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Airline deregulation and the tourist industry
Airline deregulation and the tourist industry Stephen Shaw Deregulation can be blamed for airline financial losses only if one plays down other factors (eg the recession, rising costs), and ignores those airlines making profits in deregulated markets. Other benefits arising from deregulation include freedom to change fares and networks rapidly. Given the importance to the tourism industry of having efficient airlines cater for their customers, the tourism industry should be favouring further liberalization.
Commercial air transport has always been notable for the system of government regulation which has been imposed on it. Governments have regulated market entry and exit policies of airlines. They have dictated the kinds of service which carriers might offer. Also in many cases they have decided the amounts of capacity which might be provided. Finally, they have commonly regulated prices with the effect of eliminating almost all public price competition. It is not the aim of this article to consider why regulation should have come to be imposed on the industry,' but to concentrate on the changes to the regulatory framework which have occurred recently, and to deal with the implications of these changes for tourism.
Keywords: civil aviation;transport
Changing regulatory policies
economics;deregulation
Stephen Shawis directorof Aviation ContinuingEducationServices,Cityof LondonPolytechnic,Schoolof Business Studies,84 Moorgate,LondonEC2M8SQ, UK.
1. See S. Shaw,Air Transport -- A Marketing Perspective (Pitmans,
London, 1981) pages 90-113. 2. See R. Doganis, "Air transport-a case study in international regulation", Journal of Transport Economics and Policy, 1973, 7, pages 109-33. Also R.M. Smithies, "The changingdemand for air transport -- the North Atlantic case", Journal of Transport Economics and Policy, 1978, 7, pages 231-249.
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Moves towards less regulation have a long history in some aviation markets. For example, the growth in charter services which took place in Europe and on the North Atlantic during the 1960s and early 1970s was a first development of less regulated services outside the highly controlled scheduled service environment. 2 However, since the mid-1970s, the pace of development has accelerated, and one can list the following examples of aviation markets which are now significantly less controlled: • The US domestic market has been freed from a large amount of economic regulation under the Airline De-regulation Act of 197 8. • In some other countries, although developments have stopped short of those in the USA, there has been a progressive liberalization of domestic air services. Canada and the UK provide illustrations. • In international service, the North Atlantic has seen a relaxation of controls, with more direct routes, more airlines allowed entry, and greater freedom on pricing. • Also in international service, a number of other routes to and from the U S A have been liberalized as the USA has negotiated bilateral agreements allowing for freer entry and flexible pricing. In particular, the agreements negotiated by the Carter administration between 1976 and 1980 (eg with Israel and Singapore) have left a strong mark on the industry. • There has been a change in the rate-making role of the International Air Transport Association (IATA). During the postwar period, I A T A has provided a forum within which airlines meet and attempt to agree fares and rates, subject to the approval of governments. Following criticisms of both the ineffectiveness and the anticonsumer connotations of IATA, the Association has been reformed so that member airlines can innovate with low
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Airline deregulation and the tourist industry
fares outside the confines of traffic conference agreements. Such flexibility in publicly available fares is being strengthened by the willingness of airlines to engage in price competition even where agreed fares exist, by the offer of cheap fares through discount travel agencies. • Within Europe, a move towards liberalization of scheduled services has been restricted by a number of intransigent governments. However, the development of basically unregulated charter services has continued. • Finally, on routes to the Far East, the U K government has initiated an experiment by its liberalization of services on the L o n d o n - H o n g Kong route. Three airlines are now operating this route, in contrast to one previously, with intense competition in price and service. This development has been important for consumers in the L o n d o n - H o n g Kong market; it has also had "parallel route" implications, of sucking in demand from routes between Europe and South-east Asia, where a freer economic regime has not yet come. This is forcing innovation on governments and airlines which may be opposed to greater freedom, but which cannot ignore the effect of a less regulated route on their traffic. This phenomenon is observable in other similar situations, eg intense price competition in the London-Miami market has affected the Caribbean and Central and South American routes. More examples could be cited, 3 but they all indicate that regulatory conditions are now easier than they were a few years ago. Although in most markets this easing has stopped short of'deregulation', there has been a pronounced softening of the hand of government.
