A delusional view of the aviation market

I often enjoy reading economic analysis of the aviation industry. I usually feel like I’m learning something new and the nuance is generally interesting. I was quite surprised when reading an OpEd piece in the New York Times last week to uncover what would appear to be a rather ridiculous suggestion: Small and mid-size markets in the USA would benefit from foreign carriers being given permission to operate on wholly domestic routes. The basic claim is that there is insufficient competition in the market today, allowing fares to creep higher and planes to be more full. And service to small and mid-size markets is enduring the brunt of the pain; most of the "heartland hubs" (CLE, CVG, PIT, MEM, STL) have seen major capacity cuts in recent years, with their status as a hub in question. And the solution, according to Mr. Winston, is opening the skies over the USA to anyone who wants to operate here.

That is, unless policy makers do what they should have done a long time ago and allow foreign airlines, including discount carriers like Ryanair and global players like Qantas and British Airways, to serve domestic routes in the United States. Why, after all, should an industry that has ingeniously used free-market principles to squeeze the most revenue out of each middle seat be protected from competing in a real free market?

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. And even if that were made available it still is an unlikely solution. Or at least not likely a good one. After all, what’s the value proposition being suggested? 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.

There is a certain amount of discretionary travel demand which increases as fares drop below a certain threshold. I believe that number is roughly $100 each way these days. But just flooding the market with inventory to drive the fares down that low doesn’t mean that enough people will necessarily buy the seats in a volume which pays for the service. In fact, it is rare that flights operated at that discretionary demand point are profitable to the airlines at all.

Mr. Winston notes that passengers have likely saved $5bn annually thanks to Open Skies agreements between the US and Europe. Not surprisingly the airlines are trying to claw some of that revenue back, cutting service and striking joint ventures which allow them to cut costs and pool revenue and collude on prices. Are these agreements good or bad for passengers? If only measured by average fare paid then they are probably bad. But that’s not really the only metric. Look at the carriers who have gone bankrupt in the interim. For those customers  – and those employees and creditors – the $5bn in annual savings means a lot of losses, not gains.

Mr. Winston also suggests that one upside of the competition is that it will help reduce unemployment:

Competition from foreign airlines would put downward pressure on wages, something that union workers may object to. But by reducing fares and expanding service, it would also increase the demand for air travel and related services — thus, presumably, creating additional jobs during a time of persistently high unemployment.

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?

So if the fares are driven sufficiently low, to the point that they cannot cover the costs of operating the flights, then other airlines will want to jump in to the market, right? Certainly then Singapore Airlines will show up to operate on Sarasota – Cincinnati, making the service better and the price lower, right? That’s what is being claimed in the piece.

The reality is that opening up the US skies to foreign carriers would see those carriers do the same thing that pretty much every other start-up airline has done in recent years: cherry pick. JetBlue started by cherry picking routes between JFK and upstate New York or Florida. Virgin America has picked heavy business routes and seems to be losing a ton of capital doing so. Oh, and that’s with the fares higher now; things would be much, much worse for them were the fares depressed further.

So where can these foreign carriers make money operating in the USA? Certainly the grandmother trying to get from Sarasota to Cincinnati (his example, not mine) worried about fewer flights and higher fares won’t benefit from Qantas getting local traffic rights on their LAX-JFK flight. And even if Singapore Air could operate to Sarasota, why would they? The market demand there isn’t very high. So instead of the smaller markets getting more service the carriers who serve them today suffer from lower yields on their more profitable routes. That means they scale back the less profitable routes. So grandma gets even fewer options, not more.

Maybe easyJet or RyanAir could set up shop in the USA and make it work. But SkyBus certainly couldn’t. Maybe the others would actually serve the airports in the cities they advertise, but they often don’t in Europe. RyanAir’s idea of service Paris is an airport 60+ miles away. That’s like flying in to Trenton for service to New York City.

Competition is good. Monopolized markets are not very consumer friendly. But neither are unstable markets. A few people might win, playing in the margins, but the big picture effects of pursuing open skies on all domestic markets would be a disaster for the US economy. And for the passengers such a change supposes to help.