The Airline Revolution

Gordon Mills

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781317045304
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

When starting new airlines in response to government deregulation, entrepreneurs in the U.S. and Europe reduced some traditional service qualities (to reduce costs), concentrated on non-stop services between city pairs not already so connected, improved on-time performance, and offered low fares to win leisure travelers from the incumbents and to encourage more travel.

In recent developments, some of the new airlines have offered optional extras (at higher fares) to attract business travelers and entered major routes alongside the legacy carriers. Within both the U.S. and Europe, deregulation removed most geographical barriers to expansion by short-haul airlines. Later, limited deregulation spread to other world regions, where many short-haul routes connect city pairs in different countries, and where governments have retained traditional two-country mechanisms restricting who may fly. To gain access to domestic routes in other countries, some new airlines are setting up affiliate companies in neighboring countries, with each company legally controlled in the country of domicile. With air travel growing strongly, especially in Asia, a common result is intense, but potentially short-lived, competition on major routes. The recent developments give clear signposts to likely mid-term outcomes, and make this an opportune time to report on the new-airline scene.

The Airline Revolution will provide valuable economic analysis of this climate to students, airline professionals advancing to senior positions, public servants and others who provide advice to governments.

Part I New airlines around the world

1 USA and Canada

DOI: 10.4324/9781315612348-3

1.1 Deregulation in the US: the early effects

1.1.1 Airline services before deregulation

For inter-state airline services, regulatory power rested with the US (Federal) government, which had long controlled both route entry and fare levels. During that era, the list of major airlines changed little; and the regulators shaped the route networks of each of the airlines in the ‘club’. In the light of later experience, it is notable that the overall airline network included quite a number of (so-called) ‘milk-runs’: in order to provide service to small cities, a flight commencing at a major port might stop at intermediate ports (sometimes three or four of them) before reaching its destination at another major city. The regulated fare structure also favoured local travel: low fares there were cross-subsidised by the airline’s profits from the mandated high fares on dense, longer routes that provided non-stop service between large cities.

For routes within a single state, however, the power to license and control lay with the government of the state. Although most states are too small in area to support much by way of intra-state services, Texas and California were and are major exceptions. As aviation developed after World War II, each of those states became home to an important (low-cost) airline that was later to grow and challenge the established national and regional carriers.

In the post-war years, California saw a number of airline start-ups, notably that of Pacific Southwest Airlines. When founded at San Diego in 1949, that company leased a single DC3 aircraft, and started a weekly service between San Diego and Oakland (just across the Bay from San Francisco), with an intermediate stop at Burbank (in northern Los Angeles). With very limited financial resources, the new airline needed to be a low-cost carrier.

Less predictable was its adoption of an informal style, intended to make the flight a ‘fun’ experience for passengers. The informality also supported good staff relations – of particular importance when many staff, including pilots, had to help with tasks other than their principal roles. (The informality was later adopted by some other new carriers, notably Southwest Airlines, a Texas intra-state airline which launched in the 1970s – on which, see §1.2.1 below.)

From 1949, Pacific Southwest grew larger, though with mixed financial results. It sold shares to the public and to employees in 1962, and began operating B727 jets in 1965. It and other Californian carriers attracted hostile reactions from some of the major inter-state airlines, which engaged in localised price-competition.

The 1980s saw the absorption of the surviving local carriers. In 1988, Pacific Southwest itself became part of US Air (later merged into US Airways, which in turn became a part of American Airlines; see www.psa-history.org and www.en.wikipedia.org/wiki/Pacific Southwest Airlines, both accessed 18 April 2009).

1.1.2 Deregulation and the entry of new carriers

In 1978 the US Congress passed the Airline Deregulation Act, and the long-standing structure of inter-state services was soon transformed. Many new airline companies were established; almost all of them adopted a low-cost, low-fare strategy. And almost all of them died at an early age – usually by bankruptcy. A most spectacular example involved People Express which grew at an astounding rate but then collapsed dramatically (see Borenstein, 1992 on events in the first decade or so after deregulation).

While the task of managing an established airline that serves (truly) competitive markets is a demanding task, steering and expanding a new airline company is even more difficult. The penalty for error is usually considerable: one significant mistake or mis-judgement can bankrupt a small company. (In contrast, the managers of a large, established airline can make the occasional medium-size error without imperilling the company.) Thus for many of the new airlines, inadequate managerial performance contributed to the company’s demise.

Needless to say, the established airlines often helped. In particular, they engaged in targeted fare-discounting on routes entered by the new airlines (Kahn, 1991). For the large companies, such discounted tickets were but a small proportion of all the tickets they sold, and so their strategy was financially affordable. In contrast, the entrant airline that matched the discounts on all of its (few) routes could easily run out of cash, notwithstanding its lower cost level. Although much of the selective fare-discounting of the established majors might be regarded as ‘predatory’ (in simple terms, deliberately ‘selling below cost’, with malevolent intent), the few anti-trust/trade practices challenges from government have not been warmly received by the courts; see, in particular, US District Court of Kansas (2001).

The established, major airlines also sought additional strength from mergers. Even when a merger resulted in diminished competition on some non-stop city-pair routes, regulatory scrutiny was not always effective. Eventually the number of remaining majors became small enough to permit (tacit) cartelisation (on which see §15.2.4).

