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THE SHIFTING OF REGULATION IN A DEREGULATED ENVIRONMENTi
PROSPECTS FOR A MISLABELED MARKET
Paper for the fulfillment of requirements for the program of Mathematical Methods in the Social Sciences
Glen Sarvady May 29, 1984 "...The encouragement, development, and maintenance of an air transportation system relying on actual and potential competition to provide efficiency, innovation, and low prices, and to determine the variety, quality, and price of air transportation services,,,"
-stated aims of the 1978 Civil Aeronautics Act
"•••(avoidance of) The uneconomic, destructive competition and wasteful duplication of services,,,the air carriers and the traveling public are protected against unreasonable and discriminatory passenger express rates, unfair trade praetiffieB_.and monopolies in restraint of competition,,,"
-stated aims of the 1938 Civil Aeronautics Act IOTRODUCTION/ABSTRACT
The Civil Aeronautics Act of 1938 was a farsighted piece of legislation intended to assist a fledgling airline industry blossom into an efficient and thorough transcontinental transportation network. The
Act was so successful in anticipating future conditions and necessary actions that it remained on the books, virtually unaltered, for forty years. Many argue, with a fair amount of justification, that the 1938 Act had reached obsolescence and merited replacement long before its expiration in 1978.
During its tenure, the airline industry had reached maturity and enjoyed great prosperity, albeit achieved through a highly regulated environment.
By the 1960s, the industry had grown to a point where the current legislation was no longer relevant or effective at steering the airline network in the path desired by the Civil Aeronautics Board.
In 1978, attempts to revise the existing laws resulted in a swing to the opposite extreme. After forty years of price controls, route allocation, and other strict jurisdiction at the hands of the CAB, Congress decided to pursue a course of deregulation in the airline industry. The bulk of the CAB's powers had been eradicated by I983, and subsequent revisions in the 1978 Act went as far as to dismantle the CAB entirely by 1985.
A glut of articles and reports, both predictive and analytical in nature, have resulted from the new state of affairs, as academians and bureaucrats alike strive to evaluate the success and ramifications of the new system. The literature includes purely speculative prose, highly abstract models, projections made from the waning years of regulation, and statistical analyses based on what little data has been amassed since 1978. However, one common thread can be found linking these diverse works. The vast majority appear to be written from extreme positions of pro-deregulation bias. In fact, many seem to begin with an attitude of 'deregulation is a godsend' and proceed to delve for any and all evidence supporting their devotion, in the process squelching any hopes for an objective presentation.
This paper purports to dispel several fallacies surrounding the new legislation, first of all, the term 'deregulation' is a severe misnomer most likely attached to the current market for reasons of political efficacy, A relaxation of regulation has occurred for the major airlines, and all carriers enjoy a newfound freedom in fare determination. However, the 19?8 Act and its effect on the industry as a whole can most accurately be termed a shifting of regulation. The CAB, or any agency assuming residual duties upon its demise, how has a hand in the direction of carriers over which it did not previously hold power.
The 1938 Act contained a series of objectives, many of which proved to be mutually exclusive. The deregulated environment (I shall continue to refer to it as such despite my objections, since the term has been coined and accepted) has alleviated some of these problems, yet contradictions still exist. The i9?8 Act pledges "to rely on competitive 1 market forces to determine the nature of air service," a promise not yet realized. It is not clear that if such a system were actually installed, the resultant air service network would be at all consistent with the CAB's 1938 vision or any idyllic contemporary wishes. Nor is it certain that such an industry, serving as a basis and support system for numerous private and public functions, should in fact be dictated solely by market forces.
I hope to provide new interpretations of documented facts and present data in such a manner as to shed light on the current state and direction of the deregulated airline industry. I shall also present original equations describing carrier exit and entry from small and perimeter markets, illuminating the changes in the amount and complexion of air service since 1978. It is my intention that an unbiased evaluation of the effects of the 1978 Civil Aeronautics Act will result. The Civil Aeronautics Act, drawn in 1938% laid the groundwork upon which federal control of commercial aviation would be based for the next forty years. The Act created the Civil Aeronautics Board, an agency entrusted with the control of firm entry, route structures, fare levels, subsidy allocations, and safety measures for the airline industry. (A list of the official objectives of the CAB is included on the following page.)
Scheduled air service had begun in the mid 1920's, operating mainly to ship mail, with the federal government virtually serving as the carriers' sole client. Passengers began to fly in addition to cargo, and the scope of service changed as a result.
From its inception, the CAB adopted as its primary function the development ©f a far reaching nationwide airline system requiring a minimum of government subsidization. Since the main competition for passenger transportation in 1938 was the railroad, one of the CAB's first moves was to set airfares to the going first class rail rate. This strategy catalyzed a situation which remains as one of the prime areas of debate regarding the viability of deregulation. Unlike the rail system, air travel operating costs exhibit considerable economies of scale. Airline costs per seat per mile significantly decrease as the distance travelled increases, mainly owing to matters of fuel efficiency. Consequently, from the start long haul routes have been more profitable than short haul jaunts. The
CAB exploited this fact, balancing the route portfolios of each carrier between short and long haul routes. In this way, excess profits earned on long hauls could be used to internally subsidize the short haul runs.
