Airline Competition 1980-2010 R.I.P.
Part 1 : Economic theory and
background to airline competition
How is it that we're being told, every time airlines
link together to form another airline alliance, that this
competition is good for us when economic theory generally
says the opposite?
Part one of a series on airline competition
- see extra articles listed in the right hand column.
Air travel has steadily grown
in the almost 100 years the industry has existed. More and
more people are flying to more and more places, and more
There are more planes in the
air, more airports, and more most other things to do with air
travel than ever before.
But there's one notable
exception to this growth. Although this seems entirely
counter-intuitive, the number of different independent airlines
and/or airline groups is steadily reducing and reducing.
Even more seriously, the
massive monolithic airline alliances now make it close to
impossible for new non-aligned carriers to compete. So how
exactly are we, the traveling public, benefitting from the US
Department of Transportation's grants of anti-trust immunity to
the airline alliances?
Regulation, De-regulation, and
now Regulatory Immunity
The last thirty years or so
has seen a trend away from over regulation, ending up now not
only with almost no regulation but with the other extreme - immunity
from existing regulatory controls that broadly apply to most
other types of businesses.
Timeline - why 1980
The heading of
this article mixes together two not completely related events,
both of which have vague rather than exact timings.
We've chosen 1980 to mark
the start of the deregulated airline industry. This
deregulation process commenced on 24 October, 1978 when the Airline Deregulation Act was signed into
law. Its provisions successively deregulated the formerly
rigidly controlled airline industry over the several years that
followed, culminating in the final
demise of the Civil Aeronautics Board in 1985.
You can more or
less pick and choose from various dates between 1978 and 1985 to
choose a date on which the airlines were finally and completely deregulated.
We choose 1980 as a compromise date and as a round figure.
Timeline - why 2010
In setting an end date of 2010 we are referring primarily
to international airlines (including US airlines that fly
internationally) and the services between the US and Europe.
Competition of sorts still exists domestically,
although we've argued in the past that the 'competition' that
exists domestically is more anti-competitive than competitive - see articles listed on the
above left, and in particular 'Is
Airline Competition Always Fair'.
for choosing 2010 as a 'death date' relates to the anointing of
the third of the airline alliances with anti-trust immunity by
the US Department of Transportation, meaning the member
airlines of all three alliances (Skyteam, Star and now Oneworld
too) can work together as closely as they wish with their
fellow alliance members, no longer
competing against the other members of their alliance, and now
'competing' solely against the other two alliances.
We've gone from 50+ airlines
independently and competitively flying across the Atlantic to three major alliances and several
minor unaligned airlines, most notably Virgin Atlantic that now
must struggle to survive.
Less Regulation is Not Always
We are enthusiastic
supporters of the open market. But, and like all other
open market advocates, we recognize the imperfections of the
open market. Adam Smith's famous commentary in 1776 about
the open market having an 'invisible hand' that guides itself is
true in some situations, but false in others. There's an
excellent discussion of the concept
The reality is that,
notwithstanding any fancy corporate mission statements, most
companies are quite correctly most interested in pursuing their
own profit maximization goals and are most motivated to benefit
their shareholders. Sometimes they can achieve such venal
seeming goals without requiring the sacrifice of their lofty
public statements, and sometimes they are willing to make some
sacrifices and compromises as between the often conflicting
requirements of public benefit and private profit.
In most industries and
market places, the factor that most primarily businesses honest,
ethical and fair is the competitive force of other businesses
combined with an informed public that will preferentially choose
those businesses that provide the best products and services, at
the best values, and with the best associated customer service,
support, and overall corporate reputation. This is the
embodiment of Adam Smith's 'invisible hand' concept.
If one company, even if
it is a market leader, starts to move away from acceptable
standards, the market will welcome the establishment of a
'better' competing company and product, and will preferentially
shift their business to this alternate company. We've seen
such trends and shifts in any number of fields of business, from
foodstuffs to computers (both hardware and software) and on to
automobiles and many other examples.
So normally, according to
the free market, there is no need to regulate industry, because
the free market has this 'invisible hand' by which industry self-regulates
But sometimes the invisible hand fails us
Situations requiring regulation
The self regulation concept
starts to fail when certain marketplace conditions are absent.
These include lack of market transparency, lack of market
choice, barriers to entry preventing new enterprises from
competing with established enterprises, and monolithic companies
that will act to squash new competitors.
Which sort of describes the
airline industry, doesn't it.
Recognizing both the
potential and the sometime reality of situations where the
'invisible hand' failed to positively guide the marketplace, and
in response to some very unfair actions of market leaders, the
US created a series of laws in the late 19th and subsequently in
the 20th century to set limits on the behavior of corporations
and to encourage free full and fair competition between
companies of all sizes.
