Thursday, June 5, 2008

Uh-Oh, Airline Re-regulation?

With jet fuel prices soaring and almost nothing left for airlines to cut (removing the seats altogether appears to have been too much for the FAA), it looks like it’s routes and jobs under the knife now. United announced substantial cuts earlier this week, grounding its 737 fleet, following previous moves by American some two weeks ago, and Continental is following with plans to cut routes and jobs as well. Expect similar moves from other US and international carriers in the near future. United has announced it will shed roughly 15% of its domestic seats on offer and American and Continental are in a similar range. Airline analysts have long talked about the need for domestic carriers to drop nearly 20% total seats on offer to regain profitability, so further cuts could be in order. So far, going back to Delta’s cuts at the end of 2007, most carriers have cut in the 12% - 15% range, but with fuel costs up over 80% in the last year, those cuts are likely to be seen as insufficient.

Despite the economic downturn/recession, demand for flights remains high, at this time. This means one thing. Expect rising fares on remaining routes. Of course should these fare increases work in tandem with further recession, we may see falling demand at some time in the future. That of course may lead to further route cuts, getting to a point where we have very limited service and high expense on a number of routes. But wait, we’ve been there before. Thirty years ago de-regulation was promoted to increase competitiveness in the industry and produce increased service and lower prices. Now after thirty years, and the coming and going of some 200 airlines in the US, the question of regulation is again under discussion.

Is it more regulation or less regulation that is needed to pull the airlines out of their slump? There’s definitely room for debate. On the one hand, deregulation did spur competition and lead to increased airline capacity and lower prices. This was undoubtedly good for consumers. Unfortunately, a lot of short-lived, predatory competitors emerged under de-regulation, rising on the scene under-capitalized, extracting fairly painful concessions from unions with a promise of a brighter future, slashing prices to generate passenger trial (and drive those stock prices up in the short term), and then going out with a whimper after being unable to sustain operations at rock-bottom prices. In the meantime, they succeeded in slashing total industry profitability and causing real pain at the major domestic carriers. If you think about it, have the US carriers ever been “well” since the so-called crisis of the First Gulf War? Of course, one of the major complaints inside the industry is over the 25% limit on ownership by foreign interests of domestic airlines. There is a view that these limits have diminished investment in the industry and contributed to the death by a thousand cuts inflicted by the small-cap, fly-by-night (had to work that in there somehow) come-and-go airlines.

“Limited re-regulation is the only long-term solution for an industry that is continually seeking government assistance," Robert Roach Jr., an executive with the International Association of Machinists and Aerospace Workers, said at a recent Senate Commerce Committee hearing on the state of the airline industry. James Little, international president of the Transport Workers Union of America, believes that to save the faltering airline industry, "I think the time has come for some kind of re-regulation… For labor, we need some kind of transition program, so that pension plans can be saved if there are mergers and acquisitions." With employees having born a substantial cost in the fight for competitiveness over the last decade, this call for some form of “re-regulation” will come as no surprise. Certainly few would argue that while de-regulation brought with it more flights at cheaper rates, it also brought diminished in-flight service and, overall, a less pleasant flying experience.

But hold on a minute. What is it that people want? Lot’s of cheap flights with admittedly Aeroflot levels of service, or fewer, more expensive flights pitched more at the Singapore Airlines level of service? Obviously what consumers want are cheap flights with fantastic amenities, but recognizing that this scenario is unrealistic, the answer is that what the country wants is lots of cheap flights. And in the post de-regulation era, that’s what it got. The result was a massive expansion in airline travel by Americans. According to the Bureau of Transport Statistics (please see last week’s Blog), in 1977, people paid for 149.5 million flights on US domestic airlines. In 2007, that number was 769 million. That growth (five times as many domestic seats sold in 2007) cannot be accounted for by population growth – or growth in corporate travel budgets. The fact is that America got what it wanted: cheap flights. The price it paid was horrible service, massive congestion, under-investment in infrastructure, and vicious competition.

The industry itself is not convinced that re-regulation is an answer, although government measures to limit competition under any other name would be most welcome. They would love to see higher barriers to entry for new airlines (diminishing the number of one route wonders that slash major carrier profits before disappearing in a Chapter 11 cloud), and would likely welcome measures that effectively establish minimum prices on certain less profitable routes (provided it isn’t actually called price controls). But mostly one hears about more deregulation: a freeze on government fees (have you looked at the fees and taxes section of you airfare lately – there’s a healthy tax-farming business afoot if nothing else); a reduction in fuel taxes (unlike the average motorist, a break on Avgas would add up); easing competition rules on airline M&As, and most of all; the removal of the 25% limit on foreign ownership of US airlines.

It is a point well made. There is virtually no other sector of the US economy in which this limit on foreign direct investment exists, certainly not one as mundane as cattle carting. The fact is that that sometime in the next year or so, Emirates Airlines of Dubai will become the world’s largest passenger carrier. Look at booked sales for Boeing and Airbus – the Middle East and Southeast Asia are leading the charts. If consolidation of the domestic industry is generally seen as a bad idea, then direct foreign investment or acquisition is the likely answer. There really are no legitimate security concerns and, before screaming blue murder, the unions should consider that most European airlines are used to much more costly deals with labor than the US unions can even imagine.

Predictably, the Bleeding Heart and Bloated Plutocrat had strong and widely variant views on the matter. “De-regulation was just another excess of the 80s. We saw the folly of big hair, shoulder pads, and Boy George, why can’t we accept that airline deregulation was a Gordon Gecko fantasy gone wild. The unions have been bled dry by successive agreements that saw them paying for bad corporate planning. With the fuel crisis and economic downturn, it’s time to reestablish a regulatory framework for the airlines that will ensure good service for consumers, better safety, and decent wages for airline employees”, said the Bleeding Heart. “Well, I’m torn”, noted the Bloated Plutocrat. “I’d love to get rid of all the commoners who fly and return to the days when flying was an enjoyable experience for the select few that could afford it. But it won’t happen. There’s no turning back the clock. All we’ll end up with is an inefficient, slightly expensive system in which large people in clothes that are too small for them continue to fly. No. Open the doors to foreign investment. When Singapore and Emirates are operating the New York – LA route, we’ll at least have a jolly good First Class service!”

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