Airline Economics and Deregulation Part 4

A fair fare would probably be identified by most people as an air fare that accounts for the true costs of flying from point A to point B non-stop using the right aircraft to supply the capacity.  As a matter of fact, that was what the Civil Aeronautics Board tried to adjudicate when setting fares. 

 

Now, such a model might sound familiar.  It sounds like what LCC carriers such as Southwest Airlines and Airtran do.  In many sense, yes it is.   Legacy carriers, focused on hubs, hurt themselves with those hubs every time they carry a connecting passenger.   The hub and spoke system demands that they carry more passengers a farther distance using more resources and economies of scale no longer allow them to make a profit doing so. 

 

Let’s use as an example travel from Midland / Odessa to Albuquerque.   You have 3 basic choices for travel in this scenario.  You can fly Southwest Airlines non-stop for about $260 round trip or you can choose another carrier for a non-direct, connecting route that starts at about $550 round trip.   Another carrier might be American Airlines, Continental Airlines or Delta Airlines. 

 

If you choose American Airlines, you’ll fly EAST to DFW and then WEST again to ABQ and it will take  . . . wait for it . . . from 4.5 to 6.5 hours to complete your travel.  Since you are connecting via DFW, you’ll be making two take-offs and two landings and one of those landings (remember, part of an airline’s cost is a landing fee) will be at a major hub airport.  Take offs are expensive too.  They are the part of the flight that consumes the most fuel so two take-offs is bad.

 

If you fly Continental Airlines, you’ll connect through IAH (Houston) and the economics are the same but the distance flown is even greater.   If you fly Delta, you’ll first fly to Houston and then to Dallas and then to ABQ and your price will be in excess of $1000 round trip.  By the way, your total travel time using Delta will be over 10 hours.

 

Now, if American Airlines or Continental Airlines (let’s just leave Delta out of this because such a scenario is absurd) want to compete for the passengers traveling from Odessa to Albuquerque, they have to offer a fare that is somewhat competitive.  If they do, they’ll come at least close to matching Southwest’s fare of about $300 and that means that their costs are higher and they make less profit or no profit.   Since Southwest has the lowest costs, they get to set the price. 

 

Now, some people such as Robert Crandall advocate re-regulation of fares in some form.  In a speech to the Wings Club in June 2008, Mr. Crandall offered that this might take the form of mandating a “minimum fare” that is the sum of “locals”.   What he suggests is that a fare between two cities that connects via a hub should be the sum of the fare(s) between Point A to Point B (a hub) and Point B (a hub still) to Point C (the final destination.  In the alternative, he suggests that flights that connect via a hub be required to have a “connection” charge.  His goal is to remove any incentives airlines might have at present for operating a hub.  It becomes officially un-economic to fly that route via a hub.

 

Quite honestly, I find that a poor solution since he proposes to disrupt the systems of the very airlines that his solution purports to help in the long term.  It disrupts a 30 year institution among legacy carriers and assumes the staff and leadership who have operated in such a manner to be able to adjust to a new model that they have no experience with.  It is, at best, a very awkward solution to the problem and only addresses revenues (once again) instead of the whole equation.  Even more important, it is hard to imagine the political will required for such a change.

 

No doubt the adjustments have to be made and I would suggest that might need to take the form of actually allowing a large legacy carrier to go out of business (which then removes some barriers to entry for other, more efficient carriers) or you have to find a way to reasonably deregulate costs so that airlines no longer must use hubs to fight for their very existence.  Those costs are principally labor.  The latter solution is better (both in the short and long terms) because it doesn’t necessarily involve massive unemployment or relocation for employees. 

 

An airline needs to be able to efficiently locate staff at various “base” cities in a way in which costs are not concentrated in one particular city because it is merely a popular place to live.  You don’t want all of your high cost employees (i.e. the senior staff) to locate themselves in Miami where much of your traffic might be low yield leisure travel.   Second, an airline needs to be able to competitively bid for staff on an open market.   A seniority system as used by airline unions ties staff to one airline and forces the airline to “wait out” their term of employment (as much as 40 years) until they can hire new, lower cost staff to fill a particular position.  Further, it denies them access to qualified personnel for expansion because staff won’t leave another airline for a new job because they don’t want to start out at the bottom of the seniority list.

 

If we deregulated (by legislation) the seniority system in airlines as a first start, airlines could suddenly re-allocate labor and gain more productivity and reduce their costs on routes where necessary.   For a first round, you could even leave in a seniority system for earning pay and determining furloughs but just remove the seniority system as it pertains to bidding for line routes and it would allow the airline to locate their labor (by cost) where they most needed it and gain more productivity.  That change alone might well serve to offer legacy carriers a legitimate opportunity to earn a profit regularly (with all other things being operated effectively).  It would at least be a good first step in trying to solve the problem.

2 Responses to “Airline Economics and Deregulation Part 4”

  1. Thank you for this very insightful analysis. I would love to see the the end of the seniority system.
    Although I have been reading Terry Maxon’s blog religiously to follow the AMR bankruptcy case I just discovered yours. It is hard to find a good aviation blog where opinions are given.
    I am a 40 year old flight instructor thinking of taking the airline plunge but it is a tough sale for my wife and myself. I am sure you understand why…
    There is one type of information I find very hard to come by: the new aircraft orders and delivery schedules. This information would be very telling as to where the industry is going. Specifically, will American Eagle get 70 to 90 passenger jets anytime soon?
    I will be reading, thank you for your work.

    Nicolas

  2. Nicolas, in many ways I can’t think of a better time in the past 30 years to enter the US airline industry. The models have changed, the businesses (in most cases) have been re-set and a person does know what they’re getting into. I think that the anger that we see in long term employees is that they entered in a different era of the airline industry. A time when it was post-deregulation and not a single airline knew what to do. Labor circumstances followed a pre-deregulation model.

    Almost all of that has changed. You do have some certainty going forward. No, it isn’t the glory days of a Braniff captain earning $200K / year in 1978. That was crazy by any standard then or now. But it’s an interesting career still and one that still pays quite well after a bit of seniority is gained.

    Consolidation is (mostly) over and what little remains should be concluded shortly. If you think that 2 behemoths such as Delta and United will be allowed to combine, well, no, they won’t.

    The only area of dysfunction left is in the regionals. That’s where I think there is still some strife and some hard times coming. In some ways, the original reasons for regionals has evaporated (cost advantages) and the new reasons (flexibility) aren’t addressed well by the regional industry. Not yet anyway. Those businesses have to find a sustainable business model and start change within their own organizations. Their problems really aren’t labor costs nearly so much as it is a revenue problem. There will be some consolidation and regionals will shrink some but they’ve got to find a revenue solution with the airlines they serve. I suspect that is at least 5 years down the road.

    Do I think American Eagle will fly larger jets? Yes, I absolutely do. Is it a pathway into a major airline? I honestly don’t know. I suspect that jumping from regionals to majors is going to get harder, not easier. I think those who want to be in the business with a major would do better to try to enter a major as quickly as possible rather than building 10 years of experience at regionals.

    Regionals are a valid stepping stone but not a place to establish a career. Treated as such, they’re fine. But I see a lot of regional pilots getting too comfortable at those airlines and staying past the moment of opportunity to start working for a major airline.

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