regional sector will be smaller tomorrow than today, bringing economic carnage for affected communities.

Analysis of Large Hub Airports

The FAA defines an airport as a large hub if it accounts for at least one percent of all enplanements.  But an analysis by MIT graduate student Joe Jenkins that assesses individual airport’s domestic origin and destination (O&D) traffic reveals some interesting trends about air traffic, inflation-adjusted fares and the quality of individual airport access to the air transportation grid in the United States.

According to Jenkins’ analysis, between 2000 and 2010, the nation’s 29 large hub airports grew a paltry 1.1 percent. In terms of O&D, the fastest growing airports were New York – JFK, Charlotte, Denver, Ft. Lauderdale and Orlando.  Those losing the most domestic O&D traffic were Newark, Detroit, Los Angeles, Atlanta and Chicago.  In each case the trends are pretty clear:  Traffic declined at 15 of the 29 large hub airports over those ten years.

The main factors at play were capacity reductions by the network carriers, which depressed demand in hub markets, and a meaningful low cost carrier presence in the fastest growing markets.

In 1980 Orlando ranked 22nd among the large hub airports; in 2010 it ranked number 3.  Only Los Angeles and Las Vegas are larger in terms of local traffic.  On the opposite side of the scale, Miami ranked number 9 in 1980 and number 29 in 2010 (no doubt a function of the growth of Ft. Lauderdale, which ranked 24th in 1990 and 13th today.)

Jenkins also determines whether a market is experiencing improved access to the air transportation grid by looking at how much traffic is traveling nonstop versus connecting.  Only nine of 29 large hub airports saw decreases in access quality for each passenger.

Meanwhile, domestic fares fell on average 30 percent when adjusted for inflation between 2000 and 2010. Airports with the largest decreases in real fares during the period at Ft. Lauderdale, Denver, New York – JFK, Philadelphia, Boston and San Francisco.  Honolulu is the only one of the 29 large hub airports that realized an increase in real fares, which can be explained by the increase in longer distance flying between the US mainland and Hawaii and the liquidation of Aloha. 

Imagine that in the course of one decade, average real fares in the largest US domestic markets fell 30 percent.  And the regulators worry about too little competition? 

Analysis of Medium Hub Airports

At medium hub airports which handle between .25 percent and less than one percent of domestic enplanements, O&D traffic declined by an average of 6.2 percent over the 2000 - 2010 period.  Southwest is almost entirely responsible for the creation of medium hub airports.  During the carrier’s infancy (1980s - 1990’s), the “Southwest Effect” stimulated new demand by offering lower fares than were prevalent in the market before the LCC’s entry.  Today (2007 – present), the “Southwest Effect” diverts demand from surrounding airports more than creating new demand.  Maybe someday the regulators will understand this.  But I digress.

Of the 35 airports medium hub airports, 20 experienced a traffic decline. While Ft. Myers and Milwaukee grew over the decade, San Jose, Reno, Cleveland, Hartford, Providence, Ontario, Cincinnati, Pittsburgh and St. Louis all lost traffic.

The economic troubles confronting the industry have not been solely relegated to the network carrier sector. The drawdown of network carrier hubs at Pittsburgh and St. Louis have been the subject of much discussion within the industry, as has Cincinnati, a hub for Delta.  But many medium hub markets were hurt much more than Cincinnati.  Jenkins’ analysis makes clear to this analyst that Delta is doing nothing more than rightsizing Cincinnati to meet local demand - a prudent business decision. 

Clearly, the loss of air service is problematic to any community, and no two markets were more affected that Pittsburgh and St. Louis.  But Pittsburgh and St. Louis were also among the airports that realized the largest decline in average fares, along with Milwaukee, Orange County, CA, Cincinnati, and San Jose.  Those experiencing the greatest increase in average fares between 2000 and 2010 were Dallas Love Field, Burbank, Reno and Houston Hobby which, interestingly, all are markets that Southwest calls home.

Analysis of Small Hub Airports

Only the small hub airports – those that handle less than .25 percent of traffic and more than .05 percent -- realized a significant increase in traffic between 2000 and 2010.  The airports with the biggest gains were Orlando Sanford, Long Beach, Newport News, White Plains and Akron/Canton.  Of the 63 small hub airports, one-third of the airports enjoyed a double digit increase in traffic despite the most difficult decade for US airlines ever.   The worst performers in the group were Greensboro, Tallahassee, Colorado Springs, Corpus Christi and Stewart Airport in New York.  With the exception of Corpus Christi, there is no meaningful LCC presence in this group.

