Essay/Term paper: Deregulation of the airline industry

Essay, term paper, research paper:  Humanities Essays

Deregulation of the Airline Industry


The airline industry has been subject of intense price competition since
it was deregulated, and the result has been a number of new carriers which
specialize in regional service and no-frills operations. These carriers
typically purchase older aircraft and often operate outside the industry-wide
computerized reservations system. In exchange for these inconveniences,
passengers receive low fares relative to the industry as a whole. This research
examines two low fare air carriers, ValuJet and Southwest Airlines. By
investigating these air carriers, we can better understand the economic impacts
of price versus service in the airline industry as a whole, as well as, the
impacts on passenger and investor confidence.
Until 1978, air transport rates were approved by the government, which
meant that price was not a primary competitive factor. Instead, airlines would
compete on service and image. The airline industry was dominated by giants
(American, United, TWA) which offered nationwide and some international service,
and by regional carriers, such as Southwest, which offered short trips between
airports not served by the nationals.
Deregulation of the airline industry brought about in 1978 introduced a
situation in which the national and regional carriers were suddenly able to
compete in an environment that resembled a free market. Rate schedules were
lifted, price fixing was eliminated and route management was removed. The main
factors that affected whether an airline could serve a particular city was
whether or not that city had enough gates for the new carrier, and whether the
carrier was able to afford to purchase them. Companies such as Southwest
recognized potential for low fares, and began building a niche for themselves by
offering low fares with equivalent low levels of service. Southwest's success
gave rise to a new generation of low fare airlines, with ValuJet entering the
market in the early 1990's. Unfortunately, ValuJet suffered a string of
accidents which brought the future of this air carrier into question.
ValuJet is a low-priced airline that offers inexpensive tickets for
regional travel. Based in Atlanta, the airline serves the Southeastern United
States and competes with Continental Airlines as well as with other small
regional carriers. It serves 31 cities primarily in the southeastern United
States. The airline began its service with flights to Tampa and Orlando from
Atlanta in 1993. The no-frills strategy paid off for the fledgling airline,
which posted half again as many revenue passenger miles in April 1996 as it did
in April 1995. However, the company announced that it was slowing the expansion
of its services, voluntarily, at the same time that it posted this impressive
revenue mark (Cole & Pasztor, 1996, p. A6).
Perhaps due to overexpansion or to poor luck, Valujet experienced a
series of mishaps in its short history. In January 1994, a DC-9 skidded off a
runway in Washington which resulted in the entire airport being shut down. In
June 1995, a ValuJet flight went through an emergency evacuation after an engine
failed and shrapnel flew into the cabin. Additional incidents, including one
where the landing gear collapsed after a particularly forceful landing, led the
FAA to begin an intense review of ValuJet in February 1996. This review found
that ValuJet was in compliance with FAA regulations, but cited concern about
pilot training and aircraft maintenance (Larson, 1996, p.30).
In May 1996, Valujet flight 592 crashed in the Everglades, killing all
aboard and resulting in a shutdown of the carrier for several months. When
ValuJet began flying again, it did so with a reduced schedule, and considerable
speculation about whether the company will be able to continue operations long-
term. The company is also involved in litigation resulting from the crash, and
the long-term prospects for the company are questionable.
The following chart identifies key operating statistics for Southwest
(seat miles are in millions, cost factors are in cents)

(Shammas, 1996, p. 5541P):
1995 1994 1993

Revenue Passenger Miles (RPM) 2,624 941 44
Available Seat Miles (ASM) 3,813 1,471 63
Load Factor 68.8 % 64.0 % 69.7 %
Revenue per RPM 13.4 13.8 13.1
Cost per ASM 6.8 6.8 9.8

Because Southwest's flights are generally an hour or less in length, the airline
saves money by not having to serve meals. It has a liberal work rule
arrangement with its unions, so productivity is high, and overall costs are low.
For example, Southwest gets 672 hours per year on average from pilots versus 371
for American Airlines pilots, and 60 percent more passenger miles per flight
attendant (Levinson, 1993, p. 34). These figures enable the company to realize
profits during years in which the industry as a whole was suffering. The
following chart identifies key operating statistics for Southwest (seat miles
are in billions, cost factors are in cents) (Klein, 1996, p. 2077):

1995 1994 1993

Revenue Passenger Miles (RPM) 23.33 21.61 18.83
Available Seat Miles (ASM) 36.18 32.12 27.51
Revenue per RPM 11.83 11.56 11.77
Cost per ASM 7.07 7.08 7.25

