The planes and the bees

Marie Force, the archives manager at Delta Air Lines, posts fascinating historical items at Delta’s blog Under the Wing. Today she notes the anniversary of the death of one of Delta’s founders, C. E. Woolman, who had a quotation worth sharing here: “Running an airline is like having a baby: fun to conceive, but hell to deliver.”

Delta’s Founder and First CEO: C. E. Woolman [Under the Wing]

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The air travel a-la-cartel

At Cato at Liberty, Michael Cannon writes:

With fuel prices surging, commercial airlines have started charging passengers for once-gratis amenities (sodas, the first checked bag, pillows-n-blankets) and have increased fees for other amenities (alcoholic drinks, additional checked bags).  A recent [Washington Post] editorial ["Pillows and Planes," August 13] describes these fees as “picking passengers’ pockets” and “idea[s] to separate you from your money.”

Are you kidding me?  Those amenities weigh down the plane.  The fees therefore distribute higher fuel costs to passengers who consume more fuel.  As important, they allow passengers to avoid getting their pockets picked by avoiding those amenities.  (Don’t want to pay for checked baggage?  Pack light.)  The only people those fees hurt are the free-riders whose amenities were being subsidized by everyone else.  The fees don’t allow pocket-picking; they put an end to it.

Warren Meyer comments:

I have seen several writers of the progressive ilk all up in arms about these extra fees.  Which in my mind confirms that there is no foundational position among progressives on such matters, only opportunistic attacks on corporations for whatever they happen to be doing.  They want air travel pricing to be bundled into one rate, covering all potential services one may or may not use.  But wait, they want cable TV pricing to be unbundled, with a la carte pricing rather than one rate so viewers can pay for only what they use.

Regular readers will know that I harbor little regret for the a-la-cartization of air travel; indeed, as I’ve previously written, “Governments and consumer advocates would do well to keep in mind that air travel price competition is thwarted by snowballing customer service requirements.”

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It’s easy being green

A much-trafficked article yesterday from Ireland’s Sunday Business Post offers a thorough takedown of Richard Branson’s green claims about the Virgin Group’s airlines:

In September 2006, Virgin boss Richard Branson pledged €1.9 billion towards tackling global warming. For the next ten years, he announced, the profits from his aviation and rail businesses would go towards combating the biggest, most complex problem that mankind has ever faced. . . . However, a look at the not-very-small print revealed that this amazing gesture would not be a matter of taking the profits from Branson’s polluting industries and using them to protect vast tracts of the Amazon.

In fact, the money would go to a new division of the Virgin conglomerate, called Virgin Fuel. Branson was simply gearing himself up to make more money. But as always, the PR spin was that he’d be doing the rest of us a favour in the process.

Branson has built an empire on this perception. . . . Whether it’s flights, records, mobile phones, cola, radio, television, hotels, trains or holidays, sticking the word ‘‘Virgin’’ in front of something supposedly makes it cheaper yet cooler, with the bearded, grinning boss fronting many of his own ad campaigns. Because if a hippy says it’s all right, then it must be. Mustn’t it?

Since Virgin Fuel was set up in 2006, the tide has very much turned against bio-fuels with the realisation that far too much agricultural land could be eaten up by fuel crops. Palm oil, one of the major biofuels, is contributing to global warming as virgin (no pun intended) rainforests in countries such as Malaysia and Indonesia are decimated to make way for palm plantations.

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“Stop Oil Speculation Now” won’t make oil cheaper

I’m going to resist the airline lobby’s link bait for their Stop Oil Speculation Now website (google it if you care), but the airline CEOs’ letter calling for passengers to lobby Congress for tighter regulation of oil futures “speculation” deserves some attention. The aviation blogosphere sees through this as the bad proposal it is (see Elliott, Snyder, PlaneBuzz, Upgrade, TJI). Indeed, economists from across the ideological spectrum — from Paul Krugman to WSJ op-ed writers — don’t blame “speculation” for the rapid run-up in oil prices. While some of the run-up looks bubblicious, for the most part, oil futures prices reflect estimates of existing and projected demand and existing and projected supply. As Craig Pirrong writes, “Futures and swap markets facilitate the efficient management of price risks, and speculators are an important part of that process. For instance, a producer of oil may want to lock in the price at which he sells his oil in the coming months in order to hedge against fluctuations in its price.” Another economist whose work I follow recently wrote, “Financial markets are driving today’s prices to match expectations of tomorrow’s values.” Speculators are doing the work of price discovery.

And for crying out loud, what is with the airlines’ complaint about “speculators who trade oil on paper with no intention of ever taking delivery”? Do they really want only those who will personally use oil to buy it? What if I’m a sharp, entrepreneurial guy who can make money buying and selling oil? (I’m not.) Why should the government limit my ability to “truck and barter” in a commodity that’s otherwise freely traded? Instead of making oil cheaper, it would restrict the full measure of price information a functioning market can provide.

