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Airline Competition 1980-2010 R.I.P.

Part 2 :  Rebuttal of arguments in favor of bigger/merged airlines
 

United Airlines has sometimes been one of the country's - and world's - largest carriers.

But being big in no way means that United has been more successful than any smaller airline.

Part of a series on airline competition - see extra articles listed in the right hand column.

 

 

The consolidation of airlines into fewer, but larger, airlines, and a few overarching airline 'alliances' that are mega-airlines in all but name are justified in the name of larger size equating to greater efficiency, better service, greater profit and lower fares.

Some of these claims are hard to evaluate and substantiate, either before or after a merger.

Although the US Department of Transportation regrettably has never subjected any such claims to a post-merger analysis to see if claims offered in favor of merging proved to be correct, we look at a few claims that can be analyzed, and find no grounds to support the claims used to justify the steady loss of airline competition.

Are Big and Dominant Airlines Good or Bad

Does it really matter if airlines are big or small?  Aren't big airlines better for the traveling public, because they offer more routes to more places, more ways to earn and redeem frequent flier miles, and everything else?  Don't economies of scale in a large airline make for more efficient operations and lower fares?

These are the types of claims offered by airlines when seeking anti-trust exemption to merge their operations or work together.

But are they true?

Big Airlines Offer More Routes to More Places

Yes, it is undeniably true that a bigger airline flies to more places, but so what?  Does it really matter if you fly on Brand X or Brand Y (or any other) airline each time you fly somewhere?

One possible benefit to this would be a commercial one, for companies and their corporate travel departments.  Perhaps they could negotiate better deals with fewer airlines by offering to place all their business with just one airline.

But - this ability to negotiate a 'better deal' only applies if the big airline truly competes with other airlines.  Otherwise, if it is a dominant airline, the big airline doesn't have to negotiate any deals at all.  It can say 'We know you have no choice but to fly us between here and this other place, and so if you don't give us your business on other routes where you do have choices, we won't give you any deal on this route'.

This is not just conjecture - as any corporate travel manager well knows, it is a commonly used ploy by airlines, choosing to use their size and route dominance on some routes as a lever to get extra business from companies on routes where they're not so dominant.

The flip side of big airlines is unavoidably fewer airlines, and so the negotiating power, when there are fewer airlines, actually moves to favor the airlines rather than the travelers.

Competitive route analysis overlooks the real world

This real world scenario also makes a mockery of traditional competitive analyses of air routes.

Sure, some routes may seem truly open and competitive, but the effective competition on that route is diminished by airlines using their strong positions on other routes as bargaining levers to give them extra advantage on competitive routes (as well as the obvious advantage it gives them on noncompetitive routes).

This 'hidden' linkage between competitive and uncompetitive routes does not show up in some route analysis, but is truly a factor when negotiating airline contracts.  An airline with a dominant role on one route will use its strength as a lever when negotiating a contract that includes both its dominant routes and routes that, on the face of it, appear to have a more level playing field.

The airlines own your travel information - and use it against you

The airlines have and use computer tools to analyze buying patterns that allow them to see who are booking and buying their tickets on which routes, and use this information to enforce market-share agreements.

Did you know that the information on every ticket you buy - who you are, where you are traveling, on which airline, when, and on what class of service - is not considered private personal information belonging to you, but is deemed to be information belonging to the airlines which they can and do trade amongst themselves - it is called Marketing Information Data Transfer or MIDT data.

Here's a good article that contrasts what the airlines say about their use of MIDT and what the real world has experienced.

Our conclusion - this first reason why big airlines are good is an illusion, not a reality.  The reality is that big airlines can use their size to dictate terms to travelers, not vice versa, and not just on routes where the dominate, but across the board.

This conclusion, by the way, although at odds with what the airlines wish us to accept, is entirely consistent with traditional economic and marketing theory.

Big Airlines Give Better Frequent Flier Programs and Rewards

The second reason offered to support the claim that bigger airlines are good (for us) is that it enables us personally/individually to concentrate our flying on one particular carrier and to also concentrate our frequent flier miles, earning us an elite level status, courtesy upgrades, priority wait lists, free luggage checking, better free seat assignments, and so on.

