Airline Handbook Chapter 2: Economic Deregulation

Commercial aviation helps drive more than 10M American jobs and 5 cents of every dollar of U.S. GDP
Commercial aviation drives more than $1 trillion per year in economic activity
In 2012, U.S. airlines moved more than 48,000 tons of cargo per day
In 2012, the value of a kilogram of U.S. merchandise exported by air averaged 121 times the value exported by sea
For every 100 airline jobs, some 360 are supported outside of the airline industry
Federal taxes constitute $61 – or 20% – of the price of a typical $300 domestic round-trip ticket
In 2011, U.S. airlines carried 16 percent more passengers and cargo using 10 percent less fuel than in 2000
Domestically, airlines drive 5% of economic activity but account for 2% of man-made GHG emissions
From 2000-2011, airlines reduced GHG emissions by 11% while transporting 16% more passengers and cargo
From 1975-2011, U.S. airlines and their partners reduced significant noise exposure by 99%
Commercial air travel is the safest form of intercity transportation in the United States
In the most recent decade, scheduled air service on U.S. airlines was seven times safer than in the 1970s
From 2000-2012, U.S. airlines improved the on-time arrival rate from 72.6% to 81.9%
From 2000-2012, U.S. airlines reduced the flight cancellation rate sharply from 3.30% to 1.29%
Airfares are a bargain: From 2000-2012, U.S. CPI rose 33% while average domestic fare rose just 14%
Adjusted for inflation, the average round-trip domestic airfare fell 15% from 2000
2007 domestic flight delays cost the United States approximately $31 billion
In 2012, the value of U.S. merchandise exported by air reached an all-time high of $427B
In 2012, U.S. exports of air-travel services reached an all-time high of $39.5B, driving a $5.1B trade surplus
In 2012, U.S. passenger and cargo airlines spent more than $50B on fuel, averaging 36% of operating expenses
In 2012, U.S. airlines posted the lowest annual rate of mishandled baggage ever recorded
FAA projects U.S. air travel demand to top 1 billion passengers in 2027
In 2012, US airlines flew 83.4 million passengers in scheduled international service - a record high
In 2012, the total value of merchandise exported from or imported to the United States by air exceeded $927 billion
In 2012, 7.15 teragrams of merchandise was exported from or imported to the United States by air

	Airline Handbook Chapter 2: Economic Deregulation
	PubZone1 Airline Deregulation The Airline Deregulation Act Today’s airline industry has changed radically since Oct. 24, 1978, when Congress passed the Airline Deregulation Act, signed into law four days later by President Carter. Previously, the industry resembled a public utility, because a government agency, the Civil Aeronautics Board (CAB), determined which routes each airline flew and the fares that it could charge. Today, principally the market drives the industry, with customer demand, total cost of operation and airline network competition determining prices and the level of service. [Note: The Federal Aviation Administration (FAA) continues to regulate airline safety.] Pressure for airline deregulation had been building for many years, particularly among economists who pointed out that numerous studies showed that intrastate airfares were substantially lower than fares for interstate flights of comparable distances. However, it was a series of developments in the mid-1970s that intensified the pressure and brought the issue to a head. Events Leading to Deregulation One of those developments was the advent of wide-body aircraft, which significantly increased airline capacity on many routes, making it harder for airlines to recover the cost of extra seats in the market without adjusting pricing. Another was the OPEC oil embargo in 1973, which led to skyrocketing fuel costs and inflation. These events placed a severe strain on the airlines as passenger demand fell against a backdrop of rising capacity and soaring fuel prices. Also, the CAB had become increasingly unwieldy and many observed that consumers traveling in intrastate domestic markets, which were not regulated by the CAB, typically enjoyed lower fares. In line with its mandate to ensure a reasonable rate of return for the carriers, the CAB responded by allowing carriers to increase fares and approved a series of agreements among the carriers to limit capacity on major transcontinental routes. These actions occurred in the middle of a four-year moratorium on authorizing new routes, limiting the carriers’ ability to serve certain markets. None of these moves, which made flying more costly, was popular with the public. Furthermore, the CAB action did little to improve the carriers’ financial condition. Despite fare increases and capacity constraints, earnings remained poor throughout the mid-1970s. In 1974, the Ford administration began to press for governmental regulatory reforms, in response to growing public sentiment that existing regulations were overly burdensome to U.S. industry and contributed significantly to inflation. Shortly thereafter, hearings of the Senate Subcommittee on Administrative Practice and Procedure, chaired by Sen. Edward Kennedy, concluded that airline prices in particular would fall materially if government constraints on competition were lifted. The staff of the CAB reached the same conclusion in a report issued in 1975. The report said the industry was “naturally competitive, not monopolistic,” and that the CAB itself could no longer justify controls on market entry or public utility-type pricing. On its own, the Board began to loosen its grip on the industry, acting at first under the leadership of John E. Robson and later under Alfred E. Kahn, who became CAB chairman in 1977. Mr. Kahn, an economist, persuasively argued that the board should give the airlines greater pricing freedom and easier access to routes. Air Cargo Deregulation Congress took the first legislative steps toward airline economic deregulation in November 1977, when it granted cargo carriers the freedom to operate on any domestic route and charge whatever the market would bear. Congress also declared that, one