Deregulation and Privatization of Deregulation and Privatization of the Air Transport Industrythe Air Transport Industry

Kenneth ButtonUniversity Professor

George Mason University

June 2008

“Only the psychologically disturbed or inadequate want transport for its own sake.”

Denys Munby, 1968

Some quotes

“These days no one can make money on the goddam airline business.The economics represent sheer hell”

C.R.Smith American Airlines

“People who invest in aviation are the biggest suckers in the world” David Neeleman, jetBlu Airways, 1999

“If the Wright brothers were alive today Wilbur would have to fire Orville to reduce costs”

Herb Kelleher, Southwest Airlines, 1994

“They don't realize that while you're sitting here talking, someone is f**king you. Changing a fare, changing a flight, moving something. There's no autopilot, and that's why I've seen a lot of guys come and go”

Gordon Bethune, Continental Airlines, 2004

“There are always going to be some stupid people who will invest in airlines” Kenneth Button, Washington Post, 2005

Institutions

• Formal: laws, regulations, contracts• Informal: “ways of doing business,

interpretation of laws• Personal: habit

Do institutions matter?

• Coase said in Nobel speech:

“These ex-communist countries are advised to move to a market economy, and their leaders wish to do so, but without the appropriate institutions no market economy of any significance is possible.”

• Matthews in his Royal Economic Society address said:“.. Economics of institutions has become one of the liveliest areas of our discipline. …institutions do matter…the determinants of institutions are susceptible to analysis by tools of economic theory”

Do institutions matter?

However, Williamson points out:

“we are still very ignorant about institutions”

“Chief among the causes of ignorance is that institutions are very complex. That neo-classical economics was dismissive of institutions and much of organization theory lacked scientific ambitions have been contributing factors.”

“New” institutional economics

• Old institutional economics– Descriptive– Legalisic– Historic– Often negative (attacking neo-classical economics)

• “New” institutional economics– Holistic approach to economics– Analytical in nature

Linkages between economic institutions

Resource allocation and employment

continuous

Institutional environment: formal rules

(10-100 years)

Embeddedness: customs, traditions

(over 100years)

Governance: especially contracts

1-10 years)

Neoclassical economics/agency theory

Economics of property rights/political economy

Transaction cost economics

Social theory

Characteristics of air transport

• Long/medium distance• Fast and reliable (important for some types of freight)• Highly flexible (spatially and temporally)• Quick to put in place (relatively low fixed costs)• Significant development about terminals• Relatively secure (no track)• Relatively safe• Relatively easy to develop private/public structures

Airlines part of an air transport system

Flow control

Tower controlTower control

Airport A Airport B

Ground control Ground control

Air transport is a major industry

• 1,600 million passengers a year• 3.9 million jobs• $260 billion turnover• 18,000 aircraft• 15 million kilometer network• 10,000 airports• 130 billion revenue ton kilometers• 30 million tons of freight

Further features of the global market

• Large industry in its own right (1% of Western European GDP, more than 1% of US GDP)

• Important for key modern industries (high-tech management flies 60% more than traditional industries)

• Important for long term economic/political integration• Lubricant for the economic system• Half of tourists outside of Europe travel by air

Dimensions of economic benefits of air transport

• Simulates macro economic growth• Regional effects• Access to remote regions• Sector effects (e.g.tourism)• Air cargo (high value goods)• International markets• Foreign exchange earnings• Social cohesion • Retaining family/social ties• Cultural understanding

Air transport can benefit economic development

• Primary effects. (e.g., building an airport) • Secondary effects. (e.g., running an airport)• Tertiary effects. (e.g., using an airport)• Perpetuity effects. (e.g., changing the

economy)

Some studies of airport impacts

• US MSAs - hub airport increases region’s employment by 12000

• Chicago O’Hare – 50% increase in traffic will increase employment in the region by 185,000.

• Atlanta - 264 foreign-based firms, direct international services was 3rd most important thing in location

• 57 companies in Europe – air transport network the 3rd most important factor in location.

• Zurich – 34% of firms considered the airport as ‘very important’ and 38% as ‘important’ as location factor.

• Schiphol Airport (Netherlands) – 85,000 jobs for the country.