In addition, the company has a 70 percent average load factor in an
industry that averages 63 percent, and operating costs per passenger mile are 22
percent less than industry average. It has one of the youngest fleets in the
industry (6.9 years compared with an industry average of 12.9 in 1992), and the
best on-time and baggage handling records in 1992 (Gold, 1993, p. 29). Each of
these factors contributes to the company's financial and marketing success.
Southwest's success has come about because it is providing a product
that the market wants, no-frills regional air travel, at a price that is
attractive. Despite its no-frills orientation, the company maintains strong
customer service satisfaction and high levels of customer service, encouraging
repeat business. When the airline enters a new market, such as Baltimore, its
fares are as much as 85 percent less than those of its higher-priced competitors,
attracting passengers quickly and forcing the competition to either match the
price or lose market share. In its target markets, Southwest has positioned
itself to even compete favorably with traveling by car (Thorpe, 1996, p. 262).

Southwest's success has not been without problem, and the company has
again demonstrated an ability to find creative solutions to those problems. For
example, the company has traditionally expanded its 737 fleet by adding older
aircraft available at discounts (sometimes as much as 30 percent) (Kripanlani,
1992, p. 20). Since the company's ability to enter new markets is determined
in part by the size of its fleet, and since the company is committed to staying
with homogenous fleet of 737s, it runs the risk of ending up with a large number
of older aircraft that it no longer needed (depending on the market), or that do
not meet new environmental standards.
Southwest solved this problem by beginning a lease-back program in 1988.
Under the program, Southwest sells some of its older 737s, then leases them back
for its own use. As of the beginning of 1992, the company had done this with
more than half of the Boeing 737-200 aircraft that it operated (Brown, 1992,
p.57). This program enables the company to release aircraft that it no longer
needs or that no longer meet the stringent new environmental standards. At the
same time, the company can modify its remaining 737-200s in order to make them
compatible with noise and pollution regulations if it needs the capacity.
The company's stock has split three times since 1990, and its price-
earnings ratio is a healthy 13.1 percent. Its load factor is well within the
industry norm of 67 percent (Sanborn, 1996, p. 251), and the company's
commitment low fares and its safety record should help it maintain good
performance even in light of the ValuJet crash (which brought increased
attention to all low fare carriers).
The crash of Flight 592 has brought increased scrutiny to ValuJet (and
to low-fare carriers in general), and the long-term effect on ValuJet is not yet
known. The stock, which had two, two-for-one splits in 1995 and which peaked at
more than 30 dollars per share in late 1995, has plummeted to below 12 dollars
per share in late 1996. Investors with high tolerance of risk might consider
the stock at this low level, and the company might be a takeover target in the
future as other carriers seek its routes. However, the company's aging aircraft
fleet would not be an asset to most carriers, and it is unclear whether
stockholders would realize a reasonable profit, even at today's low prices.
The outlook for Southwest is considerably brighter than for ValuJet.
The company has one of the highest safety records in the industry, and the
company has also benefited from higher ticket prices and increased passenger
traffic. The recent reinstatement of the federal excise tax is not expected to
have a negative effect on Southwest demand since it has indicated it will
increase fares in only 20 percent of its markets, but this will affect
profitability. The company's strategy is to make up the difference of lower
revenue with increased demand through its lower fares (Thorpe, 1996, p. 262).
The airline industry has become one of the most competitive segments of
our economy. The economic realities of operation costs versus passenger demand
for cost-effective travel has forever changed the face of the travel industry.
After deregulation in 1978, the airline industry was forced to abandon its
service-oriented philosophy and consider the competitive pressures since they
affected the various companies bottom line. Price had suddenly become the
benchmark in the airline industry. Companies such as Southwest and ValuJet
recognized the potential for low fares with commensurably low levels of service.
With the changing paradigms in the airline industry comes risk, not only
to the individual airlines but also the public in general. At what point do the
economic pressures of making a profit for the airlines affect passenger safety?
If the trend toward more airline disasters continues and those accidents can be
attributed to cost-cutting measures, surely Congress will intervene. The
airline industry must be disciplined in its approach to solving the economic
pressures, while, at the same time stay focused on safety issues. If the
airline industry is to survive and give the consumer choices, passenger
confidence cannot be sacrificed for the sake of the bottom line!