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  • Airline Competition Has Been Crushed

    Posted by Carl from Chicago on May 16th, 2015 (All posts by )

    If you’ve flown much in the last few years, you’ve probably seen what I’ve experienced, as well – completely full planes, high prices, and aggravating extra charges for baggage, wi-fi, etc… This is really a symptom of what has actually occurred, which is that airlines have finally moved past an era of competition into an era of oligopoly.

    The real indication of their new status isn’t the high prices and full planes – it is in the stock price.

    Here you can see the major carriers which have survived and consolidated the US market – Southwest, American Airlines, Delta, and United / Continental. For years and years the stock prices of major airlines have languished – per Warren Buffet

    He said that a durable competitive advantage in the airline industry “has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down,” he joked. “The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit.”

    Each of the major airlines has predominantly broken their strong unions and taken medicine from bankruptcy to mergers in order to restore their finances. Instead of a focus on expansion, they are operationally focused in terms of filling every seat on every plane at the highest price possible, in terms of ticket costs and extra fees. Today they charge you for every sort of upgrade; “economy plus” which is a seat that you can sit in and get work done, costs extra, as well as for checking bags.

    There is absolutely nothing wrong with a company doing all they can to maximize profits, especially after savaging investors for many years with poor stock prices and a lack of dividends (and the high risk of total financial collapse). The airlines have finally figured out technology as well – if you want to upgrade any element of your flight experience, from business to first class to economy plus to a daily club pass – it is all right there as long as you are willing to give them your credit card number.

    The airlines have also figured out that their frequent flyer programs provide benefits but also can be a millstone. Rather than rewarding miles, they are looking at the prices of the tickets paid by each traveler which rewards those that actually provide the greatest benefits to the airlines. If you’ve tried to actually use your benefits (except for Southwest), you’ll find that seats are very limited and you need to plan far in advance to receive benefits from these perks.

    The airlines received a huge windfall with declining fuel prices. If the industry was in a mode of high competition, you’d expect customer prices to fall as the airlines would be forced to pass on some of these benefits to the consumer since the costs would move closer to their marginal price. However, there has been no sign of price reductions – the airlines aren’t competing with each other (substantially) on price and each of them are going to use this windfall to buy back stock and pay higher dividends.

    Delta Air Lines Inc. said on Wednesday that it plans $6 billion in new stock buybacks and added dividends through 2017, the biggest single cash return to shareholders by an airline and the latest sign of the industry’s unprecedented financial strength. Also Wednesday, Southwest Airlines Co. launched its own $1.5 billion stock-buyback plan and raised its quarterly dividend by 25% to 7.5 cents a share.

    For the consumer, there isn’t a lot of good news in the future. There don’t seem to be any significant domestic competitors coming in to the market, and likely if they did arrive in a single region, the incumbent airline would just drop prices for a while to match and then after the upstart was weakened they’d go back to their old high prices. The only major types of price wars that could be beneficial would occur if the major airlines started to attack their adjacent oligopolists but this doesn’t seem to be in the cards; money that could have been used for this sort of expansion is going back to the shareholders in the form of stock buybacks and dividends rather than on grand expansion plans.

    The long term threats to the US carriers and their dominance of the US market come from the mega foreign carriers based in the Middle East – Emirates Airline, Etihad Airways and Qatar Airways. Unlike the penny pinching, cost focused US airlines, who are now concentrating on earning high profits and returning cash to shareholders, these Arab airlines spend lavishly on expansion and large, spacious airplanes with major amenities. The services offered by these carriers set the standards and once they start competing with US carriers on international routes they likely will offer stiff competition. Since the US airlines do make a lot of their profits on international routes ultimately this may weaken them and open the door to other upstart domestic carriers who could spy an opportunity to pounce.

    You can tell how serious the competition is because US carriers are already saying that “unfair” subsidies by foreign governments means that they should not be allowed to compete on US routes. They even brought in the Chicago mayor (you’d think that he has better things to do with our debt being rated as “junk”) to pipe in here.