Jobs and income from having a local airport (per million passengers)

Jobs Economic Impact ($millions)

Direct Total Direct Total

High 2000 8000 225 1600

Medium 1500 6000 75 650

Low 750 2500 35 130

Tourist growth ($millions) by destination

1995 2020 % Annual Change

Europe 338.4 717 3.0Americas 108.9 282 3.9East Asia/Pacific 81.4 397 6.5Africa 20.2 77 5.5

Middle East 12.4 69 7.1South Asia 4.2 19 6.2Intra regional 464.1 1,183 3.8Intercontinental 101.3 378 5.4Total Trips 565.4 1,561 4.1

Trend in air transportation

• Growth in both passenger and freight forecast• Lower fares

– Deregulation; Technology; Improved management (low cost carriers)

• Lower cargo rates– Improved management (supply chain logistics)

• Integrated networks– Mergers; Alliances

• Internationalization– Open Skies; European Union; Role of ICAO, etc

Traditional regulation

• Economic efficiency• Largely static• Major concern with monopoly practices

– Monopolies– Predatory pricing– Mergers– Barriers to market entry

Regulation of air transport

• Airlines– Fares– Market entry– Revenue allocation– Ownership

• Information/booking systems– Displays

• Airports – Ownership – Rates

• Air navigation systems– Ownership – Rates– Profits

Social regulation

• Covers environment, labor protection, consumer protection, etc.

• Growing in importance• Often uses command-and-control regulation rather

than fiscal instruments (such as prices)• Can interact with economic regulation (e.g., change

relative prices and affect market structure)• Sometimes captured to achieve economic objectives

(e.g., redistribute income)

Problems with traditional regulation/public ownership

• Regulatory capture– By industry– By regulators

• Political manipulation• Lack of efficiency• High transactions costs (policing, administrating)• Lack of dynamism in adjusting parameters• Impedance to innovation

Vertical or horizontal regulation

• Problems of impact on value chain of regulating one element

• Problem across sectors if one value chain is regulated because of linkages

Porter’s value chain

Inboound logistics

Outboound Logistics

ServicesOperations Marketing and sales

Primary activities

Support activities

Procurement Human resource management Infrastructure Technological development

Phases of Regulatory Reform in Aviation

THE LEGACY• To 1910 -> gentle assistance for innovation• 1910-1918 -> military importance• 1920s -> national integration (mail services)• 1930s -> internationalism (esp. Empires)• 1940s+ ->military development• Late 1940s-1970s -> economic regulation

–Chicago convention–domestic price/ market access controls

MODERN AGE• 1970s+ -> “deregulation of operations”

–domestic from late 1970s in US–international (Open Skies, EU packages, etc)

• 1980s+ -> “deregulation of infrastructure”• 2000s+ -> environmental regulations

Forces for regulatory reform

• Academic work (Levine, Jordon)• Issue of capture (Stigler, Peltzman)• Ideas of contestability (Baumol)• Concepts of “competition for the market” (Demsetz)• Role of countervailing power• Better understanding of cost structures• New forms of regulation (price-capping)

Winners and losers

• Regulation always has winners and losers - i.e., not usually a Pareto benefit

• Net benefits should be positive!• Effects may be long term so winners and losers may

involve future generations• Often adverse effects of regulations are widespread

while benefits are more focused

Normative income considerations

• Policy makers more concerned with equity than efficiency - Frey

• Interpersonal comparisons of welfare• Equity (Bentham, Rawls)

– Income– Wealth– Spatial– Inter-generational (sustainable development)

Privatization

• Objectives– Raise revenue for government– Make industry more efficient– ‘Share owning democracy’ (Thatcher)

• Methods– Sell shares– Sell to managers/employees– Outsource– Allow private companies to compete with state owned ones– Sell to a single company

• There are financial costs in privatization

Privatization and regulation

• State ownership – Extreme form of economic regulation

• Privatization equals more regulation– Social regulation– Mergers policies– Anti-trust/competition policy