This system was very politically attractive in the early stages, Self Professed Goals of the 1938 Civil Aeronautics Act
In the exercise and performance of its powers and duties under this Act, the Board shall consider the following, among other things, as being in the public interest, and in accordance with the public convenience and necessity:
The encouragement and development of an air transportation system properly adapted to the present and future needs of the foreign and domestic commerce of the United States, of the Postal Service, and the national defense.
The regulation of air transportation in such a menner as to recognize and preserve the inherent advantages of, assure the highest degree of safety in, and foster sound economic conditions in such transportation, and to improve the relations between, and coordinate transportation by, air carriers;
The Promotion of adequate, economical, and efficient service by air carriers at reasonable charges, without unjust discriminations, undue preferences, or unfair or destructive competitive practices;
Competition to the extent necessary to assure the sound development of an air-transportation system properly adapted to the needs of the foreign and domestic commerce of the United States, of the Postal Service, and the national defense.
The promotion of safety in air commerce, and,
The promotion, encouragement, and development of Civil Aeronautics.
Source; Civil Aeronautics Act of I938.
t as the network was strengthened with a minimum of subsidy infusion from the government. However, economic theory dictates that such cross subsidization is inefficient and will be doomed when exposed to free market forces. An airline would prefer to keep excess profits earned on the long hauls rather than squander them on other routes. Furthermore, an airline without the short haul runs to support could conceivably enter only the long haul markets and cut fares below industry standards while still receiving the same amount of overall profits. In economic terms, this is a result of artificially setting marginal cost curves too high for the long haul and too low for the short haul. If 'true' marginal cost and revenue curves were allowed to infiltrate the marketplace, the system would inevitably break down.
No such collapses were to befall the industry for several years, due to the trade's infant status and barriers constructed by the GAB.
The 1938 Act aimed to prevent "...the uneconomic, destructive competition, and wasteful duplication of services..." accomplishing this by decreeing
"...that no person nor company may engage in air transportation without 2 first receiving a certificate of Public Convenience and Necessity."
In other words, no carrier was allowed to enter and compete without a certificate, and certificates were virtually unattainable. The sixteen carriers existing at the time of the 1938 Act were awarded such certificates; they comprise what are known as the trunkline carriers. The number of trunks has shrunk to ten, but not a single carrier has been admitted to this elite group since 1938. Even if one of these carriers by chance received a route allocation presenting them with a favorable average cost curve, rigid fare controls prevented them from pursuing any course of predatory or even competitive pricing. Furthermore, through the mid l940's EFFECTS OF GAB FARE STRUCTURE
MRlc
MR,la
AMR =AMR c a
MRs „a
MR sc Q where MR, • marginal revenue of long haul flights given CAB fares lc MR - marginal revenue of short haul flights given CAB fares sc MR • MR = marginal revenue (estimated) of long, short haul la sa flights if left to free market forces
AMR • marginal revenue as an average over all flown routes In theory, this level would be equal with or without controls.
V me f • AC MR sa :' s'
MR sc
Q
Given CAB fares, carriers would opt to shut down short haul operations since MC is everywhere above MR. The CAB induces service by offering excessive profits on long haul routes, and must consequently construct trade barriers to support such levels. even long haul routes were at best breaking even. Though carriers were not stringently required to operate over all of their apportioned short haul markets (by law,Aairline could leave dormant a route entrusted to it, leaving the market with no air service), no carrier was about to act contrary to the wishes of the GAB, upon whose subsidies their very existence was dependent.
Such respect died soon after World War II. By 1952, long haul routes had become so profitable that all but one of the trunks went off subsidy. Adopting an attitude of "What have you done for me lately?* toward the CAB, the trunks began to leave many of their short haul markets.
As a result a new class of carrier, the local service line, came into being in the mid 1940's ?.s the CAB searched for new methods to realize their goal of providing consistent and reliable service to outlying and
low density regions. The local service carriers assumed these abandoned
short haul routes and their accompanying subsidies. In order to weave
around their own guidelines and provide financial aid, The CAB issued temporary certificates of Public Convenience and Necessity to nineteen
local service carriers between 19^-5 a^d l95l» These five year certificates were later extended and begrudgingly made permanent, more than doubling the number of firms in the 'legitimate* air travel industry.
Difficulties persisted in serving these small communities, however. The amount of subsidy needed to support small market service was drastically underestimated by the CAB, Government pressures to reduce costs ultimately forced the CAB to award some high density, longer haul routes previously held by the trunks to the local service lines, A new round of cross subsidization ensued, and the result was predictable. The local service carriers were transformed into mini-trunks which gradually metamorphosed into autonomously viable ventures. They soon became more
interested in retaining profits and competing with the major trunks, in the process turning their backs on the small communities whose needs prompted their creation in the first place. Some of the blame clearly belongs in the CAB's corner, as their policies toward the local service carriers were self contradictory. The CAB encouraged growth and self sufficience, at the same time providing an impetus to ignore small communities.
The story now jumps to 1978, when criticism of the 1938 Act has become severe enough to merit action. Trunklines, including the new
•mini-trunks', continued to reap the benefits of the outdated acti entry barriers and prices set to inflated levels, yet had long since discontinued offering reciprocation in areas where the GAB desired their help. The all-inclusive transcontinental network was in place and prospering. Hoping to further improve service, Congress drafted the 1978 Civil Aeronautics
Act, pledging!