N e e d for a tourism policy towards aviation liberalization
3. These developments are covered in detail in Shaw, reference 1, pages 102-112.
Moves towards economic liberality have shown that the old regime was a distorting factor on the operations of the airline industry, with the need to overcome these distortions the most important challenge facing airline managers today. Before pursuing this theme, it is worth examining the broader question of policies for the tourism industry towards aviation liberalization. First, it is essential for the tourism industry to have such a policy. Aviation operations in less regulated markets will be different from those in regulated ones, in ways which cannot fail to have important implications for tourism. Also, the economic importance of tourism means that, in many countries, the tourist industry has an effective lobbying power, which must be exercised in the correct direction. The need for a policy then begs two questions. First, what are the features of aviation services which will meet the needs of the tourist industry? Second, will a less regulated environment help in securing the provision of services which show these features? Regarding the needs of tourism, it is wrong to expect that all sections of the tourism industry will have identical requirements. Needs will vary and will, to some extent, be conflicting. Even if it is possible to define a set of all-embracing needs, there may be conflicts within the needs themselves, where one feature (say, expensive service provision) excludes another (eg low prices). Therefore, even if we can set down the features which a tourism-orientated aviation
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Airline deregulation and the tourist indust~
service should show, it will still be necessary to strike a difficult balance between many features. Having said this, it is possible to argue that the tourism industry of a country will be supported by aviation services which show as many as possible of the following characteristics: • safety of service - - a basic requirement; • broad route networks, allowing tourism to draw its clientele from as wide an area as possible; • consistency of service, allowing the tourism industry to plan with confidence the provision of infrastructure; • adequate capacity - - especially important to a tourist destination facing peaking in demand; • provision of service by efficient airlines - - prices of air service to tourism destinations have always been a difficult issue. Some destinations (perhaps Kenya is an example) have seemed to be seeking high air fares, to remain a location patronized only by wealthy visitors. Other destinations (eg Spain) have gone for low air fares, often founded on a liberal attitude to charter services. We take the view that air fares may need to be coordinated between tourism and airline authorities when defining strategies. For example, an airline should operate its services with basic standards, if the accommodation sector is offering large quantities of budgetpriced accommodation. Conversely, expensive accommodation indicates high standards (and prices) from the airline. Although prices are a difficult question, a clear criterion for policy can be set down. We argue that liberalization should be supported if it enhances the probability of services being provided by efficient airlines. Services by inefficient airlines will require additional resources to be devoted to the airline sector; as most tourism destinations will encounter resource shortages (particularly of capital), inefficient airlines are an unjustifiable luxury.
Implications of liberalization for tourism Debates about air transport regulation have a long history, and are continuing today? In evaluating the arguments, we are now in the fortunate position of having several markets where greater economic freedom has arrived, and where several years have elapsed to allow the new regime to settle down. Equally, there are markets where liberality has been resisted (eg in Africa, the Middle East, South America and, for European scheduled services). Therefore, to evaluate how far liberalization is favouring tourism, we must take the criteria given above, and examine the extent to which they are being met by liberalized markets. The conclusions we reach will be reinforced if we can show that trends in regulated markets have been different. Financial performance
At first sight, the prospects for being able to conclude that liberalization is working in the interests of tourism are remote. The period from 4. For asummaryofthese arguments, 1978 until 1981 has been notable for the biggest ever financial turnsee Civil Aviation Authority, around in the aviation industry. 1978 was one of the few years to Domestic Air Services -- A Review show reasonable profits. Since then, many carriers have been making of Regulatory Polic). CAP 420 (London, 1978), pages 6-I 1. serious losses (see Table 1 ). Furthermore, those airlines which have
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Airline deregulation and the tourist industry Table 1.
