Clifford Winston, who knows as much about the US air transport system as anyone in the country, had an op-ed last week in the New York Times arguing that foreign airlines should be allowed to operate routes in the U.S.
They should. But the benefits Winston claims are far exaggerated. If there are underserved routes that could be operated profitably by new airlines, why does he think that incumbent airlines aren’t flying them? In fact he focuses on routes that have been losing service, cutbacks that have been made precisely because existing airlines found it unprofitable to operate those routes.
It may well be that when the US market gets opened up to competition, that a lot of foreign investment floods the market in spite of the likelihood of losing money. US consumers would benefit from additional service and lower fares until the capital dries up.
That ought to be allowed. But the suggestion that there would be huge and enduring benefits from the change probably goes a bit farther than is actually supported by the evidence.
Still, and while I find much of Wandering Aramean‘s writings on the airline industry to be insightful and often spot-on, even, his response to Winston is way off the mark.
Winston uses the rhetorical device to argue that aviation is supposed to be a free market but the government protects airlines from foreign competition (true enough), Wanndering Aramean rebuts,
Well, we can start with the part about how that isn’t actually a “real free market” based on a lack of reciprocity in the other countries.
It’s certainly true that the US aviation market is far from a free market now, but that has nothing to do with European and Asian markets being unfree.
Aviation is one of the most tightly regulated industries in the country, and one of the most heavily taxed as well. Governments own almost all the airports. Government operates air traffic control. Governments certify the planes that can be flown. Almost all of what can be done — aside from where to fly and when (and at some airports there are slot controls) — are specified by the government or at least approved by the government. Even in a post-deregulation world. “De-regulation” meant that airlines could decide where to fly and at what price, everything else remains heavily regulated.
Apparently the key to improving the UA aviation market is to flood it with more capacity, driving down fares. But that increased supply will somehow also drive demand. Last I checked that’s not how the basic supply/demand curve works, though I will admit I dropped my Econ class after the first exam because I didn’t really like it.
Well it is and it isn’t what we would expect. And it certainly is what the ‘basic supply demand curve’ suggests. The ‘Southwest effect’ in aviation refers to the idea that bringing in a new low cost carrier stimulates demand, lower prices induce more people to travel and not just because they can now make discretionary trips (though that’s part of it) but also because more people fly rather than drive.
Not all traffic is price sensitive. After 9/11, after air service resumed but while planes were still flying empty, average airfares went up, not down. Anyone making discretionary trips simply wasn’t making those trips, and lowering price wasn’t going to induce people into the skies. The people who were flying really needed to be flying and weren’t especially price sensitive.
It isn’t at all times and everywhere about price. But lower prices do tend to increase demand.
Meanwhile, Winston claims that foreign carriers flying domestic routes would be good for employment. Wandering Aramean disagrees:
Can someone explain to me how cutting the salaries of US-based employees and creating an environment where the domestic airlines will struggle more to maintain their margins is actually going to increase the employment rates?
More airlines operating more routes increases the demand for people trained to do the key jobs in the industry. There’s a limited supply of pilots, it’s likely to drive their wages up. It’s likely to bring furloughed employees back into the industry. Sure, airlines operating at high margins tend to pay more to their unionized workforces. So lower margins will put pressure on that process. And some US carriers could re-enter Chapter 11 bankruptcy when they find they can’t compete with new entrants into the market. But that’s not necessarily something that public policy should stand against.
And Winston is certainly right that it would increase demand for airline employees and employees in the industries servicing aviation. It would increase demand for airline caterers. And that demand is likely to expand service opportunities, and infrastructure, and over time allow for innovations which drive down price (even if in the short run competition for existing services could increase prices and thus costs relative to what incumbent carriers currently pay).
Ultimately though the idea that Singapore Airlines would start service out of Sarasota is a bit of a stretch, and it’s unfortunate that Winston picks this as an example for his piece because it creates something of a straw man. It’s more likely that — if Sarasota were to get service — that service would come from a new US subsidiary of Tiger Airways, not Singapore or even SilkAir. Or from AirAsia. And that much of that service will fail. If easy money could be made in the US market, perhaps the good folks at United or Delta aren’t well enough positioned to make it, but you’d expect that Southwest or Allegiant could.
In the end there aren’t really credible arguments to keep airlines owned by investors outside the U.S. out of the domestic market. But that won’t matter. Because there’s no popular uprising demanding a change to the law, and U.S. airlines will fight any change vigorously. Current law is protectionist, designed to benefit US corporate interests. They’ll lobby to keep those protections. And few resources will be spent lobbying to change those laws.