year following enactment of the bill, the CAB could certify new domestic cargo carriers, as long as they were found “fit, willing, and able.” No longer would there have to be the more demanding, more restrictive finding of public convenience and necessity. Express Package Delivery There was another important development following cargo deregulation – the rapid expansion of overnight delivery of documents and small packages. Deregulation produced dramatic results for all aspects of the cargo business, but particularly for express package delivery. Overnight delivery of high-value and time-sensitive packages and documents began in the early 1970s. However, it was deregulation that really opened the door to success for such services. Deregulation gave express carriers the operating freedom that such high-quality services demand, resulting in dramatic growth over the next decade. In 1994, Congress further encouraged the development of this part of the airline industry by preempting state efforts to regulate intrastate air/truck freight and air express package shipments. Passenger Deregulation The same principle of free-market competition was applied to the passenger side of the business in the Airline Deregulation Act of 1978. Congress mandated that domestic route and rate restrictions be phased out over four years. It provided for complete elimination of restrictions on routes and new services by Dec. 31, 1981, and the end of all rate regulation by Jan. 1, 1983. The CAB actually moved more quickly than that. It began granting new route authority so readily that within a year of the law’s passage carriers were able to launch virtually any domestic service they wanted. The CAB ceased to exist on Jan. 1, 1985, although several board functions shifted to other government agencies, primarily the Department of Transportation (DOT). What Remains Regulated International Aviation Among the CAB functions transferred to DOT was the authority to select carriers to serve limited-entry international markets, to enforce fair competitive practices in both domestic and international markets, and to review tariffs for foreign air transportation. Certain other international functions, including reviewing merger proposals, evaluating intercarrier agreements and granting antitrust immunity remain with the DOT. International aviation services are usually governed by bilateral air-transport service agreements that are negotiated between two countries. Bilateral civil aviation negotiations involving the United States are led by a team from the Department of State and DOT. Traditionally, bilateral agreements specify how many airlines from each country may operate, what routes may be flown, which cities may be served, how many times per week an airline may operate, how prices may be determined, and whether or not an airline can pick up passengers and/or cargo in that country and transport it to a third country. In the 1990s, prompted largely by groundbreaking commercial developments such as the collaboration between Northwest Airlines and KLM Royal Dutch Airlines, the United States made a concerted effort to liberalize its international aviation policy and achieve an open aviation regime worldwide, recognizing the importance of aviation with respect to the globalization of the world economy. Since the first “Open Skies” agreement was signed in 1992 (with the Netherlands), this effort has been very successful, and as of August 2011, the United States had concluded 103 “Open Skies” agreements, which reduce government interference in airline business decisions and allow airlines to offer more affordable, convenient and plentiful service to the flying and shipping public. “Open Skies” agreements have been very successful in increasing international trade and tourism, improving industry productivity and facilitating economic growth. “Open Skies” agreements can be either bilateral or multilateral; such an agreement allows an airline designated by the United States and the foreign signatory unlimited access to points in each partner’s country and unlimited access to intermediate and beyond points. Airlines are free to make their own market decisions on routes, capacity and pricing. Moreover, “Open Skies” agreements have liberalized conditions for passenger, all-cargo and charter operations, as well as for cooperative marketing agreements. In cases where the bilateral agreements are less liberal and restrictions exist, U.S. policy is to withhold liberal access to the U.S. market from those countries. In those agreements where limited or restricted opportunities are imposed on U.S. airlines by a bilateral partner’s country, DOT will determine which airline or airlines are awarded operating authority based on a legal proceeding. Interested U.S. airlines must compete for the limited authority by presenting a case demonstrating why they should be awarded the limited right. Antitrust Exemption The CAB, because of its comprehensive regulatory jurisdiction over the airline industry, had the authority to approve agreements between airlines and to grant antitrust immunity to those transactions that it approved. With the sunset of the CAB, DOT received the authority to approve and immunize agreements affecting international air transportation; however, the authority over domestic transactions lapsed. Essential Air Service Another function assigned to DOT with the demise of the CAB was the responsibility for maintaining air service to small communities. With carriers free to fly wherever they want and set prices accordingly, Congress anticipated that some of the lightly traveled and unprofitable routes would lose commercial air service. To assure appropriate service, Congress established the Essential Air Service program, which provides subsidies to carriers willing to serve domestic locations that otherwise would be economically challenging to serve. DOT administers the program, determining subsidy levels and soliciting bids from carriers. Safety The Airline Deregulation Act ended certain economic regulation of air service, particularly with respect to route entry and pricing, but left unaltered the active governmental role in regulating