Operating and net r e s u l t s -
scheduled airlines of ICAO Contracting States, 1 9 7 5 - 1 9 8 0 . a Operating result
Year
Operating revenues US$ (millions)
Operating expenses US$ (millions)
1975 1976 1977 1978 1979 1980
38 43 50 58 70 87
37 41 47 55 70 88
309 400 344 769 755 500
579 244 715 669 019 000
Amount US$ (millions) 730 2 156 2 628 3 100 736 --500
% of operating revenues 1.9 5.0 5.2 5.3 1.0 --0.6
Net result
Amount US$ (millions) --67 825 1 656 2 412 588
% of operating revenues
Direct subsidies US$ (millions)
Income taxes US$ (millions)
--0.2 1.9 3.3 4.1 0.8
167 132 127 116 69
--50 --610 --631 --540 --145
aEstimates for 1980 are preliminary; USSR domestic operations not included.
Source: ICAO Annual Report 1980.
been operating in liberalized markets have fared badly; total losses sustained by airlines in the US domestic market and on the North Atlantic have been large. Those in the tourism industry might think that poor financial performance should merely be the concern of airlines and their managements. Unfortunately, this is not so. In the liberalized markets, instability of service is becoming significant, with route withdrawals a common feature, especially in the US domestic industry. Also, the spectre of airline bankruptcies.is beginning to emerge. For private enterprise airlines, profit-making is the cornerstone of continued existence. However, already one US airline (Braniff) is in serious financial difficulties. Indeed, liberalization is raising the possibility of f'mancial instability affecting the development of the private enterprise sector in the same way as happened in the highly liberalized European air charter market during the 1960s and early 1970s. For publicly owned airlines, the threat of lossmaking leading to a cessation of services is presumably less severe; they will usually be bolstered by their governments. However, sustaining loss-making airlines should be of even greater concern to tourism; such carriers are in direct competition for scarce resources. Even where loss-making is not so severe as to bring withdrawal of services or a need for subsidy, poor financial performance should still concern the tourism industry, because such airlines are surviving only by drawing on depreciation reserves, or by failing to make adequate provision for depreciation out of current income. Such actions stave offshort-term problems, but at a penalty of threatening the airline's ability to replace and expand capacity with new aircraft. Thus financial problems today may affect tourism in the future by causing an under-supply of service. If we can then proceed to a further conclusion, that the twin developments of regulatory liberality and worsening financial performance have a causal connection, then the tourism industry should lobby government to end liberal policies. This article argues that this would be an untenable conclusion. Instead, we must look in more detail at the present situation, to isolate the broader effects of regulatory liberalization. We then see that its effects have been mixed, and that some have been highly beneficial for tourism.
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It is clear there is no simple causal relationship between regulatory liberalization and worsening financial performance. Instead, during the past two years, aviation (and its profits) have been influenced by three developments - - of which liberalization is one. Cost escalations. The first factor has been cost escalations (see Table 2). 5 The period from early 1979 until mid-1981 has seen the price of aviation fuel rise by 250%. Fuel now accounts for 30% or more of operating costs; such increases have had a major impact on airline unit costs. Airport landing fees and charges for air traffic control and air navigation services have also risen steeply. Payments in travel agent's commissions have been increasing quickly, too. A typical scheduled airline is now paying 7-8% of its costs in commissions. Commission payments are of course, an example of a 'controllable' cost, potentially within the control of airline management, in contrast to fuel and landing charges which are 'uncontrollable', in that airlines have no choice but to pay the prices demanded by outside suppliers. This is an important destinction, to which we return later. Given that aviation has traditionally had falling costs (in real terms), it is not unreasonable to suggest that cost escalation will have had a significant impact on financial performance.
5. These cost escalations are discussed in detail in Shaw, reference 1, pages 44-56.
Economic recession. The second factor influencing financial performance has been recession in the world economy affecting aviation especially severely. The amount of business travel has been reduced, while a slowing of real income growth has affected the leisure travel market. Table 3 shows the extent of the stagnation in the markets available to airlines. For the aviation industry, the seriousness of traffic stagnation cannot be overemphasized. Airlines normally make fleet planning decisions several years before capacity comes into their fleets, when they have no real idea what economic conditions will be. Also there is a tendency to take a hopeful view of the future, partly out of optimism, but also because of the promise of lower seat-mile costs which large aircraft bring. Traffic stagnation or decline therefore almost always finds airlines with excess capacity, together with a range of costs which cannot easily be avoided. There is no possibility of storing output until market conditions improve, and so traffic decline is usually accompanied by a deterioration in financial performance, often hastened by discount pricing to sell surplus seats. Although such practices may have short-term cash flow advantages, in the long-term they will worsen financial results further, because of their effect on revenue yields. Table 2.
