Premium #158 – Competition, Trust Busters and Barriers to Entry |

The recent drop in oil prices has not resulted in an equivalent drop in air fares, as airlines are attempting to keep additional profitability from lower costs whenever they can. Perhaps the most egregious indication of this trend is Qantas, which eliminated its fuel surcharges, only to raise its normal fares to the same level as with the fuel surcharges. So while many of us enjoy the impact of $1.69 gasoline for instead of $3.69, when we book flights we find equivalent savings not being passed on. This type of behavior is what is expected when an economic oligopoly exists, and a handful of carriers, through merger and acquisition, become dominant players in the industry. The impacts of economic concentration: In the late 1970s, when deregulation began in the US market for airlines, the United States had far more competitive pricing and fares than Europe, which had protectionist national carriers acting like a cartel than competitors. Fast forward to today, and the situation appears to be reversing, with the Big Four in the US acting as an oligopoly, while Europe is enjoying low airfares due to intense competition from upstart low-fare carriers which keep pushing the frontier. Pre-deregulation, the US Market was competitive, with no single carrier holding a market share of more than 16.2%, as shown in the chart below: Let’s take a look at the competitive picture today. In September 2014, the increasing concentration can be clearly seen in the chart below, with the top four accounting for 83.6% of the market directly, and likely a bit more influence, since within the 7% other category are regionals like SkyWest, which provides contracted lift priced by its major airline partners. So the pricing power for the Big Four is likely between 85-90%; definitely in the oligopoly category in Economics textbooks. Oligopolistic behavior typically entails restricting capacity and through that process maintaining prices that are artificially high. We’re now there in the United States market, as evidenced by increasing load factors and higher yields in recent years, after a long downward trend in real yields. Load factors have continued to increase to record levels, reflecting “capacity restraint” among the Big Four to not grow capacity and thereby enable prices to rise. Interestingly, those same carriers seem to have the ability to increase capacity at will when an innovative new competitor challenges them in a market. Virgin American is an example of a well-capitalized start-up with differentiated service that should be competing effectively against the incumbent new entrants. Unfortunately, it tends to run into an increase in service and lower fares from major carriers competing with it whenever it opens a route, decreasing fares and making it more difficult to go from the red to the black. After several years, one would think that an airline with service this good would catch a break, and begin to earn a steady profit. But like most oligopolies, cut-throat competition is reserved for those who would try to join the club and take a larger share of the pie. Carriers like Alaska and Hawaiian, which have been regional niche players, are now beginning to face additional pressure. Alaska is fending off Delta in Seattle, and Hawaiian, as it expands in the mainland, is beginning to see additional attention as well. JetBlue, with a new premium class to compete on coast-to-coast flights from New York to LA and San Francisco will be in for increased competition from American, Delta and United. Each of the remaining regional operations have been mentioned as the potential “next up” acquisition target for the Big Four. Where did the Trust Busters go? Teddy Roosevelt’s Bull Moose party endorsed the Trust Busters, and enforcement of the Sherman Anti Trust Act to ensure fair competition at the start of the 20th century. But nearer to the start of the 21st century, anti-trust review on airline mergers became perfunctory approvals. The determination that there would be little competitive impact we can leave to the economists, but the results have become quite clear - we’ve passed the point of no return since the mergers of Northwest into Delta, United into Continental retaining the United brand, American into USAirways retaining the American brand, and AirTran into Southwest. This latest round of consolidation is what pushed a somewhat competitive industry, with eight airlines moving to four, into a cartel. While no single company has a dominant market share, in many hub cities, the dominant carrier is over the traditional 66.7% market share threshold for antitrust considerations. But because it isn’t nationwide, but a regional monopoly, and other hubs compete for one-stop travel via connections, those positions aren’t considered problematic by economists and regulators. In many markets with dominant hubs, it is often cheaper to fly through the city to another destination, on the same flight, than it is to fly to that connecting city itself. It is illogical that the same flight plus another flight should be cheaper than the first flight alone. Yet often it is, reflecting the market power of the airline in dominant hub cities without competition. Try getting an inexpensive non-stop to a dominant airline hub. It doesn’t happen anymore. The only competition is for one-stop flights, as consumers often have a choice of airlines with less convenient service. But Prices are Down in Real Terms The airlines will tout that prices have come down in real terms substantially in recent years, and that air travel is more of a bargain today than ever before. But the same could be said prior to deregulation as well. The following chart using data from the Air Transport Association (now Airlines 4 America) shows that both prior to and after deregulation in 1978, the cost curve continued on a similar trajectory. Competition from Low Cost Carriers, which were invented in the US by PSA, Southwest and others, has largely disappeared. Southwest is no longer a low cost carrier, despite its historic reputation, and has higher average yields than any of its major counterparts, as shown in the chart below summarizing DOT statistics data from September, 2014. It is notable that Spirit and Frontier, the ultra-low cost carriers in the US market, have markedly lower yields than Southwest and JetBlue, once low cost carriers, the regional operations, and the majors. But with less than 3% of the market, their impact on the overall market is marginal. In Europe, the LCCs, including Ryanair, Easyjet, WizzAir and others have carved out a larger segment of the market, putting pressure on the majors. From a market share perspective, the majors in Europe - AF/KLM, IAG, and Lufthansa Group have less power and the top nine carriers share 64% of the market, compared with the 83% of the market shared by the Big Four in the US. That leaves 36% of the market for a competitive dogfight, which it causing airfares to fall in Europe while they rise in the US. This is a full reversal of the situation in place when the US market deregulated. The Bottom Line From a consumer perspective, is there anything that can be done? We can’t very well break-up the airlines that just merged, and force them to compete. Re-regulation isn’t widely viewed as a potential answer, although it could help spawn new competitors. The most feasible way to introduce new competition into the marketplace would be to allow foreign airlines to enter the market and compete, and provide true “open skies” with new competition. We have seen how the US carriers have reacted to potential overseas competition from Norwegian. Low cost competitors from outside are feared. In the interim, we appear stuck with airlines that will increasingly add fees, reduce seat pitch and width, restrict capacity (unless driving out new entrants) and keep airfares high. Welcome to the unanticipated consequences of deregulation and competition.

US Flight Planner	Airbus vs Boeing
US Airline Schedule Performance	Daily Production & Deliveries

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