There's a good history and explanation of US antitrust issues
However, showing an
enlightened approach to the marketplace, the legislators
also recognized that a 'one size fits all' approach to regulating the
more obvious, extreme, and detrimental manifestations of
anti-competitive behavior would not always apply fully and
fairly to all situations in all industries. So they
provided processes whereby companies could seek and obtain
exemptions from the standard default provisions of the
anti-trust legislation, usually by application to either the
Federal Trade Commission or the Justice Department.
Exemption for Airlines
In the case of airlines,
such applications and approvals are granted via a formal process
through the Department of Transportation. Antitrust
Immunity was enacted as Section 414 of the Civil Aeronautics Act
of 1938 (52 Stat 1004).
Generally, this was seen as
a logical offshoot of the requirement that airline mergers,
interlocking relationships, and agreements affecting air
transportation be approved by Civil Aeronautics Board. See
sections 408, 409 and 412 of same statute.
It was presumably reasoned
that an industry so tightly regulated and controlled as the
airline industry was back then could not possibly conduct any
monopolistic behavior, and/or that the monopolistic behavior
that was being regulated and sanctioned by the CAB should not
then be susceptible to investigation and prosecution by another
part of the government.
But when the airlines were
deregulated, and the CAB disbanded, the provision to allow
airlines anti-trust exemptions remained. Sure, the
provision was cloaked in high minded terms, and only to be given
for 'good' reasons, but, due to this historical process, the now
unregulated airlines found themselves with their anti-trust
immunity provision carried forward, largely unchanged.
When making an application,
companies have to show that while they are doing something that
on the face of it is anti-competitive, there are reasons why
they are doing this that actually work to either benefit
consumers or at least not to harm them.
The most common line of
reasoning is that allowing a corporation or a group of
corporations to act in a manner which is, on the face of it,
anti-competitive (ie anti-trust) will be a good thing because
the benefits that the company or companies will enjoy from such
behavior will flow through to consumers in the form of better
products/services and lower costs.
In more extreme cases,
companies simply say 'If we don't do this, we'll go out of
business, reducing the competitive pool of companies in the
market - better that we are a little bit uncompetitive than not
there at all'.
But are the claims of
flow-on benefits to consumers real? In the case of airline
applications to the Department of Transportation, we don't know.
In email correspondence, a Department of Transportation
spokesman first said he wasn't sure 'to what extent we can
quantify the benefits of these alliances during their actual
operation' and subsequently made the stunning revelation
The orders in the individual cases will contain discussions
of the anticipated benefits, but we haven’t done the
analysis to quantify specific after-the-fact benefits.
It is relevant also to note
that the 'discussions of anticipated benefits' tend not to be at
all quantified. Nowhere have I seen a statement like 'this
will result in a 10% reduction in average fare levels' - instead
the statements tend to be vague generalizations completely
lacking in specifics.
So it seems no-one is ever
holding the airlines accountable to their claims of consumer
benefits. Does that sound right to you?
Monopolies and Oligopolies
The airlines may act in a
monopolistic manner, and indeed in some particular city pairs
they may even be a true monopoly, but most of the time, they are
oligopolies rather than monopolies.
A monopoly does not
require only one supplier to exist, but simply requires one
supplier to be able to dictate the pricing and other terms of a
market. Other competitors might also be present, but are
so small and insignificant as to be unable to impact on the
market dominance of the one major supplier.
An airline monopoly might be
in a situation where one airline controls perhaps 90% or more of
a given route, with one or two other airlines having a mere 10%,
and all other airlines not adding more capacity, either because
they can not (lack of capacity at airports to handle more
flights) or will not (for whatever reason - perhaps for fear of
getting into a bruising unprofitable fight with the present
In such a case, it doesn't
really matter what the other airlines do in terms of price and
policies, because 90% of all passengers are forced onto the
monopolistic airline just because there are no seats on the
other airline. So the major airline truly can dictate
pricing and everything else.
An oligopoly is a slightly
more interesting situation, where there are a number of major
suppliers, and they act strategically in the market, based on
the anticipation and reality of how the other major suppliers
This is often shown in
airline situations, for example, one airline will announce a
fare increase, then other airlines will choose to copy or not,
then the first airline might then cancel their fare increase if
they don't think enough of the other airlines have copied.
How to determine if a market
is a monopoly or oligopoly
There is a simple (and
simplistic) way to determine if a market might be a monopoly or
oligopoly. This is by determining the market share belong
to the largest firms in the market - what is termed the
'Concentration Ratio'. Usually a four firm concentration
ratio (CR4) is used.
If the four largest firms in
a market have between 80% and 100% of the market, then this
usually means that the market is a monopoly. If the four
largest firms have between 50% and 80% of the market, this
usually means the market is an oligopoly. As the
percentage drops below 50%, the marketplace trends away from
being an oligopoly and getting closer to the nirvana of perfect
The Changing Government
Approach to Regulating Airlines
Initially the government
adopted a regulatory approach to airlines. It willingly
allowed - indeed, it mandated - that the airlines should be
somewhere between oligopolies and monopolies, restricting the
ability of airlines to compete against each other and limiting
the ability of new airlines to enter the market.
