Airline Deregulation

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i Airline Deregulation: The Benefits Versus the Detriments Nathan DeRosa

Transcript of Airline Deregulation

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i

Airline Deregulation: The Benefits Versus the Detriments

Nathan DeRosa

Economics 470

Dr. Jason Dunick

April 13, 2012

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Introduction

The U.S. airline industry has faced substantial changes in the way it operates

since they were deregulated just over thirty years ago. Prior to deregulation, the airlines

were tightly controlled by the Civil Aeronautics Board (CAB), which controlled prices

and limited the airlines to where they could provide service. Barriers to entry for new

airlines were formidable, and the existing major carriers had oligopolistic control over the

market. In fact, the ten largest airlines controlled 90% of the market with the remaining

portion controlled primarily by small regional airlines (Maynard, 2008). Proponents of

deregulation sought to increase competition among the airlines as well as lower fares—

two factors that had been largely absent from airline market.

Lowered Fares and Lowered Barriers

By eliminating price controls on airfares and lowering the barriers to entry for

new airlines, deregulation supporters predicted that it not only lead to increased

competition, but ultimately lead to lower fares in general and better quality service.

Since the Airline Deregulation Act passed in 1978, the rise of low-cost carriers (LCC’s)

as well as regional carriers had developed resulting in part to less expensive fares. With

lower fares and lower barriers to entry, it also meant more people would be able to afford

flying and more competitors could be introduced into the market, which has all lead to a

considerable increase in traffic volume since deregulation. The gradual elimination of

the CAB by the Airline Deregulation Act is also attributed to lower airfares. By measure

of competition and airfares, supporters have predicted that deregulation has accomplished

the task of lowering airfares as well as the barriers to entry and exit.

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Negative Effects: Job Losses and Service Cuts

On the other hand though, other measures have been used to argue that

deregulation has yielded unintended consequences that challenge the benefits of

deregulation. While deregulation has benefited passengers in the form of consumer

savings, it has taken a toll on airline workers. As supporters were pushing for the Airline

Deregulation Act, opponents cited that he legislation would result in job losses, a loss of

service in many cities, and higher fares (Maynard, 2008). While fares are generally less

expensive than they were before deregulation, opponents were partly right in that it

would result in a loss of service and jobs. Since the beginning of the 2000s, the airlines

collectively shed approximately 100,000 jobs.

With the Deregulation Act passed in 1978, many rural communities were fearful

of airlines pulling out, resulting in a loss of service as well as jobs. To remedy this fear,

the Essential Air Service Program, or EAS, was established. The goal of the program is

to keep airline service in rural communities deemed unprofitable by the airlines trough

direct government subsidies to the airlines serving that community. Small cities were not

the only places to have lost service as some larger cities have as well. Maynard points

out that cities such as St. Louis and Pittsburgh, which were once large hubs for American

and US Airways respectively, have far less service as a result of airlines trying to control

costs and fares generally go up in these instances as a result.

Unforeseen Consequences: Fuel Costs, Alliances, and the Hub-and Spoke System

Another negative factor that also comes into play are persistently high fuel costs,

which airlines attribute to their financial troubles and even bankruptcy. Between 2001

and 2006, the airlines collectively lost about $30 billion and any profits that were made

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were dwarfed by the losses. This is something that Alfred Kahn, the chief architect of

airline deregulation, has said that proponents did not foresee (Maynard, 2008).

Deregulation proponents also failed to foresee the rise of the hub-and-spoke system, in

which airlines maintain a large base from which flights either originate or serve as a

conduit between two non-hub cities. With the goal of deregulation to spur competition,

the hub-and-spoke model creates incentives for customers to stay with one airline rather

than shop by price since the hub airline has dominating control on pricing.

In addition to the rise of the hub-and-spoke model, deregulation supporters also

did not foresee the rise of airline alliances, which offered larger route networks but also

provided another incentive for travelers to stay with one airline and further inhibiting

competition rather than facilitating it (Maynard, 2008). While there have been many

changes since the Airline Deregulation Act was implemented, deregulation itself did not

take effect immediately and as a result, neither did the outcomes. Even thirty years after

deregulation became law, the airlines continue to discard inefficiencies. The process of

deregulation did not officially end until the mid-1980s with the dissolution of the CAB,

and innovations such as the selling of fares on the Internet in the mid to late 1990s would

not have been developed as it would have been illegal under CAB authority.