"...the encouragement, development, and maintenance of of an air transportation system relying on actual and potential competition to provide efficiency, innovation, and low prices, and to determine the variety, quality, and price of air transportation services."
Gone was the need for a certificate of Public Convenience and
Necessity and with it any legislated trade barrier. After a five year period during which fares could be set from 90-150?? of a declared industry standard, all pricing constraints vanished as well. Carriers no longer had soverlegn rights to their routes. Exit from markets, though previously possible, was considerably simplified. Any line, including upstarts, was free to enter any city, especially those left dormant by its formerly allocated carrier.
Possibly the most important development from the CAB's standpoint was that it was no longer constrained in the carriers to which 10
it could offer assistance. During the 1960's, another new class of carrier had evolved. The commuter lines concentrated mainly on marginal communities neglected "by the trunks. Since they had lacked certification, commuters were earlier limited to equipment handling twenty passengers or less and a negligible number of scheduled flights per week. Commuters operated through the 1960's mainly in the capacity of an *air taxi' service, carrying groups "by appointment. However, commuters assumed an increasing position of importance in the 1970's and given the new freedom of the 1978 Act, the CAB is now turning to commuters to fill the roles that the trunks and local service lines have forsaked after being aided into a larger market.
The argument behind leaving the short haul markets to the commuter lines rests on the fact that they can run fleets of smaller planes with higher load factors and lower operating costs, thus allowing for profits in situations where the majors would sustain losses. In the regulated environment, the CAB pegged fares according to industry costs.
Therefore, the decreed rates had to be high enough to sustain the most inefficient carriers. What this policy served to do was promote industry wide inefficiency. As fares were set to an unnecessarily high level, the optimal strategy of airlines was to run more frequent flights, carrying a lower load factor on all. Though operating costs were increased, overall profits were maximized given the fare, A vicious circle developed because of these policies. If prices had been cut, passenger demand would have increased, quite possibly to an extent where the number of flights run at CAB fares could have been justified, with higher load factors.
The perfect experiment of these premises was run in Texas and
California, Even during the heyday of CAB regulation, controls applied only to interstate carriers. These states contained routes fully within li
OVERPRODUCTION INCENTIVES CAUSED BY INFLATED GAB FARES
P (fares)
MR (at CAB rates)
MR (at estimated free market levels) /AC
*a Q. Q (in number of flights)
Originally, trunks with CAB set fares will operate Q flights at P,, while those at 'free market' fares such as Southwest and PSA will limit themselves to Q . Though the free market (P_,Q9) is more efficient, trunks also maximize profits given P..'
Assuming inelastic passenger demand F., load factors of the free market flights will be higher, as clearly F. F,
Q Q 1
Given sufficient elasticity of demand, the inequality will
intensify, the number of travelers may increase to F such that F?P?^>F1P1
providing an impetus to increase Q to a level approaching Q1. 12
their "borders of sufficient length and market density to support Intrastate airlines of considerable impact. Southwest Air and Pacific Southwest
Airlines (PSA) , without the constraints of fare and route regulation or the existence of long haul routes to provide cross subsidies, flew in direct competition with the trunklines- and posted higher profits and greater efficiency at lower fares. These newcomers used the same planes as the majors, hut added capacity by eliminating first class (the main source of empty seats) and removing kitchen and galley space. The latter action did not detract from service, as meals were seldom served on jaunts of under 300 miles, which were the trips that these intrastate carriers made. Their reduced prices resulted in load factors of 70% (AirCal) and 6z% (PSA), compared to ranges of y)-5&% for the trunklines. The increased demand did help to justify flying with a frequency similar to that of the majors.
When dealing with short haul markets of lower density, matching the equipment of the majors is not the answer. NASA studies have shown that substantial fuel savings are attainable on short and medium hauls when new technologically advanced turhoprops, rather than jets, are used.
In factj
"Efficient low cost carriers like Delta and Northwest as well as new specialized carriers such as PSA, Southwest, New York Air, and People's Express have the capability of establishing rates which will not be profitable for high cost competing carriers. Thus, it may prove impossible for a carrier with a three engine, three man cockpit crew plane of the wrong size operating over non-optimal stage lengths to survive against a new technology-twin engine two pilot, properly sized aircraft. •*
These savings are, however, contingent upon the public's acceptance of propeller craft as a replacement to their beloved jets, 13
Personal experience booking business itineraries in a travel agency has shown that business travellers are willing to alter their schedules by hours or even days in order to avoid small propeller driven planes.
In cases of small markets located near larger ones, people have displayed a tendency to travel a few extra hours to the larger town for the benefits of larger planes, broader schedules, and lower fares. Responding to federal questionnaires, representatives of some small communities stated that their areas suffered no hardships from the loss of all air service, as those needing to travel were served equally well by using land transportation to get to nearby hubs.
As might be expected, the newfound ease in exit from and entry to markets brought about by the 1978 Act has caused an increase in the number of departures and available seats between between large and medium market city pairs. However, these gains have come at the expense of declines in, and sometime total loss of, service to and between smaller communities.
As part of the 1978 Act, the GAB has ensured that service will continue to be provided to 555 smaller communities for at least ten years.
To be guaranteed such Essential Air Service, markets had to be served by at least one certificated air carrier at the time of deregulation.
