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Mar062013

« US and AA: AIRLINE MERGER and SMALL COMMUNITY AIR SERVICE MEET AT LGA AND DCA »

Note:  this blog is largely comprised of the text contained in a white paper written by me, William S. Swelbar. I would like to acknowledge Mr. Michael D. Wittman for his data collection efforts and deft analytical work that is included in the white paper. All of the air service related tables included in the white paper have a basis in Mr. Wittman’s research.  The conclusions and implications are William Swelbar’s.  The airports are referenced as large, medium, small and non-hub per the FAA’s definition of airport size.

EXECUTIVE SUMMARY

Small community air service and the structural factors that threaten it are certain to be a topic for policy makers in the immediate future.  The threats begin with the per barrel equivalent price of jet fuel in excess of $120; the fact that there is no replacement aircraft in production or even on the drawing board configured at 50 seats or less (the right size for small community air service) because of the high price of oil and associated capital costs [other than the ATR-42]; a looming pilot shortage that will impact the regional sector of the industry before it impacts other sectors; the new flight time/duty time regulations scheduled to be implemented in 2014 that will only exacerbate a potential pilot shortage; and new legislation that requires 1500 hours of flight time for a regional pilot versus the current 500 hours.

Many of these factors stem from past policymaking decisions. The unintended consequences will be reduced service to the nation’s smaller communities.  As the U.S. nears the end of the airline industry consolidation process, policy makers may be faced with yet another decision that could have a further negative impact on small community air service:  a reallocation of slots at each Washington Reagan National Airport (DCA) and New York LaGuardia Airport (LGA) because of the proposed American Airlines – US Airways merger announcement.

If slot divestiture is decided to be necessary, there are important facts to keep in mind:

  1. It is the network carriers that are the air service lifeline to small community markets keeping them connected to the national and global air transportation grids – not the low cost carriers;
  2. In 2012, US Airways offered service to 40 small and non-hub markets from Washington – DCA while all the low cost carriers combined served 2 such markets;
  3. In 2012, Delta Air Lines offered service to 25 small and non-hub markets from New York – LGA while all the low cost carriers combined served 3 such markets;
  4. Even before any slot divestiture, service to small and non-hub markets from each DCA and LGA is less than 20 percent of the total service offered from each respective airport.  To disenfranchise these small markets from one or two of their largest passenger demand markets would not be good policy; and
  5. Today’s perceived low fare carrier is not yesterday’s low fare carrier:  Between 1995 and 2011, average fares for the low cost carriers as measured by yield increased 45%, average fares for Southwest increased 41% and average fares for the network carriers increased only 14%.

Small community air service faces numerous headwinds just to remain viable over the medium and long-term.  Some of those headwinds cannot be controlled while others stem from policy decisions already put in place.  To exacerbate a situation where small community air service would certainly suffer if slots were to be required to be divested at each DCA and LGA would not be good policy at this late stage of industry consolidation.

BACKGROUND

There is little dispute among the analyst community that the announced intent on February 14, 2013  to merge American Airlines and US Airways will result in the last “big deal” among U.S. airlines.  In the final analysis, the four largest U.S. airlines (American/US Airways, Delta, United and Southwest) would possess more the 85 percent of the capacity flown domestically.  While there may be some consolidation among carriers comprising the remaining 15 percent, no remaining transaction will be the size of American and US Airways or the three transactions that preceded it. 

American Airlines and US Airways have networks that are largely complementary—there are only twelve domestic city-pairs that receive duplicate service by both airlines out of nearly 900 routes in the combined AA-US network.  However, the combined slot holdings of the merged airline at each Washington Reagan National Airport (DCA) and New York LaGuardia Airport (LGA) will undoubtedly receive scrutiny by the US Department of Transportation (DOT) and the US Department of Justice (DOJ).

We don’t have to look too far back in time to find a transaction that involved slots at DCA and LGA.  In August of 2009, US Airways and Delta Air Lines entered into an agreement to swap slots with each other at each DCA and LGA.  In the initial transaction, US Airways agreed to transfer 125 slots at LGA to Delta in exchange for 42 slots at DCA.  Delta was seeking to expand its presence at LGA to establish a domestic hub just as US Airways was looking to augment its position at DCA and bolster connectivity for an increasing number of small communities it proposed serving from National. 

