Airline Deregulation

Airline Deregulation

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Airline Deregulation Act of 1978

Today's airline industry is radically different from what it was prior to 1978. At that time, the industry resembled a public utility, with a government agency, the Civil Aeronautics Board (CAB), determining the routes each airline flew and overseeing the prices they charged. Today, it is a market-driven industry, with customer demand determining the levels of service and price.

The turning point was the Airline Deregulation Act, approved by Congress on October 24, 1978 and signed into law four days later by President Jimmy Carter. Pressure for airline deregulation had been building for many years, particularly among economists who pointed out, in numerous studies, that unregulated intrastate airfares were substantially lower than fares for interstate flights of comparable distances. However, it was a series of developments in the mid-1970s that intensified the pressure and brought the issue to a head.

Events Leading to Deregulation

One of those developments was the advent of widebody aircraft, which significantly boosted airline capacity on many routes. Another was the Middle Eastern oil embargo in 1973, which led to skyrocketing fuel costs and contributed generally to price inflation. Both coincided with an economic downturn that put severe strain on the airlines. Business was falling at the same time that capacity and fuel prices were rising.

In line with its mandate to ensure a reasonable rate of return for the carriers, the CAB responded to this crisis by allowing carriers to increase fares. It also embarked on a four-year moratorium on authorizing new services and approved a series of agreements among the carriers to limit capacity on major routes.

None of these moves were popular with the public. It cost more to fly. Furthermore, the CAB action did little to improve the carriers' financial picture. Earnings were poor throughout the mid-70s, despite these fare increases and capacity constraints.

In 1974, the Ford Administration began to press for government regulatory reforms, in response to a growing public sentiment that government regulations were overly burdensome to U.S. industry and were contributing significantly to inflation. Shortly thereafter, Sen. Edward Kennedy chaired hearings of the Senate Subcommittee on Administrative Practice and Procedure that concluded airline prices in particular would fall automatically if government constraints on competition were lifted.

The staff of the CAB reached the same conclusion in a report issued in 1975. The report said the industry was "naturally competitive, not monopolistic," and that the CAB itself could no longer justify entry controls or public utility-type pricing. On its own, the board began to loosen its grip on the industry, acting at first under the leadership of John E. Robson, and later under Alfred E. Kahn, who became CAB chairman in 1977. Mr. Kahn, an economist, was persuasive in arguing that the board should give the airlines greater pricing freedom and easier access to routes.

Air Cargo Deregulation

Congress took the first legislative steps toward airline economic deregulation in November of 1977, when it gave cargo carriers freedom to operate on any domestic route and charge whatever the market would bear. Congress also declared that one year following enactment of the bill, the CAB could certify new domestic cargo carriers as long as they were found "fit, willing, and able." No longer would there have to be the more demanding, and therefore restrictive, finding of public convenience and necessity, as there had been in the past.

Express Package Delivery

There was another important development following cargo deregulation - the rapid expansion of overnight delivery of documents and small packages.

Deregulation produced dramatic results for all aspects of the cargo business, but particularly express package delivery. Overnight delivery of high-value and time-sensitive packages and documents began in the early 1970s. However, it was deregulation that really opened the door to success for such services. Deregulation gave express carriers the operating freedom such high-quality services demand, and the result was outstanding growth for that segment of the aviation industry over the next decade.

In 1994, Congress further encouraged the development of this part of the airline industry by preempting state efforts to regulate intrastate air/truck freight and air express package shipments.

Passenger Deregulation

The same principle of free-market competition was next applied to the passenger side of the business in the Airline Deregulation Act of 1978. Restrictions on domestic routes and schedules were eliminated along with government controls over domestic rates. Eventually, the CAB itself was disbanded.

Congress mandated that domestic route and rate restrictions be phased out over four years. It provided for complete elimination of restrictions on routes and new services by December 31, 1981, and the end of all rate regulation by January 1, 1983.

The CAB actually moved much more quickly than that. It began granting new route authority so readily that within a year of the law's passage carriers were able to launch virtually any domestic service they wanted.

The CAB ceased to exist on January 1, 1985, although several board functions shifted to other government agencies, primarily the Department of Transportation.