• Public corporations– State involvement– Non-profit

Features of contestable market

• No sunk costs - ultra free entry and exit• There may just be one supplier• No excess profits are earned because of fear of hit-

and-run entry when there is perfect contestability• Perfect competition is a special case of perfect

contestability

Competitive, contestable and monopoly markets

Feature Perfect Competition Perfectly Contestable Monopoly

Profit maximization Yes Yes NormallyNo barriers to entry/exit Yes Yes NoPerfect mobility of inputs Yes Yes NoUbiquitous information Yes Yes NoLarge number of firms Yes Maybe NoHomogeneous product Yes Maybe YesFirms confronted by same cost functions Yes Yes YesU-shaped average cost functions Yes Maybe MaybeProfits Normal Normal Monopoly rent

Structure of regulatory change

• Big-bang– Sudden reform

– Stranded costs

– Quick payback

– Little scope for capture

• Gradualism– Phased reform

– More time to adjust resource use

– Longer time before benefits emerge

– Scope for industry to capture the system

Big bang or gradualism?

Big-bang approach

Phased approach

Time

+

Š

0

Net benefit

A B

Nature of liberalization

• US : ‘Big Bang’ • Airline Deregulation Act 1978• Open Skies Policy from 1979

• EU: Phased liberalization• Add hoc reforms (from early 1980)• Package 1 (1988)

– Opening up the existing structure• Package 2 (1990)

– Liberalizing the EU international market• Package 3 (1993)

– An open European air transport market• Extra-territorial authority (2003)

Measuring efficiency of deregulation/privatization

• Benchmarks (Quality constancy)– International (comparable data)– Public/private or regulated/deregulated (counterfactual)– Time trends (trend shifts)

• Simulations• Expert opinion

Internal African liberalization

• 1988 Yamoussoukro Declaration• 1984 Mauritius guidelines• 1997 Banjul Accord • 1998 ACAC Agreement • 1999 CEMAC Agreement• 1999 COMESA Agreement• 1999 Yamoussoukro II Decision• 2000 Abuja Treaty

Factors influencing EU air transport

Market Conditions

EU Air TransportPolicy

Related EU Policies National Air TransportPolicies

Impact on EU AirTransport

Intra-EU BilateralAgreements

Extra-EU BilateralAgreements

New EconomicIdeas

DemonstrationEffects

Airline Alliances SafetyParameters of

Competition Infrastructure

Relative efficiency of European airlinesRelative efficiency of European airlines

UK Civil Aviation Authority (1983) EU airlines costs were double US trunk carriers. Starkie/Starrs (1984) Comparing 5 years to 1975 with the subsequent 5 years found

productivity growth of US carriers continued at pre-US deregulation levels but declined 40% for non-US airlines.

Barrett (1987) In 1984, the productivity of US airlines was 36% greater than their European counterparts in terms of traffic units per staff member.

Caves et al (1987) for the period 1970 to 1983 found EU carriers to be less efficient than their US counterparts.

McGowan/Seabright (1989) In the late 1980s US majors enjoying 1.6 million revenue passenger kilometers per employee compared to 1.1 for the best European carrier.

Encaoua (1991) Convergence of European airline costs between 1981 and 1986. Good, et al (1995) European airlines from 1976 to 1986 would have saved about

$4billion a year (1986 dollars) if they became as efficient as US airlines. Distexhe/Perelman (1994) Reduced X-inefficiency amongst EU airlines 1973 to 1983. Oum/Yu (1995) 1986 to 1993 saw productivity improvements in the European carriers

compared to US counterparts.

Passenger numbers by distance of service

0

10

20

30

40

50

60

70

Under 1000 1000 to 2000 2000 to 3000 3000 to 4000 4000 to 5000 over 5000

Distance (kilometers)

Per

cent

age

of p

asse

nger

s

United States Europe

Travel mix in the US and Europe

0

10

20

30

40

50

60

Business Sightseeing Visting friends Other

Reason for Travel

Pe

rce

nt

of

Trip

s

United States Europe

Airline labor physical productivity in Europe (ATK per employee)

100

110

120

130

140

150

160

170

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Year

Inde

x (1

991=

100)

Passenger and cargo yield for European Union scheduled airlines

70

75

80

85

90

95

100

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Year

Index (

1991=

100)

