Swelbar Writes Op Ed; Stilwell Wins; and the Wissinger Flop

On September 18, 2014 Aviation Week and Space Technology ran a Viewpoint column penned by Captain Lee Moak about the pilot shortage being a myth.   As someone who spends an inordinate amount of time in communities of all sizes talking about air service issues, the simple fact is that a pilot shortage is underway as evidenced by frequency cuts and crews timing out.  Whereas I have tremendous respect for Captain Moak, I simply disagree and believe that the unions have had a lot to do with certain of the issues impacting the supply of pilots.  I penned the following rebuttal which is in this week’s edition of Aviation Week and Space Technology.   I will include the text below as well.

But before I go there, anyone who knows me appreciates the importance of golf in my life.  Of course it runs second to family.  My stepson, Sam Stilwell, one of the coolest dudes on the planet, plays for the Wittenberg Tigers.  This week he won his first college tournament in the cold, wind and the rain.  He shot a second round 69 that included a penalty stroke when a gust of wind caused his umbrella to touch his ball.  Bummer, but in golf they call that the rub of the green.  In addition, Sam was named the North Coast Athletic Conference Player of the Week.  Way to go dawg.

One of Sam’s teammates, Jared Wissinger, hit one of the greatest flop shots I have ever witnessed in the Gordin Classic last week.  Jared hit his second shot well left of the par 5 8^th green during his third round.  Facing a short side pin, a bunker and a green running away from him Wissinger hit an improbable shot to six feet and made birdie.  In track and field we have the Fosbury Flop and now we have the Wissinger Flop in golf.  Give someone 50 tries and few if any would have been inside Jared’s shot.

Whereas there are many negative comments on the Aviation Week site regarding my piece, I am sure to get more here. 

Opinion: How Unions Contribute To Pilot Shortage

No one should have been surprised to read on this Viewpoint page that the Air Line Pilots Association (ALPA) thinks there is no pilot shortage in the U.S. (Opinion: The Pilot Shortage Myth, AW&ST Sept. 15, p. 58). Instead, ALPA President Lee Moak blames a pay shortage, particularly at the regional airline level. While Moak tells many half-truths with regard to numbers, he forgets to mention a truism: It is his union and other labor organizations that collectively bargain for the pay and work rules at the nation’s regional airlines.

ALPA talks about creating a level playing field without referencing the union’s own role in determining pay and benefits at the regional level. A race to the bottom has been a part of organized labor’s DNA for decades, in part because low labor rates at regional carriers cross-subsidize the higher rates paid at the mainline airlines. 

Pilot union interests and small-community air service issues are often in conflict. Now the truth is out: The economics of the regional market are distorted, influenced by middlemen like ALPA and unresponsive to markets dependent on regional airline service.

The news media are just beginning to focus on the pending pilot shortage—a story that will play out at least through 2022 unless something is done. Regional air service in the U.S. could die a death of a thousand frequency cuts and isolate communities now dependent on this sector for access to the national air transportation grid.

At more than 265 mainland U.S. airports today, more than 90% of departures are by regional operators. Regional airlines provide more than half of the departures in 35 states and account for 22% of the nation’s flights to airports large and small.

Three legislative and regulatory changes have had a profound impact on pilot staffing. In 2007, Congress passed a law that moved the mandatory retirement age for commercial pilots to 65 from 60. Then, in response to the 2009 Colgan Air crash near Buffalo, New York, the FAA and Congress increased the flying time required for an Air Transport Pilot (ATP) rating to 1,500 hr. from 250. Finally, this year, new crew rest regulations went into effect, essentially forcing airlines to hire additional people to do the same level of flying. Regional airlines are now struggling to fill classes of pilots that meet the new requirements at the same time qualified pilots are moving to network carriers.

The Age 65 Rule by itself does not impact the number of pilots needed per se. However, a substantial number of pilots are facing mandatory retirement at the network carriers, and this will have a major impact on the number of replacement pilots needed going forward. Between 2015 and 2022, more than 14,000 pilots are expected to retire from the “Big Four” U.S. airlines alone. That many will need to be hired just to retain today’s level of flying at American, Delta, United and Southwest. This does not take into account any growth or count the needs of other U.S. carriers. Assuming today’s regional pool of pilots will be the primary source of labor, demand will easily surpass the 18,000 flying for regionals today.

At the regional level, pilot availability is akin to a Ponzi scheme. Today, an airline can trim enough frequencies to fly some or most of its network, but at some point those airlines will have little choice but to exit their least profitable markets. And only when vacated markets reach a critical mass will legislators and the regulators take note that the nation’s route map architecture is forever altered.

At risk are millions, if not billions, of dollars in economic impact on those communities that rely on regional service to support their economies. Perhaps ALPA needs to acknowledge its role in the problem and be part of the solution by advocating a more equitable distribution of pay across its member base. 

This is an industry problem that will require broad stakeholder involvement—and action—in addition to ALPA revisiting its methods on pay distribution across its membership. This is an issue that could result in lost air service for some communities as an unintended consequence of ill-advised legislation. The FAA and Congress need to revisit the legislation mandating 1,500 hr. for an ATP license. And a push from the Transportation Department, which historically has championed small-community air service, would not hurt, either. 

Message to Joe Sharkey: At Least Tell More of the Story

Despite best efforts to get this piece placed in the New York Times, I was unsuccessful.  So when that does not work, use your own vehicle they say.  I wrote in response to Joe Sharkey’s recent column titled:  Losses at Smaller Airports Are Unlikely to Be Reversed - NYTimes.com. 

I read with interest Joe Sharkey’s column on March 31, 2014 regarding air service losses at the nation’s smaller airports.  In the interest of disclosure, I was a co-author on the MIT studies cited in the story and am an executive in a consulting firm that assists communities of all sizes attract air service. 

Sharkey begins with “Air travel has a lot of new realities.”  What a colossal understatement. Unfortunately, he only references surface issues and fails to mention the many structural forces that are having a profound impact on service levels at the nation’s smaller airports. 

The simple economic issue affecting airline decisions to serve smaller markets is the price of jet fuel.  It is the price of jet fuel that caused the nation’s air service providers to engage in a strategy of “capacity discipline” whereby fixed costs needed to be cut in order to mitigate higher input costs.  Operationally, the number of seats per aircraft will continue to increase in order to best maximize revenue and amortize these costs.  Not all communities have a sufficient demand base to support the larger equipment. 

The US government has also taken some legislative and regulatory actions that contributed significantly to the unintended consequence of less air service at smaller airports.  And now we have a shortage of pilots willing to work for the wage offered by the industry’s regional service providers that only further exacerbates the issue.

It is suggested in the article that small communities need to be told the truth about the realities of remaining a node on tomorrow’s air service map.  The market is telling the truth about tomorrow and it is a difficult message for many small communities.  But the market told the truth about the viability of the nation’s network carriers in the early 2000’s and inevitably every one of them except Continental filed for bankruptcy protection in order to fix a broken model and live to fight another day.  There were casualties as well.

But, in an industry that is rapidly changing, what is the truth?  And, how long will that “truth” be the truth?  This much we know:  Airline service is critical to a community’s economic development and it is incumbent on communities to try to increase their service.  If, in the short-run, that means offering incentives, then so be it. 

The second “truth” is that nature abhors a vacuum.  Currently, the aircraft industry is not producing aircraft that are economic for some of the markets at small communities.  If it makes economic sense to revisit a small airframe, then the market will build a replacement.  That too is the truth.

Sharkey’s column references incentive programs being tried in Tucson and Reno.  As the industry structure changes, so must approaches in economic and air service development.  Airports tout the economic activity they enable in their local communities.  If airports enable, then airlines facilitate.  The future will likely involve re-investing a portion of that economic activity back into air service.  Airlines will likely require some risk mitigation guarantee for the airline to provide the service – not to all markets but likely to the smaller markets that remain on the map – at least until the local market demonstrates its viability

Airline service is expensive and capital intensive.  Airline debt holders and shareholders demand returns on their respective investments.  Those calculations are easy to quantify.  So too will it be easy for airports and economic development agencies to find it easy to quantify a return on their investment.  If an airport drives economic activity of $100 million and is being asked to invest $5 million to ensure that the remaining $95 million remains in the community, then it is an investment worth making.

But if a community is happy to drive to a competing airport as Mr. Sharkey is, then people should understand that air service is a use it or lose it proposition and no amount of incentive can change the air travel consumer’s behaviors.  Retaining the air service a community has today will prove to be very hard business and will face some difficult odds.  We are still some years away from a catharsis – so there is time to chase various alternative solutions instead of ghosts.

William S. Swelbar

Executive Vice President

InterVISTAS Consulting LLC

Republic Pilots: Forget the Leaks and Prepare to Change Vessels

Since writing the last blog titled “A Race to the Bottom,” I have received a lot of mail, much of it critical.  Many readers wrote about the ratification votes on tentative agreements for pilots taking place at American Eagle/Envoy and Republic.  After a heavy travel schedule, I finally got around to perusing my e-mailbox.

I have long challenged the approach of the Airline Pilots Association (ALPA) and other collective bargaining agents on the mainline-regional relationship, so the last post should not have come as a surprise.  Simply put, the relationship needs fixing but the fix is not going to come from one pilot group voting down a contract in the false hope that a “pilot shortage” will resolve differences between regional carriers and the unions representing pilots. The only fix will come with a far more strategic effort on the part of many industry stakeholders – management, labor unions, universities, Congress and the regulators.  

Consider the Republic situation. I’m hearing rumors of a concerted “Vote No” campaign intended to put the screws on management and extract more money. Based on my analysis of the industry, Republic pilots should take a step back and think long and hard about that approach. Republic is well-positioned to be a major player in the US domestic airline industry of tomorrow – an industry that will look much different than it does today.  So what is important in the interim is to negotiate the very best agreement – one that addresses the makeup of a carrier’s seniority list today and ensures pilots a seat at the table looking forward.

What I like about Republic’s tentative agreement are things that address the future like an early re-opener.  It calls for a four-year contract, allowing for adjustments when the contract is amendable at just about the time we’ll start to see significant changes in the industry. The TA also paves the way for what appears to be a more open relationship with the company to address scheduling and operations. These issues are critical to running the very best regional airline possible.  American and Envoy took a different approach – an approach some call concessionary whereas Republic is offering improvements.

