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Who says airlines can’t make a profit?

June 18, 2008 by Evan Sparks

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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Posted in Evan's News and Quick Takes | Tagged business, history, regulation | 4 Comments

4 Responses

  1. on June 18, 2008 at 10:12 pm Occam's Razor

    Hi Evan…..

    Operating Profit is a useful measure. In fact a very useful measure.

    However, Operating Profit does not include a Cost of Capital charge. The last time I checked….investors don’t loan you money and expect nothing in return.

    In fact, Operating Profit margin does not include taxes paid to the government on that profit. The last time I check, Uncle Sam still wanted his money of such profit.

    Now….if there’s anything left….you have an aging fleet that needs to be replaced.

    Of course if the your investors aren’t earning a return…..why would anybody loan/invest for you to buy new fuel efficient fleet.

    Have you read the Kenneth Button paper I gave you? After reading this paper, the risks of investing in an airline should be apparent to most investors. Why would they? There are much better industry returns for considerably less risk.

    Occam


  2. on June 18, 2008 at 10:30 pm Evan Sparks

    Occam —

    I did not receive the Button paper.

    The regulation era was not a golden age of capital investment. Their narrow operating profits provided no better an incentive for investors than after deregulation. Some airlines fell far behind (leaving themselves at a competitive disadvantage post-deregulation); others overextended themselves (Pan Am nearly went bust getting the first 747s).

    Furthermore, airlines have always had access to investment. Lots of people want to run airlines; many investors think they can do it better than existing management. As (I think) Warren Buffett said, “How do you make a million dollars in the airline industry? Start with $100 million.”


  3. on June 19, 2008 at 7:42 am Occam's Razor

    Evan,

    Sounds like you may have read….TK Smith’s article about sexy rotting bananas. That’s the first article below.

    The second is Button’s paper on core theory. He also has one on the industry’s inadequacy of capital returns as it relates to core theory, but that’s a “pay” article.

    The 3rd is Raghaven’s.

    tinyurl.com/4cv8f6
    tinyurl.com/53whor
    tinyurl.com/3usdao

    The main thesis of all of these articles is that the “free market” presents the airline industry with a unique competitive dilemma ……. unlike other industries.

    For the various reasons listed in these articles….the industry finds itself without a competitive core or equilibrium. Telser notes that such a competitive situation creates a LESS efficient allocation of resources to the industry and LESS economic benefits to society of the long term. As new investors enter the empty core, creating more instability and find themselves confronted with the same competitive dilemma as others in the industry.

    This inefficiency is an outcome not predicted by “free market” theorists. Their models alway have “equilibrium” at its core. Here we have 30 years of instability….thus to mind…experience has proven Telser’s theories. If there is no core…….then forcing “unfettered” competition on an industry with no core will not benefit society and thus it becomes a Public Policy concern.

    The Europeans, as Crandall notes are not champing at the bit to enter this competitive furball. Their objective is a simple one. Access the large US population centers for global feed. They don’t give a hoot if the USA has a satisfactory domestic route structure. It’s not their job.

    Crandall…
    THUS, IT SEEMS CLEAR THAT THE OBJECTIVE OF THOSE SEEKING U. S. CARRIER OWNERSHIP IS PRIMARILY DIRECTED AT USING A U. S. BASE TO FEED INTERNATIONAL FLIGHTS AND TO DISCOURAGE THE CREATION OF INCREMENTAL COMPETITIVE CAPACITY BY RESURGENT U. S. COMPETITORS. THUS, I AM MYSTIFIED BY THE APPARENT WILLINGNESS OF U. S. NEGOTIATORS TO FURTHER WEAKEN THE DOMESTIC SYSTEM BY TURNING OVER CONTROL TO PEOPLE WITHOUT ANY STAKE IN MAKING OUR DOMESTIC SYSTEM WORK.

    I realize it’s difficult for Orthodox believers in the “free markets” to give up their ways. But…..there are some markets where a free market solution does not exist. We simply can’t ignore 30 years of experience or say that that’s not enough time.

    I hope you and other students of public policy will take the time to read and understand the articles I’ve posted. There’s more to core theory than what’s available on the web.

    OR


  4. on June 19, 2008 at 7:58 am Occam's Razor

    Here’s a quote from the Button paper I like….hopefully it will pique the curiosity of policy makers.

    K Buttonn said…..
    “The underlying aim of air transport policy is assumed in this paper to be that of following the Anglo-
    Saxon School of thought on regulation and to create ’workable competition’. That is, to allow markets
    to function unless there is demonstrable evidence that the market is seriously failing.”

    Crandall’s “sum of the locals” idea…is aimed at creating workable competition.

    30 years of instability? Is that enough demonstrable evidence?

    Anyways…….In a nutshell, according to Telser….there’s two ways out of the competitive dilemma of Empty Core markets…

    Regulate the destructive behaviors of competitors.
    or
    Allow the competitors to collude for equilibrium.

    As Telser notes….collusion in this instance is not for the purposes of “rent seeking” it’s to establish equilibrium. He makes this difference quite clear.



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