Passenger Cargo

The proportion of UK business passengers traveling business class

35

40

45

50

55

60

65

1986 1988 1990 1992 1994 1996 1997 1999

Year

% P

rem

ium

Cab

in

Longhaul Shorthaul

Weighted average fares within the EEA

0

50

100

150

200

250

300

350

400

Business Economy Promotional

Ticket Type

Jul-92 Jul-97 Jul-98 Jul-99 Jul-00

Growth of no-frill carriers

0

150

300

450

600

750

900

1050

1995 1996 1997 1998 1999 2000 2001 2002

Year

Thousa

nd S

eats

Ryanair Virgin Express EasyJet Debonair GO Buzz bmibaby

Cost differences between a no-frill carrier and a legacy carrier

0

20

40

60

80

100

No-frills Classic

Type of Carrier

Catering GDS Commissions Sales Advertsing

Cabin Crew Cockpit Crew Handling Landing ATC

Insurance Fuel Maintenance Aircraft

Simplified theories of migration

Capital La bor Capital Skilled La bor

I U

I U

I U

I U

Classical Model New Growth Theory Model

Regional A Regional A

Regional B Regional B

The notion of gateways

Hub City Gateway City Gateway City

Impact of opening more gateways

QuickTime™ and aTIFF (LZW) decompressor

are needed to see this picture.

Inbound passengers from the EU to the UK using Stansted and Luton airports

Passenger type

Passengers 2000

Passengers 2005

2000 to 2005 change

Percentage of total in 2000

Percentage of total in 2005

Business 0.9 million 1.8 million 98% 22% 17% Leisure 1.6 million 4.0 million 150% 39% 38% Visiting friends & relatives

1.6 million 4.8 million 198% 39% 45%

Operating margins of airlines

-10

-8

-6

-4

-2

0

2

4

6

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Europe US Global

A few failed airlines

Air Canada Tango Air South America West Airlines ATA A irlines Canada 3000 Compass East-West Eastwind Airlines Greyhound Air Hooters Air Impulse Airlines Independence Air JetGreen Airways Kiwi Airlines Kiwi International Air Lines LAPA MetroJet Midway Airlines National Airlines Oasis Hong Kong Airlines

Pacific Southwest Airlines Pan Am Pearl Air PEOPLExpress Safe Air Saro Skybus Airlines SkyValue Song (Delta) Southeast Airlines TAESA Tower A ir U Air United Shuttle ValuJet Vanguard Airlines Vistajet Western Pacific Airlines Zip

Economic margins in the air transport sector

0%

5%

10%

15%

20%

25%

30%

35%

GlobalDistribution

Systems

AircraftManufacturing

AircraftLeasing

Companies

AirportHandlingServices

Catering Airports Airlines

Industry

0

5

10

15

20

25

30

Global

DistributionSystems

Aircraft

Manufacturers

Airports ATS Airlines

Industry

Margins in segments of European air transport

-5

0

5

10

15

20

GlobalDistribution

Systems

LeasingCompanies

AircraftManufacturers

Airports Catering Airlines

Industry

Op

era

tin

g M

arg

in (

%)

European & US schedule passenger airlines operating margins (by 2002

revenue)

Europe United States

Lufthansa Group 9.4% American Airlines -19.2%Air France Group 1.5% United Airlines -19.9%British Airways 3.8% Delta Air Lines -9.8%SAS Group 11.2% Northwest Airlines -8.9%KLM Royal Dutch Airlines -2.1% Continental Airlines -3.7%Alitalia -2.4% US Airways -18.9%Iberia Airlines 5.3% Southwest Airlines 7.6%Swiss -21.2% Alaska Air Group -4.0%Austrian Airlines Group 1.7% America West -7.8%

Returns of airports in Europe

Airport group Operating margin (2001) Operating margin (2002)

BAA plc (UK) 29.8% 30.6%Fraport (Germany) 18.0% 15.8%A¸roport de Paris (France) 6.0% 9.2%Schiphol Group (Netherlands) 31.7% 32.0%Luftartsverket (Sweden) 3.7% 9.1%Flughafen Mnchen GmbH (Germany) 11.8% 3.7%Avinor (Norway) 22.9% 17.1%Aeroporti di Roma Spa (Italy) 16.8% 21.2%SEA A eroporti di Milano (Italy) 11.5% 10.4%Manchester Airport Group (UK) 19.2% 19.3%

The main GDS providers, 2003

Company Revenues ($ millions) Operating margin Operating result ($ millions)

Amadeus 2,195 16.6% 365Cedent Group* 10,034 15.3% 1,534Sabre 2,045 8.1% 166Worldspan 929 9.7% 90

* This represents the companyÕs total travel services, some 55% of its overall business.

