Risky Flight-Path

Dec. 21, 2004
Big airlines are on a collision course with Washington and corporate America.

If U.S. airlines needed any more proof that corporate America is fed up with the state of the nations airways, they got it on June 17. Thats the day that two of Americas Big Three automakers agreed to throw a portion of their travel business to a tiny Detroit-based airline named Pro Air. Under the separately negotiated five-year agreements, Pro Air became a "preferred airline" of General Motors Corp. and Chrysler Corp. Officials at the companies would not divulge many details of the program, but Pro Air President and COO Craig Belmondo says the companies each will pay a flat monthly fee in return for "unlimited business-travel access." Chrysler spokesperson Rocki Rockingham says that the company expects to save $1 million to $3 million annually through the agreement. GMs Peter Rowe puts the automakers savings at $6 million a year. The deal is a pat on the back for the scrappy upstart that flies to four cities out of Detroits in-town airport and a slap at Northwest Airlines, the fourth largest airline in the U.S. and the dominant carrier at Detroits main airport, Metropolitan. The agreement also marks the latest salvo in an escalating dispute between Americas big airlines and the companies that depend on them for travel. Companies have long criticized the major hub-and-spoke carriers -- American, Continental, Delta, Northwest, TWA, United, and US Airways -- for their pricing policies. Specifically, business is upset because leisure customers who make their reservations in advance and will agree to a Saturday night stay-over get lower fares, while business flyers with less flexibility pay hundreds of dollars more. Monthly bulletins from American Express Travel Related Services that show steady increases in "typical business fares" provide ammunition to corporations. Such fares rose 16% in 1997 compared with 1996 and were up another 5% in March. Kevin Mitchell, chairman of the Business Travel Coalition, is lobbying Washington and airlines on behalf of companies seeking to change the current fare structure. One problem, he says, is a lack of new competitors at "fortress" hubs such as Detroit, Atlanta, Denver, and Dallas/Ft. Worth that are dominated by one carrier. Mitchell believes that throwing more business to small airlines such as Pro Air is one way to challenge the big guys hegemony. Airlines dont dispute that they charge more for business tickets, but they argue that much of the outrage is based on misleading or incomplete data. Granted, unrestricted fares are up an average of 3.1% per year, or about 23% since 1990, but airlines point out that almost nobody pays full fare anymore, not even business flyers. In fact, the "typical unrestricted" fares tracked by American Express represent only about 6% of all airplane tickets sold in the U.S. last year, while the average ticket price rose less than half a percentage point compared with 1996, according to airline data. Moreover, carriers argue that seats are not priced the same because they do not cost the same. Business travelers want to fly during the heaviest travel times of the day and week. Since capacity is fixed by airplane size, airlines cannot shrink or add seats. Instead, they use price to manage demand, offering cheaper fares to encourage discretionary travelers to fly during off-peak times. Business travelers also tend to travel on shorter notice. To ensure that space always will be available, airlines charge higher prices for some seats. This reflects not only the greater value a corporate flier places on that seat, but also the risk to the airline that that seat will go unsold. Airlines point out that even at a time of record air travel demand, 30% of airline seats go unsold, and every empty seat represents a permanent loss of revenue. As United Airlines Chairman and CEO Gerald Greenwald explained recently, "Business travelers pay more because of the convenience and flexibility they demand. We fill our seats with people who can make a long-term commitment to us that theyll take that seat on that plane for the trip at that time. And simple economics dictates that we have to charge more to make sure seats are available to the people who cannot give us that commitment." Lately, this war of words has moved to Washington where lawmakers and federal regulators are debating a number of related issues, including:

  • Whether fares at fortress hubs are too high.
  • Whether air service to small and medium-sized communities has deteriorated.
  • Whether the major airlines are using their size and marketing muscle to crush fledgling airlines such as Pro Air.
This last issue, in particular, has become a cause clbre at the Dept. of Transportation (DOT), which believes low-fare carriers "are the key to the competitive vigor of the U.S. domestic airline industry," in the words of Patrick Murphy, a senior DOT official. The DOT recently proposed a competition policy statement aimed at protecting them by punishing major airlines with fines and other penalties if they play too rough against the small airlines. The statement takes specific aim at a tactic favored by incumbents when dealing with unwanted entry into their markets: matching the entrants lowest discount fares and adding seats until the upstart is driven off. New entrant carriers, some members of Congress, and some in private industry welcome the proposed statement. But it has stirred up a hornets nest of opposition as well. Surprisingly, much of the criticism comes from the very constituencies DOT says it wants to protect, in particular, consumer groups. Both the Aviation Consumer Action Project and the National Consumers League have warned that the policy will lead "to higher not lower fares," because big airlines will be afraid to offer cheap seats, for fear of drawing the ire of federal regulators. This is the position taken by established airlines and their trade group, the Air Transport Assn. of America (ATA), which claims that DOT would harm "those who most depend on low fares: families, seniors, students, and others." Small communities, including Chattanooga, Tenn., and Fort Smith, Ark., and their elected representatives in Washington, also have weighed in against the rules, arguing that their travel options will be diminished by the policy. Even worse, ATA and others see this as the first step down the road toward re-regulation of the airline industry. Sen. John Ashcroft (R, Mo.) warned in a letter to Transportation Secretary Rodney Slater that "by imposing ambiguous pricing and service guidelines the [DOT] would reverse course and unnecessarily tinker with the free market." Darryl Jenkins, director, the Aviation Institute, George Washington University, says "DOTs new policy would accomplish exactly what Congress and the country left behind 20 years ago -- a regulatory quagmire." He and others point to an obvious paradox: If ticket prices are too high and competition is too weak, why are record numbers of passengers getting on airplanes every day, and why has the average price of a ticket, indexed to inflation, fallen nearly 40% since the industry was deregulated in 1978? Furthermore, if airlines are guilty of using their market power to overcharge for tickets, why do they earn so little compared with other industries? As Credit Suisse First Boston analyst Thomas S. Schreier Jr. observed in a recent report: "If airlines are monopolists, they are the worst sort -- unsuccessful ones." These responses do not satisfy the regulators at DOT or Rep. Louise Slaughter (D, N.Y.) and Rep. James Oberstar (D, Minn.). Slaughter, Oberstar, and others are angry that major airlines succeeded in adding language in pending aviation legislation calling for more study before DOT issues a final policy statement. Oberstar recently warned: "If you think this is re-regulation, you aint seen nothing yet." Indeed, even as airlines strive to delay or defuse DOTs proposed policy statement, Congress is besieged by special interest groups to take action to cure this or that perceived ill of airline deregulation. Yet a cooler look would reveal that the airline industry functions far more efficiently than it did 20 years ago. Isolated problems may exist, but critics at DOT, in Congress, and corporate America have fallen into the trap of holding the industry up to a "laboratory" standard of competition rarely achieved in the real world, rather than measuring it against how it would function if the government were still telling airlines where and when they could fly and how much they could charge for a seat. For example, fares to and from concentrated hubs may be somewhat higher than at less-concentrated airports. However, the "hub premium is so small, relative to the fare reductions from deregulation, that travelers still pay less than they would have under regulation," says Clifford Winston of the prestigious Washington-based think tank, the Brookings Institution. Winston, coauthor of The Evolution of the Airline Industry (1995, Brookings Institution), recently warned that "its premature to conclude that you can fix the abuses without doing greater damage to a broadly competitive system." New-entrant airlines are few and far between, but the average number of competitors per route is up more than 30% since 1977, says Winstons coauthor, Steven A. Morrison, a professor of economics at Northeastern University, Boston. But neither Washington nor business seems inclined to accept these arguments. Constituents are complaining. The strong economy means airplanes are more crowded than ever. Full cabins make it harder to redeem frequent-flier awards, another sore spot with Americas weary road warriors. In this environment, a seemingly beneficial response from the airlines would be to show more sensitivity to the concerns of their corporate customers and their representatives in Washington. Instead, they have embarked on a flight path that will put them into greater conflict and draw more calls for some kind of re-regulation. Last January Northwest agreed to purchase controlling interest in Continental for about $519 million. The two will coordinate flight schedules and market each others flights as if they were their own in travel-agency reservations systems (code-sharing) while operating as standalone entities with no integration of employees or management. Similar partnerships (although without any exchange of equity) were announced between American and US Airways and between United and Delta last April. Thus, about 82% of the industry will be concentrated among these three groupings. The participants say consumers will benefit from shared frequent-flier programs and the ability to make through connections on different airlines as though they were the same carrier. Competition will not be harmed because the partners will continue to compete even as they sell tickets on each others flights, they claim. Washington is unconvinced. The General Accounting Office recently estimated that a quarter of the traveling public potentially could pay higher ticket prices if these "domestic alliances" occur. Both DOT and the Justice Dept. have pledged to take a hard look at them. Rep. William O. Lipinski (D, Ill.) stated, "I am outright opposed to these mega-alliances." Rep. Oberstar warned they "threaten to reduce competition substantially." Thus, at a time when they need friends in high places to thwart re-regulation, the big airlines may be their own worst enemy. Perry Flint has reported on the commercial airline industry for 14 years. He currently is executive editor of Air Transport World, a Penton Media magazine.

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