When examining the airline industry’s nearly nine-decade existence, it had been

regulated for nearly half of its lifetime, and it has nearly taken that amount of time for the

industry to transition from a regulated market to a deregulated one. Essentially,

deregulation has had positive effects on the industry through more affordable fares for

customers as well as enabling the entrance of new competitors. However, airlines have

endured billions of dollars in losses and have significantly cut their workforce in an effort

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to curb rising costs such as fuel, and airline workers have seen a general decline in

earnings and continue to see a downward pressure on wages. Overall, this paper studies

airline deregulation and the economic outcomes it has yielded, and my focus is on the

deregulation of passenger fares and flight routes as well as the fare savings, traffic flow,

financial performance, and labor issues.

Research Method

Most of the research I collected on this matter thus far has been mostly in the form of

literature reviews, and I plan on conducting my research in kind. That is, the method I

plan on using is a literature review. The sources I have obtained are diverse and vary

from sources in transportation, law, economics, business, and public policy. Some of the

more prominent sources in economics have come from the Journal of Economic

Perspectives and the National Bureau of Economic Research. I have also obtained

additional sources in economics coming from the Industrial and Labor Relations Review,

International Journal of Industrial Organization, and the Economics Bulletin. Other

prominent sources have also come from the public policy think-tank Brookings

Institution as well as sources in law such as the Yale Journal on Regulation and Houston

Law Review. I have also obtained sources from aerospace such as Taking Stock of Air

Liberalization, American Institute of Aeronautics and Astronautics, and the

Transportation Research Forum. Notable business sources have been published in the

Journal of Applied Business Research, and the Journal of Financial Economics. In

addition to the more academically based sources I have obtained, I also have incorporated

a source from the well-known newspaper The New York Times analyzing the airlines

under the past three decades of deregulation. Overall, my sources represent different

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disciplines encompassing economics, politics, business, finance, law, and aerospace. As

a result, these sources also represent unique perspectives from academia, business

professionals, and other researchers.

Main Findings

Although the airline industry has been deregulated for the last thirty years, it has

spent a longer time, though not significantly longer, regulated by the government. In

order to have an understanding of airline deregulation, it is important to examine

regulation, the rationales for it, as well as the events that led to deregulation in 1978. The

rationale for regulation can be traced back as early as the American Industrial Revolution

in the late 1800s, before the dawn of aviation as we know it today. The case for

regulation was made under two claims. With the rise major industries, concentrations of

market power could ensue leading to monopoly prices being forced on consumers and

potential competitors. As a result, governments deemed it necessary to hold corporations

accountable and preserve competitive markets if not to produce outcomes that were

sufficiently market-like (Eisner, 2008). The second claim, which was more prominent in

the 1930s during the Great Depression, was that “ruinous” competition would result in

market instability through price wars, destabilizing price fluctuations, and bankruptcies if

major companies were left to their own devices (Eisner, 2008).

Birth of the Airline Industry

Even though the case for regulation of industry was made before the development

of commercial aviation, it nevertheless coincided with the development of commercial

aviation in the early twentieth century. While in the 1920s the government did not

officially regulate the emerging airlines, they were greatly influenced by public policy.

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Starting in 1918, the federal government used private air carriers to supplement military

airmail carriage, with early payloads devoted to mail, not passengers. In 1925, while the

airlines continued to develop, the Kelly Airmail Act was passed which set up a

competitive bidding system for private airmail carriage. Following this legislation,

amendments were passed that allowed the Post Office to award contracts with payments.

This, along with the Ford Motor Company’s introduction of a 12-seat aircraft, facilitated

the expansion of air service in the young, struggling airline industry (Borenstein and

Rose, 2007). By the 1930s, in the onslaught of the Great Depression, regulation became

an even more serious issue, and the airlines were not excluded from this. As a result of

bid rigging and market dividing efforts over airmail contracts by the Postmaster General,

Congress passed legislation that enabled the Interstate Commerce Commission (ICC) to

regulate the airlines (Levine, 1987). However, economic regulatory responsibility would

be shifted to the Civil Aeronautics Board with the passing of the Civil Aeronautics Act

(CAA) in 1938 (Borenstein and Rose, 2007). The objective of the regulation created by

the CAA was “‘to…foster sound economic conditions in the industry (U.S. Statutes at

Large 52 : 973 (1938), 101(b)). Price and entry regulation in the airline industry was

deliberately designed to promote the financial stability of airlines” (Kohl and Lehn,

1998). This was something that both politicians and airline managers greatly desired. As

a result, policymakers and industry executives alike willingly accepted the coordination

efforts by the government over the perceived volatilities of the market. In addition,

“perceived national defense interests in a robust domestic airline industry added to the

appeal” with World War II looming in the near future (Borenstein and Rose, 2007). The

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establishment of the Civil Aeronautics Board essentially marked the official beginning of

regulation in the airline industry.