The whole point of his argument is that to restore service to secondary and tertiary markets we must allow a truly free market. But no one is going to build networks to fly to those smaller markets at discounted rates. The so-called “Southwest” effect doesn’t have legs over the long term and the value of the short term impact is most definitely questionable.
The suggestion that such a move will create demand in a volume to support the additional services is specious. And suggesting that it will increase demand for certain roles such as pilots, increasing their wages is counter to the idea that these companies will be able to operate at lower costs than the legacy US operators and therefore be able to charge lower fares and remain profitable. It also is not clear that these airline employees will be US-based rather than something like the Bangkok base for the Norwegian 787 crews.
You seem to believe that cutting prices on most markets and allowing a capacity glut will be good for the market. How is that possible? Good for some consumers, perhaps, as they get more cheap flights, but that’s not the same thing as good for the consumer. If there are consumers who will only buy a product when it is being sold below cost that is rarely useful to an industry. Especially if they can trim capacity sufficiently so as to not need that marginal revenue.
Basically it is an invitation to race to the bottom in price. That’s theoretically good for consumers but not it in the long term. It ignores the actual costs of doing business and what it takes to maintain a network which covers the entire market, not just the top business routes.
You have previously claimed that selling bargain fares to FFers is good for the airlines because someone has to fill those seats which keep the routes viable for the business traffic which is less price-sensitive. The airlines have been cutting routes and capacity. They’ve also been cutting the number of these cheapest fares on offer. And they’re actually making money now. So how’s that argument working out for you?
Whatever short-term benefits to the consumer would inevitably be outweighed by the long-term detriment to the employees and investors (both US and foreign-based). The market would also stabilize over time, so the net effect on reducing fares would be minimal.
I’d rather see slightly higher fares if it meant keeping airlines out of constant bankruptcy.
But, really, none of these arguments matter, because airlines have become at least marginally good at adjusting capacity based on demand. The US market is saturated as it is, there is no perceptible reason why foreign carriers would want 5th freedom rights.
If the goal really is to expand the amount of destinations served, I think the answer is what is happening right now. That is to say, consolidation. Having a limited number of airlines means that they can service less-profitable routes they would otherwise have to cut service to, but can be profitable with a hub-and-spoke model. Consolidation is inevitable, but it remains to be seen what effect this will have on fares. IATA reports that the growth of the hub-and-spoke model, coupled with point-to-point LCCs, has continually lowered the cost of airfare in the past 30 years, in spite of higher fuel prices. This would seem to indicate that an environment serviced by a few large airlines is more beneficial than 5th freedom rights primarily because size creates an immunity to market fluctuations.
Just something to consider. Other than that, great article!
@Seth – I think you’re making arguments for me that I am not making, and trying to refute THOSE. 🙂 If you re-read my post I’m suggesting that there’s not actually much money to be made here. That the Winston argument as-presented in the op-ed isn’t a very good one, although for reasons slightly different than those you made in your post. There’s not much money to be made in these ‘underserved’ markets. There’s not that much clamor currently for foreign airlines to get into the US market as a result. Some might come, probably lose/waste a good bit of capital doing so. Which doesn’t mean the restrictions are justified. But the restrictions won’t go away in any case, because there’s no real counterweight to the lobbying US airlines will do to keep their government protection.
Yes we are protectionist, but does anyone have a clue why USA airlines didn’t buy foreign airlines on those countries that are not protectionist?
I think the point is being missed a bit. The reason for British Airways to fly, say, New York to Wyoming is because there is not enough demand to fill a plane from Wyoming to London.
But a direct flight from Wyoming on a BA plane, which stops over for an hour to pick up more passengers in New York, may work. BA needs to be able to sell tickets from NYC to Wyoming, though, or the extra hop won’t pay.
The real winners here would be the people of Wyoming who get a direct flight to London. There are no real losers – AA would codeshare it and sell seats under their code anyway.
All this would do is add more traffic between hubs like JFK and LAX …. For example, maybe a European Airline flying once a day from JFK to their own hub once a day. They see enough traffic to fill 1.5 planes from JFK and 0.5 planes from LAX…. so they can operate the second plane LAX-JFK-Europe. Then they want to fill half the LAX-JFK flights with domestic traffic… in the end, passengers in New York and LA both win and domestic airlines flying that route lose, since the international airline may only want to cover costs with those domestic seats, and not worry about a profit, since the international leg is where the profit comes from.
I should preface my comments by saying I don’t typically pay for airfare at all. I have access to millions of Skymiles/MR/UR/etc from business credit card spend. I am not the reason a carrier will come to my city in the least. In fact, the biggest hassle that I have experienced from my home airport at CVG is my access to direct flights has reduced in frequency.
