US airlines cap capacity: Economics or collusion?

A marketing proposition discussed at a recent IATA (International Air Transport Association) conference in Miami has opened a can of worms. It seems that airlines are recognizing that it is in their joint interest to cap capacity so as to maintain airfares if not keep them high. It is a lesson learnt from the global financial meltdown that led to a reduction of capacity and cancellation of unprofitable routes, a lesson that many of the airlines are stretching into recovery, and antitrust observers have expressed concern that this may become permanent.

In more justifiable business parlance perhaps, airline executives are calling it “capacity discipline”. That, however, implemented jointly across the industry suggests possible collusion to limit competitive pricing which the Justice Department is investigating.

The suspicion is not helped by US airlines turning in record profits as the economy recovers, unmitigated by the fact that while jet fuel prices are falling, airfares are not moving in the same direction. In the past two years, US carriers together close to US$20 billion, and higher profits are expected this year as fuel prices remain at their low levels, having already dipped by some 35 per cent compared with last year’s prices. On the other hand, airfares are at a record decade high.delta

American<a Justice Department spokesperson Emily Pierce confirmed the probe to look into “possible unlawful coordination by some airlines.” The four major airlines in the US – American Airlines, United Airlines, Delta Air Lines and Southwest Airlines – also confirmed they have been contacted to provide information and would comply. You bet these airlines were not picked randomly. If there were any collusion, they would be the ones in the strongest position to jointly impact the market. Together, they fly about 80 per cent of the nation’s domestic passengers.southwest logo

united logoExcluding Southwest, the US Big 3 are making the authorities reflect on the wisdom of approving the mergers of their erstwhile entities, creating mega carriers that as a consequence results in reduced competition as the merged airlines rationalize their operations to reduce routes and capacity. US politicians are not falling short in criticism of the new reality. US senator Richard Blumenthal warned of widespread “anti-competitive, anti-consumer conduct.” The issue is that airlines are not matching the increased demand for seats in an improved economy, and that can only lead to increased prices. Mr Blumenthal said: “Consumers are suffering rising fares and other added charges that seem to be the result of excessive market power concentrated in too few hands and potential misuse of that power.”

Indeed, as another senator, Charles E Schumer, pointed out, “It’s hard to understand, with jet fuel prices dropping by 40 per cent since last year, why ticket prices haven’t followed.” While some airlines outside the US have bowed to pressure to adjust airfares or reduce fuel surcharge, US airlines have stuck to their guns to not do so but instead return millions to their shareholders. It is a clear indication of where their priorities lie. Yet what could be wrong with that but for the alleged collusion to foster an oligopoly where the customer is deprived of choice, the very situation decried by the airlines themselves and the authorities alike?

Not surprisingly, the US situation in the light of falling fuel prices may suggest the tacit support that the major airlines give each other to not return the savings or part of it to their passengers, that no airline should be disadvantaged by a competitor cutting airfares. The mega conglomeration seems to have made that easier, so Mr Schumer said: “We know that when airlines merge, there’s less price competition. What we need now is a top-to-bottom review to ensure consumers aren’t being hurt by industry changes.”

The problem is magnified when you consider the rising trend of cross border mergers and acquisitions not excluding mega alliances that can wield as much power to jointly ensure that prices are kept high even as oil prices dip, and by their size are able to erect entry barriers to new competitors. Fortunately the environment outside the US is less homogeneous and the market too diverse. There are also socio-political differences, if not often conflicting. US carriers have derided as unfair competition the apparent non-conformity to US standards and other operating situations such as low wages that make it possible for foreign carriers to charge lower fares.

Courtesy Emirates Airlines

Courtesy Emirates Airlines

Interestingly, the Justice Department’s investigation of alleged collusion among US carriers comes at a time when the US airlines (with exceptions) are seeking to block the expansion of Gulf carriers into the US citing unfair competition as they believe those airlines – namely Emirates Airlines, Etihad Airways and Qatar Airways – are advantaged by state subsidies. Emirates CEO Tim Clark has rebutted the accusation by the US Big 3, calling their move “repugnant” while insisting that Emirates is “absolutely not subsidized, and our operations do not harm these legacy carriers, but instead benefit consumers, communities and America’s national economy.” He aptly touched on the goals of Open Skies, which include among other things “greater competition, increased flight frequency (and) consumer choice”, the very issues that the US Big 3 may be guilty of flouting domestically if allegations of collusion were true.

Sir Tim stated in his rebuttal that Emirates is “offering US consumers, communities and exporting companies direct flights to more than 50 cities not directly served by any American carrier… connecting America to some of the fastest growing economies in the world, in Africa, Asia and the Middle East.” And he pointedly asked where the US carriers were. Yet could US carriers be faulted for not operating to destinations of poor demand? But should they then begrudge another airline filling avoid and envy its success in growing the traffic? So much about being the dog in the manger, while not denying it is an intricate issue.

Without competition to differentiate the carriers by product, service, fare, schedule convenience and network, reputation and frills, airlines have a tendency to move towards uniformity. Fuel surcharge is an example. All it took was one airline raising the surcharge in the days of spiralling fuel prices, and others followed quickly. Unfortunately, it is not quite the same when the oil price dips, so US carriers have taken what appears to be a collective decision not to pass on the savings to their customers.
Ever since the introduction of the fuel surcharge as a separate fee from the airfare, airlines learn very quickly to unbundle charges to be levied separately. What appears to be in the interest of the consumer who will pay for only what he or she needs, such as a checked baggage fee, has turned out to be a big money spinner for the carriers. Today, there are charges levied by some airlines for not only checked baggage but also seat requests and physical check-in at the airport. Passengers are often not any wiser about the real cost of their ticket, an issue that authorities in the European Union, US and Canada are taking airlines to task for misleading representation. Checked baggage fee and no meals on domestic flights are the norm in the US. However, US carriers may be disadvantaged internationally by foreign carriers that provide free checked baggage carriage and even meals for the short-haul. It is the competition that will make the airlines work for their money by being more productive and less wasteful, more innovative and more customer-oriented.

As the Justice Department investigates US carriers for alleged collusion, the corollary is whether real competition still thrives in the US. While shareholders’ pockets are loaded up, collusion can have many damaging effects, resulting in bloated, inefficient and costly operations. Or do they even matter considering the speckled history of US airlines seeking Chapter 11 protection and teetering on the brink of bankruptcy?

This article was first published in Aspire Aviation.

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About David Leo
David Leo has more than 30 years of aviation experience, having served in senior management in one of the world's best airlines and airports. He continues to maintain a keen interest in the business, writes freelance and provides consultancy services in the field.

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