    “We echo Mayor Emanuel in urging the Obama administration to take all necessary steps — including a freeze on new routes by the Gulf carriers while consultations proceed — to ensure that the open-skies agreements our nation has entered into are being complied with by all participating parties. Hundreds of thousands of middle-class airline employees who work hard and play by the rules expect our country’s trading partners to do the same. Our livelihoods depend on it.”

    There you have it! The billions that are being returned to stockholders and high dividends, along with being crushed in a tiny seat and paying for every single amenity by the drop – that’s the “American way” and it all goes to support middle-class families apparently. Meanwhile these foreign carriers, trying to encourage passengers with new planes and amenities like high quality, comfortable service, should not be given entry to the US market.

    Another sign of a comfortable oligopoly is using the political process to preserve market share rather than competing on traditional elements of price and quality. This is a fine example of the former, not the latter.

    Whatever thoughts you may have about the US airline industry, think again. Instead of being a competitive market ruled by expansionist companies, you have a cozy market with little competition where windfalls like low fuel prices and low interest rates (which help a capital intensive industry) will remain with the companies, not be passed on to consumers. And their long term threats aren’t US competitors, but foreign competition similar to those that ultimately upended US industries from autos to clothing to toys.

    Cross posted at LITGM

     

    12 Responses to “Airline Competition Has Been Crushed”

    1. DirtyJobsGuy Says:

      I work in the Electric power generation business and my clients see the same environment. High Capital investments, big fuel cost role and very little to differentiate your product from a competitors. The only difference is that your power plants are fixed to one spot. You live or die by total demand and your ability to sit out low markets. Right now air travel is reasonably robust, the airlines have invested in new aircraft and rationalized their work forces. But if demand goes down can you keep “filling the planes to capacity”? Yes you can drop flights, but do you then furlough staff? Tough for a heavily licensed/credentialed workforce. Do you sell aircraft into a depressed market. Delta has taken the approach of buying older planes for shorter domestic flights (old MD-90’s and B717s) to reduce this risk. I think the unions know this risk as well. On several recent flights the Captain has made a special thank you visit to the business class section and it was not totally corporate speak. US Union pilots still live or die by seniority at their current airline, so they could lose a lot if they had to switch.

      The international long haul guys like Emirates pay the same prices for fuel and planes as anyone else, but they have cheap cabin staff. Their pilots are also contract types working in a more open market. Note that the Euro carriers like Lufthansa/Air France/BA have the same beefs with the Gulf boys.

      One last note, in our engineering office I have to retrain the younger staff from focusing on raw ticket price when making reservations. It’s nice they are conscious of costs to the firm, but it takes time to have them look at total price (baggage, rebooking fees etc) and value (schedule, risk of delays in that route). The airlines customers still focus on the base price of the ticket on the web, not their total costs.

    2. Mike K Says:

      I have largely quit flying much the past few years. This year, I will go to South Carolina on Southwest and to Greece on British Airways. A few years ago when I was going to Europe more, I flew Air France business class which had a relatively low price advance purchase program. The same ticket to Paris on American was $10,000 and Air France was $7,000 for two.

      Anyway, I am living on a lower scale these days so will mostly stay home. Long flights are a concern. Nothing like a stroke and an MI to curtail travel.

    3. David Foster Says:

      So, what is the business model and/or technology that will sooner or later disrupt the airline industry and do bad things to the incumbent operators?

    4. dearieme Says:

      A young family member tells me that Emirates are fine to fly with. Whether they are as good as Singapore Airlines I don’t know. Said youngster complains about the standards of service when he flies within the US, or across the Atlantic with a US carrier (which he avoids whenever he can).

      We flew Ethiopian Airways once. We dined out on the story for several years.

    5. Carl from Chicago Says:

      I think the disruptive forces are these Arab carriers. They are staffed and run by western experts and have high standards of service. I know some of the individuals that they’ve recruited and they are high caliber. They also have a lot of funding and an expansionist zeal.

      The US carriers are ripe for disruption and not investing in service or anything to make people more loyal. When a better option arrives, customers will gladly flee. It will be like the US cars in the 1980’s when Japan started kicking our rear.