Problems for European airlines

• Issues– Bankruptcy (Sabena, Swissair)– Large losses (Alitalia)– Cut-backs by the “legacy” carriers

• Reasons– Advent of internet meant loss of ability to yield manage– High load factors (and some taxation) reduce value of frequent flyer

miles– Low cost carriers “creaming traffic” from hub-and-spoke system– Number of “protected” international routes– Power of other elements in value chain

Issues with contestable markets

• Power of potential versus actual competition– Moore; Morrison and Winston

• Continuing need for anti-trust policy?• Degree to which unbundling is possible• Handling elements of production where there are

sunk costs

Excessive competition

• Problem of recovering full costs when there is competition and declining average cost curves

• Leads to violent fluctuations in supply OR undersupply

• Normal solution in the past was subsidies or public ownership

• Fear of poor quality (or dangerous) services• Unreliability of service

Concerns with excess competition in practice

• Regulations in Europe/US from 1920– Trucks– Buses– Taxis

• Setting up of the EEC ‘Common Transport Policy’• Controls over some professions

– Doctors– Architects

Instability

• Definition– Predictable cycles– Unpredictable cycles

• Problems– Problems “down the line” for investors– Lack of investment in the long-term– Questions of quality of service– Social costs to those in the industry (workers)

Conditions leading to instability

• Fixed costs/fluctuating demands• Fixed costs/highly competitive markets• Indivisibilities• Lags in supply adjustment (institutional/technical)• Speculation

Empty core problem

P1

P1+P2

D

MC1+MC2

MC1

Ac

Methods of full cost recovery• Subsidies/public ownership

– Now largely illegal– Loan guarantees (US and Italy)

• Statutory monopolies – Now gone except on some international routes (“Open Skies”)

• Pre-payment – Charters hit by low cost carriers in Europe

• Bankruptcy– Common US practice

• Airline quasi-monopoly power– Frequent flier programs (devalued by high load factors)– CRS systems (legal controls)– Yield management (ubiquitous information with web)– Dominate hubs (low cost carriers)– Vertical integration (travel agents but limited)– Mergers (anti-trust authorities)– Complementary activities (belly-hold cargoes)

Subsidies

• Direct subsidies– Opportunity cost of raising revenue– X-inefficiency– Stifles incentive– Transactions costs

• Cross subsidies– By means such a joint licensing etc– Inefficiency in ‘taxed’ supply

Network structures

Point to Point Network Hub and Spoke Network

10 different routes 4 different routes

The “dog-bone” international hub-and-spoke network

A B

a

b

c

i

x

y

z

j

TAP networks (1990)

Figure 3a - European network in 1990 Figure 3b - South American network in 1990

Figure 3c - North American network in 1990 Figure 3d - African network in 1990

TAP network (2004)

Figure 7a - European network in 2004 Figure 7b - South American network in 2004

Figure 7c - North American network in 2004 Figure 7d - African network in 2004

Banks at Lisbon Airport, January 9, 2004

6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

outbounds

inboundsHoras

US and European airlines that are part of the three main strategic alliances

Star Alliance oneWorld SkyTeam

United Airlines American Airlines Delta AirlinesLufthansa British Airways Continental

BMI Aer Lingus NorthwestTAP Portugal Iberia Alitalia

Finnair Air FranceLauda Air CAS Czech Airlines

LOT Polish Airlines KLM Royal Dutch AirlinesSpanair

SAS Scandinavian AirlinesAustrian AirwaysTyrolean Airlines

European and US passenger airlines revenues ranked by 2002 revenue

Europe United States

Lufthansa Group (4) $16,123 American Airlines (1) $17,299Air France Group (7) $12,697 United Airlines (5) $14,286British Airways (8) $11,940 Delta Air Lines (6) $13,305SAS Group (13) $6,977 Northwest Airlines (10) $9,489KLM Royal Dutch Airlines (14) $6,490 Continental Airlines (12) $8,402Alitalia (20) $6,400 US Airways (37) $6,977Iberia Airlines (21) $4,600 Southwest Airlines (18) $5,522Swiss (31) $2,771 Alaska Air Group (33) $2,224Austrian Airlines Group (32) $2,278 America West (39) $2,047