Airlines are still permitted to cease operations to such communities, but must serve notice to the CAB before doing so. When terminations would affect the Essential Air Service offered to the community (normally defined as eighty inbound and outbound seats at a 50-65$ load factor) the GAB must actively seek replacement carriers for the market, offering subsidies if necessary. The current airline may be forced to remain for a time if no newcomer is found, with resultant losses covered by the CAB. Unlike pre-deregulation guidelines, it is now permissible for these operating subsidies to be given to commuter airlines. The provision seems logical, since the equipment of commuters can serve small markets more efficiently. However, the 1978 Act contains no clauses tying financial aid to the type of equipment used to fill the need. Subsidies were designed to OOVBXLAII losses and provide a ±2% return on investment.
After two years, another carrier may petition to assume the service
(and subsidy) if it can prove it is able to provide service more efficiently, thus cutting the government outlay. Such hollow incentives are unlikely to cause competitors to line up, considering that resources can be committed to much more profitable ventures. In lk$ of the 555 Essential
Air Service markets (26.1$), all major carriers have pulled out and the remaining service is offered solely by commuters. In 88 cases (15«9$)i the solitary airline is supported via subsidies.
Furthermore, at the time that the 555 cities were assured of ten years of service by virtue of their affiliation with a trunkline carrier
(a purely arbitrary qualification set by the CAB), 203 other communities of similar size received no such guarantees because their service was already limited to commuter lines. Of these, 5^% have since lost all scheduled air service.6
The Essential Air Service program expires in late 1988, and it is uncertain whether funding will be extended. If not, most currently subsidized cites are likely to lose service at that time. However, no provisions have benn made for any early cutoff of subsidies to those communities which clearly hacse no hope for retaining service or no ascertainable need for it. Suggestions have been made that the CAB provide higher subsidies in an attempt to cultivate markets, planting seeds so that once the subsidies cease, service can continue without 15
outside aid. Others feel that state governments should be entrusted with the task of ensuring that their small communities by continually served. Regions can provide subsidies of their own, offering tax breaks and other varied incentive programs to airlines.
A less publicized and seldom used provision of the 1978 Act incorporates many of the above recommendations. In addition to the 555
Essential Air Service markets, the door is left open for those cities whose certificated air service was discontinued in the ten years preceding deregulation. These communities are allowed to petition for a renewal of air service, and if the GAB finds their arguments compelling, they too will be eligible for subsidization. In such cases, subsidies are normally offered on a 'use it or lose it' basis. Once service is reinstated, subsidies will again be terminated if an insufficient amount of demand or support is shown (usually defined as an average of five passengers per flight). Therefore, the burden of proof of the need for service, as well as the responsibility of its promotion, lies squarely in the lap of the municipality. Subsidies to the consenting carrier can be in the form of cash, but often include other nonpecuniary perks as well. For example, one proposed use it or lose it test involved an offer by Mississippi Valley
Airlines to provide four daily roundtrips from O'Hare to Beloit and
Janesville, WI, In return, MVA would be rewarded with four permanent
(and very valuable) gate slots at O'Hare, to be retained even if the test failed. The arrangement was never enacted, as the FAA could not provide the slots. However, the conditions were perfectly legal, and many similar pacts have been approved.
Unfortunately, only four of the 172 communities eligible under this clause have filed for subsidies. There is no opportunity for markets not meeting these criteria to receive subsidies, and not surprisingly no such town has experienced the establishment of new scheduled service.
Any town and airline are free to enter into agreements requiring no federal funding or aid from the CAB, however.
The general effect of deregulation has been pretty much what one would expect, given the country's industrial history. Nearly every carrier has taken a look upward and decided to make an effort to climb up one rung of the ladder. In airline terms, this means that all carriers are looking to service longer routes in higher density markets. Interviews with airline executives support this contention. Leaders such as American and United see themselves taking on a smaller but more profitable role
(addition by subtraction, if you will), deleting short haul flights unless they serve as a feeder to their own top priority long haul routes.
The most pervasive attitude can perhaps be embodied by
Republic Airlinos* By its own admission, before deregulation Republic viewed its niche in the marketplace as a regional carrier bringing people from small cities to large hubs, at which point the majors could take over.
Now that all controls have been lifted, that plan has been thrown out the window. Republic now plans a no-holds-barred fight to compete on a par with the former trunks, using satellite airports such as San Jose and
Ontario, GA as its in to many major markets.
Somewhat more tempered in its approach is Frontier, an airline of approximately the same size as Republic. As president G. L. Ryland put it, "Remember, being big didn't save the dinosaur." Frontier plans to expand "only to boomine- regions." Since 1978, they have added 25 7 markets while jettisoning 27 "loser cities." Not surprisingly, the new destinations represent densities of 6$-105% higher than those dropped.
As Republic, Frontier, and the likes move on to bigger and better things, someone must be willing to pick up their crumbs in order 17
for deregulation to succeed. Air Wisconsin has filled that role superbly.
Until recently a very small carrier, it now services 12 communities
(ironically, of these only Appleton is located in Wisconsin), the majority of which were dropped "by other lines. Their profits have been among the highest in the country, mainly because Air Wisconsin staunchly avoids routes where any competition exists. As a result, the line has been able to charge fares yielding an average of 380/mile, as opposed to 120/mile for the majors. Air Wisconsin intends to assume an ever increasing role, mainly by adopting 'unprofitable* routes abandoned by others. This implies that their expansion will continue solely through locations in which they will be the only carrier, providing the degree of monopoly power that enables them to retain such high fare yields.