Per the initial transaction, “US Airways would raise its share of departures at DCA from 47 to 58 percent. US Airways' share of slot interests at DCA...would increase from 44 percent to 54 percent...Delta would ascend to a dominant position at LGA, raising its share of departures from 26 percent to 51 percent. Delta's share of slot interests at LGA would more than double, growing from 24 percent to 49 percent.”  To protect the “public interest”, the FAA proposed a divestiture of slots.  The slots would largely be made available to Southwest Airlines and other so-called low cost carriers (LCCs).  This was found to be unacceptable by each Delta and US Airways.

In 2011, a compromise deal was reached between the two carriers and the FAA.  The compromise deal shifted about 20 percent of the LGA slots from US Airways to Delta where about 3 percent of those slot holdings were divested.  At DCA, about 8 percent of the slots were transferred from Delta to US Airways and 2 percent of the slots were divested.  Ultimately this framework was approved and a final order was issued permitting the transaction to move forward.

If slot divestitures are ultimately required at DCA and/or LGA as a result of the combination of American and US Airways, then the same type of analysis of the “public interest” is necessary.  Some regulators, as well as Southwest and other so-called LCCs, will likely suggest using the AA-US merger as an opportunity to reexamine the service makeup of these slot controlled airports. They are likely to claim that at this late stage of consolidating the U.S. market structure to be one of the last opportunities to readjust the competitive profiles at LGA and DCA.  However, an important tradeoff exists between allocating slots to LCCs instead of network carriers: while additional LCC slots may contribute to more robust frequency competition in highly-served city-pair markets or to vacation destinations, it is unlikely to bolster service to struggling small community airports.  On the other hand, further network carrier service allows for small communities to remain connected to the strategically and economically important Washington and New York markets. 

While the network carriers have invested hundreds of millions of dollars in their respective operations to ensure that these smaller markets have access to the nation’s and the globe’s air transportation grid, LCCs have traditionally shown very little interest in serving smaller U.S. markets

In 2012, 44 small and non-hub sized markets received nonstop service at DCA.

In 2012, 35 small and non-hub sized markets received nonstop service at LGA.  

Given the strength of the small community air service network provided from both DCA and LGA and US Airways’ concerted effort to build a connecting hub at Washington National to connect northeastern and southeastern U.S. cities, a comprehensive slot divestiture program at these slot controlled airports as a result of the AA-US merger would likely have a detrimental effect on the nation’s smallest airports that have already been negatively affected by network carrier capacity reductions over the last six years.

TRENDS IN SMALL COMMUNITY AIR SERVICE ACROSS THE ENTIRE U.S. TRANSPORTATION NETWORK

Small community air service as a whole has suffered in the last six years. As a result of the rampant increase in the price of jet fuel and the prolonged economic downturn, U.S. airlines—in particular, the network carriers—began to rethink their service strategies. As a result, the entire U.S. air transportation system has seen a wide-scale reduction in both departures and seats since 2007. Between 2007 and 2012, nearly 1.7 million yearly departures have been removed from the US domestic system in response to the economic shocks mentioned above.  While most U.S. airports were affected by this newfound “capacity discipline,” a disproportionate share of the cutbacks occurred in the non-large hub airports.  In 2012, only 40.6 percent of US domestic departures were flown in non-large hub markets as compared to 44.2 percent in 2007 when there were 1.7 million additional departures.  A large percentage of this reduction in service was due to network carriers—on average, network carrier flights were cut by 27.2% at smaller U.S airports.

However, it was not just the network carriers that were reducing service at the nation’s smaller airport markets.  Southwest Airlines, the carrier hailed as the archetypal LCC, has also started to behave like the network carriers by practicing “capacity discipline” across its network.  In addition to reducing capacity in smaller markets, Southwest also made a decision to vacate 13 small community markets previously served by merger partner AirTran Airways:  Allentown, PA; Asheville, NC; Atlantic City, NJ; Bloomington/Normal, IN; Charleston, WV; Harrisburg, PA; Huntsville, AL; Knoxville, TN; Lexington, KY; Moline, IL; Newport News/Williamsburg, VA; Sarasota-Bradenton, FL; and White Plains, NY.  Southwest flights at smaller airports have been cut by 9.8% since 2007.

On the other hand, other LCCs and ultra-low cost carriers (ULCCs) generally increased service over the analysis period. 