Sure, all these benefits are very real, and large airlines allow us to concentrate our flying and allow the most frequent fliers to stand out more noticeably than would be the case if our flying was fragmented among 10 or even 20 smaller carriers.  So for the people who do achieve elite level frequent flier status, there are definitely benefits to be enjoyed.

Ignoring the question of underlying fairness, whereby one flier gets better treatment than another, even though they both paid the same fare - well, actually, let's not fall into the trap, as most people do, of ignoring that question.  Who do you think it is who subsidizes the elite small percentage of frequent fliers who get all those benefits?  Nothing is free, everything has to come from somewhere.  Either the airline, or the airline's other passengers, are in effect supporting and subsidizing the free benefits and preferential treatment of an elite few.

In the new paradigm of 'unbundling' where every airline service is now charged rather than included in the base ticket price, the most notable remaining bundled benefits are those given to frequent fliers.  The airlines want to have their cake and eat it too - they tell us it is fair and proper that 'the user pays' for luggage, for meals, and for everything else, but then they contradict themselves and extend preferential free benefits to frequent fliers.

The commercial truth has to be, just as with other benefits now unbundled, that the people not receiving the benefits are subsidizing the people who are enjoying the benefits.  Perhaps the reason we pay $25 to check a piece of luggage rather than $20 is so some passengers can check their luggage for free.  The reason we have to pay good money to get upgraded to first class is so the airline can afford to give free first class upgrades to some other passengers.

The reason you have to wait a long time for your bags at the carousel is because the frequent flier's priority bags are coming off first.

Or, if you prefer, take another viewpoint on the matter - maybe the real source of payments for frequent flier benefits comes from the frequent fliers themselves.  In their most truthful moments, most frequent fliers will confess they have spent hundreds, even thousands of dollars unnecessarily, every year, by flying their preferred airline rather than some other carrier, just so they can enjoy the 'free benefits' of their elite level frequent flier program, and so they can accumulate enough miles each year to retain their elite level status for the next year.

If a frequent flier is confronted with the choice of two flights, with similar departure/arrival times, the first of which is on his preferred airline and is available for $250, and the second of which is on an airline he has no status with, and costs $230, which do you think he'll choose?  Almost every frequent flier will choose to pay the $250 price.

What say the price differential widens from $20 to $30?  To $40?  And so on?  How much price premium will an elite frequent flier pay to maintain his high status and to enjoy the 'free' benefits of it (especially if it is his company, not himself, who pays the added cost)?  So, are these 'free' benefits really free?

Some frequent fliers have adopted a different approach to this difficult question.  They ask not to be told about alternatives on other airlines at all, perhaps on the basis that ignorance is bliss.

Oh - and what about the frequent flier miles we all accumulate when we fly?  What are they worth?  That question is a bit like asking 'how high is up' but whatever the answer is, the uncontrovertible fact is that miles are worth a lot less now than they formerly were, because these days more miles are required to earn the same awards as before, and in addition to miles, airlines are frequently adding fees to redeem them - fees which sometimes meet or exceed the actual cost of a regular ticket on sale!

So are frequent flier benefits really of any value at all?  Or are they a clever marketing illusion?

Lastly, if frequent flier benefits are real, why are they exclusively the purview of the biggest airlines?  Could not smaller airlines cross-credit their customers for miles earned on each other?  Of course they could - this practice used to be quite common, and the same for the related practice of allowing reciprocal redemption rights too.

Maybe completely independent companies could also create and manage frequent flier type programs (as is already evolving with airlines selling off their frequent flier operations) - an an open competitive marketplace, there would presumably be a free market for such independent third party companies to buy, trade and sell miles.

In some other countries, third parties already administer huge loyalty programs with airline participation as part of their program.

So frequent flier benefits are, at best, a seductive option full of hidden and high costs, and at worst, an unfair construct that penalizes most passengers in return for giving preferential treatment to a select few.

Big Airlines Offer Economies of Scale

Part of the underlying American business ethos is that bigger is usually better than smaller, with the concept of 'better' denoting greater efficiencies, and therefore, either (or both of) greater profits and/or lower prices.