An entirely different situation exists at Midway Airlines, a carrier whose very existence is owed to the phenomenon of deregulation.
At its inception, Midway's battle plan was to serve only high density markets with a no-frills approach, employing many of the strategies successfully employed by intrastate carriers in California and Texas.
After sustaining early losses, however, they shifted gears to model themselves as a businessman's luxury line, still slightly undercutting industry fares, but operating through less congested alternative airports.
This second approach has turned Midway into a profitable carrier.
With everyone else looking up, the GAB realized it was necessary to find carriers to fill the niche left open in many small markets. To do this, they greatly expanded the role to be played by the commuter lines. The GAB expanded the capacity of planes considered to be commuters from 30 to 60, made them eligible for subsidies, and allowed them to enter into joint fare agreements with other airlines.
This last paint holds important implications, and shall be explained 18
later.
However, judging by current trends,
"...it seems almost inevitable that airlines originally- set up as commuters lose sight of old goals and begin to think in terms of 100 passenger planes (formerly reserved for trunks) and 500 mile routes,.,,"
Through its attitude and subsidies, isn't the CAB simply exacerbating this process, leading the commuters to they same conclusion that the trunklines and local carriers reached in earlier years and again leaving short haul routes unrepresented? Possibly, but some of the former follies have been eliminated. One difference in how the CAB handles its current subsidies as opposed to its past practices is that grants are doles out solely on the basis of losses incurred on the subsidy-eligible route, rather than the entire system flown by the airline. The new program eliminates some subsidy abuses and rules out the use of internal subsidization which earlier efforts proved futile. On the other hand, the current system provides less incentive for a carrier to enter an admittedly unprofitable market, committing equipment for a mediocre guaranteed rate of return, A growing camp supports the idea of larger subsidies paid over a shorter period of time, presumably to cultivate the market to profitable levels.
How have the commuter lines responded to their new role in the marketplace? In the first year after deregulation, non hubs and small hubs actually saw increases in flight frequency of 6,8% and 4.9%, respectively. Local service carriers previously entrusted with such duties could not afford to make the short, frequent runs with the large jet equipment which their regional trunk status dictated. Consequently, commuters made more flights over these routes, using planes with much smaller capacities.
By I960, the commuters were serving as many passengers annually 9 as the trunklines had in 1948. The commuter air fleet has doubled since deregulation, with ridership up 3k% over the same period. Thirty percent of all flights are now commuter; still, only ,7% of the Industry's fuel supply was consumed by commuter lines. In 1972, 68% of all commuter passengers flew in planes able to hold nine passengers. By 1983 > 80% 10 of commuter planes had 19 or more seats.
Such statistics quickly scramble into meaninglessness unless the reader is provided with a scope within which they can be evaluated.
In the deregulated environment, it was hoped that commuters would provide point to point transportation between low density, short haul markets, and also serve as a feeder in the hub and spoke system, bringing passengers from small markets to a hub where they would connect to a larger carrier and complete their journey. Figures make it unclear if one of these goals is suffering at the hands of the other. A decreasing majority of commuter passengers connect to other flights; however, the proportion has dropped from 80% in I978 to 70% in I98I to 66% in I982.
Concurrently, the average stage length of a commuter flight increased dramatically. In 1978, lllmiles was the average. Eighty-seven percent of all commuters were under 250 miles, a condition true of only six percent of all certificated flights. By I98I, however, the average commuter stage length was up to 141 miles, and trends gave every indication that it would rise significantly further. Obviously, the increased distances were positively correlated with the adoption of cities abandoned by local service and trunk lines. It cannot be ascertained whether addition of these markets enabled passengers to reach their destination without connecting, or whether the decrease in the proportion of connecting travellers was compensated for in sheer numbers by the increase in flights.
If the GAB still purports to provide small communities with as equal an access to the air transportation as possible, and plans to use the hub-spoke concept and commuter airlines to achieve this goal, it it unfathomable why they have allowed the joint fare program to expire.
A joint fare is a single charge for connecting service which is less than the sum of the fares of its individual legs. The discount reflects the savings of airlines in areas such as ticketing an baggage handling. The mandatory joint fare program ensured that connecting discounts would be offered on all routes, calculated with a formula if not already published by inter-airline agreement. Such, a system helped to reduce the 'penalty' of living in a small town, since two individual connecting fares are almost invariably higher than direct flights to the same location. Empirical studies have shown that since the program's January 1, 1983 expiration date, major carriers have been very selective in choosing joint fare partners, accepting only those lines that can offer them a significant passenger feed to fill their target services. Most commuters do not . possess the necessary clout to negotiate joint fares individually without government backing. As a consequence, significant fare increases are expected to continue for connecting flights, especially those originating in small markets.