This created a complacent
and stable situation where airlines were treated in a manner
similar to utilities. They were given approval for the
routes they operated and the fares they charged, and they
operated on a 'cost plus' type basis that provided little or no
encouragement (or even ability) for them to be cost sensitive or
to add new services and routes.
In the mid 1970s this
structure was becoming increasingly less appropriate, and so
starting from late 1978, the airlines were deregulated in the
hope that open market competition would prove a more effective
method of getting the best mix of products, services, and values
to the traveling public.
Although many people have
criticized deregulation, there can be no doubt that it has been
spectacularly successful. Airfares plunged in cost, and
the American public started to fly in greater and greater
numbers every year. Deregulation, combined with newer
larger better planes opened up air travel to everyone in the US.
But the airline industry is
not a 'perfect' industry (using the economic definition of
perfection here). Perhaps as a carry-over from the
regulated days, the marketplace continued to be distinguished by
a small number of dominant carriers. This, combined with
the capital intensive nature of starting a new airline made it
difficult for new airlines to get established, and the
aggressive tactics adopted by existing carriers to obliterate
new entrants, passively empowered by the US regulatory agencies
that saw no harm in such actions, has meant that while there has
been a massive growth in air travel, there has not been a
matching massive growth in airlines.
A similar loosening of
international airline regulation was expected to lead to a
growth in new airlines and new air services, but this has not
occurred. Rather than empowering and encouraging the many
different international airlines to compete aggressively between
themselves, the airlines have instead used the loosening of
regulation as a way to build monolithic blocs of carriers of
seemingly unassailable size and strength.
These monolithic blocs (they
like to describe themselves by the much more harmless sounding
term 'alliance') are dividing the world and its air routes up
between them in a way that makes it somewhere between difficult
and impossible for new entrants to appear.
They tell us that this is
for our own good, and that by reducing the market from one with
no major dominant airlines to one with three major players and
almost no-one else, this will result in us getting lower
airfares and better services and more flights.
If these claims should be
proven true - and to date, there is not only no evidence of the
truth of these claims, but also a pronounced lack of interest in
pursuing them by our regulatory bodies - then it would be a
unique exception to the fundamental underpinnings of western
free market economic theory.
The Airline Alliances are
Oligopolies if not Monopolies
Remember that the definition
of an oligopoly is a market in which the largest four companies
have between 50% and 80% of the market, and a monopoly is where
the four largest companies have between 80% and 100% of the
Economists rarely view
either monopolies or oligopolies as good things. But by
successively approving request after request, the Dept of
Transportation has created a situation now where three (not four
but three) airline groupings, with each airline grouping acting
as a single unique entity, always control at least 50% of the
market, often control more than 80% of the market, and sometimes
control over 90% of the market.
In future parts of this
series we'll try and establish if this move, allowed by the Dept
of Transportation, is a good thing or a bad thing.
The one measure that implies
airlines are not monopolies
One measure of a
monopolistic (or oligopolistic) market is where the companies
are able to make an above average return on capital and profit.
Clearly, by this measure,
airlines are the most failed of any would-be monopolies.
But the lack of super-profits does not mean that the airlines
are not engaging in monopolistic behaviors, it merely means
that, even with market control and dominance, they still can't
manage their businesses successfully.
The correct response to such
a scenario is not to give them further protection, but instead
to open the market up more fully to newer better more able
competitors. Might not some strong new competition force
the existing airlines to do better, in a much more dramatic
process than would ever occur by allowing the airlines to
perpetuate and expand their current practices and failings?
In simple form, a free
market is self regulating and acts to balance corporate needs
with consumer needs, creating a fair level of win-win to all
But there are a number of
situations where a free market can't act freely. These
situations range from limited supply of resources through to
restrictions on competitors entering the market, through to many
When the free market model
starts to fail, then the balance between corporate and consumer
benefits starts to fail as well, and typically corporations
start to get a disproportionate return on their activities.
One measure of if a market
is open and free and a model of 'Perfect Competition' (an
economic term) is the degree of oligopolistic or monopolistic
dominance of suppliers in the market. Many other measures
By most measures, airlines
are oligopolies or monopolies, and the current trend
to approving airline 'alliances' (or mergers or buyouts) is
making this a near universal scenario.
We are told this is for our
own good. Economic theory disputes this claim, and there
is no actual evidence available to confirm the reality of such promises
Is this, in fact, a massive
failure of the regulators that are supposed to be protecting us
from exactly this type of marketplace situation?
Part of a series on airline competition
- please see extra articles listed at the top
in the right hand column
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5 Mar 2010, last update
19 Dec 2013
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