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Airline Mismanagement

There are over 250 airlines in the world today.

But these 250+ airlines have now reduced down to only three choices on one of the busiest and most lucrative routes in the world - that between the US and EU.

Is this a good thing?  Or is it the end of airline competition, first across the Atlantic and inevitably everywhere else in the world too?

 
 
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Airline Competition 1980-2010 R.I.P.

Part 1 :  Economic theory and background to airline competition
 

How is it that we're being told, every time airlines link together to form another airline alliance, that this reduction in competition is good for us when economic theory generally says the opposite?

Part one of a series on airline competition - see extra articles listed in the right hand column.

 

 

Air travel has steadily grown in the almost 100 years the industry has existed.  More and more people are flying to more and more places, and more frequently.

There are more planes in the air, more airports, and more most other things to do with air travel than ever before.

But there's one notable exception to this growth.  Although this seems entirely counter-intuitive, the number of different independent airlines and/or airline groups is steadily reducing and reducing.

Even more seriously, the massive monolithic airline alliances now make it close to impossible for new non-aligned carriers to compete.  So how exactly are we, the traveling public, benefitting from the US Department of Transportation's grants of anti-trust immunity to the airline alliances?

Regulation, De-regulation, and now Regulatory Immunity

The last thirty years or so has seen a trend away from over regulation, ending up now not only with almost no regulation but with the other extreme - immunity from existing regulatory controls that broadly apply to most other types of businesses.

Timeline - why 1980

The heading of this article mixes together two not completely related events, both of which have vague rather than exact timings.

We've chosen 1980 to mark the start of the deregulated airline industry.  This deregulation process commenced on 24 October, 1978 when the Airline Deregulation Act was signed into law.  Its provisions successively deregulated the formerly rigidly controlled airline industry over the several years that followed, culminating in the final demise of the Civil Aeronautics Board in 1985.

You can more or less pick and choose from various dates between 1978 and 1985 to choose a date on which the airlines were finally and completely deregulated.  We choose 1980 as a compromise date and as a round figure.

Timeline - why 2010

In setting an end date of 2010 we are referring primarily to international airlines (including US airlines that fly internationally) and the services between the US and Europe.

Competition of sorts still exists domestically, although we've argued in the past that the 'competition' that exists domestically is more anti-competitive than competitive - see articles listed on the above left, and in particular 'Is Airline Competition Always Fair'.

Our reason for choosing 2010 as a 'death date' relates to the anointing of the third of the airline alliances with anti-trust immunity by the US Department of Transportation, meaning the member airlines of all three alliances (Skyteam, Star and now Oneworld too) can work together as closely as they wish with their fellow alliance members, no longer competing against the other members of their alliance, and now 'competing' solely against the other two alliances.

We've gone from 50+ airlines independently and competitively flying across the Atlantic to three major alliances and several minor unaligned airlines, most notably Virgin Atlantic that now must struggle to survive.

Less Regulation is Not Always Better

We are enthusiastic supporters of the open market.  But, and like all other open market advocates, we recognize the imperfections of the open market.  Adam Smith's famous commentary in 1776 about the open market having an 'invisible hand' that guides itself is true in some situations, but false in others.  There's an excellent discussion of the concept here.

The reality is that, notwithstanding any fancy corporate mission statements, most companies are quite correctly most interested in pursuing their own profit maximization goals and are most motivated to benefit their shareholders.  Sometimes they can achieve such venal seeming goals without requiring the sacrifice of their lofty public statements, and sometimes they are willing to make some sacrifices and compromises as between the often conflicting requirements of public benefit and private profit.

In most industries and market places, the factor that most primarily businesses honest, ethical and fair is the competitive force of other businesses combined with an informed public that will preferentially choose those businesses that provide the best products and services, at the best values, and with the best associated customer service, support, and overall corporate reputation.  This is the embodiment of Adam Smith's 'invisible hand' concept.

If one company, even if it is a market leader, starts to move away from acceptable standards, the market will welcome the establishment of a 'better' competing company and product, and will preferentially shift their business to this alternate company.  We've seen such trends and shifts in any number of fields of business, from foodstuffs to computers (both hardware and software) and on to automobiles and many other examples.

So normally, according to the free market, there is no need to regulate industry, because the free market has this 'invisible hand' by which industry self-regulates itself.

But sometimes the invisible hand fails us all.

Situations requiring regulation

The self regulation concept starts to fail when certain marketplace conditions are absent.  These include lack of market transparency, lack of market choice, barriers to entry preventing new enterprises from competing with established enterprises, and monolithic companies that will act to squash new competitors.

Which sort of describes the airline industry, doesn't it.

Recognizing both the potential and the sometime reality of situations where the 'invisible hand' failed to positively guide the marketplace, and in response to some very unfair actions of market leaders, the US created a series of laws in the late 19th and subsequently in the 20th century to set limits on the behavior of corporations and to encourage free full and fair competition between companies of all sizes.  There's a good history and explanation of US antitrust issues here.