Signals have surfaced hinting that even with the emergence of the commuter as a viable force in the airline industry, short haul travelers may nevertheless be worse off than they were under deregulation. Granted, commuters have done the most efficient job of matching plane seat capacity 21
to passenger demand. However, even commuters have begun to pull out of smaller markets, at most recent count 68 towns in 28 states. In most of these cases, management cited the difficulty in obtaining gate space in destination hub cities as their reason for exit. Closer FAA regulation could remedy this situation, though probably at the cost of expansion freedom of long haul routes. Also, it was earlier mentioned that half of all cities served only by commuters in 1978 and therefore ineligible for
Essential Air Service subsidies have since lost all service. Another
9% of these markets have suffered flight frequency cutbacks of over y>% and considerably greater decreases in available seats, since smaller planes have been shifted to these runs. Furthermore, local officials claim that in many cases, the cities made eligible for subsidies show much less need than other airports with no guarantees which have lost all service as a result. In 1978, the city of Wise, Virginia was served by 5 inbound commuter flights per day carrying 70 passengers which were showing healthy profits. An attempted expansion failed, and rather than cutback to the former successful level, Appalachian Airlines pulled out of the market entirely. Residents of Wise now face 1 hour and 45 minutes of ground transportation to reach Tri-Cities Airport in Tennessee and their closest air service, Lakeport, California is over an hour's drive from its nearest service (Sacramento), and the Community has documented a "significant" number of passengers who have chartered a plane to connect in San Francisco, At the expense of local tax dollars, Lakeport plans construction of a runway to handle such service.
Beside simple service changes, deregulation has catalyzed shifts in other facets of air transportation. When fares were set according to the jurisdiction of the 1938 Act, carriers could only compete through service channels. Airlines attempted to obtain an edge through scheduling, meal quality, courtesy, and other aesthetic features. Since the pocketbook has become an accepted battleground, depersonalization and inconvenience for customers has increased markedly. Some would argue this is only a case of the market searching for an equilibrium between price and service, but other unsavory byproducts have accompanied this search for balance. As carriers scramble to maximize profits on decreased fares and sparser flight schedules, the industry has seen an increase in the amount of overbooking. This means that an increasing number of travelers who hold tickets and have every reason to believe thy hold confirmed reservations arrive at the gate to discover that their plane is filled. Despite this preponderance of overbooking, overall system load 11 factors have mysteriously decreased after peaking in 1979,
Deregulation has certainly shown its advantages. Without the freedom to adjust fares, carriers would never have been able to cope with spiralling fuel costs, which increased ninefold in the past decade. If forced to endure the time lag inherent in bureaucratic approval hearings, the losses incurred would have been exorbitant. In the subsidy department, the post-deregulation cost to the taxpayer has actually increased, as federal outlays have remained approximately constant while state and local governments have gotten into the act as well,
A major concern of critics was that deregulation would result in mergers, increasing monopoly po^er. Of the trunks, only Pan American and National have joined forces. More common, however, is the combination of local service lines serving contiguous areas, pooling financial resources and route structures to emerge as a new trunkllne. It was in this fashion that North Central and Southern banded together to form 23
Republic and pursue a national market. Through such growth processes, long haul markets faced greater competition while low density locales tend to shrink to one carruer. As a consequence, major lines have suffered post-deregulation losses while commuters, whose degree of monopoly power and access to subsidies closely simulate the regulated environment, have posted profits. The proportion of markets served exclusively by commuters has increased from 5&% in 1978 to &¥f<> in I98I, With this increase comes more monopoly power, as in the vast majority of cases only one commuter situates itself in a community. Even though service is not lost, the assumption of routes by commuters translates to a loss of direct flights.
Deregulation has resulted in lower fares in some (mostly large) markets, higher fares in others. Caught in the middle of the battle are the medium sized communities still large enough to warrant jet service.
"The Department of Transportation remains concerned about the trend of the larger air carriers to discontinue service to such (smaller) markets in favor of the higher volume markets... Cutbacks in -^__ service at some communities have largely resulted from shortfalls in available aircraft...because carriers have chosen to serve those markets where the greatest profits can be made, even though^some of the smaller points were still profitable."
Hopefully the larger 60-100 seat planes on order by commuters will fill this void, but once again the temptation will surface to abandon smaller markets. Posing even greater difficulty is the task of finding gate space in a finite airport system to accomodate all of these planes.
The entire intent of the I978 Act will not be installed in the marketplace until I988, Even at that time, it would be naive to expect the* industry to assume all the characteristics implied by the i 111 * iniiitfUnNi 2^
terra 'deregulation.' When the GAB is dismantled in 1985» most of the duties it performs will not cease 5 many will be transferred to the jurisdiction of the Depertment of Transportation and other agencies.
One must show some concern for the fact that the most successful post deregulation carriers have been those facing a market closely resembling the pre-deregulation environment, and enjoying a degree of monopoly power greater than the regulation levels which the 1978 Act pledged to eliminate. In many ways, the 1938 Act prevented monopoly, as it allowed several carriers into major markets and controlled the solitary carriers in smaller areas much like a public utility.
The current Essential Air Service program officially expires in I988. It is hard to believe that it will not be continued in one form or another. If it in fact is extended, deregulation will come to represent a shifting of regulation from majors to previously exempt commuters, using the carrot rather than the stick by employing 'positive' controls to meet the government's desired ends. In some cases, the subsidies currently offered translate to a per passenger cost greater than 12 the price of a ticket to the nearest hub. Such a situation is clearly ludicrous, but the elimination of all subsidies as planned would result in a loss of service to at least 96 communities. The staunchest supporters of the I978 Act might adopt a position of "If the marketplace can't justify the service, then it should be discontinued." The implications of a thorough air transportation network merit further investigation, however. Efficient, high speed transportation is required for many forms of business to operate, much less compete. Without a reasonable opportunity to utilize air service, it is inconceivable that a firm located in a small remote area could compete with one in a major thoroughfare in an industry requiring immediate transport and person 25
to person communications,, A cycle develops, as corporations will "be
unwilling to locat in towns without access to air service, thus stunting
growth and thwarting any opportunities for the potential of new service,,
As the Commissioner of the Vermont Aeronautics Board stated shortly before
deregulation?