the airlines on all matters affecting safety. The government has performed this regulatory role since 1926, and continues to do so through the Federal Aviation Administration. Effects of Deregulation Increased Competition, Discount Fares and Growth in Air Travel Increased competition unleashed by the Airline Deregulation Act spawned discount fares and the proliferation of new service, which travelers found to be the most important benefit of airline deregulation. The appearance of new airlines, combined with the rapid expansion into new markets by many of the established airlines, resulted in domestic fares having declined more than 40 percent in real terms since 1978. They have become so low, in fact, that with rare exception interstate bus and intercity rail have become hard-pressed to compete with the airlines, which today provide the primary means of long-distance common-carrier transportation between U.S. cities. With greater competition on the vast majority of routes, extensive discounting and more available flights, air travel has grown rapidly since deregulation. In 1977, the last full year of governmental economic regulation of the airline industry, U.S. airlines carried 240 million passengers in scheduled service. In 2006-2010, they carried an average of 736 million passengers annually. In 2000, in Deregulation of Network Industries: What’s Next, economists Steven Morrison and Clifford Winston noted that, “Accounting for fare and service quality changes, the annual benefits to travelers from airline deregulation currently exceed $20 billion.” While the real reductions in fares were “widely shared,” Morrison and Winston also noted that travelers “gained substantially from the increase in flight frequency facilitated by the acceleration of hub-and-spoke operations.” Today, the overwhelming majority of U.S. airline passengers have a choice of two or more carriers, with airlines competing intensely in virtually all major markets. The advent of overlapping national aviation networks resulted in greater competition in hundreds of small markets that would not support competitive service in a linear route system. Proportionately, the largest increase in competition occurred in small and medium-sized markets. New Carriers Deregulation did more than prompt a reshuffling of service by existing carriers. It opened the airline business to newcomers just as Congress intended. In 1978, a total of 43 carriers were certified for scheduled service. Today there are well over 100 certificated U.S. air carriers. The number has fluctuated over the years with changing market conditions. Since 1990, the industry has seen a wave of new airlines operating different business models ranging from low-cost, hub-and-spoke and point-to-point network operators to regional carriers operating smaller aircraft for their mainline network partners. Networks A major development that followed deregulation was the widespread development of hub-and-spoke networks, which existed on a more limited basis prior to 1978. Hubs are strategically located airports used as transfer points for passengers and cargo traveling from one community to another. Airlines schedule banks of flights into and out of their hubs several times a day. Each bank includes dozens of planes arriving within minutes of each other. Once on the ground, the connecting passengers and cargo from those flights are transferred conveniently to other planes that will take them to their final destinations. Airlines developed networks in order to efficiently serve far more markets with a given fleet size than they could if they only offered direct, point-to-point service. Geographic location, of course, is a prime consideration in deciding where to build a hub. Another is the size of the local market. Airlines prefer to locate their hub airports at cities where there already is significant “origin and destination” traffic (as opposed to connecting traffic). At a hub, local and connecting travelers benefit from high-frequency service throughout the day to many different domestic and international cities. Carriers also found that integrated hub-and-spoke systems allowed them to achieve higher load factors (percentage of seats filled) on flights to and from small cities. For example, a city of 100,000 residents is unlikely to generate enough passengers to any single destination to fill more than a handful of seats aboard a commercial jet; however, that city may very well generate passengers going to a number of different destinations. Operating a jet into a hub, where passengers can connect to dozens of different cities, therefore, makes economic sense for smaller markets. Frequent-Flyer Loyalty Programs Deregulation also sparked marketing innovations, the most noteworthy being frequent-flyer loyalty programs, which reward customer loyalty with tickets, cabin upgrades, priority check-in, priority boarding, lounge access and other benefits. Most airlines have such a program and the essential elements are the same. Once customers enroll, they can earn points for the number of miles flown or the number of trips taken on the sponsoring carrier or its partners. These points are then redeemed for rewards that include tickets and upgrades. The first modern frequent-flyer program was initiated in May 1981 by American Airlines, followed soon thereafter by programs from United Airlines, Delta Air Lines and British Airways. A more recent development has been the growth of partnership marketing arrangements tied to frequent-flyer loyalty programs. Because of their extensive membership rolls, frequent-flyer programs are very attractive to nonairline companies who are willing to pay for the privilege of participating in them as marketing partners. In addition, the airline benefits as its loyalty program becomes more attractive through its relationship with partners: it is now possible to earn frequent-flyer points by purchasing nonairline goods and services and redeem points for nonairline products. Typically, a partner company will pay the host airline per mile earned when a frequent-flyer member uses the partner’s goods or services, but such arrangements vary by airline and