SENIORITY DIFFERENCES

There are, of course, profound seniority differences between Envoy and Republic. Envoy is a “Legacy Regional” because of its relatively high seniority, while Republic’s seniority makeup is quite different.  Among the many difficulties network legacy carriers faced in negotiating labor agreements in bankruptcy, seniority issues more than any other exacerbated the problem of cutting costs to compete with lower cost carriers.  As I have said over and over, you cannot restructure seniority.  Envoy took one approach in negotiating a way around seniority by significantly improving the flow through agreement with American.

Republic has gone another route by negotiating the very best pilot agreement it believes it can afford over the next four years taking into account the progression through the pay scales.  Affordability matters. Republic is currently performing flying under contracts negotiated with mainline partners before this new pilot agreement was negotiated.  Because those terms are set, increased pilot costs only degrade the airline’s margins.

It’s all about balance.   Capacity purchase agreements are a reality for now, no matter how outdated the model, so the most realistic remedy is to accept that as fact and improve the situation one step at a time.

THE NATIONAL MEDIATION BOARD

I can hear the battle cries now:  the NMB will release us and allow us to strike.  Republic pilots will say that, after seven years of negotiations the agreement is simply unacceptable. But the union(s) should understand that the threat of a strike is not what it was 15 years ago.  The NMB would be hard pressed to make a case to the White House that a sector-leading agreement in many important economic areas is not a good outcome and therefore allow the pilots to engage in a work action.

And, yes, commerce would be disrupted. Regional airlines provide the only air access for hundreds of smaller communities, making it even more unlikely that the NMB would grant a release.  [Being remanded back to mediation only prolongs a process already gone too long] Consolidation in the mainline sector only compounds this factor as there is no longer sufficient capacity to accommodate the disenfranchised demand that would result from a work stoppage.

Yes it may be true that smaller cities could in the future lose air service in part because of a shortage of pilots willing to work for the regional carriers, but that argument would not outweigh the risks of a strike today. Are regional pilot salaries too low? Based on the education and skills required for the job, I think the clear answer is yes. But at a time the administration is focused on truly low wage workers and income inequality, it is highly unlikely that the White House would allow this issue to distract from its efforts to raise the minimum wage and allow a work action that could bring more financial pain to areas already punished by a weak economy.

So Republic pilots should perhaps think twice about the conditions for this particular battle and instead focus on the bigger picture and positioning for the future.

A SECTOR IN FLUX WITH THE POTENTIAL TO BE SIGNIFICANT

I’ve been putting a lot of thought into this subject, in part to prepare for a presentation I gave last week on what the North American airline industry will look like in 2025.  Projections this far out are never easy, particularly in a business in which long-term planning is too often viewed as planning for the next month.  I gave it a go, however, and came down on the side of today’s freight railroad industry.  This is an industry that has a created a blueprint for sustainability that began with the passage of the Staggers Act and the departure of large railroads from their non-core businesses like passenger rail. 

I see the Big Three airlines soon shedding small market service as it becomes less and less a part of their core business.  If Southwest can influence more than 95 percent of demand by serving just a fraction of the markets served by the network carriers, so too can American, Delta and United who will concentrate their service on the nation’s top 100 or so markets along with transoceanic flying. 

As costs creep up at the largest airlines, serving more markets won’t make economic sense, whether they do it themselves or in conjunction with a partner airline. Capacity purchase agreements won’t go away, but it is likely that carriers in today’s regional sector will become hybrid carriers that offer service to many markets the mainline carriers vacate.

THE NAYSAYERS

I fully expect that naysayers will take a page out of an antiquated playbook to say that the economics will suddenly improve because the network carriers will “fix” agreements in place with their regional partners.  As Lee Corso says every Saturday on ESPN’s College Gameday as the group picks winners and losers:  “Not so fast.”  You won’t hear it from the network carriers because it wouldn’t be politically astute for them to say it out loud, but my guess is that they would be very happy to begin exiting many of the small markets they now serve.

You don’t have to look too far to appreciate this fact as nearly every hub that has, or had, regional fleets as the backbone of its flying are now disbanded.  Delta is trending away from 50-seat aircraft as quickly as it can in exchange for larger 76-seat and B717 aircraft for service to its smaller markets.  Whereas in the past the network carriers would participate in subsidized Essential Air Service flying, that trend is dying. American will surely park the “scope-buster fleet” at Envoy.  That leaves United which, in the midst of a $2 billion cost-cutting exercise, will certainly be looking hard at the billions of dollars it spends on regional lift and questioning how much is too much.

There is nothing in the data or the trend lines to suggest that legacy carriers will be willing to change the terms of existing capacity purchase agreements just because the economics of regional carrier labor agreement need fixing. These trends do, however, suggest that the regional sector as we know it will be smaller and that will mitigate some of the pilot shortage concerns in the short-term.  The medium and long-term are another story but that is not going to get fixed in this round or address the pending problem of putting a qualified supply of pilots into the commercial airline pipeline. 

SURVIVORS AND LOSERS

I see two big winners in the regional sector in 2025: Republic and SkyWest, in part because of their commitment to running the very best regional airlines.  Yes, Envoy and the former US Airways’ wholly-owned carriers may evolve as stand-alone airlines, but their success is uncertain.

Republic and a SkyWest, by contrast, can successfully transition as hybrid carriers, much like Class II railroads did.  Think airlines with multiple code share agreements on the same flight.  At-risk flying will be more the norm. There will be capacity purchase agreements with the network carriers, albeit fewer, but only for those who demonstrate a track record of reliable service. Republic and SkyWest have that record where a carrier like Mesa does not. Ultimately, it will be Republic – assuming it can move forward with a new pilot agreement - and SkyWest who command the markets too small to be big enough for network carrier’s mainline aircraft.

CONCLUDING THOUGHTS

Warren Buffet said:  “In a chronically leaking boat, energy devoted to changing vessels is more productive than energy devoted to patching leaks.”  Republic pilots who vote “no” on the current tentative agreement to protest realities of the market are doing nothing more than trying to patch leaks, and not successfully. The sector is changing and will change and the best energy now should be spent looking ahead to the next contract with greater clarity about what the business will be four years from now. 

An early re-opener allows time to do just that: change vessels and improve the economics for those who want to stay and have a career at Republic [and Envoy].  Voting “no” does a disservice to the pilot profession because the problem is simply bigger than one carrier’s collective bargaining process.  Voting “no” may feel good for a moment, but the long-term impact leaves Republic pilots with no seat at the table or real influence in fixing the industry’s medium and long-term economics. Does voting “no” send a signal?  Perhaps, but in my view its equivalent to throwing the life preservers out of a leaking boat in a futile protest of reality.

A Race to the Bottom

I shouldn’t have been surprised to read that the Air Line Pilots Association (ALPA) has joined forces with several U.S. carriers in fighting a foreign carrier permit for Norwegian Air.  After all, in ALPA’s view, the Ireland-based carrier is in a “race to the bottom” in establishing wage rates and working conditions for its workers.

This blog isn’t, however, about Norwegian. It’s about the race to the bottom that has been a part of the network carriers’ DNA for decades.  It is about the relationship between mainline and regional carriers.  It is about the fact that low labor rates at regional carriers cross-subsidize the higher rates paid at the mainline, and what that could mean to hundreds of communities.

I need more than fingers and toes to count the number of smaller airports that are deeply concerned about their future as a dot on the airline network grid.  Many of these communities have strong underlying economics that suggest that their place on that map is safe.  But as the industry evolves, that is not necessarily the case.  The real question is whether the network carriers will actually need all of the feed from their regional partners to fill those mainline tubes as they serve only bigger and bigger markets?  At risk is service to smaller communities as airlines gravitate to only the largest markets in a network map that could look much like it did when deregulation began with the primary difference being a map that is hub-centric.

In my opinion, the industry went too far during restructuring in its use of third-party providers in the out stations. It made sense when the industry was trying to bank every possible nickel and, perhaps, makes some economic sense today.  But the fact is that no third-party provider really cares about an airline’s customers the way an in-house employee does.  As airlines compete more on service, this has to change.

I fear that, in investing in this industry, the focus on the mainline ignores the critical piece of the network served exclusively by regional carriers.  When it comes to regional lift, business still goes to the lowest bidder.  And one result is that regional pilots get whipsawed despite the fact that there is a real live pilot shortage that will impact the industry well beyond the regionals. 

Part of the blame goes to Congress which, in its infinite wisdom, now requires 1500 hours of flying to qualify for a commercial pilot license.  And while Congress mulls more hearings, the regional carriers are suffering the consequences, intended or otherwise.

New flight and duty time rules only compound the problem.  With the day’s last inbound flight often canceled, the first departure in the morning is also affected. And in small communities, these are the flights that allow business to be conducted in a day. This is not the fault of the airlines any more than it is the fault of employees who are “timed out” for the day. The customers, however, pay the price, as do the small communities so reliant on reliable air service.

Meanwhile airfares for service to those small communities continue to rise even as larger markets gain the benefit of more competition. Those customers are not, however, getting more for their money.

Don’t get me wrong. I am a fervent believer in the direction the mainline airlines are going.  Recent investments in the fleets, cabins, services and people of the mainline carriers are making for a much better product– domestically and internationally.  But I am disgusted with the price the regional carriers and their people are paying, be it through the whipsaw or the general neglect of a critical component of our domestic air service.

When a market doesn’t fit, it’s time to attrite. So let’s start trimming back that service now rather than delaying the inevitable.  Let’s begin to build a pool of pilots to service the 250 or so markets that will make the cut – a pool big enough to meet the demand driven by Washington’s arbitrary regulations. ALPA advocated for consolidation for all of the right reasons, first and foremost a stable industry. So why is it only the mainline pilots who should enjoy that benefit?

ALPA cannot make its race to the bottom case against Norwegian without first addressing the race to the bottom here at home – a downward plunge the union itself created. The economics of the regional market are distorted, influenced by middlemen and unresponsive to consumer demand. Now is the time for the industry to work with ALPA to fix the problem – and that probably involves bringing some, if not all, of the work back in-house. 

A Walk Across the Last Five Business Cycles

On Monday January 13, 2014 I am pleased to be joining two panels at the 93^rd meeting of the Transportation Research Board in Washington, DC.  On one panel, Airline Consolidation: Impacts on Stakeholders and the Industry, I will be joined by my MIT colleague Mike Wittman to speak to a series of MIT white papers on small community air service.  The panel will be moderated by one of the industry’s good guys, Paul Aussendorf of the Government Accountability Office.