"Convenient, fast transportation is a first priority if these firms and communities are not to become completely handicapped,.owe New Englanders can't afford a four hour drive once a day to the air freight receivers at Logan,, Neither can we afford to have our customers, our managers, or our salesmen enjoying the rustic splendor of New England hour after hour on the Interstate Wnen airlines aren*t flying to a point weather or a lack of fuel has presented a viable excuse to hold*~
their "big airplane for a more productive runl.O. .
The claim has been made that there will always be new
commuter entrants to replace those carriers whose plans have outgrown
their small communities. Sueh a proposition, while possibly true, poses
several problems. First, methods must be found to obtain gate space
in hubs for small flights originating from these low density markets.
Sue:, slots are limited, and history has predictably seen them doled out to longer haul traffic, since the majors hold control of most of these gate slots. Further, a new line may not decide to assume service until the market has been vacated for several months. With such ease in exit and entry, lines may initiate and discontinue service at whim, depending on the current state of the economy and the potential comparative rates in return in different areas. Such a practice may be perfectly in keeping with economic theory in a free market environment, but it is at the cost of consistency of air service, aestrtDyfiigfl consumer confidence and potentially undermining formerly profitable routes who can no longer count on service when they need it0 The ramifications of changes in our air transportation system, which serves as a support for much of the nation's industry, are far too great to allow them to "be dictated solely "by market forces. In many ways carriers do serve the role of a public utility, and were treated similar to such before 1978. As a Vice-President of Delta Airlines stated in
1975 &s ari argument against proposed deregulation»
"The cost of the (Breguiated) system as a whole is lower than it would be in a situation of open competition. Regulation, by virtue of its protected status of the license, reduces investor risk and thus reduces the cost of capital. Economies of scale, which are based on large scale fixed investment requirements have caused a market structure which forms the basis for the objective of maximizing the airlines* capabilities. By granting the airlines partial monopolies through limitation of entry into various markets, they are able to serve a market at a lower *^ average cost than several competing airlines could." •
The 193S Act is outdated and clearly had its faults. However, the faults in the 1978 Act are just as severe. Even if they are implemented under the auspices of deregulation, there certainly exists a need for some level of governmental control in the modern air industry. While regulation previously existed to protect carriers, it is today necessary to protect the public and the economy. 27
MATHEMATICAL EVALUATIONS OF THE DEREGULATED ENVIRONMENT
Drawing conclusions on the success of the 1978 Act based on data gathered since is a risky proposition. Several factors must be taken into account which are exogenous to the effects of deregulation. If fares are to be used as a judgment criterion, one need consider the rampant inflation of the late 1970's as well as the 900% increase in jet fuel costs which specifically hit air carriers. Nominal values of passenger traffic should be interpreted with caution, since a lengthy recession obviously held demand below normal levels. Flight frequency and shifting of service was also constrained by the I98I PATGO strike, since landing privileges in many markets (mainly majors) were restricted. However, much of the data set if treated carefully can still be examined to shed light on the current state and direction of the industry.
SYSTEM LOAD FACTORS FOR THE TRUNKLINE INDUSTRY
1970-76 (comp.) 37.1% 1977 53.6% 1978 55.9% 1979 63.2^ I98O 58.9^ 1981 56 Mo I982 (1st half) 56.2^ ej Transportation Journal Vol.;
Despite the recession, the low proportion of filled seats in I98I-82
is surprising, since by this time the trunks had exited many small
markets where they had been using jets on routes that could not
justify such service and were thus flying virtually empty. 28
PASSENGERS CARRIED BY COMMUTER AIRLINES
1970 4,270,000 1971 4,698,000 1972 5,262,000 1973 5,688,000 1974 6,842,000 1975 7,243,000 1976 7,914,000 1977 9,185,000 1978 11,026,000 1979 13,972,000 1980 14,810,000 1981 15,400,000 1982 18,550,000 (sourcei Regional Airline Assocation 1982 Annual Report, p.14)
As a point of comparison, while commuter carriers have transported more carriers over longer distances, trunklines have seen a 6.2% decrease
in revenue passenger miles since deregulation.
GROWTH OF SEATING CAPACITY ON COMMUTER FLIGHTS
percentage of fleet capacity I978 I982
1-9 28.8^ 9M 10-20 27.8^ h-b.1% 21-30 3UQ% 12.0% 31+ 11.6% 35A%
(sourcei Regional Airline Association I982 Annual Report, p.18 and original research)
Obviously, commuters are retooling to focus their fleets on
10-20 and 31+ capacity planes to fill the needs of specific markets. It should be kept in mind that sveral 60-100 passenger planes are currently on order by commuters, a fact that will certainly shoot up the 31+ proportion. 29
COMPARISON OF PRE AND POST DEREGULATION SUBSIDY PAYMENTS
(in millions) SECTION SECTION YEAR 406 419 1976 72.5 1977 82.2 1978 73.9 1979 72.1 0.5 1980 80.1 9.0 1981 106.7 15.0 1982 55-1 26.0 1983 13.5 39.8 1984 50.8 (source; Regional Airline Association I982 Annual Report, p.41)
Section 406 subsidies, in effect since 1950, were paid on the basis
of the entire route run. Section 419 subsidies, brought into being by the
I978 Act, were paid on an individual route basis^were available to
commuter lines. Section 406 was to remain valid until I988 (as is Section
419), but was discontinued by the Reagan administration in I982 as part
of the acceleration of the lifting of controls. In years where the
programs ran concurrently, the sum of government outlays were greater
than they would have been under Section 406 (pre-deregulation) alone.