What Remains Regulated

International

Among the CAB functions shifted to other parts of the government were the responsibility for awarding landing rights and other privileges in foreign countries to U.S. carriers. International air services are usually governed by air-transport service agreements, referred to as bilaterals, between two nations. These agreements specify such things as the cities each nations' airlines may serve, the number of flights they may operate, and how much regulatory authority the governments will exercise over fares. Bilateral negotiations involving the United States are led by the State Department, with active DOT policy input and participation.

In the 1990s, the United States made a concerted effort to liberalize its international aviation markets, in view of strong airline traffic growth, more liberal trade policies by many partners and the increasing importance of global airline alliances. This effort has been very successful, and as of April 2000, the U.S. had concluded 45 "Open Skies" agreements, which exchange traffic rights, without any limitation on routes, the number of carriers or capacity; and provide liberal regimes for pricing, charters, cooperative marketing agreements and other commercial opportunities. In cases where the agreements are less liberal and some restrictions exist, it is the task of the DOT to decide which U.S. airlines get those rights through traditional administrative processes.

Antitrust Exemption

The CAB, because of its comprehensive regulatory jurisdiction over the airline industry, had the authority to approve agreements between airlines and to grant antitrust immunity to those transactions that it approved. With the sunset of the CAB, DOT received authority to approve and immunize agreements affecting international air transportation; however, the authority over domestic transactions lapsed.

Essential Air Service

Another function assigned to DOT with the demise of the CAB was the responsibility for maintaining air service to small communities. With carriers free to go wherever they want, Congress anticipated that some of the lightly traveled routes would lose service. To assure appropriate service, it established the Essential Air Service program, which provides subsidies to carriers willing to serve domestic locations that otherwise would be economically infeasible to serve. DOT administers the program, determining subsidy levels and soliciting bids from carriers.

Safety

As Chapter 6 explains in greater detail, the government continues to regulate the airlines on all matters affecting safety. The government has performed this regulatory role since 1926, and continues to do so through the Federal Aviation Administration. The Airline Deregulation Act ended government economic regulation of airline routes and rates, but not airline safety.

Effects of Deregulation

Hub and Spoke

A major development that followed deregulation was the widespread development of hub-and-spoke networks, which existed on a more limited basis prior to 1978. Hubs are strategically located airports used as transfer points for passengers and cargo traveling from one community to another. They are also collection points for passengers and cargo traveling to and from the immediate region to other parts of the country or points overseas. Airlines schedule banks of flights into and out of their hubs several times a day. Each bank includes dozens of planes arriving within minutes of each other. Once on the ground, the arriving passengers and cargo from those flights are transferred conveniently to other planes, that will take them to their final destinations.

Airlines developed hub-and-spoke systems because they enable them to serve far more markets than they could with the same size fleet, if they offered only direct, point-to-point service. At a hub, travelers can connect to dozens, sometime hundreds, of flights to different cities, and often can do so several times of day. An airline with a hub-and-spoke system, thus, has a better chance of keeping its passengers all the way to their final destination, rather than handing them off to other carriers. Travelers enjoy the advantage of staying with a single airline.

The carriers also found that with hub-and-spoke systems they could achieve higher load factors (percentage of seats filled) on flights to and from small cities, which in turn lowered unit operating costs and enabled them to offer lower fares. A city of 100,000 residents, for example, is unlikely to generate enough passengers to any single destination to fill more than a handful of seats aboard a commercial jet. However, it may very well generate passengers going to a number of different destinations. Operating a jet into a hub, where passengers can connect to dozens of different cities, therefore, makes economic sense for small-city markets.

Most of the major airlines maintain hub-and-spoke systems, with hubs in several locations across the United States. Geographic location, of course, is a prime consideration in deciding where to put a hub. Another is the size of the local market. Airlines prefer to locate their hub airports at cities where there already is significant "origin and destination" traffic to help support their flights.

New Carriers

Deregulation did more than prompt a major reshuffling of service by existing carriers. It opened the airline business to newcomers just as Congress intended. In 1978, there were 43 carriers certified for scheduled service with large aircraft. Today, the number of carriers has doubled.

The number has fluctuated over the years, with changing market conditions. By 1998, however, the number again was on the rise as new airlines offering direct, low-cost, no-frills service began to emerge. The new airlines were a result of several factors, most notably low prices for used aircraft and the availability of pilots, mechanics and other airline professionals.