The Regulation Era

However, since regulation began in 1938 and carriers such as American Airlines,

Delta Air Lines, and United Airlines had commenced operations before the CAB’s

establishment, existing carriers such as these had their operating authority in their

respective markets grandfathered in. Any airline that commenced operations after the

CAB’s establishment found it extraordinarily difficult to enter the market while

facilitating the operations of the major carriers. However, “the CAB bowed to pressure

to authorize entry by carriers providing service to and from smaller communities” during

and after the Second World War (Borenstein and Rose, 2007). While it was difficult for

new airlines to enter the market, it was also difficult for already existing major carriers to

expand. Any carrier that was wishing to expand had to show the Board that their

expansion would not hurt the incumbent carrier as there was already very little route

overlap between the carriers (Borenstein and Rose, 2007). It was in this way the Board

regulated entry of air carriers and route structure of the already existing airlines. In

addition to regulating entry and route structure, the CAB regulated fares as well. The

goal of regulating fares was to essentially ensure profit adequacy. As a result of the

Board’s focus on profits and subsequently continued development of air transportation,

they generally approved of most fare increases initiated by air carriers (Borenstein and

Rose, 2007).

However, higher passenger fares regulated by the CAB did not translate into

higher profits for the airlines. Borenstein and Rose refer to a study conducted by

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Theodore Keeler, in which “he argued that high fares in conjunction with apparent

normal rates of return to capital for airlines suggested that ‘airline regulation extracts

high costs in inefficiency on high-density routes.’ Carriers responded to high margins

with behavior that increased costs, reduced realized returns, and raised the cost of

meeting a given level of demand for air service.” As a result of the higher prices and

subsequent behavior of the airlines, the carriers focused on competing for passengers

based less on fares and more on other aspects of service, such as seat spacing and quality,

food and beverage service, and entertainment, which raised costs for the airlines and in

turn produced lackluster profits.

While the major carriers under CAB regulation did not fare well in terms of

profitability, the smaller, local carriers that the Board allowed to begin operations in the

1940s turned higher profits while charging lower fares than their major counterparts.

Since these carriers served smaller communities and did not fly across state lines, they

were not subject to CAB regulation as the CAB only had jurisdiction over interstate

markets dominated by the major airlines. Unlike the major airlines that were competing

in non-price ways, the small intrastate carriers competed with each other based on price.

As a result, the smaller local carriers charged fares based on the market, which were

lower, and as a result, the frequency of flights and passenger load factors were relatively

higher than the major carriers (Borenstein and Rose, 2007). Of course, it was difficult for

the intrastate carriers to expand because by their very nature they provided service within

one state, but also if they wanted to expand, it would mean that they would be subject to

federal regulation. Ultimately, the structure of the intrastate market provided a glimpse

of what a deregulated airline market on a large scale might look like given that the

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biggest local markets were California and Texas, which were comparable to the interstate

markets of the east coast (Borenstein and Rose, 2007). Given the generally higher rates

of profitability among the smaller, local airlines like Pacific Southwest compared to the

major carriers such as United Airlines throughout the 1960s and 1970s, critics began to

question the Board’s effectiveness in regulating the airlines (Chung and Szenberg, 1996).

The Push for Deregulation

In the 1970s, the push for deregulation of the airline industry gained more

momentum with stagflation and surging oil prices plaguing the economy. The time

became politically ripe to push for deregulation of not only the airline industry, but the

communications, financial, and utilities industries as well (Eisner, 2008). While it would

not be until the late 1970s that the Airline Deregulation Act would become law and

deregulation would officially begin, economic deregulation started four years prior with

experimentation with discount fares by the Board (Winston, 1998). While the CAB

traditionally was skeptical of discount fares, pro-reform appointments to the CAB such as

John Robson and Alfred Kahn changed the agency’s attitude toward regulation

(Borenstein and Rose, 2007). Finally in 1978, Congress passed the Airline Deregulation

Act that would change the way the airline industry operates. It should be noted, however,

that regulatory regimes are not dismantled overnight, and it took five years for the

airlines to be fully deregulated economically with the elimination of regulations on fares,

entry, and exit (Winston, 1998). It would not be until 1985 when the Civil Aeronautics

Board would be disbanded (Borenstein and Rose, 2007). The Federal Aviation

Administration, which was established in 1958 to regulate the safety of civil air travel,

would remain in its role .

