Saturday, May 16, 2015

Airline Competition Has Been Crushed

If you've flown much in the last few years, you've probably seen what I've experienced, as well - completely full planes, high prices, and aggravating extra charges for baggage, wi-fi, etc... This is really a symptom of what has actually occurred, which is that airlines have finally moved past an era of competition into an era of oligopoly.

The real indication of their new status isn't the high prices and full planes - it is in the stock price.
Here you can see the major carriers which have survived and consolidated the US market - Southwest, American Airlines, Delta, and United / Continental. For years and years the stock prices of major airlines have languished - per Warren Buffet
He said that a durable competitive advantage in the airline industry “has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down,” he joked. “The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit.”
Each of the major airlines has predominantly broken their strong unions and taken medicine from bankruptcy to mergers in order to restore their finances. Instead of a focus on expansion, they are operationally focused in terms of filling every seat on every plane at the highest price possible, in terms of ticket costs and extra fees. Today they charge you for every sort of upgrade; "economy plus" which is a seat that you can sit in and get work done, costs extra, as well as for checking bags.

There is absolutely nothing wrong with a company doing all they can to maximize profits, especially after savaging investors for many years with poor stock prices and a lack of dividends (and the high risk of total financial collapse). The airlines have finally figured out technology as well - if you want to upgrade any element of your flight experience, from business to first class to economy plus to a daily club pass - it is all right there as long as you are willing to give them your credit card number.

The airlines have also figured out that their frequent flyer programs provide benefits but also can be a millstone. Rather than rewarding miles, they are looking at the prices of the tickets paid by each traveler which rewards those that actually provide the greatest benefits to the airlines. If you've tried to actually use your benefits (except for Southwest), you'll find that seats are very limited and you need to plan far in advance to receive benefits from these perks.

The airlines received a huge windfall with declining fuel prices. If the industry was in a mode of high competition, you'd expect customer prices to fall as the airlines would be forced to pass on some of these benefits to the consumer since the costs would move closer to their marginal price. However, there has been no sign of price reductions - the airlines aren't competing with each other (substantially) on price and each of them are going to use this windfall to buy back stock and pay higher dividends.
Delta Air Lines Inc. said on Wednesday that it plans $6 billion in new stock buybacks and added dividends through 2017, the biggest single cash return to shareholders by an airline and the latest sign of the industry’s unprecedented financial strength. Also Wednesday, Southwest Airlines Co. launched its own $1.5 billion stock-buyback plan and raised its quarterly dividend by 25% to 7.5 cents a share.
For the consumer, there isn't a lot of good news in the future. There don't seem to be any significant domestic competitors coming in to the market, and likely if they did arrive in a single region, the incumbent airline would just drop prices for a while to match and then after the upstart was weakened they'd go back to their old high prices. The only major types of price wars that could be beneficial would occur if the major airlines started to attack their adjacent oligopolists but this doesn't seem to be in the cards; money that could have been used for this sort of expansion is going back to the shareholders in the form of stock buybacks and dividends rather than on grand expansion plans.

The long term threats to the US carriers and their dominance of the US market come from the mega foreign carriers based in the Middle East - Emirates Airline, Etihad Airways and Qatar Airways. Unlike the penny pinching, cost focused US airlines, who are now concentrating on earning high profits and returning cash to shareholders, these Arab airlines spend lavishly on expansion and large, spacious airplanes with major amenities. The services offered by these carriers set the standards and once they start competing with US carriers on international routes they likely will offer stiff competition. Since the US airlines do make a lot of their profits on international routes ultimately this may weaken them and open the door to other upstart domestic carriers who could spy an opportunity to pounce.

You can tell how serious the competition is because US carriers are already saying that "unfair" subsidies by foreign governments means that they should not be allowed to compete on US routes. They even brought in the Chicago mayor (you'd think that he has better things to do with our debt being rated as "junk") to pipe in here.
"We echo Mayor Emanuel in urging the Obama administration to take all necessary steps — including a freeze on new routes by the Gulf carriers while consultations proceed — to ensure that the open-skies agreements our nation has entered into are being complied with by all participating parties. Hundreds of thousands of middle-class airline employees who work hard and play by the rules expect our country's trading partners to do the same. Our livelihoods depend on it."
There you have it! The billions that are being returned to stockholders and high dividends, along with being crushed in a tiny seat and paying for every single amenity by the drop - that's the "American way" and it all goes to support middle-class families apparently. Meanwhile these foreign carriers, trying to encourage passengers with new planes and amenities like high quality, comfortable service, should not be given entry to the US market.

Another sign of a comfortable oligopoly is using the political process to preserve market share rather than competing on traditional elements of price and quality. This is a fine example of the former, not the latter.

Whatever thoughts you may have about the US airline industry, think again. Instead of being a competitive market ruled by expansionist companies, you have a cozy market with little competition where windfalls like low fuel prices and low interest rates (which help a capital intensive industry) will remain with the companies, not be passed on to consumers. And their long term threats aren't US competitors, but foreign competition similar to those that ultimately upended US industries from autos to clothing to toys.

Cross posted at Chicago Boyz

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