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Safeguards and Sustainability of Air Services – Protection for Whom, From Whom?. Dr. Peter P. Belobaba Concordia University and MIT March 2003. Deregulated, Not Fully Competitive Open Markets.

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Safeguards and Sustainability of Air Services – Protection for Whom, From Whom?

Dr. Peter P. Belobaba

Concordia University and MIT

March 2003


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Deregulated, Not Fully Competitive Open Markets for Whom, From Whom?

  • Since US deregulation, pressure for less government control over airline markets has spread worldwide:

    • A result of the perceived overall success of US deregulation and other experiences in Canada, Australia, Europe and elsewhere

  • Deregulation has not meant totally free competition:

    • Gave freedom to airlines to choose routes, frequencies, and prices in domestic markets with less government intervention

    • But, operational and safety regulations remain, through airline certification, crew training requirements, maintenance standards, etc.

    • Bilateral agreements still limit access to international markets

    • Ownership restrictions limit ability of airlines to raise foreign capital

    • US airlines still required to operate certain “essential air services”

    • Other regulations govern CRS/GDS distribution channels


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US Deregulation Experience Generally Positive for Whom, From Whom?

  • Overall benefits have been clearly demonstrated:

    • US domestic air travel more than doubled in first ten years of deregulation, a growth rate well above pre-deregulation times

    • Average real (inflation adjusted) air fares continue to decline today

    • Development of some very successful new low-fare carriers, with rapid growth in recent years (e.g., Southwest, AirTran, JetBlue)

    • No statistical evidence of reduced airline safety

  • But some parties have suffered:

    • Labor unions experienced reduced power, jobs and wages

    • Greater disparities in fares paid by business and leisure travelers

    • Small cities saw commuter airlines replace larger jets

    • Profit volatility and bankruptcies raise questions about airline investment and sustainability of traditional airline operations


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Changed Competition Under Deregulation for Whom, From Whom?

  • The removal of economic regulations has added new dimensions to airline competitive strategies:

    • Cost cutting and productivity improvement

    • Economies of scale in operations to reduce unit costs

    • Price competition and revenue management to increase revenues

    • New marketing and distribution programs

    • Increased network coverage and market dominance

  • Quite simply, airline managers now actually have to make management decisions and trade-offs:

    • In contrast to regulated times when government control ensured price increases to cover increased operating costs.

    • “Airline management” was relatively easy under government regulation and subsidization of flag carriers


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The March Towards Global Liberalization for Whom, From Whom?

  • Overall success of the US experiment has led other countries to deregulate domestic airline markets:

    • Australia and Canada were among first to follow

    • Japan, Brazil, United Kingdom loosened restrictions

    • European Union has also moved toward “open skies”

  • Although differences exist, many similar impacts have been observed in deregulation outside the US:

    • New entrants with lower costs and fares, that face stiff competition and potentially predatory practices from incumbent airlines

    • Potential for volatility and destructive competition arises, especially in periods of reduced demand and excess capacity

    • Recent dramatic shifts in airline industry have begun to shift momentum of change to low-cost, low-fare new entrants


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Protection of New Entrant Airlines for Whom, From Whom?

  • Initial efforts by new entrants to compete were in effectively rebuffed by larger incumbent airlines:

    • Incumbents had significant advantages of frequency, network coverage, service quality, and frequent flyer programs

    • Revenue management systems allowed incumbents to match new entrant’s fares while limiting revenue dilution, offering better value

  • Aggressive responses by incumbents in some cases raised questions of “unfair” competition:

    • Lower fares and/or increased capacity to drive out new entrant

    • Potentially predatory actions, subsidized by revenues from other parts of incumbent’s network

    • Hoarding of gates and/or slots to prevent new entry and growth

  • Led to serious policy discussion for “re-regulation”


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The Remarkable Growth of Low Fare Carriers for Whom, From Whom?

  • Recent conditions favorable for low-fare airlines:

    • Less business travel overall; reduced willingness to pay for premium services; reduced quality of traditional airlines

    • More stable demand for price-sensitive leisure travel, primarily in high density point-to-point markets

    • Greater awareness of low-fare options through internet channels, and growing acceptance of “alternative” air travel services

  • Low-fare carriers now threaten viability of traditional network airlines:

    • Share of US domestic passengers flown by low-fare carriers increased to 20% in 2002, from 16% in 2000 and only 5.5% in 1990

    • Largest low-fare carriers increased both capacity and traffic in 2002, in sharp contrast to most traditional network airlines


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Who Needs Protection Now? for Whom, From Whom?

  • In North America and Europe, legacy airlines now face unprecedented operating losses:

    • Major airlines are looking for new “business models” to respond to changed environment and to compete with low-fare airlines

    • Low-fare competition, combined with Internet distribution and inability to support revenue differentials mean no pricing structure alone can return legacy airlines to profitability

    • After 2 decades of deregulation, US Major airlines now finally face the reality that their cost structures are simply unsustainable in a competitive environment

  • Protection for new entrants has become moot:

    • Southwest, JetBlue, RyanAir and EasyJet are among most profitable airlines in the world, while legacy airlines declare bankruptcy

    • Government intervention to protect legacy airlines now a possibility


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When Is Protection Warranted? for Whom, From Whom?

  • Government intervention to “protect” airline services might be warranted in limited cases:

    • Sustainability of airlines and assurance of air services in developing countries

    • Where tourism-supported economies depend on air services

    • Isolated or remote communities requiring air services for movement of population and goods

    • Under conditions of catastrophic national/global events or war

  • Even in these situations, not clear that inefficient air carriers should be supported or protected:

    • Government regulations and (even worse) financial support inevitably cause market distortions and inefficiencies

    • In most situations, development of new services, by new airlines, with more efficient operating models will ultimately fill any void


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Sustainability, Not Protection of the Status Quo for Whom, From Whom?

  • Very real need for sustainable air services must not be used as an excuse to prolong inefficiency:

    • Need for national flag carriers, fear of losing air services often cited as reasons for government protection

    • Yet, highly regulated national flag carriers have been among the most poorly managed and least efficient airlines in the world

    • Experiences throughout the world have demonstrated how open market conditions ultimately lead to sustainability and efficiency

  • A balance between effective safeguards and unnecessary protection is required:

    • Recognize that many essential air services can and will be provided by more efficient carriers, given reduced regulatory constraints

    • In nobody’s long-term interest to support and protect inefficient air carriers – emphasis should be on sustainability AND efficiency


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