The other panel, Economic Deregulation of Airlines: A Promise Realized?, will have as its moderator another industry good guy in Robert Peterson of Boeing.  Some might say deregulation is a tired topic, but there are many critical lessons to learn from the past 35 years as we anticipate what’s ahead for investors and stakeholders in today’s industry.

ACROSS THE BUSINESS CYCLE

With shareholders now demanding profitability across the entire business cycle, I’ve analyzed the industry since deregulation across five distinct economic rounds.  It was interesting to look back on each of the five cycles and what insiders and observers said about the airline business. Consider Alfred Kahn, the so-called Father of Deregulation, who in 1977 admitted he did not know one plane from another.  “To me,” he said, “they are all just marginal costs with wings.”

Based on that over-arching simplification by the man in charge, the industry was being led down the marginal cost path all the while that a fully allocated cost approach should have been adopted.  Ah, hindsight. It was too late, but the story is a great one.  It’s got colorful characters like Marty Shugrue and Frank Lorenzo, smart guys like Michael E. Levine and Warren Buffet, and current wisdom from the guys now running the big airlines, including Jeff Smisek and Richard Anderson.

A hard look at the financial data shows that the industry actually made a few pennies on a pre-tax basis through the fourth quarter of 2001, the end of the third business cycle.   The average cost of fuel was then $0.62, down from $0.84 during the first business cycle.  On a cost per seat mile basis, labor costs were managed with a deft touch during the entire 35-year period, despite that fact that the average cost per employee grew roughly at the rate of inflation.  Average wage growth outpaced productivity growth.  And any financial or economic efficiencies were competed away in the form of low and lower fares.

Warren Buffet said it best:  “The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines.”

All told, the industry lost $36 billion on a pre-tax basis, or 1.2 cents on every dollar of revenue.  But that is changing.  Load factors are up over 14 points across the last two business cycles as capacity growth slows. The current cycle is producing an operating profit margin that is 1.2 points higher than that earned during the best performing cycle – and after 17 quarters, the macroeconomic indicators are starting to be true tailwinds.

I can’t overstate the effect of load factor and ancillary revenue on unit revenue.  In the current cycle, the increase in unit revenue actually outpaces the increase in the consumer price index – an achievement long overdue.  Yet despite what is described by one prominent analyst as a “Goldilocks economy,” margins remain below the targeted level.

The first four cycles were defined by cost cutting and sheer survival.  Given that there is little low hanging expense fruit remaining on many airline income statements, the current cycle is all about the revenue.  As it should be.

WHAT COMES NEXT?

Whereas the current cycle shows incredible promise for profits, without some technological breakthrough that allows us to fly faster and longer, where will we find the efficiencies on the expense side of the ledger? Spirit and Allegiant are prospering by carrying passengers that the network carriers cannot afford to carry.  So how much more can airfares rise before an Ultra Low Cost Carrier (ULCC) revolution breaks out in the US domestic market?  As we test the limits of price elasticity, cost creep is a reality in labor and non-labor unit costs. 

Near-term, all things point bullish on the airline sector.  However, we know that growth prospects are limited for the higher cost network carriers in the domestic market.  Internationally, the next logical step (or the only step remaining after joint ventures) is to allow cross-border mergers. Is that the answer? I think not, at least if I am a US carrier looking to buy something outright.  Removing barriers is a good thing, but I can’t see too many U.S. carriers buying a European alliance partner that operates at 21 cents a seat mile - a cost that likely goes higher before it goes lower.

With all going so well, why even bring this up?  Because we need to be thinking from the position of financial strength that has taken so long to reach.  I trembled a couple of weeks ago when a headline in the Washington Post read:  GDP Grows an Adjusted 4.1%.  With indifferent macroeconomic indicators in play during the first phase of this business cycle quickly becoming tailwinds today, one hopes that the lessons learned this decade stick.  The cost creep found in some areas of the income statement gives pause particularly if one believes, as I do, that the industry is approaching a passenger revenue inflection point.

Robust periods of past business cycles have led to some bad management decisions.  I hope the leaders of today’s airlines will not repeat them.

Not the Last Swelblog -- Swelbar to Join InterVISTAS Consulting

Today, it is being announced that I accepted the position of Executive Vice President with InterVISTAS Consulting.  The press release.

I began drafting “The Last Swelblog” about a week ago thinking that a look back would be a nice way to end the writing of the blog.  But lo and behold, my new boss, InterVISTAS President and CEO Deb Meehan, said she did not want to be the one to end the swelblog.  So we will keep it going and I promise to write more than I have in 2013.

Much of this year has been spent looking for opportunities to get back into the game some way, somehow all the while continuing to do what I love – working with MIT rock stars like Michael Wittman and many others.  I miss the advocacy opportunities that day to day consulting provides. I miss working with a team each and every day and that is something I have not had since 2006.   As the industry embarks on its “new normal”, it is time for me to establish my “new normal”.  Thanks to Deb Meehan for making me an offer I could not refuse.

Without a doubt, this is the most exciting time in the airline business than any other time during my career.  The consolidation of a fragmented industry is largely done.  A new vernacular when discussing the business is in place.  Capacity discipline presents a “Prisoners Dilemma” for the carriers engaging in the practice.  And now we wait to see who breaks the mold.  There is a lot of capacity that could be deployed quickly by simply increasing the utilization of the respective carrier mainline fleets.

Is what is going on between Delta and Alaska in the west a precursor of what is coming?  Or is it simply an acute geographic battle between two carriers with different network orientations and strategic objectives?

The “LCC” and ULCC strategies will be interesting to watch.  Does Bill Franke have the magic in him to transform what has been a directionless Frontier into another success story like Spirit?  While not a true believer in today’s magic of Southwest, it will be exciting to watch the carrier as it vies for slots and gates the DOJ required American and US Airways to divest; it will be fun to watch the strategy employed at Love Field as the Wright Amendment goes away; and finally it will be interesting to watch the carrier approach international markets from its Houston gateway in 2015.  Southwest will indeed be a carrier to watch over the next couple of years whether from a network as well as a labor cost perspective.

Finally, kudos to the New American for tying a portion of their compensation to the achievement of certain post-merger synergies.  A really nice touch and message to the employees of the new company.

Anyway, More to Come.

US and AA Labor: Stop Hiding Behind the Idea of Consumer Benefits

When it comes to Wall Street analyst commentary on the proposed merger of American and US Airways, I have come to appreciate the work of John Godyn at Morgan Stanley.  He is a pragmatist.  His analysis and commentary are not fraught with emotion and Henny Pennyish ramblings as if the sky is falling if a deal does not get done.  He models the industry assuming a deal does not get done.  Certainly Godyn would prefer a deal versus no deal.  However, he assigns a probability of less than 50 percent of a deal happening, much like this observer.

This week’s Wall Street analysis and media coverage caught my eye.  First US Airways’ Captain Bill Pollack, a man I know and respect, wrote an op-ed in the USA Today in support of the merger. The subtitle reads:  “Airline employees have made concessions to survive. It's time our sacrifices paid off.”  Godyn hosted American’s flight attendant union, APFA, to a lunch to discuss the merger.  Like Pollack, the unions tout what they claim are enormous benefits to the consumer but fail to define them.  Then a note comes across my desk:  “Today, Representatives Marc Veasey (D-TX) and Ed Pastor (D-AZ) and 66 of their Democratic colleagues sent a letter to President Barack Obama calling on the Department of Justice (DOJ) to allow American Airlines and US Airways to move forward with a merger.”

Imagine what Jim Oberstar is thinking now?  Imagine, 68 Democrats supporting a merger of two airlines that will ultimately put 87 percent of domestic supply into the hands of four companies.  A party that prides itself in being the protector of the consumer.  Let’s stop kidding ourselves; this merger is about labor and the notion, and a near-term truth, that a consolidated industry can pay more than a fragmented industry. 

This would-be merger is perhaps the most sophisticated labor deal ever struck in the deregulated airline industry.  But don’t be fooled by the rhetoric. This is not about the consumer.  This is not about small communities.  This is about a very clever strategy by a management team to win over labor in order to achieve an exit strategy for US Airways - a highly performing company in search of an identity in tomorrow's industry.  In my view, Doug Parker’s US Airways was no true competitor to the network giants, even before they merged.  So to get there, he agreed to write a check to the airline unions that US Airways – I mean the “New American” - may not be able to afford . . . now, or in the future.

What’s wrong with this picture?  For one, union interests run contrary to consumer interests even if simply when labor costs go up, consumers pays more.  The unions say the merger is necessary to compete with the Delta and United duopoly. What does that mean? Even Parker agrees that mature industries yield few growth opportunities, so the synergies that the “New American” touts are likely to come from a share shift away from incumbents rather than generating new business.  Do we really think that Delta and United are going to sit back and surrender their market to a “new competitor” without a fight?  I don’t think so either.

But the check to labor has been written.

As Glenn Engel points out in his work, “being important is better than being big.”  This is based on the fundamental economics of the S-Curve in which each capacity share point above 30 percent in a given market drives a greater than 1 percent share of revenue up, at least until some point when the law of diminishing returns takes over.  In a merger that touts little to no overlap, where is the consolidation of two carrier’s positions that results in outsized revenue gains to the tune of $1 billion?

That’s right, the check has been written.

In Godyn’s note he talks with the APFA about the lack of a Plan B: “Consistent with what we heard from the APA, the APFA is universally focused on ‘Plan A’ which is to help management raise the probability that LCC is successful and is not actively pursuing any standalone plan alternative,” he wrote. “They also reminded us that no standalone plan had actually been formally submitted and approved by the creditors. Thus, if the deal does not go through, a new reorganization plan would need to be created and approved by creditors.” 

Godyn continues:  “Why are labor costs omitted from the complaint? The APFA expressed real concern that if a deal did not go through the short-term ramifications could cause existing labor contracts to be revisited and the pension to be put at risk, depending on how the new plan of reorganization is shaped as well as the judge. A restructured labor contract could not only include lower wages but also workforce reduction – not to mention labor discontent.” 

Exactly right because this a labor deal.