But this is demonstrably not the case with airlines.  Airlines show their costs in standard measures of cents per available seat mile flown, and these costs typically range somewhere from about 8/mile up to slightly less than 20 a mile.

The good news is there is a huge spread in costs from the lowest cost-base airlines to the highest cost-base airlines, so any differences based on size should be obvious, not subtle.

Here's a table (source) of airline costs per available seat mile for the third quarter of 2009 :

Airline operating costs (cents/available seat mile)
July - Sept 2009

Airline

Cost

Major Network Airlines

US Airways

15.0

Delta

14.2

American

13.9

 United

13.4

Northwest

13.1

Continental

12.8

Alaska

11.7

Seven carrier total

13.7

 

Low Cost Carriers

 Southwest

10.7

 Frontier

9.9

 JetBlue

9.4

 AirTran

9.1

 Virgin America

8.6

Allegiant

8.3

 Spirit

7.9

 Seven carrier total

9.9

   
   

 

From this table, we can see that the smallest major network airline (Alaska Airlines) has the lowest operating cost of the seven major network carriers (the opposite of the claim that bigger is better), whereas the largest of the low cost carriers (Southwest Airlines) has the highest operating cost of the seven so-called 'low-cost' carriers (again the opposite of the claim).

Here's an interesting chart that plots billions of miles flown in Q3 of 2009 against the cents/mile operating cost (source Bureau of Transportation Statistics) of the 14 carriers above, and adds a 'line of best fit'.

The 'bigger is better' concept suggests this line should slope from the top left to the bottom right - in other words, highest miles flown should have lowest costs, while lowest miles flown should have highest costs.

But, as you can clearly see from the raw data and the Excel calculated line of best fit, the slope is exactly the opposite.  Smaller airlines are more efficient, with lower costs, than bigger airlines.

It is true this summary data embodies a lot of hidden variables.  For example, it isn't strictly accurate to compare one airline's results, with lots of short flights, with another airline's results that feature long haul international flights.  But, even accepting the approximate and simplified nature of these numbers, it is clear that the only correlation between an airline's size and its operating costs is - and quite the opposite of what the airlines claim - smaller airlines have lower costs than larger airlines.

This is because most of an airline's costs are tied in to the operating costs of each plane and each flight.  The fact that an airline operates one plane or one thousand planes; ten flights or ten thousand flights a day, doesn't really matter much, because the costs per flight are largely unchanging - primarily airplane ownership/operating costs, fuel, and labor.

Yes, there are some slight savings - a bigger airline might be able to negotiate a lower price to buy the plane in the first place, and might be able to get a slightly better price on jet fuel, but offsetting these advantages, smaller airlines tend to have more productive staff who do more work for less money, giving the smaller airline much lower labor costs.

In other words, it is management and work patterns, not size, that is most significant in determining an airline's underlying costs.  Small airlines, not big airlines, have the lowest operating costs.

This is a vital point to accept.  Bigger airlines do not demonstrate any economy of scale at all.  On the basis of this data, if lower costs lead to lower fares (an unproven assumption), we should be breaking airlines up, not allowing them to merge and combine.

Mergers Lower Costs

An oft repeated trope by airlines seeking anti-trust exemptions is that if they can work together, they'll lower their costs.

Well, we've already cast enormous doubt on the claim that larger sized airlines have lower operating costs, as shown in the table above.

But what about the 'if we can work together' part of the claim.  Look back up at the table again, and in particular, look at the highest cost airline of all 14 airlines listed - US Airways.  With an operating cost of 15.0/mile, its costs are 10% over the average of the major carriers, and 28% higher than the lowest costed of the major carriers.  Its costs are also nearly twice as high as those of the lowest of the low cost carriers.

This is significant because US Airways is the most recently merged of the major carriers, being the merged result of what was formerly America West plus the former US Airways (merged in 2005).  Clearly its merger has not given it any industry advantage at all from a cost point of view.

Looked at from the lens of mergers reducing the operating costs, the most recent example completely contradicts that claim.