The “S-curve”

100%

100%0Frequency share

Mar

ket s

hare

Case A

Case B

United out of Chicago O’Hare 1990 and 2003 with a single competitor

ORD UA 2 comp

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

0.0% 20.0% 40.0% 60.0% 80.0% 100.0%

% frequency

% p

asse

ng

ers

(mar

ket

shar

e)

UA ORD 2 comp

0.0%10.0%20.0%

30.0%40.0%50.0%60.0%70.0%80.0%

90.0%100.0%

0.0% 20.0% 40.0% 60.0% 80.0% 100.0%

% frequencies

% p

asse

ng

ers

United out of Chicago O’Hare 2003 with two competitors

UA ORD 3 comp

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%60.0%

70.0%

80.0%

90.0%

100.0%

0.0% 20.0% 40.0% 60.0% 80.0% 100.0%

% frequencies

% p

asse

nger

s

Temporal-fares offered; curves, previous work

Paper Market Research Technique

Pels & Rietveld (2004)

London-Paris routes for legacy carriers

Statistical analysis, short-run airline responses to competitorsÕ price Partial analysis. SUR estimation. Regression of residuals on lagged residuals (autocorrelation)

Pitfield (2005a) Low-cost services from the UK

Cross Correlation Analysis, subject to a variety of lags. Series pre-whitened using ARIMA or Box-Jenkins to determine:

- Cross correlation functions (CCF) - Autocorrelation functions (ACFs) - Partial Autocorrelation Functions (PACFs)

Pitfield (2005b) Low-cost services from the

UK

ARIMA time series models, CCF, ACFs, PACFs.

Barbot (2006) Low-cost services Paris Millan

OLS regression, no lags introduced Theoretical model based in Bertrand competition

Button & Vega (2006)

Low costs carriersÕ internal service competition in the US

Graphical analysis, case studies

Button, Costa & Cruz (2007a)

Price leadership for routes from Portugal

Graphical analysis and Granger causality tests

Button, Costa & Cruz (2007b)

Price leadership for routes from Portugal

Graphical analysis, comparative statistics

Competitive Market

Monopoly markets

Porto - Palma : 19 May

0

50

100

150

200

250

300

350

March April May

€ Air Berlin

Porto - Palma : 30 May

50

100

150

200

250

April May

€ Air Berlin

Two legacy carriers

Lisbon - London : 19 May

0

100

200

300

400

500

600

700

800

March April May

€TAP

British Airways

LCCs/legacy carriers

Porto - Frankfurt : 19 May

100

150

200

250

300

350

400

450

500

550

March April May

€Lufhtansa

Air Berlin

Porto - Frankfurt : 30 May

200

400

600

800

1000

1200

1400

1600

1800

April May

€Lufhtansa

Air Berlin

Porto - London : 19 May

0

50

100

150

200

250

300

350

400

March April May

€

TAP

British Airways

Ryanair

Regional LCCs/legacy carriers

Lisbon - Paris : 19 May

150

250

350

450

550

650

750

March April May

€

TAP

Air France

Air Luxor

Lisbon - Paris : 30 May

0

100

200

300

400

500

600

700

April May

€

TAP

Air France

Air Luxor

Porto - Paris : 30 May

150

200

250

300

350

400

450

500

550

600

April May

€

TAP

Air France

Air Luxor

LCCs/LCCs

Phoenix - Kansas City : 1 August

150

200

250

300

350

400

450

July

$Southwest 05:45-16:20America West 09:07-17:35

Internal competition between air services

Phoenix - Sacramento : August 1

100

150

200

250

300

350

400

July

$America West 07:33-18:20Southwest 08:00-17:20Southwest 06:50-17:20

Phoenix - Minneapolis ; 1 August

200

300

400

500

600

700

800

900

1000

1100

July

$America West 08:52-17:15Northwest 09:15-17:20Northwest 06:55-17:20

Phoenix - Austin : 1 August

150

200

250

300

350

400

450

July

$America West 09:11-18:00Southwest 06:40-16:15Southwest 09:25-16:15

Trends in the transatlantic air services market

0

50

100

150

200

250

300

350

400

450

1985

1990

1995

2000

2001

2002

2003

2004

Years

Rev

enue

pas

ssen

ger

kilo

met

ers

(bill

ion)