It is time that we start thinking about Plan B. Let’s assume that, because a number of senior US Airways’ executives have already moved to Dallas and enrolled their kids in school, Parker et al will run the “New American.”  But he has a track record in this type of case, and that is that the company will likely get smaller before it gets bigger. [An idea that will make Wall Street happy.]  A network considered inferior to others cannot pay its workers the same as can larger competition. The workforce will likely need to get smaller rather than reap the benefits promised. Parker’s conundrum is his exuberance to parcel out the synergies before they were realized.  Remember that share shift idea.

Suddenly, Plan B gets somewhat complicated even with the Golden Boy in charge.  In the event a merger is blocked, what if another party enters the fray and files a separate plan of reorganization?  That could happen in a Plan B scenario and my guess is capital would likely be treated more favorably than labor in that case.  So it may not be only Tom Horton who ends up on labor’s dart board.

I have long been critical of labor leaders who indulge in the overpromise and under deliver message.  But it is no different than Parker and his merry band buying labor favor without first proving on the battlefield that it can win the revenue necessary to fund those promises.  Remember, this is a labor deal. And US Airways may have reached too far in its assumption that it can accomplish what Delta and United did after being number 4 at the altar.  I am not aware of fourth mover benefits.  Think of the concept of the S-Curve and the idea that being important is better than being big.

The merger’s proponents are right that the “New American” will be able to offer more destinations. They are right that it will be able to offer more services in competition with Delta and United.  But proponents also are right in acknowledging that Plan B would result is something far less than labor has been promised. 

Where the unions get this wrong is in the assumption that because they have been to the table and made concessions they are entitled to the same compensation paid to employees of Delta and United, which have generated the revenues to support higher labor costs.  Other than an expanded network, where/what are the benefits for consumers?  I see many benefits for US Airways’ flyers; I see fewer for today’s American flyers.  Other benefits like investing in a re-fleeting and international growth are being implemented.

The DOJ is right to at least challenge the combination.  It may not win, but it is right to challenge.  The industry’s structure is much more concentrated than when it considered and approved the prior three mergers.  If this is indeed the last big deal in the US airline industry, it deserves a very close look.  Based on the combinations that preceded it and the string of events that have impacted the industry since the first merger was approved, it is really difficult to find any consumer benefits other than the fact that a profitable industry is finally investing in products that the consumer wants and desires.

In advocating for the merger, unions are doing what they should be doing to reap the promises the new management team made.  I would be doing the same.  But they should stop hiding behind the consumer because their interests are not aligned.  It will take customers to pay off Doug’s dubious deal and, as a result, customers will pay more - a necessary fact for decades.  And that’s the reality.

Note to readers:  I am long in the equities of Delta Air Lines, United Airlines, Sprit Airlines and Hawaiian Airlines.  Thank you to many readers that have reached out over the past months encouraging me to return the keyboard.  It is nice to be back.

FINANCING THE AIRPORT SYSTEM SHOULD REFLECT A CHANGING NETWORK ARCHITECTURE

Note:  I was asked by Barbara Cook, Editor of AAAE’s Airport Magazine to write an article on financing the airport system.   I always appreciate Barbara asking me to write on such non-controversial subjects.  That said, I agreed all the while appreciating that there are fewer answers in the immediate term than there are questions.  I agreed all the while appreciating that all airlines and all airports are not on the same page regarding the subject.  My attempt is less about having the final answer and more about appreciating that the airline, and thus the airport, system is being forever changed as a result of consolidation of the US domestic network architecture.  Somehow I am confident that neither the airline sector nor the airport sector will like all of what I have to say.  Nonetheless it is time to seriously think about what the airline/airport grid looks like tomorrow and where investment makes sense while keeping the air travel consumer at the forefront of the thinking.

ARTICLE

The macro view says that airport financing will be different five years from now than the current decades-old practice.  The days of simply going to the capital markets to fund airport infrastructure projects is also likely to change as debt amortization will result in increased enplanement costs as growth in the North American market slows.  At the same time, limited government funding for such infrastructure projects are a surety given the political realities in Washington.  In some circumstances where shortfalls in funding exist, the time may be right to explore public-private partnerships in order to ensure that capital projects necessary to keep an airport an economic catalyst are instituted.

The micro view begins and ends with an industry that has consolidated around four major domestic carriers.  American/US Airways, United, Delta and Southwest will control 87 percent of the enplanements.  A close analysis of those airlines reveals an industry de-fragmenting their respective networks.  Look at major metropolitan areas with multiple airports and you will see services being centered on one or two airports, not three or four, while many secondary and tertiary hubs are dismantled to remove duplicate services.

An airline industry that managed to lose more than $60 billion over ten years would hardly seem a model for other businesses. But airlines, which lost more than 17 cents on every dollar of revenue in 2008, are today making a marginal profit.  While the industry has to do better than marginal, any business that demonstrates an 18 point profit margin improvement in four short years deserves a look.  As Delta Air Lines’ CEO Richard Anderson told analysts on a conference call in 2012: Today’s airline industry “is not a hobby.”

The new airline industry vernacular offers a blueprint for the airport community.  By diversifying revenue (finding sources of revenue other than passenger fares); de-leveraging the balance sheet (using excess cash on the balance sheet to pay down expensive long-term debt); driving profitability across the entire economic cycle (making money during downturns as well as good times); and earning an adequate return on invested capital (investing only in projects that promise a financial return relative to the capital expended to fund the project), the airlines have turned around a decade of underperformance.

This new approach can work in a consolidated environment even as it did not, and could not, work in an industry that was highly fragmented.  The days of growth for growth’s sake are over.  This fact is both a problem and an opportunity. 

The problem is that yesterday’s model was driven by a market share mentality that resulted in unprofitable growth that commoditized the airline product.  Under the old model, if marginal revenue exceeded marginal cost then added capacity could be justified.  Growth increased the unit cost denominator making the calculation of marginal revenue exceeding marginal cost an easier one.  But when the fully allocated cost model turned into religion, it became painfully clear that the industry had grown too big to generate profitable revenue generation capabilities.

What does this evolution mean for airports? In theory, it should be easier for airports to finance projects in a more stable industry environment.  Yet it is troubling that the airline side of the industry rarely mentions airports as stakeholders that will benefit from consolidation. The airport winners and losers in the airline consolidation process have yet to be fully identified. Until that process plays out, understanding how airports fund necessary projects will be hard to define given the volatile environment we are in.

Putting the System into Perspective

Large Hub Airports:  6.3 percent of all commercial air service airports (29) enplane 70 percent of all passengers; handle 59.4 percent of all departures; and are served by 66.4 percent of the commercial air service seats;

Medium Hub Airports:  7.6 percent of all commercial air service airports (35) enplane 18 percent of all passengers; handle 19.1 percent of all departures; and are served by 20 percent of the commercial air service seats;

     Large and Medium Hub Airports:  14 percent of all commercial air service airports (64) enplane 88 percent of all passengers; handle 78.5 percent of all departures; and are served by 86.4 percent of the commercial air service seats;

Small Hub Airports:  16 percent of all commercial air service airports (74) enplane 8.4 percent of all passengers; handle 11.7 percent of all departures; and are served by 9.4 percent of all commercial air service seats;

     Large, Medium and Small Hub Airports:  30 percent of all commercial air service airports (138) enplane 96.4 percent of all passengers; handle 90.2 percent of all departures; and are served by 95.8 percent of commercial air service seats;

Non Hub Airports:  44.4 percent of all commercial air service airports (205) enplane 3.1 percent all passengers; handle 8.3 percent of all departures; and are served by 3.8 percent of commercial air service seats;

Essential Air Service Airports:  25.8 percent of all commercial air service airports (119) enplane .2 percent of all passengers; handle 1.5 percent of all departures; and are served by .4 percent of commercial air service seats.

After All, It Is a System

Capacity cuts since 2008 have gone a long way toward identifying airport markets that will likely survive assuming no additional exogenous shocks like $150 - 200 per barrel of oil.  Even with capacity cuts and consolidation, significant competition remains at the nation’s commercial air service airports – particularly at the large, medium and small hub airports. In 2012 there was an average of 11 competitors at the nation’s large hub airports; 9 competitors at the nation’s medium hub airports; and 6 competitors at the small hub airports.  That is robust competition at these respective enplanement levels and assures that each airport will remain a node on the airline service grid for years to come.

Given this, it is time to rethink Passenger Facility Charges (PFCs). These per passenger charges should be allowed to be increased up to some arbitrary number like $9 and scaled back to account for the relationship of O&D traffic as a percent of total enplaned traffic.  In other words, a market like Atlanta would be able to charge the maximum PFC amount because it facilitates traffic to points large and small, whereas a market like San Diego accommodates mostly local demand to other large markets and therefore has less non-local demand on the SAN infrastructure.

In a consolidated arena like the U.S., the PFC doesn’t really act as a tax or a fee as it might have just a few years ago. Given robust levels of competition in the largest 138 markets, price elasticity is also somewhat less an issue where multiple airlines offer similar base fares competing for the same passenger.  Airports like Nashville dominated by a so-called LCC, and I include Southwest in that category for discussion, would be unable to charge the same PFC as Atlanta. While carriers operating at Nashville typically serve only the largest markets, there would need to be an accounting of the fact that Southwest utilizes the airport as an omni-directional connecting point on its system.

Some cross-subsidization of non-hub markets by larger markets will likely be necessary if government support continues to decline. However, passenger hubs in the Southeast should only subsidize airports that they facilitate and not contribute to one pool to be divided by political whim or prejudice.  Likewise, LAX should not cross subsidize Valdosta, GA.  As in any business, projects should be prioritized where returns on capital warrant but that seems to be the exception rather than the rule when it comes to investing in airport projects today.

Conclusion:  After Evolving and Adapting Comes the Thriving

Airlines today are finally focusing on the customer.  Airlines today recognize that stability in the industry will permit them to finally invest in the customer – the ultimate user of the system - rather than focus solely on their survival.  That’s a positive change. But the customer in Jacksonville, NC should be as important as the customer in New York.  With a customer’s journey beginning and ending at an airport regardless of size, amenities and service should be prioritized between the airline and the airport to make the travel experience feel seamless to that passenger.

To fund the airport system of tomorrow we need to get airline and airport leadership on the same page.  Leadership in each industry needs to understand that neither can achieve its goals in a consolidated environment without the active partnership of the other.  Airports need to accept that the airline industry architecture/mindset has fundamentally changed, while airlines need to accept the fact that airports are a vital part of the customer experience and should not be ignored when discussing policy or whether or not certain infrastructure projects should be considered.