Yet other than jetBlue and Frontier, none of the other LCC and ULCCs operates a hub and spoke system per se; Spirit Airlines is an opportunist with low fares and no frills, Virgin America is struggling to be profitable and Allegiant Air is a travel company that provides only infrequent service to vacation destinations.  While they may offer low fares, these airlines do not offer their passengers high-quality connecting service to the global air transportation network.

Of course, the replacement of traditional network carrier service with LCC/ULCC service to high-frequency markets already served or to vacation destinations does indeed boost airline activity at an airport.  To be sure, many small communities are today relying on carriers like Spirit or Allegiant or Sun Country as their primary/sole provider of commercial air service.  However, is infrequent service to vacation destinations on a ULCC as valuable to air travel consumers as frequent service from a network carrier to a hub airport, from which connections can be made to other destinations within the U.S. and throughout the world?  This would seem to be a paramount policy question to consider if slot divestitures are mandated.  A small community with a nonstop flight to a single network carrier hub can open up hundreds of potential domestic and international connecting itineraries.  However, low-frequency service from an ULCC will have a limited impact on improving airport connectivity. 

Mandatory slot divestitures would cause network carriers to potentially drop direct flights from these small community airports to LGA and DCA—limiting the connecting potential for passengers at these airports and hurting small community residents’ access to the global air transportation network.  Replacing network carrier service with LCC or ULCC service is often a poor substitute due to comparatively inferior options for nonstop and connecting destinations. Already, a small percentage of domestic airport markets served by the LCCs are small and non-hub sized airports versus the network carriers where nearly two-thirds of airports served are small community markets.

On the other side of the policy aisle, the DOJ continually points to a tired argument that the entry of LCCs results in lower fares and stimulates new demand.  That may have been true in 1993, but it is less true today.  Again using Southwest Airlines as the archetypal LCC, in the markets entered by the carrier between 2006 – 2011, fares increased 4 percent and traffic increased but 10 percent.  To demonstrate the fact that the LCCs behave a lot like the network carriers today and vice versa, let’s examine system passenger yield growth for the LCCs, Southwest, and the network carriers between 1995 – 2011.  Since 1995, Southwest passenger yields have increased 41 percent on a stage length adjusted basis; all LCC adjusted yields have increased 45 percent and network carrier yields have increased only 14 percent.

SLOT DIVESTITURE AND SMALL COMMUNITY AIR SERVICE AT DCA AND LGA

In the initial Delta – US Airways slot swap comment period, Southwest spent inordinate time and resources claiming that the two carriers needed to surrender more slots than originally proposed because the transaction would “permanently lock out” low fare competition.  But each Delta and US Airways were promising more than low fare competition—the two applicants were offering to build and augment their respective connecting complexes at each DCA and LGA. 

The timing of Delta’s and US Airways’ claim could not have been better as small community markets had seen hub access and connectivity at Pittsburgh and St. Louis virtually disappear.  Hub access at Cincinnati and Memphis was being eroded in a significant way as service cuts at those secondary hubs was proving necessary in the face of high oil prices and a damaged economy.  Now there were two new alternatives for improved connectivity in the name of DCA and LGA.  Even more important was the fact that DCA and LGA are among the largest origin and destination (O-D) markets for many communities in the U.S. – big and small. Hence, DCA and LGA provided the opportunity to build connecting hubs at airports with significant existing local demand – a particularly important ingredient for sustainable air service.

The DOT listened and wrote:  “While we acknowledge Southwest’s claims regarding potential inefficiencies resulting from hub development at slot controlled airports, we must consider both potential operating inefficiencies and expected network benefits typically resulting from hub development or expansion. The Joint Applicants [Delta and US Airways] claim that numerous benefits will accrue to consumers as a result of their transaction. Among the more compelling benefits that they articulate, we are most convinced by their arguments that development of a LGA hub will lead to enhanced service to small communities (even with the small aircraft that Southwest contends would be used) and improved competition versus other east coast hubs, including United’s Newark hub and US Airways’ hub in Philadelphia.”

In that case, the carriers asserted that primary benefits of the transaction will include enhanced service to smaller communities on an overall basis.  And that is exactly what has happened. 

During 2012, US Airways served 69 airports from DCA—the beginning of a true connecting hub.  40, or 58 percent, of those cities served were small and non-hub markets. 

At LGA, Delta served 58 airports during 2012, including 25 (43.1%) small or non-hub markets.