      The fact that they are choosing regulatory barriers rather than planning to respond to the competitive threat on the basis or price or service tells me all I need to know.

      This may be a good strategy, however. The US may be able to protect them for a pretty long time. In that era investors will likely do well. This is the “castle and moat” strategy.

      They’ve tried expansion and competition in the past and it has been disastrous, for the investors for certain.

    6. Robert Schwartz Says:

      The idea of Arab run airlines being allowed free access to American airspace strikes me as suicidal lunacy. Call me back when the jihad is over on that one.

    7. Mike K Says:

      “The idea of Arab run airlines being allowed free access to American airspace strikes me as suicidal lunacy”

      I flew Royal Jordanian Airlines to Vienna in 1988 as they had the only non-stop service. It was interesting. The security was like I imagine El Al is. A guy searched all our carry-on luggage, then boarded the plane with us and flew to Jordan. The food was good; the movies a bit weird. When we landed in Vienna, we did not go to the terminal as our party of four was the only one getting off. They wheeled up a staircase and we got off. The rest flew on to Jordan after refueling.

    8. Veryretired Says:

      Flying is the modern version of Greyhound bus travel of the 1940’s or 50’s. The idea that it is somehow special or exotic has long been passe’, and comfort is no longer a significant issue with the airlines except for higher priced business/first class passengers.

      We fly Spirit almost exclusively now because of significant price advantages, but that’s also because we don’t normally have any checked luggage, and we bring our own lunch.

      If I had to guess, I might see some computer driven vehicles as possible competition in the future, especially if they were larger, more luxurious vehicles that could go for days at a time with few stops. The key element other than cost is always time, especially for a family on a vacation. When you have a week to take the kids to Disney world, extra travel time is critical.

      I can imagine computer flown vehicles, but can’t see how the price issue could be solved for ordinary family travel on any normal middle class budget. Some form of new fuel would be the enabling factor there, I suppose.

      I don’t foresee any Mideast airline being able to win over American travelers given the current hostile climate between the two cultures. As for governmental interference, I doubt that can be eliminated except as part of a broader-based reduction in state activity in general. And that will do nothing as far as foreign subsidies and/or market barriers are concerned.

    9. Parallel Says:

      Who cares about amenities? With my iPad I can have any number of books or music albums or movies. Good riddance to Skymall; as it turns out their whole business model was based on a captive audience waiting until their electronic devices could be turned back on. Just get me from place to plance and leave me alone in the process.

    10. Jonathan Says:

      American carriers receive direct subsidies in some cases. The AMR terminal at Miami International Airport, for example, cost something like $400 million that came mainly from taxpayers and municipal bond buyers.

      There is room for land-based competition on shorter routes. This is an area that should be helped by the introduction of automated cars and busses.

      The best thing that could happen for travelers, obviously, would be the opening of US markets to foreign competitors, but this seems politically unlikely unless something changes.

    11. Richard Says:

      Understand, oligopolistic markets are characterized by “rivalry” among the participants — not competition.

      Anything approaching — real economic — competition is muted and disciplined by a conscious parallelism among the few firms in the relevant market.

    12. tireddog Says:

      Re: fuel costs; when oil begins its unavoidable climb airline prices will surge again. Domestic carriers will never eat a penny of increasing costs.
      Domestics are on a bpo jihad. Near term goals include offshoring all back office functions to 3rd world paradises such as Manila and Bombay. Remaining corporate staff will be a small cadre of ‘managers’ to oversee all that 3rd world mba talent answering phones, paying the (for now) directly employed flt crews and doing ‘strategic business planning’.
      UA has just advertised for local direct hire planning ‘talent’ in Bombay, no expats need apply, fluency in Hindi required.
      If I had a creative bent I’d form up ‘Pilots r Us’, and ‘Cabin Crew on Call’ and drive the last nails in the coffins of US citizen employment at US flagged carriers. Better to make it a quick death than to draw it out, because just like manufacturing, the domestic carriers have tossed their employees into a race they cannot win.