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The Deregulation Era: Lowered Prices and Barriers

While deregulation would eventually change the airline industry, a legacy from

the regulatory era would remain, known as the Essential Air Service Program (EAS),

which has the goal of incentivizing airlines with subsidies to fly to smaller communities

that would otherwise be unprofitable for the airlines. Aside from the program, which was

kept out of political pressure, the airlines were largely exposed to market forces in an

unprecedented manner. Advocates of deregulation claimed that exposing the airlines to

the marketplace would lower airfares and make flying more accessible to the public as

well as increase competition by an influx of new competitors, as well as elimination of

other competitors. It was in these predictions that deregulation supporters were generally

correct. Between 1980 and 2005, passengers saw a general decrease in airfares by

approximately 40%, adjusted for inflation. The decrease in airfares was also met with

increased load factors as more people could afford air travel, and passenger miles more

than tripled from 188 billion to 584 billion between 1978 and 2005 (Eisner, 2008). In

addition to lower fares, competition among the airlines also surged. In February 1984,

six years after the Airline Deregulation Act became law, the total number of carriers rose

to 123, with more than half of them no longer in existence a decade later (Chung and

Szenberg, 1996). While many airlines liquidated, many filed for bankruptcy protection,

were absorbed into other airlines, made subsidiaries of larger airlines, or made into

regional carriers serving larger airlines. In 1979, Southern and North Central Airlines

consolidated and became Republic Airlines, until it was acquired by Northwest Airlines

in 1986, and Northwest would eventually merge with Delta in 2008. In 1985, United

Airlines acquired Pan Am Airlines’ Pacific routes, a move that signaled the beginning of

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globalization in the airline industry and continued throughout the 1990s and 2000s as the

major airlines looked to expand substantially internationally (Chung and Szenberg,

1996). Globalization gained momentum in the airline industry in the 1990s with the

pursuit of open skies policies, liberalization of international aviation regulations, between

the U.S. and Europe (Chung and Szenberg, 1996).

Unforeseen Outcomes: Alliances and the Hub-and-Spoke Model

What economists and policymakers pushing for deregulation did not predict was

the rise of loyalty programs. First started in 1980 by American Airlines with others

following suit, these programs offer mileage points to individual customers in exchange

for ticket purchases as well as catering to travel agents who steer clients their way and to

corporations in the form of quantity-based discounts (Borenstein and Rose, 2007). Also,

deregulation proponents did not foresee the rise of airline alliances, both domestic and

international. In terms of domestic alliances, many major airlines in the 1980s like Delta

looked to joining forces with smaller, regional airlines such as Atlantic Southeast Airlines

(ASA) that could provide access to smaller cities that would be otherwise unprofitable for

the major carrier. This kind of alliance enabled the major and commuter carriers to

coordinate their schedules and code-share, which presented the product as a single airline

ticket. This was used as an alternative to mergers, especially when antitrust laws became

more stringent after a slew of acquisitions under the first decade of deregulation

(Borenstein and Rose, 2007). In addition to code-sharing between domestic airlines,

international code-sharing partnerships were also made between U.S. carriers and foreign

ones. Essentially, the practice and end result are the same as domestic code-sharing with

the only difference being it provided access to international destinations where an airline

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could not serve due to regulatory constraints on entry into an international market

(Borenstein and Rose, 2007).

Perhaps the most unanticipated outcome in response to deregulation was the

complete transformation of airline networks from a point-to-point system to a hub-and-

spoke system. Under regulation by the CAB, most airline route networks operated under

the point-to-point model, in which flights flew from one city to another directly. That

was one of the few changes that occurred rather quickly with deregulation in 1978 when

most carriers under CAB authority switched to a hub-and-spoke system where flights

between two smaller cities had to go through the larger hub airport if the hub was not the

destination. The reason for this change in operations by the airlines is that the hub-and-

spoke paradigm provides advantages in terms of cost, demand, and competition. The

way it provides these advantages is that hubs provide travelers more flight options and

facilitate more convenient service on routes where demand is not high enough to support

non-stop flights at relatively low prices (Borenstein and Rose, 2007). Hub airports also

enable the hub airline to offer frequent service while maintaining high load factors due to

hubs having dense operations. Because hub operations at an airport are so dense, very

few airports have the economic and logistic capacity to service more than one airline.