Increased Competition

The appearance of new airlines, combined with the rapid expansion into new markets by many of the established airlines, resulted in unprecedented competition in the airline industry. Today, 85 percent of airline passengers have a choice of two or more carriers, compared with only two-thirds in 1978. The airlines compete intensely with one another in virtually all major markets. The growth of hub-and-spoke systems resulted in increasing competition in small markets that would not normally support competitive service with a linear route system. Proportionately, the biggest increase in competition occurred in the small- and medium-sized markets.

Discount Fares

Increased competition spawned discount fares, and from the traveler's perspective, the discounts are the most important result of airline deregulation. Fares have declined more than 35 percent in real terms since deregulation in 1978. They have become so low, in fact, that interstate bus and rail service has been hard pressed to compete with the airlines, which today provide the primary means of public transportation between cities in the United States.

The Brookings Institute, in 1999, estimated that the traveling public was saving in excess of $20 billion a year as a result of deregulation. Fifty-five percent of the savings resulted from lower fares; 45 percent from increased service frequency, which helps reduce the number of nights travelers must spend on the road. More than 90 percent of air travel today involves a discount, with discounts averaging two-thirds off full fare.

Growth in Air Travel

With greater competition on the vast majority of routes, extensive discounting, and more available flights, air travel has grown rapidly since deregulation. In 1977, the last full year of government regulation of the airline industry, U.S. airlines carried 240 million passengers. By 1999 they were carrying nearly 640 million. A recent Gallup survey revealed that 80 percent of the U.S. adult population had flown at least once, more than one-third of them in the previous 12 months.

Frequent Flyer Programs

Deregulation also sparked marketing innovations, the most noteworthy being frequent flyer programs, which reward repeat customers with free tickets and other benefits. Most major airlines have such a program, and many small carriers have their own programs, as well as tie-ins to larger programs. While the programs vary, the essential elements are the same. Once a customer enrolls, he or she is credited with points for every mile flown with the sponsoring carrier or with other airlines tied into the sponsor's program. The rewards (free tickets and upgrades that convert coach tickets to first class or business class tickets) are pegged to certain point totals.

A more recent development has been the marriage of frequent flyer programs with promotions in other industries in general, and the credit card industry in particular. It is now possible to build up frequent flyer points by purchasing things other than airline tickets, and in some cases to exchange miles for other goods and services.

Programs

Computer Reservation System (CRS)

Another important development following deregulation was the advent of computer reservation systems. These systems help airlines and travel agents keep track of fare and service changes, which occur very rapidly today. The systems also enable airlines and travel agents to efficiently process the millions of passengers who fly each day.

Several major airlines developed their own systems and later sold partnerships in their systems to other airlines. The systems list not only the schedules and fares of their airline owners, but also those of any other airline willing to pay a fee to have their flights listed. Travel agents using the systems to check schedules and fares for clients, as well as to print tickets, also pay various fees for those conveniences.

Codesharing

Another innovation has been the development of codesharing agreements. These agreements enable a ticketing airline to issue tickets on the operating airline and to use that operating airline's two-letter code when doing so. Codesharing agreements can be between a larger airline and a regional airline or between a U.S. airline and a foreign airline. Codesharing agreements allow two different airlines to offer better coordinated services to their customers.

The codesharing agreements also usually tie each airline's marketing and frequent flyer programs, provide for schedule coordination for convenient connections between carriers, and in most cases, permit smaller airlines to paint their planes with markings similar to those used by their larger partners.

All the major airlines have codesharing agreements with regional carriers; in most cases with several regionals and also with other nationals and majors. Some also own regional carriers outright, giving them greater control over these important services that feed traffic from outlying areas into the major hubs.

Codesharing also applies to international routes. Many U.S. and foreign airlines now have codesharing agreements that essentially enable those airlines to expand their global reach through the services operated by their partners.

Codesharing differs from interlining, a much older industry practice in which a carrier simply hands off a passenger to another carrier to get the passenger to a destination the first carrier does not serve directly. In such situations, the passenger buys a single ticket, and the airline issuing the ticket makes the arrangements for the traveler on the second carrier. However, schedules are not necessarily coordinated, there are no frequent flyer tie-ins, and there is no sharing of codes in computer reservation systems. The flights of each carrier appear independently in the CRSs.

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