Benefits of market based bilateral ASAs

Open Skies• Removal of capacity constraints (more seats/flights)• Move airline choice for passengers (move out in demand)• Easier alliance formation (lower costs/better service for

passengers)

Open Aviation Area• More flexible operations with cabotage (lower unit costs)• More flexible capital markets (lower unit costs/more stability in

airline finances)

The European based “Open Skies” initiatives (passenger services)

Netherlands In Force 10/14/92Belgium Provisional 3/1/95Finland In Force 3/24/95Denmark In Force 4/26/95Norway In Force 4/26/95Sweden In Force 4/26/95Luxembourg In Force 6/6/95Austria In Force 6/14/95Czech Repub. In Force 12/8/95Germany Provisional 2/29/96Italy Comity and Reciprocity 11/11/98Portugal In Force 12/22/99Malta In Force 10/12/00Poland In Force 5/31/01France In Force 10/19/01

Studies of the effects of strategic alliance

Study Alliances Findings

Gellman Research BA/US Air, Profits increased for all parties withAssociates (1994) KLM/NW BA and KLM gaining more than

their partners

Youssef and Hansen Swissair and SAS Increases in flight frequency; variations(1994) in fare levels; the strongest service

levels had the lowest fare increases.

US General KLM/NW, USAir/ All carriers enjoyed increased revenuesAccounting Office BA, UAL/Lufthansa and traffic gained at competitorsÕ(1995) UAL/Ansett, UAL/ expense, not industry growth.

BMA

Oum et al (2000) Star Alliance, oneWorld Increased traffic on alliance routesSkyteam, KLM/NW

Brueckner and Whalen US international Fare are some 18% to 20% lower on(2000) alliances international alliance, inter-lining routes

Brattle Group’s estimates of European airport employment effects of an Open

Aviation Area

Airline Airport Airport employment employment employment

Low bound scenario

Pricing synergies 600 188 481No output-restricting ASA bilaterals 1587 436 1092

Total 2178 624 1573

High bound scenario

Pricing synergies 3523 1124 2820No output-restricting ASA bilaterals 1578 436 1092

Total 5101 1560 3912

Ideas favoring state ownership

• Benefits go to the state not limited number of share holders• Need not just following profit motive• No foreign influence• Can be used to influence other sectors or for macro economic

management• Less uncertain than the private sector• Have access to government funds for investment• Can exploit economies of scale• Coordination with other sector and demonstration effects in

“indicative planning”

Assumptions of state ownership

• There is no capture of the system• There are incentives for static and dynamic efficiency• That size does not affect ability to manage• That there is no day-to-day political interference• That suitable management is available

Competition for the market

• Tendering for the services– Radio bandwaves

– Bus services

– Hospital services

– Social air services

– Airports

• Use of auctions– Defining the ‘product’

– Method of auctioning

– Problem of auction ‘capture’

– Cheating

State ownership

• Military (“public good”)

• Political cohesion

• Merit goods

• “Need”

• Effective way of controlling externalities

• “Commanding heights of industry”

• Effective way of controlling monopoly power

• Macro-economic Keynesian policy

• Capture of processes by administration

Evidence on state ownership

• Problems in setting objectives• Uneven flow of investment funds• Significant inert areas in management• Scale makes effective management difficult• Difficulty of getting “close” to customers• Repeated political interference• Difficulties of retracting services/output

Movements to privatization in 1980s

• Academic findings– Rampant inefficiency (econometric work, e.g on US airlines)

– Technological inertia (also knock-on effects to other industries)

– Capture by labor and by officials

– Inability to compete international

• Issues “Stagflation” (inflation and high unemployment)• Ideas of “balanced budget” in macroeconomics• Manifest failures of the Soviet style economies• Revenues could be large from selling enterprises