This results in another advantage for the hub airline by yielding considerable market

power at the hub airport (Borenstein and Rose, 2007). Coupled with majority market

power and flight frequencies, the airlines are able to exude a demand advantage on routes

out of the hub compared to its competitors. As a result, the hub-and-spoke configuration

grants the hub airline the ability to effectively influence consumer preferences by

garnering a certain degree of brand loyalty (Borenstein and Rose, 2007).

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Other Sweeping Changes

Another change that came about since deregulation of the airlines has been the

change in quality of the service provided by airlines. Certain aspects of service such as

flight options and frequency have changed in very specific ways. With the reorganization

of airline networks to the hub-and-spoke model, it led to a reduction in non-stop flights

between two smaller cities since the new model required the flight to stop at the hub

airport. Simultaneously, this also led to an increase in the number of connecting flights

for passengers, however the change was relatively small. According to Borenstein and

Rose, the share of passengers having to change planes was slightly 30% in 1979, and

increased to just over 30% in 2005. Instead, the data pointed to a more significant change

happening at the same time: distance travelled by passengers was increasing. Borenstein

and Rose found that the average trip distance had increased from 873 miles in 1979 to

1,058 miles in 2005; so “more people were flying longer distance trips on which

changing planes is more common.” While connecting flights increased rather modestly,

interline flights, connecting flights between airlines, declined drastically and then steadily

increased. In 1979, interline flights were at 45% and fell to 8% by the early-1990s

(Borenstein and Rose, 2007). This is attributed to the fact that connecting flights within

an airline was associated with improved connections and better baggage handling service.

The increase began in the mid-1990s with the further spreading of code-sharing. As a

result, interline flights were reported at approximately 42% in 2005, back to levels seen

just after deregulation (Borenstein and Rose, 2007). While the hub-and-spoke system is

the prevailing model of many airlines, the number of non-stop flights increased

dramatically to almost 70% by the late 1990s. This trend corresponds with the increased

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use of regional jets (RJ’s) by regional airlines like ASA (Borenstein and Rose, 2007).

RJ’s are aircraft with less than 100 seats and were used to replace many turboprop

aircraft that the regional airlines initially used. Lastly, load factors also changed

significantly from deregulation’s inception onward. Borenstein and Rose document that

load factors were below 50% prior to deregulation and rose over 20% in the 1980s. Load

factors rose above 70% in the 1990s hitting 77% in 2005 and remaining over 80% in the

first half of 2007 (Borenstein and Rose, 2007). Indeed, deregulation marked a significant

change in the airline industry, and it generated positive outcomes, especially for

consumers and new entrants. However, the outcomes of deregulation have been rather

mixed on other fronts such as labor, other aspects of customer service, traffic flow, and

financial performance.

Counter Arguments

While the benefits of airline deregulation have been widely noted, so too have the

negative effects. It is clear that deregulation has significantly helped in the development

of the air transportation system. Growth is most visible in terms of traffic and operating

capacity, which are measured as Available Seat Miles (ASM’s) and Revenue Passenger

Miles (RPM’s), respectively. Between 1954 and 1978, RPM’s averaged at 5.8 million

per year, and between 1978 and 2002, RPM’s averages more than doubled to 11.7 million

(Jiang and Hansman, 2006). With this rapid period of growth following deregulation,

there was the assumption among proponents that this would translate into a more

profitable industry, but the data strongly suggests otherwise. While revenues and costs

for the major, regional, and cargo airlines have grown with the rise in traffic, industry

profits have fluctuated around zero. Between 2001 and 2003, the airlines cumulatively

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lost over 23 billion dollars, outpacing the total earnings of the past. (Jiang and Hansman,

2006). In addition to the severe financial losses incurred by the airlines, many of those

same airlines were forced to file for bankruptcy protection. Between 2001 and 2006,

United Airlines, US Airways, ATA Airlines, Northwest Airlines, and Delta Air Lines all

filed for Chapter 11 Bankruptcy (Jiang and Hansman). Most recently, American

Airlines’ holding company, AMR Corporation, filed for bankruptcy protection after

nearly avoiding bankruptcy in the early to mid-2000s. While the airlines suffered from

poor financial results in the 2000s, they have collectively lost approximately 60 billion

dollars in the thirty years after deregulation. These losses have been exclusively in the

domestic market. Broken down, the airlines lost approximately 10 billion dollars

between 1979 and 1989, which was then followed by 5 billion dollars in profits in the

1990s, but the airlines once again suffered losses at an astounding 54 billion dollars

between 2000 and 2009 (Borenstein, 2011). Since deregulation, specifically since the

2000s, the major carriers’ most profitable routes were coming from international

operations, as most international routes remain heavily regulated unlike domestic routes.