However, showing an enlightened approach to the marketplace, the legislators also recognized that a 'one size fits all' approach to regulating the more obvious, extreme, and detrimental manifestations of anti-competitive behavior would not always apply fully and fairly to all situations in all industries.  So they provided processes whereby companies could seek and obtain exemptions from the standard default provisions of the anti-trust legislation, usually by application to either the Federal Trade Commission or the Justice Department.

Anachronistic Anti-Trust Exemption for Airlines

In the case of airlines, such applications and approvals are granted via a formal process through the Department of Transportation.  Antitrust Immunity was enacted as Section 414 of the Civil Aeronautics Act of 1938 (52 Stat 1004).

Generally, this was seen as a logical offshoot of the requirement that airline mergers, interlocking relationships, and agreements affecting air transportation be approved by Civil Aeronautics Board.  See sections 408, 409 and 412 of same statute.

It was presumably reasoned that an industry so tightly regulated and controlled as the airline industry was back then could not possibly conduct any monopolistic behavior, and/or that the monopolistic behavior that was being regulated and sanctioned by the CAB should not then be susceptible to investigation and prosecution by another part of the government.

But when the airlines were deregulated, and the CAB disbanded, the provision to allow airlines anti-trust exemptions remained.  Sure, the provision was cloaked in high minded terms, and only to be given for 'good' reasons, but, due to this historical process, the now unregulated airlines found themselves with their anti-trust immunity provision carried forward, largely unchanged.

Proving/Justifying Exemptions from Anti-Trust

When making an application, companies have to show that while they are doing something that on the face of it is anti-competitive, there are reasons why they are doing this that actually work to either benefit consumers or at least not to harm them.

The most common line of reasoning is that allowing a corporation or a group of corporations to act in a manner which is, on the face of it, anti-competitive (ie anti-trust) will be a good thing because the benefits that the company or companies will enjoy from such behavior will flow through to consumers in the form of better products/services and lower costs.

In more extreme cases, companies simply say 'If we don't do this, we'll go out of business, reducing the competitive pool of companies in the market - better that we are a little bit uncompetitive than not there at all'.

But are the claims of flow-on benefits to consumers real?  In the case of airline applications to the Department of Transportation, we don't know.  In email correspondence, a Department of Transportation spokesman first said he wasn't sure 'to what extent we can quantify the benefits of these alliances during their actual operation' and subsequently made the stunning revelation

The orders in the individual cases will contain discussions of the anticipated benefits, but we haven’t done the analysis to quantify specific after-the-fact benefits.

It is relevant also to note that the 'discussions of anticipated benefits' tend not to be at all quantified.  Nowhere have I seen a statement like 'this will result in a 10% reduction in average fare levels' - instead the statements tend to be vague generalizations completely lacking in specifics.

So it seems no-one is ever holding the airlines accountable to their claims of consumer benefits.  Does that sound right to you?

Monopolies and Oligopolies

The airlines may act in a monopolistic manner, and indeed in some particular city pairs they may even be a true monopoly, but most of the time, they are oligopolies rather than monopolies.

Monopoly defined

A monopoly does not require only one supplier to exist, but simply requires one supplier to be able to dictate the pricing and other terms of a market.  Other competitors might also be present, but are so small and insignificant as to be unable to impact on the market dominance of the one major supplier.

An airline monopoly might be in a situation where one airline controls perhaps 90% or more of a given route, with one or two other airlines having a mere 10%, and all other airlines not adding more capacity, either because they can not (lack of capacity at airports to handle more flights) or will not (for whatever reason - perhaps for fear of getting into a bruising unprofitable fight with the present player).

In such a case, it doesn't really matter what the other airlines do in terms of price and policies, because 90% of all passengers are forced onto the monopolistic airline just because there are no seats on the other airline.  So the major airline truly can dictate pricing and everything else.

Oligopoly defined

An oligopoly is a slightly more interesting situation, where there are a number of major suppliers, and they act strategically in the market, based on the anticipation and reality of how the other major suppliers will behave.

This is often shown in airline situations, for example, one airline will announce a fare increase, then other airlines will choose to copy or not, then the first airline might then cancel their fare increase if they don't think enough of the other airlines have copied.

How to determine if a market is a monopoly or oligopoly

There is a simple (and simplistic) way to determine if a market might be a monopoly or oligopoly.  This is by determining the market share belong to the largest firms in the market - what is termed the 'Concentration Ratio'.  Usually a four firm concentration ratio (CR4) is used.

If the four largest firms in a market have between 80% and 100% of the market, then this usually means that the market is a monopoly.  If the four largest firms have between 50% and 80% of the market, this usually means the market is an oligopoly.  As the percentage drops below 50%, the marketplace trends away from being an oligopoly and getting closer to the nirvana of perfect competition.

The Changing Government Approach to Regulating Airlines

Initially the government adopted a regulatory approach to airlines.  It willingly allowed - indeed, it mandated - that the airlines should be somewhere between oligopolies and monopolies, restricting the ability of airlines to compete against each other and limiting the ability of new airlines to enter the market.

