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Turbulence ahead for Canadian air travel

Turbluence ahead for Canadian air travel, based on US experience
Deregulation itself will not bring about competition without sufficient safeguards

In Canada, the barometer for how a competitive market should work is almost always the United States. When Canadian industries are forced to cut jobs, raise prices, or behave in a consumer-unfriendly manner, the usual rejoinder to public criticism is that the same thing is happening south of the border. The standard Canadian assumption is that the free market cauldron of the United States winnows out inefficiency, high prices, and poor customer service. Canadian utilities who have dined on this questionable folk wisdom for years have now been joined at the table by Air Canada, whose CEO has discovered the escape valve of selectively citing U.S. airline pricing statistics as proof positive of the controlling hand of the market rather than his own airline’s financial dictates.

While more than two decades have passed since Congress deregulated the airline industry, the results for airline competition in the United States are decidedly mixed. While the cost of air travel on an industry-wide basis has dropped an inflation-adjusted average of 37%, major airlines still keep prices high in many markets , while quality remains indifferent.

Public dissatisfaction is being increasingly translated into political action. By mid-1999, six consumer rights bills – one in the Senate and five in the House of Representatives had been introduced to protect passengers from arbitrary airline practices and shoddy treatment. While these Bills were not enacted following airline promises to improve service, proposed new airline mergers and reported declines in on-time performance have spurred the call in 2001 for the passage of similar measures. And though the deregulation reforms were meant to enhance choice, since 1978 the number of large airlines has shrunk to ten from thirty. With further choice-limiting mergers on the horizon, U.S. politicians are struggling to determine how the consumer interest is being served by the current airline market and regulatory structure.

The fortress hub model – remarkably effective in establishing dominant American airlines despite deregulation – appears headed for Canada

The evolution of a consumer-friendly competitive market in the US was frustrated for many reasons. First of all, lower air travel costs stimulated an overall growth in the volume of air traffic even though airports and their infrastructure could not handle the load. In 2000, the FAA noted a 42.3% increase in delays associated with volume of aircraft – 14% of all aviation delays. The high demand for air travel has had a corrosive effect upon airline performance and customer service.

The customer market has also been slow to respond to service variables other than price. Air carriers, therefore, have frequently compromised on service quality standards and, occasionally, on safety, to offer low rates. (Low prices are not an excuse for lousy service, however; Southwest Airlines, is a discount airline that consistently obtains high marks for customer service.)

In addition, airline reservations systems and general industry ticket restrictions conspire to opportunistically price travel for the maximum price, independent of cost parameters, as well as to impede customers from shopping for the best fare. At the same time, airlines have squeezed travel agents who try to provide customers with the lowest cost air fare by cutting travel agent commissions in an effort to force them to charge user fees and reduce travel agency customers.

Perhaps most importantly, the airlines have developed patterns of operation which, in effect, limit the number of competitors there will be in any air travel market for a city pair. The industry structure – the hub and spoke network – confers market power on the airline or airlines that control the huge airports acting as fortress hubs. While the hub structure achieves greater operating efficiencies and economies of scale, it also makes it extremely difficult for competitors to enter the market. Hub incumbents use marketing practices including reservation system manipulation, codesharing, travel agent deals, or market segmentation policies to ensure maximum traffic at the hub where their reputation and their ability to offer a broader range of options tends to prevail. Access to facilities for competitors is often impeded through a number of strategies that preclude or raise the cost of market entry. These include denial of gate space, extraction of excess profits on facilities, and the suffocation of potential new entrant market share through over-scheduling of competing routes.

The fortress hub model has been remarkably effective in establishing patterns of market dominance. In 1998, attorneys general from 25 US states filed a brief with the US Department of Transportation which identified 15 airports at which a dominant airline had a market share in excess of 70%. Six of the ten busiest airports in the US were on the list. These airports handle one third of all passengers boarding planes in America.

Airport Airline Dominant Firm Market Share
Atlanta Delta 79%
Charlotte US Airways 90%
Cincinnati Delta 90%
Dallas Ft. Worth American 70%
Denver United 70%
Detroit Northwest 79%
Houston Intl Continental 79%
Memphis Northwest 79%
Minneapolis Northwest 82%
Pittsburgh US Airways 89%
Salt Lake City Delta 72%

The concentration of one or two dominant airlines at fortress hubs subverts the operation of a competitive market. In 1995, the US Consumers Association cited evidence that suggested that at least three competitors for a city pair market is required as a key threshold for airline competition to be established. Other commentators believe it takes even more competition than that. Whatever the number, the effect of additional competition on airline prices tends to be dramatic. For example, when a low-cost carrier such as Southwest is introduced into a market, the fare impact is usually in the range of 35 to 40 percent.

“Competition, like exercise, is universally agreed to be good – for other people.” – George Stigler, Nobel Prize economist

The hub market dominance model is particularly costly for consumers. The 1998 multistate brief referenced earlier showed a fourfold increase in fare prices between a hub airport with a monopoly airline and a nearby competitive airport where the flights were to the same destination. Similar observations were obtained for airline fare prices before and after a competitor was driven from a market by hub incumbents.

Incredibly, air fares ranged anywhere from 600 – 1,100% higher following a US competitor’s retreat. Lawyer Mark Cooper wrote an article for the American Bar Association’s “Air and Space Lawyer” in Spring 1999 containing examples of prices rising from $122 and $70 before a was competitor is driven from the market to $843 and $800 respectively afterwards. Canadians are seeing the same thing now with Air Canada charging $99 to fly Halifax to Ottawa to compete with CanJet but $359 to fly from Ottawa from St. John’s where Canjet doesn’t fly. If the competition packs up, Air Canada’s prices would likely go up 300-400%.

When the complex computer ticket pricing systems of the major U.S. carriers are folded into this mix, US air travellers are frequently being denied the benefits of having a transparent customer choice-driven competitive market. Major consumers organizations such as Consumers Union have called for legislation such as the passage of the Airline Passenger Fair Treatment Act to ensure customers better service and to give them the legal tools to deal with what Consumers Union terms the industry’s “greedy pricing policies and practices.”

George Stigler, the Nobel Prize economist once observed that competition, like exercise, is universally agreed to be good – for other people. The behaviour of the major US airlines since deregulation confirms his observation. Deregulation itself will not bring about competition unless sufficient safeguards are put in place and enforced. Such safeguards are necessary to prevent abuse of market power and to protect market entrants from predatory and anti-competitive policies. In Canada, where we have one airline controlling over 80% of the domestic market share, setting prices and quality standards with minimal interference, these lessons are slow to be learned by our public policy makers.

Michael Janigan is Executive Director and General Counsel of the Public Interest Advocacy Centre (PIAC), an Ottawa based NGO providing legal representation and research on behalf ordinary consumers of important public services. They’re on the Web at www.piac.ca

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