The challenge of leadership is running a business in hard times as well as good. As Brookings Institution economist Clifford Winston told me recently, airline profitably depends more on the handling of “shocks” than on wringing out efficiencies. The airlines’ proposal is a Band-Aid, a substitute for actually handling the shock of rising costs.

The airline CEOs call the oil market “over-heated.” What’s really over-heated is the rhetoric and reasoning of their proposal.

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Who says airlines can’t make a profit?

One of the most-voiced complaints about deregulation is that airlines have been consistently unprofitable since deregulation. That’s not true, according to this handy chart from a 2006 Government Accountability Office report [PDF].

As you can see, airlines were only narrowly profitable in the era of regulation. After regulation, they became exposed to economic forces, making them — like most other industries — profitable during good economic times and less so during recessions. The airline bottom line was hit by the 1980, 1981-82, 1990-91, and 2001 recessions. The final one’s impact was exacerbated by 9/11. Even with the current challenges of the industry, it’s not possible to say that airlines simply can’t make money in a deregulated environment. Those who propose some measure of reregulation should make clear what they want: for airlines to be protected from the economic cycles and competitive pressures that almost every other industry faces.

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Should airlines be regulated like a public utility?

Yesterday, several outlets reported on former American Airlines CEO Robert Crandall’s speech at the Wings Club (full text here). Crandall, who ran AA during the process of deregulation and made it an industry leader in the post-deregulation era, opposed deregulation in the late 1970s, and his opinions haven’t changed: “We have failed to confront the reality that unfettered competition just doesn’t work very well in certain industries, as aptly demonstrated by our airline experience and by the adverse outcomes associated with various state efforts to deregulate electricity rates. It’s time to acknowledge that airlines look and are more like utilities than ordinary businesses.”

Because Crandall is such a legend in the airline world, I’d like to go through his remarks seriously and respectfully. The key question: should airlines be operated like public utilities? Public utilities arise from natural monopolies, in which it is most efficient for a single firm than multiple, competitive firms to provide a service. Natural monopolies usually result in infrastructure- and capital-intensive industries. Classic examples include electricity transmission or public transportation: it’s too costly for competing firms to maintain multiple networks of power lines or subway tunnels. A utility is often created because it is the only way to ensure crucial infrastructure investments are made; if multiple firms are competing, they may not be able to afford to upgrade their systems over time. Economists have been doing important work exploring whether such utilities are really natural monopolies. Back in the 1970s, a consensus was reached that airlines did not constitute such a monopoly.

Indeed, certain elements of the infrastructure of the airline industry may be natural monopolies. Would it be more efficient to have multiple air traffic control firms competing? Not likely. And communities in which there is one major airport may find that a natural monopoly. (But regions with multiple, competitive airports, like London or New York, have great potential for airline competition. BAA, the owner/operator of London’s three largest airports, was set up as a sort of private utility with so much market power because only such a structure was thought to allow sufficient investment in infrastructure. As it turns out, BAA’s common ownership in a competitive environment has retarded investment.)

But airlines themselves are no longer thought of as a utility. Why were they ever?

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Watch out for “stabilization”

One thing I’m surprised about in today’s hostile airline climate is that I’ve heard nothing about the Air Transportation Stabilization Board (ATSB), the body authorized by Congress in 2001 to distribute up to $10 billion in loan guarantees to airlines after the 9/11 attacks. With all the talk of airlines being in a crisis rivaling 9/11′s impact on the industry; a massive wave of capacity and personnel cuts at United, American, Continental, and (next) Delta; the uncertainty of when (or whether) the price of oil will fall; the credit crunch; and half-a-dozen U.S. scheduled carrier bankruptcies, don’t be surprised to hear chatter about reviving the ATSB — especially if a major carrier goes under.

The board was created to provide loan guarantees for airlines that could not otherwise access the credit markets in the tough months following 9/11, when many airlines threatened bankruptcy. Congress hastily passed the Air Transportation Safety and System Stabilization Act. Less than $1.2 billion was eventually approved for America West, US Airways, Frontier Airlines, ATA, Aloha Airlines, and two smaller carriers. None of these were or are especially healthy airlines: US Airways went into bankruptcy before merging with America West (a merger partially financed by the ATSB loan guarantee); Frontier is in Chapter 11 now, and ATA and Aloha shut down this spring. Many airlines preferred not to seek ATSB guarantees. In order to protect the government, the board negotiated options to purchase stock from guarantee recipients at below-market prices, which yielded profits during the more stable years between 2004 and 2007.

But there’s no guarantee that such activity will always generate revenue in the end, especially in the volatile airline industry. Beyond that, a bailout entails other risks. One is political intervention. Who wins, who loses? As airline deregulation expert Mike Levine points out (see page 20 of the PDF), the loan guarantee to Arizona-based America West was not John McCain’s finest moment. There’s also moral hazard. Because they can access the credit markets, well-managed airlines — like Southwest, which hedged fuel extensively — would be unable to get ATSB guarantees.