A slow growth environment means retaining the customers you have.  The total travel experience versus cheap travel should be the value proposition going forward.

WITTMAN AND SWELBAR: DESPITE SMALLER INDUSTRY, NETWORK CONNECTIVITY REMAINS

This post contains excerpts from Modeling Changes in Connectivity at U.S. Airports [it is available online here: http://hdl.handle.net/1721.1/79091] the second paper in MIT’s Small Community Air Service White Paper Series. The aim of the paper series is to examine and analyze the past, current, and anticipated future trends of small community air service in the United States. The authors of this paper series hope that these reports will serve to inform the policy debate with relevant and accurate statistical analysis, such that those responsible for deciding the future of small community air service will do so armed with factual basis for their actions.

The authors of the MIT Small Community Air Service White Paper series are members of the Massachusetts Institute of Technology’s International Center for Air Transportation, one of the nation’s premier centers for aviation, airline, and airport research. Financial support for study authors has been provided in part by the MIT Airline Industry Consortium, an interdisciplinary group of airlines, airport councils, manufacturers, suppliers, policy makers, and advocacy groups dedicated to improving the state of the practice of air transportation research in the United States. However, any views or analyses presented in this and all future reports are the sole opinions of the authors and do not reflect the positions of MIT Airline Industry Consortium members or MIT.

The first report in the series, Trends and Market Forces Shaping Small Community Air Service in the United States, reviewed changes in capacity at U.S. airports from 2007-2012. It is available online here: http://dspace.mit.edu/handle/1721.1/78844.

Acknowledgements

The authors wish to thank Peter Belobaba and the members of the MIT Airline Industry Consortium for their helpful comments and suggestions during the completion of this study.

Executive Summary

As described in the first paper in the MIT Small Community White Paper Series (Wittman and Swelbar 2013), the U.S. air transportation system has undergone a series of changes in response to the financial crisis of 2007-2009, high fuel prices, and a new wave of profitability-focused “capacity discipline” airline management strategies. More than 14.3% of yearly scheduled domestic flights were cut from the U.S. air transportation network from 2007-2012, mostly due to actions of the network carriers. Smaller airports were disproportionally affected by the cuts in service, losing 21.3% of their scheduled domestic flights as compared to an 8.8% decline at the 29 largest U.S. airports.

However, simply examining gains or losses in flight volumes does not provide a complete picture of the strength of commercial air service at an airport. For instance, many smaller airports lost service from network carriers from 2007-2012 but saw new service from ultra-low cost carriers (ULCCs) like Allegiant Air or Spirit Airlines. These ULCCs typically serve vacation destinations and offer limited connecting service to other U.S. airports or the global air transportation network. The small airports that lost network carrier service only to receive replacement service from ULCCs may not have seen significant decreases in flight volumes, but their connectivity was likely adversely affected.

As the pace of globalization has increased in recent years, commercial air service that provides connections to the global air transportation network has become increasingly important for economic, social, and demographic reasons. While air connectivity is important for communities of all sizes, research has suggested that small communities can obtain significant economic benefits from well-connected commercial air service. However, recent work has shown that small- and mid-sized airports have been disproportionally affected by cuts in commercial air service in the U.S. over the past six years.

An airport’s connectivity to the global air transportation network is challenging to measure because it cannot be observed directly through published statistics. There is currently no industry-standard metric to assess an airport’s connection to the global air transportation system. This creates challenges for airport managers and policy-makers in interpreting the effects of gains or losses in flights or seats on an airport’s connectivity. On a regional level, it is also valuable to analyze which airports have seen increases or decreases in connectivity over a given period. Previous attempts at defining connectivity metrics have often not taken into account the quality of connecting destinations, been too complex for non-technical audiences to understand and adopt, and have often included no analysis of connectivity at smaller airports. The discussion paper introduces a new, relatively easy-to-compute metric that can be used to assess these changes in connectivity to global air transportation service at U.S. airports.

The Airport Connectivity Quality Index (ACQI) introduced in the paper computes airport connectivity as a function of the frequency of available scheduled flights, the quantity and quality of destinations served, and the quantity and quality of connecting destinations. Unlike other connectivity models, the ACQI model considers connecting opportunities from a given airport as well as the quality of destinations served, such that an additional flight to a large city or a major connecting hub is more valuable than an additional flight to a smaller community with limited connecting options. The analysis also pays particular attention to connectivity at smaller airports, which have been largely ignored in previous work. The report computes ACQI connectivity scores for 462 U.S. airports for each year from 2007-2012; the ACQI scores for these airports are available in several appendices.

Similar to the capacity reductions in flights and seats discussed in the first white paper, medium-hub and small-hub airports suffered the greatest losses in connectivity over the last six years. ACQI connectivity scores at medium-hub airports fell by 15.6% on average between 2007 and 2012, compared to a 11.0% decline in connectivity at small-hub airports and a 3.9% decline at large-hub airports. The decline in connectivity can be attributed to airlines cutting capacity and destinations as a result of challenging macroeconomic events and more restrictive capacity management strategies.

It should be noted, however, that percentage changes in connectivity at most airports were less than percentage changes in flights or available seats. This suggests that some of the service cuts as a result of recent “capacity discipline” strategy did not directly harm connectivity, but instead removed redundant flying to secondary hubs. At many small airports, removing a flight to a secondary hub would not result in a substantial loss in connectivity as long as flights to other, larger connecting hubs remain. However, connectivity at the secondary hubs themselves (which are often medium-hub airports) was adversely affected over the last six years. Future changes in connectivity in the United States will largely depend on whether the capacity discipline equilibrium remains in place or if a new capacity management paradigm evolves in response to ongoing changes to the structure of the U.S. airline industry.

Computing ACQI Scores for U.S. Airports

Data sources

ACQI scores for each of 462 U.S. airports from 2007-2012 were computed using schedule data from the Diio Mi Market Intelligence Portal. The Diio Mi data is sourced from Innovata SRS, which provides up-to-date schedule data for 99% of airlines worldwide.

Data was collected for all airlines, domestic and international, with scheduled flights from the United States. Code-share connecting destinations were included by grouping appropriate airlines into each of the three major alliances: Star Alliance, Skyteam, and Oneworld.

ACQI Score Overview

In 2012, large-hub airports were roughly three times more connected than medium-hubs, six times more connected than small-hubs, and about fifteen times more connected than non-hubs. Each of the top 25 most connected airports in the U.S. in 2012 was a large hub.

The average ACQI score fell for each airport hub type during the study period, suggesting that airport connectivity as a whole in the United States has declined during the events of 2007-2012. However, just as capacity discipline strategies were not applied evenly across all airport types, all U.S. airports did not feel the reduction in connectivity equally.

Connectivity at medium-hub airports fell the most between 2007 and 2012, with these airports’ ACQI scores declining by 15.6% over those years. On the other hand, large hub airports did relatively well, only losing 3.9% of their connectivity over the same period. In all, connectivity declined by 8.3% across all airports in the United States between 2007 and 2012, compared to a 12.8% decline in connectivity at smaller airports alone during those years.

The pattern of connectivity of medium-hub airports is different than that of large-hub airports. While both large-hubs and medium-hubs lost connectivity during the economic slowdown of 2007-2009, medium-hub airports did not undergo the same recovery in 2010 and 2011 that large-hub airports did. Instead, connectivity at medium-hubs continued to fall after 2010 as a result of capacity discipline strategies that targeted these airports as a primary focus for service reductions.

Small-hubs have also been hit hard by airline capacity discipline. As with medium-hub airports, small-hubs are retaining their scheduled domestic service to large-hubs (albeit at reduced frequencies) while losing direct service to other smaller destinations. Much of this previous point-to-point service between nearby smaller airports has started to disappear as the network carriers and Southwest continue to consolidate service at their connecting points. However, the number of destinations reachable with a one-stop connecting itinerary has increased over the last six years at many airports.

In the aggregate, fluctuations in connectivity at non-hub and Essential Air Service airports have been relatively minor compared to the significant decreases in ACQI at medium- and small-hubs. The average ACQI score at non-hub and EAS airports decreased by 8.2% from 2007-2012, compared to a 15.6% decline at medium-hubs and an 11.0% reduction at small hubs. This is likely due to federally mandated levels of air service at Essential Air Service airports; these airports have so far avoided the wide-spread capacity cutting that occurred at slightly larger airports.

However, the relatively flat slope of the aggregate ACQI score decline for non-hubs and EAS airports masks some significant changes in connectivity at individual airports. Some of these smallest airports were successful in luring one or more network carriers to start service between 2007 and 2012, increasing their connectivity by many multiples. Other small airports lost all network carrier service over these years, causing a devastating drop in connectivity to an ACQI score of 0 in some years. Many of these airports have been able to win back service in recent years, often from an ultra-low cost carrier like Allegiant Air or Spirit Airlines. However, the resulting level of connectivity with ULCC service is often less than with network carrier service, since ULCCs generally provide point-to-point service to vacation destinations with few connecting itineraries available. The appendices of the report show how some airports gained or lost significant portions of their connectivity score throughout the last six years, highlighting the volatility that small airports face and the importance of each and every flight and destination in maintaining attractive levels of connectivity for potential passengers.

Capacity Discipline and Airport Connectivity

As a final question, the paper examines the extent to which capacity discipline in the form of reductions in scheduled domestic flights and available seats has directly impacted connectivity. If there is a direct correspondence between capacity discipline and connectivity, we should expect to see decreases in connectivity similar to the declines in flights and seats at these airports.

For each airport type, the percent change in connectivity was significantly less than the percent change in both domestic seats and domestic flights over the study period. This suggests that a significant portion of the airlines’ capacity discipline strategies did not directly decrease passengers’ access to the global air transportation network, and instead involved cutting redundant service. Service could be called redundant if the connecting options from one hub overlap nearly completely with connection options from another hub that is already served.  In the aggregate, these repeated cuts of redundant service at “duplicate hubs” explain the large decrease in connectivity at Memphis, Salt Lake City, Pittsburgh, and Cincinnati over the last six years.

Conclusions: Future Trends in Small Airport Connectivity in the U.S.