Generally, international routes are more lucrative to the airlines that are allowed to serve

them (Borenstein, 2011). Many industry leaders attribute the significant losses of the

airline industry to several factors.

Negative Effects: Service and Job Cuts

One factor that has had an effect on many airlines is exogenous demand shocks.

Perhaps the most well known factor that has negatively impacted the airline industry

financially is 9/11. After the terrorist attacks on September 11, 2001, air travel demand

fell sharply by approximately 20% (Borenstein, 2011). As a result of this rapid decline in

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demand for air travel, the airlines cut capacity, or scaled back operations significantly, in

order to cut costs. In addition to capacity cuts, the airlines also reduced the size of their

fleets, which contributed to a higher load factor that rose to approximately 81%, up 10

percentage points from 2000 (Borenstein, 2011). In order to spur demand in light of the

recent attacks, the airlines also cut their fares significantly, which contributed to the

airlines’ dismal financial performance, as cost would continue to outpace revenue. Even

by 2008, air travel demand remained 3% lower than it was in 2000, and in 2009 demand

fell by another 11%, suggesting that the airlines continue to suffer from a lag in demand

(Borenstein, 2011).

While external demand shocks have taken a toll on many airlines, industry

observers and participants have pointed to the rise of low-cost carriers (LCC’s) as part of

the reason for low profits. Since LCC’s are smaller and compete almost exclusively on

price, they forego many amenities and services the major carriers provide enabling them

to offer flights at lower fares, which puts pressure on the high cost major carriers to lower

prices However, there is little agreement on what the connection is between low profits

and the LCC’s (Borenstein, 2011). Some labor and industry leaders claim that LCC’s

have made excessive capacity investments during growth periods and even during some

downturns leading to depressed prices overall (Borenstein, 2011). However, the evidence

does not seem to support the notion that LCC’s have a tendency to overinvest. In terms if

fleet size, LCC fleets are generally much smaller than the legacy carriers, but fleet size

adjustments in the last thirty years have been more significant for the legacy carriers

suggesting that the major carriers have overinvested relative to their traffic growth and

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that investment decisions have not been the primary factor for industry capacity changes

(Borenstein, 2011).

In addition to pointing to overinvestment by LCC’s as a factor for poor financial

performance, an alternative explanation is that low-cost carriers have been chipping away

at the entrenched positions of the legacy carriers. It should be emphasized, however, that

the process has been slow because the legacy carriers are protected by network marketing

programs and the major carriers’ ability to control availability of gates and landing slots,

which raise barriers to entry by more efficient airlines (Borenstein, 2011).

Nevertheless, LCC’s have been growing steadily since deregulation. Despite a

loss in market share in the mid to late 1980s as a result of larger airlines acquiring many

LCC’s, the market share of low-cost carriers had increased from under 5% in 1979 to

over 60% market share thirty years later (Borenstein, 2011). Also, LCC’s have much

lower operating costs compared to the major airlines. On average, the major airlines have

maintained 30% to 60% higher operating costs per available seat-mile relative to the low-

cost carriers (Borenstein, 2011). While the cost differential is large, the average price

disparity has been shrinking. This attributable to the major carriers significantly lowering

their fares in the 2000s, and the LCC’s fares declined rather slightly, reflecting in part the

lower burden excess aircraft capacity and a large part of the reason why the LCC’s

incurred smaller financial losses in the 2000s (Borenstein, 2011).

While the growth of low-cost carriers has been deemed a factor on persistent

industry losses, taxation and high fuel prices have also been blamed for the airlines’ poor

financial record. Many industry leaders argue that current taxes and fees on tickets are

excessive, and the tax currently stands at 7.5% and fees up to $6.20 per flight flown.

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Additionally, many airports impose passenger facilities charges (PFC’s) of up to $4.50 on

each passenger boarding a flight at an airport (Borenstein, 2011). Indeed, fees have been

added and taxes have risen over time. In the 1980s, the entire ticket tax was a percentage

of the ticket value, and that was all that existed in terms of taxation and there were no

fees (Borenstein, 2011). However, PFC’s were introduced in the 1990s along with the

segment taxes, and in early 2002, the security fee was added in response to the 9/11

terrorist attacks (Borenstein, 2011). The tax rates have increased significantly since

deregulation, but the value of the taxes themselves has not changed as much. A large

increase in the tax percentage is not a result of tax increases, but rather reductions in base

fares, mainly after 9/11, which resulted in an increase on the tax burden as a percentage

of the base fare (Borenstein, 2011). Although many industry leaders point to taxes as

inhibiting financial performance, the data suggests that taxes have not had a significant

impact on the airlines financially, but rather the problem is that fares have fallen and

continue to stay low (Borenstein, 2011).