partner. Frequent-flyer programs are now integral to an airline’s product offering, complementing convenient schedules, price, safety and customer service. Alliances have increased the popularity of such loyalty programs by extending reciprocal benefits to customers of member airlines. Global Distribution Systems (GDS) Another important development following deregulation was the advent of the computer reservations system (CRS). These systems helped airlines and travel agents keep track of fare and service changes, and more efficiently process hundreds of millions of passengers worldwide. Several major airlines developed their own systems and later sold partnerships in them to other airlines. The systems listed not only the schedules and fares of their airline owners, but also those of any other airline willing to pay a fee to have their flights listed. Travel agents also paid fees to access the systems. In the 1990s, airlines began to divest from their computer reservations system, allowing the systems to become independent businesses. The systems became known as global distribution systems (GDS) because of their increased functionality. For example, individual travelers access a GDS when booking a trip online. In addition, a GDS can be used to purchase hotel stays, rental cars and other travel services. As airlines sold their stakes in GDSs, the U.S. Department of Transportation reevaluated its set of rules that regulated the systems. These rules had been designed to protect consumers by mandating, for example, that systems be objective and unbiased and that participation in each GDSs be open to all carriers on a nondiscriminatory basis. DOT regulations also required that GDS information and booking functions provided for each airline be as reliable and current as they were for the owner airline. After the ownership link between airlines and GDS was severed, DOT determined that the GDS market should be liberalized to ensure that government regulation would not interfere with market forces and innovation in the GDS and airline distribution businesses, and to allow the various systems to better compete with one another. By mid-2004, all of the rules governing the systems had been terminated. Code Sharing and Alliances Another innovation has been the development of code-sharing agreements. Code-sharing agreements allow two (or more) airlines to offer a broader array of services to their customers than they could individually. These marketing arrangements enable an airline to issue tickets on a flight operated by another airline as if it were its own, including the use of its own two-letter code for that flight. These arrangements allow airlines to market expanded networks for their passengers at minimal expense. Code-sharing agreements can be between a larger airline and a regional airline or between a U.S. airline and a foreign airline or any combination thereof. Indeed, the earliest code-sharing agreements involved national, regional and trunk carriers and their commuter feeders. Code-sharing agreements often link each airline’s marketing and frequent-flyer programs and facilitate convenient connections between the code-sharing partner carriers. (Some own regional carriers outright, giving them greater control over these important services that feed traffic from smaller cities into the major hubs or key cities. In some cases, the regional airline will paint its planes in the livery of the larger partner.) Code sharing with foreign carriers allows U.S. airlines to expand their global-network reach through the services operated by their partners. Code sharing differs from interlining, a much older industry practice, developed when the government regulated where airlines could fly, in which a carrier simply hands off a passenger to another carrier to get that passenger to a destination the first carrier does not serve directly. In such situations, the passenger buys a single ticket, and the airline issuing the ticket makes the arrangements for the traveler on the second carrier. However, schedules are not necessarily coordinated, there are no frequent-flyer links, and there is no sharing of codes in global distribution systems. The flights of each carrier appear independently in the GDS. In addition to code sharing, several groups of airlines have formed global alliances, such as oneworld, Star and SkyTeam, which compete against each other for international passengers. Each alliance consists of a number of carriers, including some that may fly under the same flag, which through multilateral agreements not only share codes on one another’s flights and link frequent flyer programs, but also offer consumers benefits such as common airport terminal and lounge facilities and coordinated flight schedules. In addition to expanded networks, participating airlines benefit from reduced costs through the sharing of staff, facilities, sales offices and ancillary services. Global alliances continue to expand because they produce, for airlines and their customers, the benefits of network economics. Global alliances sometimes include joint-venture agreements in which some airlines in the alliance decide to more closely integrate their activities with one another in such matters as schedule and marketing coordination, and revenue or profit sharing. Joint-venture agreements are a response to the longstanding existence of laws in many nations that limit the ability of a foreign airline to have substantial ownership and control of another nation's airline, known as foreign-ownership limitations. These agreements are designed to provide many of the consumer, operational and financial benefits of a transborder merger that the aviation laws of these nations today prohibit. Joint ventures, if they involve air transportation to and from the United States, require antitrust immunity from the U.S. Department of Transportation (DOT). DOT only grants that immunity if it finds the proposed transaction is in the public interest and the foreign airline that would participate in the joint venture is from a country with which the United States has an open-skies agreement (see Chapter 2: International Aviation). Go to Chapter 3 PubZone2