The Airport Connectivity Quality Index (ACQI) developed in the report provides a straightforward way to compare connectivity between multiple airports or at a single airport over a period of time. Airport managers and policy makers will likely be interested in examining the appendices of the report, which show how the connectivity scores and rankings of their local airports have changed over the past six years. In the aggregate, however, what trends can we extrapolate from the ACQI to anticipate changes in connectivity over the next five years?

Capacity discipline does indeed appear to be a dampening force on airport connectivity, particularly for smaller airports. On the whole, small community airports have struggled to gain back connectivity since airline capacity discipline started in earnest in 2011, as airlines kept domestic capacity deliberately restricted despite the start of macroeconomic recovery in the country and stability in fuel prices. Barring any significant positive or negative macroeconomic shock, the downward trend in connectivity at small- and medium-size airports will likely continue, but the pace will most likely slow as airlines have already removed most redundant flying from their networks. However, the American Airlines/US Airways merger could place further downward pressure on connectivity as schedule and route redundancies are removed from the combined airline’s new network.

This assumes that airlines will continue to practice capacity discipline strategies by adding little net nonstop service over the next five years. However, the question certainly remains whether capacity discipline is a stable competitive equilibrium. In a game theoretic context, capacity discipline could be examined in a classic prisoner’s dilemma construct. It would appear that individual airlines each have an incentive to deviate from the capacity discipline equilibrium and increase capacity in order to gain more market share and, ostensibly, increase profits. It is possible that in the near future, an airline will decide to bolster capacity in key markets, breaking with capacity discipline and perhaps causing other airlines to feel compelled to follow suit to avoid losing market share. However, if all airlines shift to a capacity expansion strategy, too much capacity will likely be introduced into the market, leading to lower profits across the industry.

In this outcome, connectivity at smaller airports would likely increase as airlines begin to compete once again on the sizes of their networks. However, this scenario currently appears unlikely. Airlines have been able to return to profitability as a result of capacity discipline, and as of early 2013 appear unlikely to break with the strategy in the near term in an effort to gain market share. Yet it only takes one airline making a move to add capacity to cause the entire equilibrium to destabilize.

Hence, we expect to see small community airport connectivity to continue to stagnate in the near future. Individual airports may, through clever packages of incentives, continue to induce airlines to provide new service, boosting connectivity on a case-by-case basis. However, only service that can prove itself to be profitable will remain a long-term part of the U.S. air transportation network. Airports that win new service should expect to see their connectivity continue to fluctuate as airlines evaluate the economic merits of the new flights and incentive packages.

US and AA: AIRLINE MERGER and SMALL COMMUNITY AIR SERVICE MEET AT LGA AND DCA

Note:  this blog is largely comprised of the text contained in a white paper written by me, William S. Swelbar. I would like to acknowledge Mr. Michael D. Wittman for his data collection efforts and deft analytical work that is included in the white paper. All of the air service related tables included in the white paper have a basis in Mr. Wittman’s research.  The conclusions and implications are William Swelbar’s.  The airports are referenced as large, medium, small and non-hub per the FAA’s definition of airport size.

EXECUTIVE SUMMARY

Small community air service and the structural factors that threaten it are certain to be a topic for policy makers in the immediate future.  The threats begin with the per barrel equivalent price of jet fuel in excess of $120; the fact that there is no replacement aircraft in production or even on the drawing board configured at 50 seats or less (the right size for small community air service) because of the high price of oil and associated capital costs [other than the ATR-42]; a looming pilot shortage that will impact the regional sector of the industry before it impacts other sectors; the new flight time/duty time regulations scheduled to be implemented in 2014 that will only exacerbate a potential pilot shortage; and new legislation that requires 1500 hours of flight time for a regional pilot versus the current 500 hours.

Many of these factors stem from past policymaking decisions. The unintended consequences will be reduced service to the nation’s smaller communities.  As the U.S. nears the end of the airline industry consolidation process, policy makers may be faced with yet another decision that could have a further negative impact on small community air service:  a reallocation of slots at each Washington Reagan National Airport (DCA) and New York LaGuardia Airport (LGA) because of the proposed American Airlines – US Airways merger announcement.

If slot divestiture is decided to be necessary, there are important facts to keep in mind:

1. It is the network carriers that are the air service lifeline to small community markets keeping them connected to the national and global air transportation grids – not the low cost carriers;
2. In 2012, US Airways offered service to 40 small and non-hub markets from Washington – DCA while all the low cost carriers combined served 2 such markets;
3. In 2012, Delta Air Lines offered service to 25 small and non-hub markets from New York – LGA while all the low cost carriers combined served 3 such markets;
4. Even before any slot divestiture, service to small and non-hub markets from each DCA and LGA is less than 20 percent of the total service offered from each respective airport.  To disenfranchise these small markets from one or two of their largest passenger demand markets would not be good policy; and
5. Today’s perceived low fare carrier is not yesterday’s low fare carrier:  Between 1995 and 2011, average fares for the low cost carriers as measured by yield increased 45%, average fares for Southwest increased 41% and average fares for the network carriers increased only 14%.

Small community air service faces numerous headwinds just to remain viable over the medium and long-term.  Some of those headwinds cannot be controlled while others stem from policy decisions already put in place.  To exacerbate a situation where small community air service would certainly suffer if slots were to be required to be divested at each DCA and LGA would not be good policy at this late stage of industry consolidation.

BACKGROUND

There is little dispute among the analyst community that the announced intent on February 14, 2013  to merge American Airlines and US Airways will result in the last “big deal” among U.S. airlines.  In the final analysis, the four largest U.S. airlines (American/US Airways, Delta, United and Southwest) would possess more the 85 percent of the capacity flown domestically.  While there may be some consolidation among carriers comprising the remaining 15 percent, no remaining transaction will be the size of American and US Airways or the three transactions that preceded it. 

American Airlines and US Airways have networks that are largely complementary—there are only twelve domestic city-pairs that receive duplicate service by both airlines out of nearly 900 routes in the combined AA-US network.  However, the combined slot holdings of the merged airline at each Washington Reagan National Airport (DCA) and New York LaGuardia Airport (LGA) will undoubtedly receive scrutiny by the US Department of Transportation (DOT) and the US Department of Justice (DOJ).

We don’t have to look too far back in time to find a transaction that involved slots at DCA and LGA.  In August of 2009, US Airways and Delta Air Lines entered into an agreement to swap slots with each other at each DCA and LGA.  In the initial transaction, US Airways agreed to transfer 125 slots at LGA to Delta in exchange for 42 slots at DCA.  Delta was seeking to expand its presence at LGA to establish a domestic hub just as US Airways was looking to augment its position at DCA and bolster connectivity for an increasing number of small communities it proposed serving from National. 

Per the initial transaction, “US Airways would raise its share of departures at DCA from 47 to 58 percent. US Airways' share of slot interests at DCA...would increase from 44 percent to 54 percent...Delta would ascend to a dominant position at LGA, raising its share of departures from 26 percent to 51 percent. Delta's share of slot interests at LGA would more than double, growing from 24 percent to 49 percent.”  To protect the “public interest”, the FAA proposed a divestiture of slots.  The slots would largely be made available to Southwest Airlines and other so-called low cost carriers (LCCs).  This was found to be unacceptable by each Delta and US Airways.

In 2011, a compromise deal was reached between the two carriers and the FAA.  The compromise deal shifted about 20 percent of the LGA slots from US Airways to Delta where about 3 percent of those slot holdings were divested.  At DCA, about 8 percent of the slots were transferred from Delta to US Airways and 2 percent of the slots were divested.  Ultimately this framework was approved and a final order was issued permitting the transaction to move forward.

If slot divestitures are ultimately required at DCA and/or LGA as a result of the combination of American and US Airways, then the same type of analysis of the “public interest” is necessary.  Some regulators, as well as Southwest and other so-called LCCs, will likely suggest using the AA-US merger as an opportunity to reexamine the service makeup of these slot controlled airports. They are likely to claim that at this late stage of consolidating the U.S. market structure to be one of the last opportunities to readjust the competitive profiles at LGA and DCA.  However, an important tradeoff exists between allocating slots to LCCs instead of network carriers: while additional LCC slots may contribute to more robust frequency competition in highly-served city-pair markets or to vacation destinations, it is unlikely to bolster service to struggling small community airports.  On the other hand, further network carrier service allows for small communities to remain connected to the strategically and economically important Washington and New York markets. 

While the network carriers have invested hundreds of millions of dollars in their respective operations to ensure that these smaller markets have access to the nation’s and the globe’s air transportation grid, LCCs have traditionally shown very little interest in serving smaller U.S. markets

In 2012, 44 small and non-hub sized markets received nonstop service at DCA.

In 2012, 35 small and non-hub sized markets received nonstop service at LGA.  

Given the strength of the small community air service network provided from both DCA and LGA and US Airways’ concerted effort to build a connecting hub at Washington National to connect northeastern and southeastern U.S. cities, a comprehensive slot divestiture program at these slot controlled airports as a result of the AA-US merger would likely have a detrimental effect on the nation’s smallest airports that have already been negatively affected by network carrier capacity reductions over the last six years.

TRENDS IN SMALL COMMUNITY AIR SERVICE ACROSS THE ENTIRE U.S. TRANSPORTATION NETWORK

Small community air service as a whole has suffered in the last six years. As a result of the rampant increase in the price of jet fuel and the prolonged economic downturn, U.S. airlines—in particular, the network carriers—began to rethink their service strategies. As a result, the entire U.S. air transportation system has seen a wide-scale reduction in both departures and seats since 2007. Between 2007 and 2012, nearly 1.7 million yearly departures have been removed from the US domestic system in response to the economic shocks mentioned above.  While most U.S. airports were affected by this newfound “capacity discipline,” a disproportionate share of the cutbacks occurred in the non-large hub airports.  In 2012, only 40.6 percent of US domestic departures were flown in non-large hub markets as compared to 44.2 percent in 2007 when there were 1.7 million additional departures.  A large percentage of this reduction in service was due to network carriers—on average, network carrier flights were cut by 27.2% at smaller U.S airports.

However, it was not just the network carriers that were reducing service at the nation’s smaller airport markets.  Southwest Airlines, the carrier hailed as the archetypal LCC, has also started to behave like the network carriers by practicing “capacity discipline” across its network.  In addition to reducing capacity in smaller markets, Southwest also made a decision to vacate 13 small community markets previously served by merger partner AirTran Airways:  Allentown, PA; Asheville, NC; Atlantic City, NJ; Bloomington/Normal, IN; Charleston, WV; Harrisburg, PA; Huntsville, AL; Knoxville, TN; Lexington, KY; Moline, IL; Newport News/Williamsburg, VA; Sarasota-Bradenton, FL; and White Plains, NY.  Southwest flights at smaller airports have been cut by 9.8% since 2007.