1.1.3 Changes in the structure of the incumbents' airline networks

A major consequence of deregulation was the re-shaping of airline networks. In general, the majors adopted a hub-and-spoke pattern, usually with at least one daily flight to each non-hub port. Though the airline might still offer direct flights between the very largest cities, many passengers travelling between non-hub ports were required to change planes at an airline hub, usually found at a major city. While such an indirect journey takes more time than would be needed for a direct flight, many such port pairs were thought to have insufficient traffic to support direct flights. Thus a hub-and-spoke network was said to allow the airline to serve more ports than would otherwise be (financially) possible.

Usually, each hub port was a hub for one airline only. An airline that served most regions of the country established perhaps four or five hubs. For some non-hub port pairs, the established airlines competed with each other by offering indirect travel via different hubs.

The hub-and-spoke pattern was also thought to defend an established airline from entry by new carriers. In particular it allows a large airline to offer a frequent service between non-hub ports that is generally beyond the reach of a small entrant. Furthermore, a hubbing airline’s frequent flights may bestow market power in respect of journeys having the hub port as origin or destination (Hergott, 1997). In support of that view, it should be noted that the fares for such journeys can be higher than the fares on otherwise comparable routes where neither port is a hub (Lijesen and others, 2001). Furthermore, the hubbing airline generally (wins a disproportionate share of the passengers whose travel originates at its hub, especially in the case of routes having a large proportion of business travellers. Such passengers are swayed by the size of the airline’s hub presence on all routes served from the hub (Borenstein, 1989).

In short, for the established major airlines, the hub-and-spoke network was seen as helping to convert size into market power and consequent profitability. In the 1980s, a common view was that such a network was essential for survival (Kaplan, 1986, p. 54). Kaplan goes on to say (p. 70) ‘Hub-and-spoke networks will continue to dominate carrier route planning.’ Of course, the subsequent growth of low-cost airlines has qualified that view.

1.1.4 Entry strategies of low-cost carriers

In the US (and, later, in other countries around the world), most of the new airlines favoured a different route structure, namely a point-to-point network, in which each flight provided non-stop service between a single city-pair, and most travellers reached their destination without change of plane. Furthermore, most of the new airlines did not encourage travellers to book connecting flights, and generally did not guarantee connections. A traveller who nevertheless did organise a connecting sequence usually had to collect any checked baggage at each intermediate port, and re-check it for the next sector. (Further discussion of hubbing and point-to-point networks appears in §§8.2.2–3.)

1.2 New airlines in the US

In 2014, there remained only six significant, ‘new’ airlines – that is, airlines widely launched on interstate routes since the deregulation of the airline sector. As seen in Table 1.1, Southwest Airlines is by far the largest of these, thanks largely to it being much older than the others. Indeed, it has become much the same size as each of the three large ‘network’ carriers (American, Delta and United) that remain after the many mergers among the legacy carriers. One further new carrier, America West (based in Phoenix), became successful enough to merge with a legacy carrier, US Airways. Still headquartered in Phoenix, the merged company retained the US Airways name, until its merger with American Airlines.

The remainder of the US industry comprises: two important airlines, Alaska and Hawaiian, each with a network initially focussed on the eponymous state, but now pursuing ambitions to grow by extending its geographical reach; and several so-called regional airlines, mainly operating small aircraft on thin and/or local routes, usually under contract to one or more of American, Delta and United. (Those regional airlines are considered later, in §11.1.4.)

The six ‘new’ airlines are profiled in the following six sections.

Table 1.1 Significant US ‘new' carriers: operations in 2014¹

	Southwest^2	JetBlue	Frontier	Virgin America	Spirit	Allegiant
Rev. passengers (millions)	126.7	26.4	11.3	6.3	12.6	8.1
RPM^3 (billions)	100.5	30.5	9.8	9.8	12.6	7.7
Load factor (%)	82.6	84.7	89.8	82.4	86.8	89.3
Flights (000s)	1,162	245	85	57	92	53
Main cities^4	Chicago	New York	Denver	San Francisco	Fort Lauderdale	Las Vegas
	Las Vegas	Boston	Trenton	Los Angeles	Dallas/Fort Worth	Sanford
	Baltimore	Orlando	DC	New York	Las Vegas	Phoenix
	Denver	Fort Lauderdale	Las Vegas	Las Vegas	Chicago	St Petersburg
Source: US Department of Transport, BTS (transtats.bts.gov/carriers) accessed on 21 May 2015 Notes Scheduled ser...

Table of contents

• Cover Page
• Half Title Page
• Title Page
• Copyright Page
• Contents
• List of tables
• Preface
• Acknowledgements
• Introduction
• PART I New airlines around the world
• 1 USA and Canada
• 2 Deregulation and new airlines in Europe
• 3 The Arabian Peninsula
• 4 Asia
• 5 Latin America
• 6 Africa
• 7 Australia Airline interactions in a small market
• PART II The airline industry
• 8 The revolution Airline operation and outcomes
• 9 Contemporary practices in fare-setting
• 10 Airline entry and the processes of competition
• 11 Regional services and route subsidies
• 12 Airlines and airports
• PART III Conclusions
• 13 Airline prospects
• 14 Public policy for airports and air navigation services
• 15 Public policy on airlines
• References
• Index