This created a complacent and stable situation where airlines were treated in a manner similar to utilities.  They were given approval for the routes they operated and the fares they charged, and they operated on a 'cost plus' type basis that provided little or no encouragement (or even ability) for them to be cost sensitive or to add new services and routes.

In the mid 1970s this structure was becoming increasingly less appropriate, and so starting from late 1978, the airlines were deregulated in the hope that open market competition would prove a more effective method of getting the best mix of products, services, and values to the traveling public.

Although many people have criticized deregulation, there can be no doubt that it has been spectacularly successful.  Airfares plunged in cost, and the American public started to fly in greater and greater numbers every year.  Deregulation, combined with newer larger better planes opened up air travel to everyone in the US.

But the airline industry is not a 'perfect' industry (using the economic definition of perfection here).  Perhaps as a carry-over from the regulated days, the marketplace continued to be distinguished by a small number of dominant carriers.  This, combined with the capital intensive nature of starting a new airline made it difficult for new airlines to get established, and the aggressive tactics adopted by existing carriers to obliterate new entrants, passively empowered by the US regulatory agencies that saw no harm in such actions, has meant that while there has been a massive growth in air travel, there has not been a matching massive growth in airlines.

A similar loosening of international airline regulation was expected to lead to a growth in new airlines and new air services, but this has not occurred.  Rather than empowering and encouraging the many different international airlines to compete aggressively between themselves, the airlines have instead used the loosening of regulation as a way to build monolithic blocs of carriers of seemingly unassailable size and strength.

These monolithic blocs (they like to describe themselves by the much more harmless sounding term 'alliance') are dividing the world and its air routes up between them in a way that makes it somewhere between difficult and impossible for new entrants to appear.

They tell us that this is for our own good, and that by reducing the market from one with no major dominant airlines to one with three major players and almost no-one else, this will result in us getting lower airfares and better services and more flights.

If these claims should be proven true - and to date, there is not only no evidence of the truth of these claims, but also a pronounced lack of interest in pursuing them by our regulatory bodies - then it would be a unique exception to the fundamental underpinnings of western free market economic theory.

The Airline Alliances are Oligopolies if not Monopolies

Remember that the definition of an oligopoly is a market in which the largest four companies have between 50% and 80% of the market, and a monopoly is where the four largest companies have between 80% and 100% of the market.

Economists rarely view either monopolies or oligopolies as good things.  But by successively approving request after request, the Dept of Transportation has created a situation now where three (not four but three) airline groupings, with each airline grouping acting as a single unique entity, always control at least 50% of the market, often control more than 80% of the market, and sometimes control over 90% of the market.

In future parts of this series we'll try and establish if this move, allowed by the Dept of Transportation, is a good thing or a bad thing.

The one measure that implies airlines are not monopolies

One measure of a monopolistic (or oligopolistic) market is where the companies are able to make an above average return on capital and profit.

Clearly, by this measure, airlines are the most failed of any would-be monopolies.  But the lack of super-profits does not mean that the airlines are not engaging in monopolistic behaviors, it merely means that, even with market control and dominance, they still can't manage their businesses successfully.

The correct response to such a scenario is not to give them further protection, but instead to open the market up more fully to newer better more able competitors.  Might not some strong new competition force the existing airlines to do better, in a much more dramatic process than would ever occur by allowing the airlines to perpetuate and expand their current practices and failings?

Summary

In simple form, a free market is self regulating and acts to balance corporate needs with consumer needs, creating a fair level of win-win to all concerned.

But there are a number of situations where a free market can't act freely.  These situations range from limited supply of resources through to restrictions on competitors entering the market, through to many other factors.

When the free market model starts to fail, then the balance between corporate and consumer benefits starts to fail as well, and typically corporations start to get a disproportionate return on their activities.

One measure of if a market is open and free and a model of 'Perfect Competition' (an economic term) is the degree of oligopolistic or monopolistic dominance of suppliers in the market.  Many other measures also exist.

By most measures, airlines are oligopolies or monopolies, and the current trend to approving airline 'alliances' (or mergers or buyouts) is making this a near universal scenario.

We are told this is for our own good.  Economic theory disputes this claim, and there is no actual evidence available to confirm the reality of such promises and claims.

Is this, in fact, a massive failure of the regulators that are supposed to be protecting us from exactly this type of marketplace situation?

Part of a series on airline competition - please see extra articles listed at the top in the right hand column

 

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Originally published 5 Mar 2010, last update 08 Jul 2017

You may freely reproduce or distribute this article for noncommercial purposes as long as you give credit to me as original writer.

 
 
Related Articles
Is Airline Competition Always Fair

Airline Competition Series.
1.  RIP, Airline Competition, 1980-2010
2. Bigger airlines are not better
3. The airlines are oligopolies
4. The demonstrated lack of growth in airlines to date
5. How airlines kill their competitors
6. The evolution of regulatory anti-trust approvals
 
 

 


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