Safeguards and Sustainability of Air Services

1
Safeguards and Sustainability of Air Services
Protection for Whom, From Whom?

• Dr. Peter P. Belobaba
• Concordia University and MIT
• March 2003

2
Deregulated, Not Fully Competitive Open Markets

• Since US deregulation, pressure for less
  government control over airline markets has
  spread worldwide
• A result of the perceived overall success of US
  deregulation and other experiences in Canada,
  Australia, Europe and elsewhere
• Deregulation has not meant totally free
  competition
• Gave freedom to airlines to choose routes,
  frequencies, and prices in domestic markets with
  less government intervention
• But, operational and safety regulations remain,
  through airline certification, crew training
  requirements, maintenance standards, etc.
• Bilateral agreements still limit access to
  international markets
• Ownership restrictions limit ability of airlines
  to raise foreign capital
• US airlines still required to operate certain
  essential air services
• Other regulations govern CRS/GDS distribution
  channels

3
US Deregulation Experience Generally Positive

• Overall benefits have been clearly demonstrated
• US domestic air travel more than doubled in first
  ten years of deregulation, a growth rate well
  above pre-deregulation times
• Average real (inflation adjusted) air fares
  continue to decline today
• Development of some very successful new low-fare
  carriers, with rapid growth in recent years
  (e.g., Southwest, AirTran, JetBlue)
• No statistical evidence of reduced airline safety
• But some parties have suffered
• Labor unions experienced reduced power, jobs and
  wages
• Greater disparities in fares paid by business and
  leisure travelers
• Small cities saw commuter airlines replace larger
  jets
• Profit volatility and bankruptcies raise
  questions about airline investment and
  sustainability of traditional airline operations

4
Changed Competition Under Deregulation

• The removal of economic regulations has added new
  dimensions to airline competitive strategies
• Cost cutting and productivity improvement
• Economies of scale in operations to reduce unit
  costs
• Price competition and revenue management to
  increase revenues
• New marketing and distribution programs
• Increased network coverage and market dominance
• Quite simply, airline managers now actually have
  to make management decisions and trade-offs
• In contrast to regulated times when government
  control ensured price increases to cover
  increased operating costs.
• Airline management was relatively easy under
  government regulation and subsidization of flag
  carriers

5
The March Towards Global Liberalization

• Overall success of the US experiment has led
  other countries to deregulate domestic airline
  markets
• Australia and Canada were among first to follow
• Japan, Brazil, United Kingdom loosened
  restrictions
• European Union has also moved toward open skies
  
• Although differences exist, many similar impacts
  have been observed in deregulation outside the
  US
• New entrants with lower costs and fares, that
  face stiff competition and potentially predatory
  practices from incumbent airlines
• Potential for volatility and destructive
  competition arises, especially in periods of
  reduced demand and excess capacity
• Recent dramatic shifts in airline industry have
  begun to shift momentum of change to low-cost,
  low-fare new entrants

6
Protection of New Entrant Airlines

• Initial efforts by new entrants to compete were
  in effectively rebuffed by larger incumbent
  airlines
• Incumbents had significant advantages of
  frequency, network coverage, service quality, and
  frequent flyer programs
• Revenue management systems allowed incumbents to
  match new entrants fares while limiting revenue
  dilution, offering better value
• Aggressive responses by incumbents in some cases
  raised questions of unfair competition
• Lower fares and/or increased capacity to drive
  out new entrant
• Potentially predatory actions, subsidized by
  revenues from other parts of incumbents network
• Hoarding of gates and/or slots to prevent new
  entry and growth
• Led to serious policy discussion for
  re-regulation

7
The Remarkable Growth of Low Fare Carriers

• Recent conditions favorable for low-fare
  airlines
• Less business travel overall reduced willingness
  to pay for premium services reduced quality of
  traditional airlines
• More stable demand for price-sensitive leisure
  travel, primarily in high density point-to-point
  markets
• Greater awareness of low-fare options through
  internet channels, and growing acceptance of
  alternative air travel services
• Low-fare carriers now threaten viability of
  traditional network airlines
• Share of US domestic passengers flown by low-fare
  carriers increased to 20 in 2002, from 16 in
  2000 and only 5.5 in 1990
• Largest low-fare carriers increased both capacity
  and traffic in 2002, in sharp contrast to most
  traditional network airlines

8
Who Needs Protection Now?

• In North America and Europe, legacy airlines now
  face unprecedented operating losses
• Major airlines are looking for new business
  models to respond to changed environment and to
  compete with low-fare airlines
• Low-fare competition, combined with Internet
  distribution and inability to support revenue
  differentials mean no pricing structure alone can
  return legacy airlines to profitability
• After 2 decades of deregulation, US Major
  airlines now finally face the reality that their
  cost structures are simply unsustainable in a
  competitive environment
• Protection for new entrants has become moot
• Southwest, JetBlue, RyanAir and EasyJet are among
  most profitable airlines in the world, while
  legacy airlines declare bankruptcy
• Government intervention to protect legacy
  airlines now a possibility

9
When Is Protection Warranted?

• Government intervention to protect airline
  services might be warranted in limited cases
• Sustainability of airlines and assurance of air
  services in developing countries
• Where tourism-supported economies depend on air
  services
• Isolated or remote communities requiring air
  services for movement of population and goods
• Under conditions of catastrophic national/global
  events or war
• Even in these situations, not clear that
  inefficient air carriers should be supported or
  protected
• Government regulations and (even worse) financial
  support inevitably cause market distortions and
  inefficiencies
• In most situations, development of new services,
  by new airlines, with more efficient operating
  models will ultimately fill any void

10
Sustainability, Not Protection of the Status Quo

• Very real need for sustainable air services must
  not be used as an excuse to prolong inefficiency
• Need for national flag carriers, fear of losing
  air services often cited as reasons for
  government protection
• Yet, highly regulated national flag carriers have
  been among the most poorly managed and least
  efficient airlines in the world
• Experiences throughout the world have
  demonstrated how open market conditions
  ultimately lead to sustainability and efficiency
• A balance between effective safeguards and
  unnecessary protection is required
• Recognize that many essential air services can
  and will be provided by more efficient carriers,
  given reduced regulatory constraints
• In nobodys long-term interest to support and
  protect inefficient air carriers emphasis
  should be on sustainability AND efficiency