CONCLUSIONS

Despite the growing connecting hubs being built by US Airways and Delta at DCA and LGA respectively, it is important to note that as a whole, small community air service at these airports is already becoming a rare commodity. Today, only about 17 percent of service offered from New York’s LaGuardia Airport is to small communities—down from about 25 percent of all departures just six years ago.

Small community service is also already limited at DCA. Today, small community air service makes up only about 19 percent of service offered from Washington’s Reagan National Airport.

An important and fundamental question to ask is:  Does it really make good policy sense, assuming that slots are required to be divested, to make a slot pair available to a carrier proposing to serve Orlando, Tampa, or Ft. Lauderdale – all markets with metropolitan area nonstop service and a plethora of connecting options by each major carrier with hub choice as well?  Or, does it make better policy sense to maintain slots for small community access to some of the nation’s largest local O-D markets that offer connections as a result of the recent US Airways – Delta Air Lines slot swap?

One more nonstop from a large market to a large market does very little in improving the quality of service for airline consumers on either end of the itinerary.  Whereas the loss of a nonstop service from a smaller community to a large O-D market that offers connections would have a significant negative impact on that smaller community’s connectivity to the global air transportation network.  It is simply intuitive.

DCA and LGA already have excellent service to the nation’s largest markets from both network and low cost carriers.  Maintaining at least the status quo of slots for small community air service at this late juncture in market consolidation helps to maintain quality air service at some of the nation’s smaller markets at a time when service is being cut and hubs are being eliminated for reasons beyond the industry’s control.

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Reader Comments (7)

Bill -This is an excellent analysis. You're correct that Southwest and other LCC carriers look more like their network peers. Now is a good time to re-examine long held beliefs about air service in North America. Your work highlights the shifts that have turned old "rules" into myths. Thank you for writing so clearly - I agree completely.

03.7.2013 | Unregistered CommenterPaul Laherty

Bill, great article. My concern is that the LCCs would or could not efficiently serve small markets at DCA like USAirways currently does because the LCCs do not have sufficient connecting opportunities. Indeed, as you point out, the LCCs do not serve these communities and requiring them to do so would not accomplish the purpose of slot divestiture. The purpose of slot divestiture is to permit carriers other than the large network carriers to compete in the DCA and LGA markets. To do that the LCCs will have to be allowed to serve their markets of choice. If the slots must be used for small communities then it seems likely that only one of the larger network carriers would use them. That defeats the purpose of slot divestiture.

03.7.2013 | Unregistered CommenterEd Faggen

C'mon Bill, you've always been the first to trash talk any un-economic capacity in the industry. Isn't this small community tirade just another example?

What's next? A protest to increase EAS subsidies?

Furthermore, how many times have we read you state how politicians shouldn't be running the airlines. Yet you publish this piece in an attempt to encourage this behavior?

It is $hameful.

03.11.2013 | Unregistered CommenterFlyby

Flyby

You are right I have talked and written often of uneconomic capacity. But ask yourself, when was much of that written? My working assumption is that much of the uneconomic capacity has been removed since 2008. Yes there is still more to go otherwise margins would be higher. Uneconomic capacity will largely be removed as smaller aircraft attrition takes place over the coming years.

What is shameful is your insinuation that I was paid for the piece. I was not. Do your homework the next time. What did I write about Southwest and the Delta - US Airways slot swap some years ago? The message is similar. The piece was written because the regulators (and they are still very important) will face a lasting decision about the tradeoffs of low cost service v. small community service at the slot controlled airports. Plenty of small communities have more than sufficient demand to warrant service at slot-controlled airports.

03.12.2013 | Unregistered Commenterswelbar

Overall, a well thought out argument. There has to be a balance between competition and essential air service to small communities. But one has to wonder, in retrospect, if US Airways wouldn't like to have a few of its old LGA slots back. But maybe not. Delta and American will still have a decent presence at LGA and DCA and each can serve small communities more effectively if they have robust network to connect passengers at their respective hubs / focus cities.

03.12.2013 | Unregistered CommenterDesertGhost

Wow! Good post. Very informative.

Another in a long line of clearly written analyses from Prof. Swelbar. In more than 40 years of thinking about air service -- from grad school through airline management to consulting -- my views on service to small communities have come full circle. There are no easy answers, but what we need are smart people like Bill asking the hard questions and laying out the facts.

05.6.2013 | Unregistered CommenterRob Britton

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