On the other hand, other LCCs and ultra-low cost carriers (ULCCs) generally increased service over the analysis period. 

Yet other than jetBlue and Frontier, none of the other LCC and ULCCs operates a hub and spoke system per se; Spirit Airlines is an opportunist with low fares and no frills, Virgin America is struggling to be profitable and Allegiant Air is a travel company that provides only infrequent service to vacation destinations.  While they may offer low fares, these airlines do not offer their passengers high-quality connecting service to the global air transportation network.

Of course, the replacement of traditional network carrier service with LCC/ULCC service to high-frequency markets already served or to vacation destinations does indeed boost airline activity at an airport.  To be sure, many small communities are today relying on carriers like Spirit or Allegiant or Sun Country as their primary/sole provider of commercial air service.  However, is infrequent service to vacation destinations on a ULCC as valuable to air travel consumers as frequent service from a network carrier to a hub airport, from which connections can be made to other destinations within the U.S. and throughout the world?  This would seem to be a paramount policy question to consider if slot divestitures are mandated.  A small community with a nonstop flight to a single network carrier hub can open up hundreds of potential domestic and international connecting itineraries.  However, low-frequency service from an ULCC will have a limited impact on improving airport connectivity. 

Mandatory slot divestitures would cause network carriers to potentially drop direct flights from these small community airports to LGA and DCA—limiting the connecting potential for passengers at these airports and hurting small community residents’ access to the global air transportation network.  Replacing network carrier service with LCC or ULCC service is often a poor substitute due to comparatively inferior options for nonstop and connecting destinations. Already, a small percentage of domestic airport markets served by the LCCs are small and non-hub sized airports versus the network carriers where nearly two-thirds of airports served are small community markets.

On the other side of the policy aisle, the DOJ continually points to a tired argument that the entry of LCCs results in lower fares and stimulates new demand.  That may have been true in 1993, but it is less true today.  Again using Southwest Airlines as the archetypal LCC, in the markets entered by the carrier between 2006 – 2011, fares increased 4 percent and traffic increased but 10 percent.  To demonstrate the fact that the LCCs behave a lot like the network carriers today and vice versa, let’s examine system passenger yield growth for the LCCs, Southwest, and the network carriers between 1995 – 2011.  Since 1995, Southwest passenger yields have increased 41 percent on a stage length adjusted basis; all LCC adjusted yields have increased 45 percent and network carrier yields have increased only 14 percent.

SLOT DIVESTITURE AND SMALL COMMUNITY AIR SERVICE AT DCA AND LGA

In the initial Delta – US Airways slot swap comment period, Southwest spent inordinate time and resources claiming that the two carriers needed to surrender more slots than originally proposed because the transaction would “permanently lock out” low fare competition.  But each Delta and US Airways were promising more than low fare competition—the two applicants were offering to build and augment their respective connecting complexes at each DCA and LGA. 

The timing of Delta’s and US Airways’ claim could not have been better as small community markets had seen hub access and connectivity at Pittsburgh and St. Louis virtually disappear.  Hub access at Cincinnati and Memphis was being eroded in a significant way as service cuts at those secondary hubs was proving necessary in the face of high oil prices and a damaged economy.  Now there were two new alternatives for improved connectivity in the name of DCA and LGA.  Even more important was the fact that DCA and LGA are among the largest origin and destination (O-D) markets for many communities in the U.S. – big and small. Hence, DCA and LGA provided the opportunity to build connecting hubs at airports with significant existing local demand – a particularly important ingredient for sustainable air service.

The DOT listened and wrote:  “While we acknowledge Southwest’s claims regarding potential inefficiencies resulting from hub development at slot controlled airports, we must consider both potential operating inefficiencies and expected network benefits typically resulting from hub development or expansion. The Joint Applicants [Delta and US Airways] claim that numerous benefits will accrue to consumers as a result of their transaction. Among the more compelling benefits that they articulate, we are most convinced by their arguments that development of a LGA hub will lead to enhanced service to small communities (even with the small aircraft that Southwest contends would be used) and improved competition versus other east coast hubs, including United’s Newark hub and US Airways’ hub in Philadelphia.”

In that case, the carriers asserted that primary benefits of the transaction will include enhanced service to smaller communities on an overall basis.  And that is exactly what has happened. 

During 2012, US Airways served 69 airports from DCA—the beginning of a true connecting hub.  40, or 58 percent, of those cities served were small and non-hub markets. 

At LGA, Delta served 58 airports during 2012, including 25 (43.1%) small or non-hub markets.

CONCLUSIONS

Despite the growing connecting hubs being built by US Airways and Delta at DCA and LGA respectively, it is important to note that as a whole, small community air service at these airports is already becoming a rare commodity. Today, only about 17 percent of service offered from New York’s LaGuardia Airport is to small communities—down from about 25 percent of all departures just six years ago.

Small community service is also already limited at DCA. Today, small community air service makes up only about 19 percent of service offered from Washington’s Reagan National Airport.

An important and fundamental question to ask is:  Does it really make good policy sense, assuming that slots are required to be divested, to make a slot pair available to a carrier proposing to serve Orlando, Tampa, or Ft. Lauderdale – all markets with metropolitan area nonstop service and a plethora of connecting options by each major carrier with hub choice as well?  Or, does it make better policy sense to maintain slots for small community access to some of the nation’s largest local O-D markets that offer connections as a result of the recent US Airways – Delta Air Lines slot swap?

One more nonstop from a large market to a large market does very little in improving the quality of service for airline consumers on either end of the itinerary.  Whereas the loss of a nonstop service from a smaller community to a large O-D market that offers connections would have a significant negative impact on that smaller community’s connectivity to the global air transportation network.  It is simply intuitive.

DCA and LGA already have excellent service to the nation’s largest markets from both network and low cost carriers.  Maintaining at least the status quo of slots for small community air service at this late juncture in market consolidation helps to maintain quality air service at some of the nation’s smaller markets at a time when service is being cut and hubs are being eliminated for reasons beyond the industry’s control.

THE END GAME: IT’S ULTIMATELY ABOUT RETAINING THE CUSTOMER

Paint me a skeptic.  Paint me a contrarian.  Paint me stupid.  I’ve been painted with worse colors. I’ve been one of the lone voices really challenging the proposed merger between American and US Airways – one that any read of the newspapers makes clear will likely go forward. And to be honest, many of the concerns I have raised about the merger have been addressed in the talks underway.

By all accounts, the deal is done but for a decision about who will lead the new airline. The analysts and the unions are betting on Doug Parker in the leadership beauty contest between American’s Tom Horton and the US Airways’ CEO.  It’s the nature of this kind of deal to want to crown a winner.

I’m not going to weigh in on the relative merits of Parker over Horton or make this about personalities or executive legacy, which misses the point. In my view, the most successful mergers focus not on the victor to whom goes the spoils, but rather focus on building a leadership structure that brings the experience necessary to maximize the synergies and fulfill promises made to stakeholders.

So for that reason and many others, it would be an error to approach a merger of AA and US as another notch in Parker’s bedpost so he can impose his personal style on the combined airline. US Airways has done a very good job of running the airline it is, but it will take a breadth and depth of experience to a run the airline the new American would be. This is the case because this merger perhaps more than any others will require a delicate marriage of cultures and operating styles.

There is little comparison to the three big mergers that have preceded it:  Delta – Northwest; United – Continental; and Southwest – AirTran.  All three had some international angle to the redrawn networks. Northwest brought the Pacific to Delta and Delta brought some Latin America to Northwest; United brought the Pacific to Continental and Continental brought Latin America to United; and AirTran brought international capabilities to Southwest, providing Southwest the ability to “take out” a potential long-term nemesis in the lower cost AirTran. 

Other than strengthening American’s presence in the northeast US and along the eastern seaboard, US Airways brings little to American from a network perspective. US Airways will transfer a nice chunk of international revenue away from the STAR Alliance to oneworld, and, of course, the sheer size of the combined carrier would return the new American to the number one spot American lost when Delta and Northwest merged.

But to effectively run the combined airline, the new American can’t alienate its high-value business customers who won’t put up with the growing pains we’ve seen with United-Continental. And if the new airline is uncertain in its pace or fails to impress those most valuable customers – many of them the core of American’s revenue base – then a successful merger is far less certain.

The award for the biggest network airline merger failure should go to the team that put together the 1987 deal to combine PEOPLExpress, Frontier and New York Air into Continental Airlines.  The idea was to merge Texas Air Corp.’s holdings to form the nation’s third largest carrier.  But instead of creating a worthy competitor for the two largest airlines at the time, the combination resulted in a balance sheet bloated with debt, unit revenue deficiencies in every corner of the network and no commonality in the combined fleets.  The merged company ultimately filed for bankruptcy protection in in 1990, emerging three years after that.  Ultimately a new management was put in place and the turnaround is legend.  

An American – US Airways combination would not be Continental circa 1987. American is simply too good of an asset.  Nor do I think it will be Delta–Northwest circa 2008, in part because the execution risk strikes me as very high, particularly considering disparities between each airline’s model and culture. One flies to China, the other to Chattanooga.  As a result, they bring two very different customer bases to the entity as well, so customer expectations will differ, too. 

Many analysts have focused on US Airways’ deft courtship of American’s labor leaders as evidence that the US Airways culture is a superior model. But I believe that analysis focuses on the wrong stakeholder group.  At this late stage of the consolidation process, American’s ability to retain existing customers and win new ones is critical to the success of the new airline. A culture transplant alone won’t get the job done. The highest barrier to success would be the one set by a new leadership team that insisted upon its way or the highway in running a combined airline.

Collaboration is critical. That doesn’t mean Tom Horton must be a part of the new American if the architects of any deal determine he’s not welcome. Nor does it mean that the entire American team in place today is necessarily the best choice.  But if the leadership crown goes to Parker’s Phoenix posse, they would be making a grave error to impose the US Airways style on the new American without leveraging American’s successes and cultural assets.