More Cost Cutting

Another factor that has contributed to airline losses during some years has been

the cost of fuel. Borenstein notes that oil prices were the highest in the first seven years

of deregulation as well as the last five years of deregulation. However, for the better part

of deregulation, oil prices have been relatively stable. From 1986 to 2004, the average jet

fuel price expressed in dollars per gallon was $1.40, and even with these rather low and

stable fuel prices the airlines still lost 31 billion dollars (in 2009 dollars) during 13 of the

19 years (Borenstein, 2011). While dramatic fluctuations in the price of fuel has

contributed to industry losses in the short term, there does not seem to be a barrier to

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capacity adjustment over three to six months in response to changes in oil prices. The

surge in oil prices in late 2008 make that clear as the airlines cut back their schedules and

work force to counter rising fuel costs. However, it should be noted that simply reducing

flight schedules does not mitigate or eliminate costs if those costs are fixed. Rather, air

carriers can adjust to unanticipated costs, such as fuel, by growing more slowly in times

of growing demand so as to avoid larger fluctuations in scheduling, fleet size, and in the

work force. On the other hand, making changes in the areas are more costly and difficult

in times of stagnant or declining demand (Borenstein, 2011). While external cost shocks

such as rapid fluctuations in oil prices and demand shocks such as 9/11 have had

significant effects on the industry’s financial performance, it nevertheless remains

unlikely that losses are due entirely to exogenous circumstances relative to management

and investor expectations and decisions given the last thirty years of deregulation.

While financially the airlines have suffered billions of dollars in losses despite

traffic growth, labor has also seen losses of its own and in some cases translating into

poorer customer service. Over the course of the first decade under deregulation, airline

workers saw a 10% decline in earnings in industry specific jobs such as pilots, flight

attendants, and aircraft mechanics s well as more general jobs such as mid-level

management and supervisory positions (Card, 1996). The decline in earnings from this

period is a result of few factors that had a rather immediate effect on labor. Soon after

deregulation was passed, many weaker airlines successfully negotiated wage cuts for

their unionized workers, and new entrants into the market began hiring non-union

workers in an industry that had been traditionally unionized (Card, 1996). In addition,

some airlines resorted to bankruptcy protection in order to force wage cuts and other

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concessions on their employees. One notable example in the 1980s was when local

service carrier Texas International bought Continental Airlines, and then filed for Chapter

11 bankruptcy in order to abrogate Continental’s union contracts with its employees

(Card, 1996). Moreover, several other air carriers including United, US Airways, Delta,

Northwest, and American have filed for Chapter 11 bankruptcy at least once, and it has

been hailed in the business press as a way to gain more bargaining power in negotiations

with the unions on wage concessions (Gittell et al., 2004). Ultimately, the continued

downward pressure on wages and alleged anti-union efforts have led relations between

labor and management at most airlines to become embittered and plagued with mistrust.

In some cases, management’s persistent attempts to cut wages and the workforce have

had a negative impact on customer service rather than a return to financial solvency.

Unlike the other legacy carriers, Delta Air Lines remains mostly non-union with

the exception of its pilots and dispatchers and was able to do so through the union-

substitution approach (Gittell et al., 2004). In this approach, Delta committed itself to

providing high wages, lifetime employment, and a “family” culture, and this approach

helped Delta maintain a reputation as a high quality carrier and ranked high in customer

service (Gittell et al., 2004). However, in 1994 amid its first significant financial losses,

Delta laid off approximately 15,000 employees and unilaterally cut wages. Subsequently,

Delta’s position as a high-ranking, quality carrier deteriorated and passenger complaints

rose from below the industry average to above the industry average (Gittell et al., 2004).