That said, I don’t believe the premium foreign carriers coming here will fix fly-over country. They’ll jump in feet first with transcons, but that’s it. BA wants no part of Jackson Hole to London via JFK as a previous poster mentioned. They have AA feeding them from small markets in the US. Singapore isn’t jumping on IND to IAH anytime soon nor is AF/KLM going after MWK to SFO. Would AF be interested in something like PHX-CVG-CDG? Maybe. If they had the ability to add a domestic flight, markets like CVG may be attractive to international carriers but Lufthansa is not coming to the rescue of SBD anytime soon.
However, I think an established foreign LCC could do some damage if they were given the opportunity. It’s hard to say CVG-SRQ wouldn’t work for easyJet or RyanAir because Allegiant doesn’t want to do it. Allegiant isn’t really in their league. I think easyJet or RyanAir would thrive on routes like that. $4 gas makes the drive to Florida pretty expensive from Cincinnati and it’s not really all that far. $49 each way gets a family of four to Disneyworld for less than $400. Even with bag fees you’ll well short of gas money to and from, not to mention if you decide to stop halfway down and back in a hotel. If I’m a new LCC in the US, I hub in Orlando Sanford and bank on the magic mouse. You may even be able to expand to the Caribbean with your hub there. It might work but I doubt the legacies ever allow that to happen.
The real problem is the actions that legacies take to keep out LCCs they can crush. An easyJet or RyanAir would be able to better withstand the all-out assault of the legacies than a Skybus or Vanguard. First, they aren’t startups hoping to not run out of money. But most importantly, they aren’t trying to buy their way into a market with cheap airfare to get established. This is their business model and they aren’t going to be talked out of it. So many times here in Cincinnati, Delta would match the LCC’s fares and, of course, have 8 flights a day instead of 1 with it being a hub. A $700 flight would become $79 until they drove the LCC out. We did it to ourselves in CVG. We didn’t patronize the startup because Delta was known, more frequent, had the same price and we earned Skymiles. And look where that got us.
It would be interesting to see each of these possibilities take root. I would love to see Lufthansa run DEN-CVG-FRA, BA run SAN-CVG-LHR, Singapore run CVG-SFO-SIN or AF/KLM run PHX-CVG-CDG. That would be great for us. But that isn’t helping a whole lot of markets. I would love to see easyJet make a home in Orlando and do what they do. Fat chance any of that ever sees the light of day. But, like I said, I don’t really have a dog in the fight. Until I run out of points and miles, that is.
I agree 100% with SCG that it’s the LCC’s which could transform the US air network. Living in Singapore, I see a blend of high price/high quality airlines along with ridiculously low fares. I used to fly SQ from Singapore to KL for $300 RT for a 20 minute flight, because it was a duopoly between SQ & Malaysian. Last flight I took was $12- the taxi to the airport was more expensive.
I do think LCC entry would be painful to existing US legacy carriers, and we would see the cycle of bankruptcies, as they have to lower their cost structure again. Even Singapore, with its highly profitable long haul and premium class sales, is struggling.
But I also think long term, the consumer would win. Seth is wrong- the LCC’s do not sell at “below cost”. In fact, Ryan Air, last time I checked, had the highest net profit % in the industry. Their mantra is to weed out cost where ever they can, to reduce the ticket price to the absolute minimum.
It’s not necessarily a world that the premium frequent flier wants to live in- minimal services, tight seats, no frequent flier point. But it works- I spend 10% what I used to spend on airfares 10 years ago.
It’s a nit-pick, but I think it’s important.
“But lower prices do tend to increase demand.”
Lower prices increase quantity demanded, not demand. Ways to increase demand (ie people want more at any price) would be better service, terrorism directed at trains, and more attractive flight attendants among other ways.
@MileValue yes that is correct, increased demand comes from a shift in the curve (exogenous events or other changes in preferences) while moving along the curve as a result of lower prices is a shift in quantity demanded
Isn’t Virgin America sort of what you guys are discussing here? A low cost, domestic airline owned by a foreign one (Virgin Atlantic)?
Virgin America is not owned by Virgin Atlantic. The “free” markets capitalist here in the use only allow airlines to have up to 25% of foreign capital.
Ahh…thanks, Miguel!
You welcome. And of course I meant «here in the USA», not «here in the use»… 🙂
BTW, Virgin America is owned in 75% by the VAI Partners and in 25% by the Virgin Group.
Well you know, come to think about it I never wondered why there was not a Delta Air Lines India or American Airlines Chile either. I guess now I know why lol…