Among the 36 of 63 small hub airports with improved access to the national air transportation grid most were Springfield – Branson, Akron/Canton, Stewart (despite seeing below normal traffic growth), Flint and Long Beach. The airports realizing their quality of access declining the most were Gulfport-Biloxi, Tallahassee, Santa Barbara, Fresno and Syracuse.

Only the large hub airports realized a fare decrease between 2000 and 2010 more than the small hub airports.  This will certainly come as a surprise to those that claim smaller airport markets have not shared in consumer benefits brought on by competition.  Average fares declined the most in White Plains, Allentown, Long Beach, Richmond, Atlantic City and Wichita, in part because of the influence of AirTran. The merger Southwest and AirTran makes even more sense to me now as Southwest’s 72-point network is significantly augmented by a network of small hub markets.  But what happens in catchment areas like Akron/Canton and Cleveland? There are many of these shared catchment areas when the merged route maps of Southwest and AirTran are examined. Only time will tell.

Analysis of Non-Hub Airports

Where the rubber hits the road in the next few years is at the very small, non-hub airports.  

Here, those most successful in generating traffic were Ft. Collins and Laughlin, AZ.  Among the worst performing were Pocatello, Sioux City, Toledo, Muskegon and Lansing.

Among these mostly small communities, some did gain better access to the US air transportation grid, including Hot Springs, Rockford, Western Nebraska, Laramie, Peoria and Toledo. But others are losing service, with Pocatello, Klamath Falls, Elko and Columbia, SC atop that list.

All the discussion of Essential Air Service in Washington underscores the importance of revenue economics in this sector.  When I looked at the traffic performance relative to the trajectory of the inflation adjusted fare line, only one non-hub really shined: Aspen Eagle.  This explains the relative levels of new service being started there.  Of the low performing airports not yet closed, Toledo and Muskegon, MI are the worst.

As a significant number of regional contracts expire through 2016, the real question will be whether it is economical for airlines to continue to serve some of these markets. The prospects are not good. In addition to punishing regulation and fuel prices, the regional sector already suffers from a pilot and mechanic shortage sure to be compounded by a coming wave of retirements at the network carriers. Further compounding manpower issues for the nation’s regional airlines is the dubious impact of new legislation that mandates 1,500 hours of qualifying flying time for regional pilots.

In keeping with Tennessee vernacular:  In coming years it will be difficult to “perfume the pig”. 

The Southwest Catchment Area and the Impact on Small Airport Markets

Let’s face it: the enemy of the small airport is the high cost of oil, a poor local economy and, yes, the presence of Southwest Airlines within a two hour drive.  Consider the facts.

With service to Pittsburgh do we really need service to Latrobe, Youngstown, Morgantown, Franklin, Akron, Johnstown, Clarksburg, DuBois, Altoona, Parkersburg, Cleveland and Erie?  For some of these markets the highway is already the first mode of access to the air transportation system.

With ample service to Raleigh/Durham, do Pinehurst, Fayetteville, Greensboro (remember their bad traffic performance), Kinston, Greenville, NC, Winston-Salem, and Jacksonville, NC need their own airports? Raleigh/Durham has been shown to be outperforming most in their peer group of airports.  The catalyst for that outperformance is because the best service in the “air service region” is offered at RDU.  Jacksonville and Greenville will never be able to offer passengers the air service menu that is available in Raleigh/Durham no matter the number of frequencies or the number of hubs served.

Some of these airports are, simply put, ripe for closure.  But some should also be candidates as tomorrow’s “essential.”  Bills doing away with the Essential Air Service Program as defined in 1978 are unfortunate.  What’s needed instead is legislation that better defines “essential” in today’s airline revenue system.  Secretary LaHood visited the Regional Airline Association Convention on Tuesday.  He said that no Reauthorization bill will exclude Essential Air Service as we know it.   And that’s a mistake.

It is high time that we begin talking about the regionalization of air service.  The market is already causing that to happen in places like Bloomington, IL.  With no replacement airframes in the pipeline to replace the flying done with 50-seat and smaller aircraft, we need to talk about air service regions.  But no one in Washington will have the guts to say that the local airport should close even if its customers would fare better (pun intended) by driving to a better performing airport in the region to access the system.  We should be investing in infrastructure at the best performing airports within regions rather than building monuments to Congressmen and local politicians that will not add value to the overall system.

There is much more to write, and I will.

[Note:  Thanks to MIT graduate student Joe Jenkins for his excellent analysis of domestic air service contained in this blog.  Mr. Jenkins plans to complete his analysis and thesis of airport network access in August 2011.]