CARRIERS FOR ESSENTIAL AIR SERVICE LOCATIONS
commuters only 54% trunks/local service lines only 20% both 26%
(source: Regional Airline Association I98I Annual Report, p.23)
By definition, just five years ago, the precentage of these markets served only by commuters was zero. No official breakdowns were found for 1978, but most likely 70% were served by commuters and trunks, 30
TOP COMMUTER PASSENGER CARRIERS
I978 1982
1. PRINAIR 671,876 1. Mid Pacific 822,000 2. Golden West Air 626,248 2. Britt Airways 798,538 3. Ransome Airlines 447,186 3. Provincetown-Boston 727,716 4. Air Wisconsin 397,248 4. Air Wisconsin 723,914 5. Metro Airlines 367,463 5. Metro Airlines 697,563 6. Rio Airways 360,293 6. Golden West Air 689,290 7. Provincetown-Boston 242,222 7. Henson Aviation 651,000 8. Henson Aviation 240,176 8. PRINAIR 620,000 9. Penn. Commuter 229,353 9. Ransome Airlines 579,531 10. Rocky Mountain 224,491 10. Empire Airlines 562,573
(sourcei Regional Airline Association Annual Reports, 1979, 1983)
All regions of the country are represented on the top ten list.
The Pacific Northwest was the only area missing, and Cascade airlines ranked
eleventh in 1978 and sixteenth in I982. The tenth biggest commuter in I978 would have ranked only 25th in I982. j 1U,M, m IJUinunwiiiOTiwwuiii .• mi imiiiiiiiiWiMMiiii; i 11 <.M-mmmammiltm« I HI mm mm4UMI&:>- 31
CHANGE IN FLIGHT FREQUENCIES OCTOBER 1977 to OCTOBER I982
PERCENTAGE HUB FAIR CHANGE
large to large -^,9% large to medium 5>7% large to small 3.1% large to nonhub -7.0% ' medium to medium 17.4% medium to small 8,3% medium to nonhub -6,1% small to small -$»h% small to nonhub -20.5% nonhub to nonhub -21.2%
(sources U.S. General Accounting Office, July 23, I983)
This table requires several qualifications, but still can be quite meaningful. Statistics were gathered over the worst period of the air controllers' strike. Landing rights in large airports were greatly- restricted to control the situation, explaining the small increases in such markets (and even the Mngr- decrease in large-large traffic, since clearance would be necessary in two restricted cities). The controls also explain the drastic increase in medium-medium traffic, since such expansion represented the carriers' optimal choice, given constraints. It can be assumed that no airport except those in large markets experienced controls. Furthermore, a decrease in service is still relevant, and if anything the strike dampened such magnitudes. Note that all nonhub combinations suffered service decreases, especially those connecting with other small markets. REGRESSION ANALYSIS
Attempts to find linear relationships between variables typifying the deregulated environment showed little if any correlation. One such regression was tried linking the distance of an Essential Air Service city to its legislated hub and/or the population of the EAS city to the gross and per passenger required subsidy payment and/or the number of travelers using the service. Subsidy payments versus distance from hub resulted in an r-squared value of I7.9 percent. This was the highest figure for any examination. Cursory glances at the data reveal imminent difficulties, as subsidy levels seem to vary on a state by state basis. Each EAS location in eastern Montana and western North Dakota receives $1,631,171 in annual aid, though only two are further than 200 miles from their hub. Upstate
New York locales receive even higher subsidies for even shorter distances.
Most states' cities receive $^00,000- $650,000 in subsidies for jaunts varying from 65 to 380 miles. It seems that caution must be taken in
overinterpreting subsidy levels for the same reason that regression analysis of nominal fares was avoided: too many hidden variables, such as regional landing right costs, etc., go into determining this one variable.
Other attempts were made to correlate such factors as percentage change in fares and ridership, change in flight frequency and available seats, and populations of small cities, nearby hubs, and other nearby locations where additional air service was available. All such tests failed to establish a relationship at anything approaching a degree of relevancy.
One final attempt to add a small town's industrial base, level of inter-city business activity, and technological development to the above factors was aborted when no meaningful measures could be found to represent these variables. In all honesty, further regressions showed little promise aafeXKi mtmmm **m<\*kmmniti,. 33
for any more success than those already tried.
The failure to establish relationships only proves that the
need of remote, low density areas for air service is quite unpredictable,
as is the necessary cash outlays to support them. BIBLIOGRAPHY
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Plalgnaud, Jaques, "Airports and the Trend in Regulatory Policies: Technical and Operational Consequences (Part Ones United State's)", Institut de Transport Aerien. Paris, 1981, "o, 2*
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