An ATSB revival would also be inappropriate because of big differences between the 2001 crisis and now. Back then, a single event (9/11) followed by several days of grounding constituted a single shock. The pressure of today’s high fuel prices leaves the future profitability of the industry an open question. Reviving the ATSB today could expose taxpayers to huge losses.

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Would a Northwest Chapter 11 filing help its merger case?

J. P. Morgan has updated a report assessing the liquidity and balance-sheet health of U.S. airlines, and it finds Northwest Airlines second most likely to file for reorganization under Chapter 11 bankruptcy. If you’ll recall my introduction to airline antitrust, the Justice Department looks more kindly on a merger if one of the parties is about to fail. But in answer to the above question, a potential Chapter 11 by NWA would not move its merger with Delta along because it does not meet the following conditions:

1) the allegedly failing firm would be unable to meet its financial obligations in the near future; 2) it would not be able to reorganize successfully under Chapter ll of the Bankruptcy Act; 3) it has made unsuccessful good-faith efforts to elicit reasonable alternative offers of acquisition of the assets of the failing firm that would both keep its tangible and intangible assets in the relevant market and pose a less severe danger to competition than does the proposed merger; and 4) absent the acquisition, the assets of the failing firm would exit the relevant market.

Northwest may be cash-flow-weak right now, but it’s nowhere near ready for the “failing firm” provision of the Horizontal Merger Guidelines. Nothing to see here, folks.

Airline bankruptcy ranking [Sky Talk]
BOTBS Version 2.0 [PlaneBuzz]

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Shame as a public policy tool

Today I’m reading Grounded: Frank Lorenzo and the Destruction of Eastern Airlines, an on-the-ground account written in 1990 by reporter Aaron Bernstein about the events surrounding Lorenzo’s ill-fated ownership of Eastern in the ’80s. (FYI: Bernstein takes a clear pro-labor angle that should be noted.) In his discussion of military man, former astronaut, and Eastern CEO Frank Borman’s actions preceding the sale, many of those whom Bernstein interviews thought that Borman was too proud to let his airline go into bankruptcy or sell it to corporate suitor Frank Lorenzo. “Borman had no desire to sell the company,” writes Bernstein. “Failure would be a bitter end to what had been a successful climb to the top of the corporate ladder.” But Borman ends up running to Lorenzo instead of buckling to union pressure.

Lorenzo seemed to have no such scruples, which led him to sell off most of Eastern’s most profitable assets, wage a demoralizing battle with the airline’s unions, leading to a disastrous strike and eventual shutdown in 1991. Lorenzo dragged capitalism through the mud, wrote William F. Buckley at the time, but “[t]here is no way a law could be written, to the effect that chief executives ought not to profiteer from the distress of companies they manage.” What remedy is left? “Some general manifestation of disdain for the abusers of capitalism is appropriate,” Buckley writes. That is to say, we should shame corporate officers who behave this way. Shame once might have been an effective tool for penalizing actually corrupt businessmen — which Lorenzo was not — but in the airline world, passengers seem not to care about honorable behavior by executives as long as they get a cheap flight. Rare is the instance in which an executive resigns in disgrace, as American Airlines’ Donald Carty did in 2003 during an attempt to extract concessions from flight attendants while offering top executives cash bonuses. (Carty did not leave the industry; he is currently chairman of Virgin America.)

I’ve written before about the decreasing stigma of bankruptcy. If the law is too heavy a cudgel to ensure upright behavior by airline bosses, and if bankruptcy judges see fit to allow airlines to shred contracts under what Herb Kelleher calls the “health spa” of Chapter 11, then we will have no choice but to shame the executives into doing the right thing. Does the American public have the moral stamina?

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Don’t kill the short hop

Ryan Avent writes:

I like the comment that short flights congest airports as much as long ones. I’m of the opinion that a carbon pricing scheme would give a boost to rail travel over both driving and short-haul flying. But a potentially more important factor in some regions might be the runway congestion charges under consideration. I suspect that auctioned spots would tend to go toward long-distance flights, for which there are few good substitutes (question to the gallery: what are the high margin flights — where do airlines make their money?). Were that the case, demand for regional rail should significantly increase.

You’ve read a lot in the past few years about airlines “shifting” to “more profitable” overseas routes, but that doesn’t quite express what’s going on. Airlines are maximizing their yields, and business-traveler-oriented long-haul international flights often have better yields than leisure-class runs to Vegas or Orlando. But the long-hauls are not necessarily high-yielding on their own, but because they access feed traffic from lots of smaller markets.

Imagine that there are 100 passengers in Washington, DC, who want to fly to Paris.

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