While Delta is one specific example of cutting costs, a trend among many airlines has

been the aggressive pursuit of cutting costs, and even after 9/11 the focus has continued

on cutting costs with the major carriers laying off 15-20% of their workforce immediately

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after the attacks (Gittell et al., 2004). As a result of a focus on cost-cutting initiatives,

there has been little focus on improving labor-management relationships. However,

notable exceptions in include Alaska Airlines and Southwest, who avoided layoffs in the

aftermath of 9/11 and have focused their efforts on engaging the unions in trying to build

a better labor-management relationship through shared governance rather than through an

adversarial relationship or union suppression (Gittell et al., 2004). While Southwest and

Alaska are smaller airlines and were able to avoid the massive layoffs the legacy carriers

could not, they nonetheless paid more attention to building labor-management relations

than the legacy carriers and have managed to avoid capacity cuts, make profits, and have

modest growth (Gittell et al., 2004). While costs are indeed a significant component of

the airline business and cutting costs proves necessary at times, the data ultimately

suggests that reduction in wages and union power will at best only bring short-term relief

from financial pressures, and that conflict and workplace culture are better determinants

of performance. Essentially, sustained improvement financially as well as in customer

service will require sustained focus on the quality of labor-management relations (Gittell

et al., 2004).

While labor has incurred losses, safety is another factor that has become a cause

for concern following deregulation. Many new entrants in to the marketplace followed

the passing of the Airline Deregulation Act in 1978, which translated into more air traffic

making the skies more congested. More congested skies have also translated into more

delays, and that trend is expected to go up if funding for better air traffic control

technologies is threatened. Although advancements such as Doppler equipment and

traffic monitoring systems like Mode C transponders and traffic collision avoidance

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systems (TCAS) have been developed, the FAA, which has a duel, conflicting role of

overseeing infrastructure development as well as safety, is running years behind air

traffic growth posing a great safety risk on the future (Savage, 1996). These conflicting

roles are attributable not only to a lack of infrastructure development to the National

Airspace System (NAS), but also to lack of safety oversight of carriers. With financial

instability and new carriers entering the market following deregulation, many carriers

have skimped over safety expenditures in maintenance and pilot training, which has

arguably contributed to some notable accidents. The 1996 in-flight fire and subsequent

crash of ValuJet Flight 592 in the Florida Everglades raised serious concerns over safety

when it was found that there were maintenance irregularities and in-flight problems with

the airline. Although ValuJet would eventually cease operations soon after, the FAA was

also faulted for a lack of oversight given the airline’s already poor safety record, and the

agency has been at times accused of regulatory capture (Savage, 1996). The crash of

regional airline Colgan Air Flight 3407 in 2009 once again brought attention to a lack of

oversight and poor personnel practices when it was found that the flight crew suffered

from fatigue and furthermore had a lack of experience despite certification. Even with

these concerns, air travel remains one of the safest modes of travel, but a failure to

enforce safety standards and commit funding to upgrade aviation infrastructure to meet

growing air travel demand could compromise that in the future.

Conclusion

Before 1978, regulators attempted to ensure a stable, yet growing airline industry

to benefit consumers and the economy, but it resulted in high fares, inefficient operations,

and volatility in earnings. The goal of the Airline Deregulation Act was to lower

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passenger fares as well as to lower the barriers to entry for new airlines in the hopes that

it would lead to a more profitable industry. Deregulation succeeded in lowering fares for

passengers, which amounted to nearly 6 billion dollars in consumer savings and overall

lower fares adjusted for inflation. Since 1978, a slew of airlines commenced operations

and gained a share in the market. Deregulation also helped to facilitate the introduction

of new technologies and innovations such as computerized reservation systems, the

selling of fares via the Internet, yield management, and frequent flyer programs.

Although deregulation undoubtedly has produced benefits to the traveling public, it has

come at a cost to the airlines financially, to labor, and necessary infrastructure

advancements have been slow to develop. Since deregulation, the airlines have lost a

combined 60 billion dollars despite increased growth in traffic, and the airlines continue

to lose billions of dollars from delays and airport congestion from a lack of upgrades to

the air transportation system. Many airlines have filed bankruptcy, failed, or merged with

other carriers, and airline workers have suffered layoffs and declining earnings in part

due to the financial instability as well as to overinvestment that led to cutbacks in

operations. Ultimately, these are issues that must be addressed and taken seriously if the

airlines want to return to profitability in this manner. If the airlines are intent on

returning to consistent profitability, they must narrow the gap between their costs or raise

the price premium they maintain, and they must pay more attention to improving the

quality of their labor-management relationships as that is tied more to productivity and

quality service more than simple, aggressive cost-cutting measures. While it is necessary

for the airlines themselves to manage their way back to financial stability, it is equally

important that funding for infrastructure improvements not be hampered, and that the

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FAA properly enforces safety standards to ensure public safety and trust. Ultimately, the

problems of deregulation are ones that must be tackled by several different actors in order

to ensure the sustainability of the airline industry.

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