August 14, 2013

Airline Scenarios: American-US Airways

Patrick Marren
Partner

[Full disclosure: the author is closely related to an airline executive, though not with one of the two companies directly affected by yesterday's DOJ decision.]

The New York Times editorial board today has passed judgment upon the Department of Justice's decision to contest the merger of American Airlines and US Airways, and their judgment is that it is good, that the merger would indeed reduce competition, reduce the number of options for passengers, and raise fares. 

They may well be correct about those effects in the short term. But let's step back a minute here and look at the larger picture.

Since deregulation, the airlines have been one of the few industries that have been exposed to something like real, unbridled, red-in-tooth-and-claw capitalist competition. What have the results been?

  • FAR lower fares, to be sure. Great for the consumer. Air fares are a fraction of what they were in 1978.
  • Creative cost-cutting. The airlines are slimmed-down and efficient and when one of them innovates, all the others copy the innovation instantly.

 

That's the positive side, and those things are indeed considerable.

On the negative side:

  • Endless airline bankruptcies as whoever happens to be the high-cost airline at any particular moment is inevitably pushed to the wall and destroyed.
  • Profit in the airline industry over the decades is nonexistent, as economists would expect in a completely open capitalist market; profits have been competed away completely. So investors get nothing. (Try to restrain your weeping for the poor investors.)
  • Endless downward pressure on airline employee wages, pensions and working conditions. And each time an airline goes bankrupt, it gets to tear itsunion contracts up and dictate terms to its (remaining) employees.
  • Endless friction between cost-cutting and customer desires. Every plane must be crammed to the limit in order to have a hope of profit; this can raise the stress of travel and degrade service levels and the on-board experience.
  • Lack of system robustness, because cramming every plane full makes for massive crises each time weather affects the schedule, because no airline can afford to keep any slack in its operation for emergencies.

 

The current Justice Department determination that the merger of American and US Air will decrease competition and raise fares would seem to be correct on its face, but when you examine it more closely, maybe not. The alternative to the merger is not an extra robust competitor (because AA and USAir remain separate), but almost certainly two weak and probably ultimately doomed airlines that will be pushed to the wall and go bankrupt again (both airlines have gone bankrupt in the past (USAir twice), as has EVERY remaining major airline except for Southwest).

The larger question is, what kind of market do we want here? Do lower and lower prices for customers determine everything? Does the overall quality of the experience of travel matter at all? Should there be no provision for slack in the system to absorb weather and other shocks? Do we completely ignore the endlessly downward trend in wages, benefits, pensions, etc. for employees of airlines?

It's refreshing to see an industry where capitalists take it in the neck as well as employees and customers, I guess, but will the DOJ action actually create a better future for anyone at all?

Highly doubtful. American and US Air occupy a very weak position from which to put pricing pressure on their competitors; in fact, they may compete most directly with each other. Any downward pressure on fares they can exert will be temporary, and will drain them of cash and life until the inevitable next bankruptcy, tearing up of contracts, and their replacement by the next highest-industry-cost airline in the bankruptcy chute.

The airline industry is a very interesting, and probably unique, experiment in a certain form of market structure. Competition is essentially all on price. Differentiation is extremely difficult; competitors can freely copy any innovation almost instantly. There is a seemingly endless supply of possibly goofy rich people who see how relatively cheap it is to get into the airline industry, and who can be relied upon to enter the market at the worst possible time, further driving down fare levels. (A few years ago the shareholder value of the entire United States airline industry was comparable to the daily fluctuation in Bill Gates' net worth; he could have bought the whole industry and not have noticed - if, that is, the DOJ could have been convinced to look the other way.)

The flies in the "perfect libertarian capitalist market" ointment are bankruptcy law, which guarantees a zombie segment of undead competitors with lower cost structures sucking the life out of the remaining (temporarily) non-bankrupt carriers; and the DOJ, which interferes with the ability of the industry to move toward its "natural" state, which might ultimately be a modestly profitable monopoly. Each is well-intentioned and hard to argue with, but when you put them together with pure price competition, it seems to end up outlawing profit, livable wages, and a satisfying customer experience.

The two best quotes about the airline industry may still be those of Richard Branson and Warren Buffett. Sir Richard said, "I have found a fool-proof method of making half a billion dollars out of the airline industry. First, you start with a billion dollars." Buffett, after being stung by an earlier investment in American Airlines, told an audience, "The best thing for airline investors would have been if someone had been there at Kitty Hawk to shoot Orville Wright out of the sky."

And from a customer perspective, we will probably continue to see dissatisfaction, because the experience of flying in our cut-rate, lowest-possible-cost airline era will still be one of being stuffed into an aluminum tube and strapped in next to a sweaty stranger, being told when one can get up, walk, eat, and go to the bathroom, of not being in control of one's fate, not having instant information when one wants it, and so on. 

And this is a shame, because the American airline industry is a miracle. It is the most complicated, gargantuan-scale, intricate, amazingly-managed enterprise in the history of the universe as we know it. No industry I know of has a greater ratio of complexity and effort to profitability. The amount of logistical complexity, the level of technology, the invisible universe of people making sure one's bags magically appear (98% of the time with one's flight, something like 99.6% on the same day) all are just stupendous. The technology used to send you to Cleveland is only a little different in kind from that used to put men on the moon. As the comedian Louis CK said a few years ago, "Everyone on board every flight should constantly be screaming 'Oh my god!' Because you're sitting... on a chair... in the sky." 

But they don't, of course. They complain about not getting peanuts on their $99 flight to Florida. And as I said above, I get it. Being stuffed into an aluminum tube and flown at 500 mph is a psychologically stressful experience for humans; it's not one for which the past 2 million years of evolution has prepared us. 

So future scenarios of the airline industry, post-1978 deregulation, all seem to share a "Groundhog Day"-like quality. The beatings, apparently, will continue until morale improves.

Thoughts?