American has proven adept at managing its regional affiliations, code share partners, joint ventures with British Airways and JAL and a loyalty program that arguably is more valuable than US Airways itself.  Its marketing and IT capabilities exceed anything US Airways has ever tried. And American knows far better than its potential new partner how to treat the premium customer who wants warm nuts and lie-flat seats in first class.

I can only hope that the “best of the best” of the two companies will be a part of any new one, because that’s the only way the new airline will compete effectively with first movers Delta, United and Southwest.

We The People: Does BTC (Business Travel Coalition) Really Stand For Bamboozling The Consumer?

[Note:  much of this blog is directly lifted from the trial transcripts AMERICAN AIRLINES, INC. v. SABRE, INC. ET AL)

To bamboozle is to trick or deceive someone through misleading statements or falsehoods. That is precisely what Kevin Mitchell and the Business Travel Coalition (BTC) are up to these days – yet again. From my perspective, this means protecting monopolists by conspiring with anybody and everybody to inflict harm on anyone or anything that might bring competition to the Global Distribution System (GDS). It is time someone calls them out on it.  For too long, the industry has looked the other way in allowing the fox (BTC) into the chicken coop (air travel consumers) under the guise that the BTC advocates on behalf consumers against the big bad airlines.

In its latest façade, the BTC has started a “We The People” campaign urging the administration to enact measures against the industry that will ensure that the “all-in” cost of air transportation is made available to all distribution channels, including the GDSs.  The petition reads:  

“Proceed immediately with a U.S. Department of Transportation rulemaking to restore air travel comparison shopping for consumers.

Airlines have been charging for services such as for checking bags and have been hiding fees by withholding information from travel agencies such that consumers cannot efficiently compare the prices of alternatives and must visit numerous airline websites. This unfair and deceptive marketing practice is harming consumers.

Airlines have been able to withhold fee information for 5 years - evidence of a failing market. Importantly, when Congress deregulated this market, consumer protections were consolidated at DOT leaving travelers with no legal recourse under state consumer-protection laws.  

DOT must require airlines, via a rulemaking, to provide fee information to sales channels where they offer base fares so consumers can see, compare and buy the complete air travel product.”

What BTC thoroughly ignores in its petition is that innovation is already solving challenges of distributing ancillary products which the airlines reasonably want to sell in as many channels as possible. But the larger question is why BTC is taking on this fight when there are far greater issues in play that impact flyers? The answer is, of course, that the consumer is not BTC’s interest here.

You see, it is impossible for the BTC to represent air travel consumers because it represents, and advocates for, a sector of the industry that monopolizes airlines.  The distribution sector of the industry conspires against airlines that challenge that monopoly even if it means harming the very same consumers BTC now claims it wants to protect.  I’ve reviewed transcripts from the American Airlines v. SABRE, Inc. trial - the best public record to demonstrate this activity by the GDS and the large travel interests, but it could be any airline in the way this plays out.  The AA-Sabre trial was settled before a jury had the opportunity to decide the case in which SABRE was accused of conspiring to harm American in numerous actions not limited to setting up boycotts and ensuring that the airline suffered economic harm.

BACKGROUND/SIMPLE PRIMER

At the heart of the matter is the relationship of the airline industry to the Global Distribution Systems. Every time a consumer works with a travel agency, the agent offers information most likely provided by a GDS. It is the airlines that supply that data to the GDS.

First, a brief history.  In the early years following deregulation, GDS were mostly owned by airlines and used to provide information to intermediaries like travel agents to sell tickets. The systems were biased toward the airline(s) that provided the technology and built using pre-internet technology. GDS were compensated for providing and maintaining these vast private networks and for acting as gatekeepers between agents and airlines.

In fairly short order, the government stepped in to regulate the bias. As a result, the GDS were no longer a distribution tool aiding the airline(s) that invested in the technology directly; instead they became a tool of the travel industry to sell a service. Today, the airlines pay an intermediary to distribute their own product – and are paying a price much higher than the GDS transaction costs. The airlines’ costs reflect an outdated model burdened by expensive technology as the GDS fight to sustain their large networks and maintain their role as gatekeeper to an airline’s own customers.

Two companies control 90 percent of US GDS services to travel agents despite the fact that there are other channels that can provide the very same information for a fraction of what airlines now pay.  But don’t be fooled:  It is the consumer who ultimately pays these costs, despite what the BTC and its members will tell you.

THE TRIAL – A STORY

Six years ago, in a boardroom of a very powerful company, a decision was made to bring American [replace with any “problem” airline] to its knees with a series of attacks to get what the powerful company wanted. These attacks hurt not only American Airlines, but also American consumers, because this is a story about how a very powerful company in a very secret way spent years planning to crush new competition to preserve their monopoly.

That plan had many parts and only began by hiding or dropping a problem airline’s flights from their display. Remember, the main product of the GDS is the display – that’s what travel agents use to book flights for their clients. So you drop one airline from the mix, and that airline doesn’t get the booking.

Next, they decided to double the problem airline’s fees overnight. And organize industry boycotts. And threaten exclusion of a problem airline from the GDS.  And use false excuses to blame American.  And hide behind secrecy and deception.  And more.

Airlines know there are two ways to sell tickets to corporate travelers. The old way is the GDS way.  The new, better, more innovative way, is through technology called Direct Connect. It can cut their costs. It can personalize the interaction with their consumers. It offers greater flexibility and a better way to sell tickets and other services and products. These are advantages already used by other airlines, including Southwest and Air Canada, to their great benefit. And in this case they are advantages American wanted, too.

Every company operates for profits, but this case details evidence that Sabre had a plan. Because Sabre is owned by private equity groups hoping to sell within five years, that plan provided a five-year exit.  It was called Project Sovereign.  The essence of the project was to do anything to protect the rich cash flows enjoyed by Sabre in order to maximize the sale price in five years. 

The  airline Direct  Connects are  attempting to have  systems where  they  can  have  the  complete view  of their  customer and  offer  these  specialized deals  for their  clients using  modern  technology. They'll be personalized. They'll be up to date. And  hopefully they'll give  the  traveler exactly what  they  want  at the best  price  for  that  customer.  The threat to the legacy GDS model is to go directly to the consumer – bypassing the middleman (GDS).

Sabre had one primary goal: To neutralize American and it’s attempt to disrupt the model. The GDS was their fortress.  In a word, Sabre would seek to delay and destroy American’s Direct Connect. 

Then in 2006, a mere two months after the new contract between Sabre and American was signed, a Sabre executive sends an e-mail to just a small group of top executives and he says, let's do an initiative -- that's corporate speak for "plan" -- let's do an initiative that targets getting as many things as possible in place. To do what? Neutralize American. Neutralize American's market move to disrupt the model.  American found out about the plan through a mis-directed email.  The plan was first called Five Plus Five so as to disguise it in case American found out about it.  Ultimately the plan was renamed Project 99. 

The plan, in the complex language favored by the GDS, involved "deployment of tools for marketplace awareness and promotions and other non-GDS airline activity."  Or, in simple terms, Project 99 would monitor American and track what the airline is doing that doesn't involve a GDS.  It also sought to "put contractual hooks into the travel agents" – referring, of course, to the corporate agents so critical to an airline’s business travel.  The goal?  To handcuff them to Sabre, and determine how to stop or limit American's marketplace actions.  Finally, it sought to "get clarity on algorithm changes" -- GDS- speak for exactly the kind of biasing the government was trying to restrict.

It began on Christmas Eve, 2010, after Sabre already had been conducting six weeks of secret biassing. According to the e-mails, on December 24 the companies doubled the intensity of the bias, from 60 percent share to 30 percent share, meaning that American’s fares were that much less likely to show up on agents’ screens.

And when did this happen? 4 a.m.  Because when you do something at 4 a.m. on Christmas Eve you do it hoping that no one will notice.  This isn’t to say everyone that ended up being a part of this plan was a willing conspirator.  The evidence showed that some big travel agencies did not want to participate. One of them was BCD Travel, which Sabre executives described as “livid” at Sabre's actions.   In the end an under pressure, however, even BCD agreed to bias in over 6,000 markets. Project 99 was operational.

At the same time all this was happening, Travelport began to put a new tax on American’s flights and then add that tax to the fare price so American’s flights fall all the way to the bottom of the list. Then Expedia started biassing and American’s flights pretty much dropped out altogether. Soon, all the big travel agencies joined the boycott and the biassing.

Enter the Department of Transportation. It takes a hard look at what’s going on and deems it deceptive and wrong.  The DoT inspector even calculated damages at hundreds of millions of dollars. That includes $188 million for Sabre’s six-year sabotage of Direct Connect and $544 million in lost cost savings and product sales.  Add another $261 million from what investigators believe were illegal contract terms and lost web sales for a total of nearly a billion dollars. Exactly what Sabre intended.

But that is only how an airline was hurt.  What about corporations?  Air travel consumers? Travel agents?  We just don’t know.  And we certainly don’t know at what frequency some of these activities take place.  Why do major travel advocacy groups ignore these actions?

THE ONLY CONSUMER ADVOCATE NOW SHOULD BE DOJ, CERTAINLY NOT BTC

On August 25, 2012, The Economist wrote:  The GDSs, meanwhile, are lobbying America’s Department of Transportation to force airlines to include “core” extras (such as bag fees and check-in charges) in the fares they quote to the GDSs, to make for fairer comparisons with carriers that offer all-inclusive fares.  My fear in this action and why BTC is pressing for signatures on a petition is only to ensure that the GDS receive information that only guarantees that their monopoly is emboldened going forward and that new technology like Direct Connect is forever blocked from mounting a competitive product.  Stifling innovation is after all what the GDS want – particularly their owners who want to sell monopoly revenue streams back to the market.

Bottom line: we desperately need an industry correction that allows a natural evolution in business practices so the free market can work. A federal lawsuit may achieve that. Free competition will spur the innovation that anti-trust laws are designed to promote. A federal lawsuit may do that. When competition wins, the consumer wins. When innovation is allowed, the consumer wins. Don’t be fooled by the GDS industry and its supporters hiding behind the false boogeymonster of “hidden fees”. Consumers have no idea how much it already pays to an industry that stifles competition each and every day. And the largest cost is the opportunity cost imposed by the GDS industry that would rather direct consumers’ attention elsewhere.  We do not need an advocacy group with these interests pretending to be the best in protecting air travel consumer interests. 

Before the DoT makes another rule, let’s hope that DOJ completes its investigation of the distribution sector so monopolists can no longer conspire to stifle innovation.