Approaches to UK privatization

Good Prospects Poor Prospects

Airlines BusesCompetitive Telecommunications Ports

Electricity generation Post office

Airports Rail trackMonopoly Water Railways

Electicity distributionGas

Nature of air navigation systems

• Intermediate product used by an intermediate producer

• Almost exclusively private good features (rival and excludable)

• Several elements (route control, tower control)• Economies of scale (network economies)• Some monopsony elements of supply (labor)• Technologically progressive• Social issues (safety, environment, security, “need”)

Ownership features of the air navigation service providers

Country Ownership

Australia 1995 Government corporationCanada 1996 Not-for-profit private corporationFrance 2003 State departmentGermany 1993 Deutsche Flugsicherung GmbHIreland 1993 Government corporationNetherlands 1993 Government agencyNew Zealand 1987 Government corporationSouth Africa 1996 Not-for-profit joint-stock corporationSwitzerland 2001 Not-for-profit joint-stock corporationUnited Kingdom 2004 Public/private partnershipUnited States 1953 State department

Regulation features of the air navigation service providers

Country Rate Regulation Safety

Australia Commission oversight Separate agencyCanada Legislated principles/appeals Separate agencyFrance Approved by transport ministry Internal but separateGermany Approved by transport ministry InternalIreland Regulatory commission Internal but separateNetherlands Approved by transport ministry Transport ministry/separateNew Zealand Self-regulating Separate agencySouth Africa Transport ministry committee Separate agencySwitzerland Approved by transport ministry Separate agencyUnited Kingdom Price capping Separate agencyUnited States Financing from taxation Internal but separate

Annual ANS provider costs by instrument

flight rules movements

60

70

80

90

100

110

120

130

140

150

1997 1998 1999 2000 2001 2002 2003 2004

Year

Fir

st y

ear

of d

ata

= 1

00

SkyGuide

NATS U.K.

Airservices AustraliaIrish Aviation

Airways NZ

DSNADFS

LVNL

South AfricaFAA

NAV Canada

Air traffic controllers pay including overtime (2004 prices)

90

100

110

120

130

140

150

1997 1998 1999 2000 2001 2002 2003 2004

Year

Nor

mal

ized

, fir

st y

ear

of d

ata

= 1

00

SkyGuide

NATS U.K.

Irish Aviation

DFS

LVNL

South Africa

FAA

NAV Canada

Trends in the number of air traffic control staff

60

70

80

90

100

110

120

130

140

150

160

1997 1998 1999 2000 2001 2002 2003 2004

Year

Firs

t yea

r of

dat

a =

100

SkyGuide

NATS U.K.

Airservices Australia

Irish Aviation

Airways NZDSNA

DFS

LVNL

South Africa

FAANAV Canada

Flights controlled under instrument flight rules

80

90

100

110

120

130

140

150

160

170

1997 1998 1999 2000 2001 2002 2003 2004

Year

Fir

st y

ear

of d

ata

= 1

00

SkyGuideNATS U.K.

Airservices AustraliaIrish AviationAirservices NZ

DSNADFS

LVNLSouth AfricaFAA

NAV Canada

En route unit rates

50

60

70

80

90

100

110

120

130

140

1997 1998 1999 2000 2001 2002 2003 2004

Year

Fir

st y

ear

of d

ata

= 1

00

SkyGuide

NATS U.K.

Airservices Australia

Irish Aviation

Airways NZ

DSNA

DFSLVNL

Air traffic management induced delays (minutes per flight)

0

50

100

150

200

250

300

350

1997 1998 1999 2000 2001 2002 2003 2004

Year

Fir

st y

ear

of d

ata

= 1

00 SkyGuide

NATS U.K.

DSNA

DFS

FAA

Number of serious air traffic management safety incidents (approxes)

-50

0

50

100

150

200

250

300

1997 1998 1999 2000 2001 2002 2003 2004

Year

Fir

st y

ear

of d

ata

= 1

00

SkyGuideNATS U.K.Airservices AustraliaIrish AviationAirways NZDSNADFSLVNLSouth AfricaNAV Canada