Lowered Costs Make for Lower Fares

The second half of the claim airlines make when seeking anti-trust exemption is that when they lower their costs, that will lead to lower fares.

On the face of it, this is a ridiculous claim to make, because airlines are not charities, and neither do they operate on a 'cost plus' basis.  They are for profit commercial entities, and they charge the most they believe they can for every ticket they sell.  If their costs drop, that does not mean they will lower the price of their tickets; it merely means they'll make more profit (or less loss).

But the airlines continue to offer this justification to support anti-trust exemption requests, and the Department of Transportation continues to accept it.

Let's have another look at the table above, but this time add two more columns.  We'll place a revenue column next to the cost column, and then an analysis column that shows what percentage of costs the revenue figure is.  The data comes from the same source.

If the airlines are to be believed, the lower their costs, the lower their fares will be :

Airline operating costs and revenue (cents/available seat mile)
July - Sept 2009

Airline

Cost

Revenue

Percent

Major Network Airlines

US Airways

15.0

15.0

100.0

Delta

14.2

14.4

101.4

American

13.9

13.3

95.7

 United

13.4

13.8

103.0

Northwest

13.1

14.0

106.9

Continental

12.8

13.0

101.6

Alaska

11.7

12.8

109.4

Seven carrier total

13.7

13.9

101.5

 
Low Cost Carriers

 Southwest

10.7

10.7

100.0

 Frontier

9.9

11.0

111.1

 JetBlue

9.4

10.2

108.5

 AirTran

9.1

9.7

106.6

 Virgin America

8.6

8.9

103.5

Allegiant

8.3

9.7

116.9

 Spirit

7.9

9.2

116.5

 Seven carrier total

9.9

10.4

105.1

 

The average network carrier makes 0.2 a mile as profit, but three of the four of the lowest costed network carriers make considerably more than this, while the higher costed airlines make the same or considerably less.

Somewhat similarly, the two low cost carriers with the lowest costs are making the biggest profits, and with the exception of Southwest, all the low cost carriers are making many times the profit levels of the major airlines.

Do you see any pattern here?  No, you probably don't, because it is hard to see any linkage at all between costs and income, other than to note that the lower cost airlines tend to make higher profits, which is quite the opposite of the suggestion that lower costs will see a proportional lowering of fares.

Let's throw these numbers into another chart and ask Excel to add another 'line of best fit' to see if Excel can compute any linkage between income and profit, and to see if a visual representation makes things clearer.

In theory, you'd expect to see an upward sloping line.  You'd normally expect that the higher the gross revenue in cents per mile, the higher the profit (in cents per mile).  But - look.  Again, the line slope is exactly the opposite.  Incredibly, airlines that earn less per mile in revenue still manage to make a bigger profit than airlines which earn more per mile.

One could - tongue firmly in cheek - argue from these figures that higher cost airlines actually provide better value to the traveling public than lower cost airlines.  But that's the sort of nonsense statement you're more likely to hear from an airline than on this website.

Again, as with the cost figures, the income figures have a number of underlying variables driving them.  This table and comparison is a simplification, but even the simplified data starkly suggests a disconnect between operating costs and operating income, and supports the contention that operating income is market based, not cost based.

This range of different figures tells us that airline costs are unrelated to airline size - it is all about airline management, not airline size.  And airline incomes are also nothing to do with airline costs - they are opportunistically derived based on airlines charging what they feel to be the highest fares possible, whether those fares result in loses (ie American), a struggle to barely break even (ie US Airways and Southwest) or way above industry profits (ie Spirit and Allegiant).

In other words, larger and merged airlines are neither likely to lower their costs or their fares.

So - Are Bigger Airlines Better?

Ummm - if you're still asking that question, perhaps you should reread this article!

Now that we've shown there are no clear benefits associated with airlines growing in size, let's move on to the next part of this article series and see if there are any negative attributes associated with the aviation marketplace reducing from many small independent airlines to fewer and larger airlines.

Part of a series on airline competition - please see extra articles listed at the top in the right hand column

 

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Originally published 5 Mar 2010, last update 02 Jul 2017

You may freely reproduce or distribute this article for noncommercial purposes as long as you give credit to me as original writer.

 
 
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