Source: International Civil Aviation Organization, Annual Reports.
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Airline unit costs, 1 9 7 6 - 1 9 8 0
Year
Average unit cost, scheduled airlines reporting tolCAO(UScentsperavailable tonneokilometre)
% change on previous year
1976 1977 1978 1979 1980
25.2 27.5 30.3 35.1 41.0
+ 1.2 + 9.1 -t-10.2 +15.8 -Jr16.8
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Airline deregulation and the tourist industD' Table 3. World aviation industry: growth in passengers carried, and growth in passenger-kilometres, 1 9 7 5 - 8 0 (scheduled services, including USSR).
Source: I C A O Annual Reports.
Year
Billion pass-km performed
Growth rate (%)
Passengers carried (millions)
Growth rate (%)
1975 1976 1977 1978 1979 1980
691 000 765000 813000 934 000 1 057000 1 071 000
+10.7% +10.6% +14.9% +13.1% + 1.3%
536 578 607 685 747 734
+ 7.8% + 5.0% +12.8% + 9.1% -- 1.8%
Annual average growth rate
+10.1%
+ 6.6%
Those who link financial performance with regulatory liberalization are presumably aware of the relationships between cost escalation, recession, and declining profitability. Thus proponents of this strong linkage6 must feel that reducing regulation has had sufficient impact to outweigh the other factors. What evidence can be found to support them?
Financial impacts of liberalization
6. For example Adam Thomson, Chairman of British Caledonian Airways, as reported in Aviation Week and Space Technology, 27 April 1981, page 42. 7. For an extreme illustration of this trend see "The US trancon r o u t e deregulation's battered child", Air Transport World, December 1980.
There are two areas where reducing regulation may be affecting airline finances adversely. In the markets where liberalization has proceeded furthest (principally, the US domestic market and on the North Atlantic), considerable freedom in market entry is possible. The effect has been that incumbent airlines have faced greater competition than before. When competition is not accompanied by traffic growth, the effect on an incumbent carrier is exactly like that of recession: traffic will not come forward in the forecast amounts, and airlines are left with excess capacity. The second impact of liberalization has been more widely based. It has been present on the North Atlantic and in the US domestic market, where greater freedom of entry has arrived. However, it has also been important in a number of markets where a tight control of entry has been retained by govemments, but where airlines have exercised greater flexibility over pricing. Before the mid-1970s, pricing in aviation was a simple affair. Regulation prevented almost all price competition; airlines and governments set the fares to be charged. Inevitably, fare levels tended to gravitate to the cost levels of higher-cost airlines, given a natural reluctance on the part of high-cost operators to agree to fares based on the costs of low-cost competitors. Liberalization has changed this. Almost always, new carriers have arrived on 'free entry' routes with innovative low fares, which have been matched by incumbent airlines. Where there has not been new entry, but incumbent airlines have begun to engage in price competition, the same process of fares moving downwards to the price level of the cheapest airlines has been clearly visible. 7 These tendencies have serious implications for airline finances. Airlines with high costs are placed in a difficult position, as low-cost airlines can price competitively against them and remain profitable. Serious though this might be for the management of such an airline, it is a less than vital problem. However, price competition does raise
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issues which are important to all airlines which are operating in markets where general price levels of discount fares are being set by one, or a few, low pricing carriers. The managements of all privately owned carriers are concerned that this situation may be brought about by state-owned national flag-carrying airlines. Accusations have been made that such airlines may cut prices, not because they have low costs, but because they are required to meet non-profit objectives by their governments. Should a low fare policy aimed at these objectives lead to losses, the airline will be s u b s i d i z e d - an option not available to private enterprise airlines with which the carrier is competing. Even more worrying for private airlines is the view that a state-owned carrier can always engage in high-risk solutions to its problems, of which discount pricing is a common example. A state-owned carrier is believed to know that, if such a risk pays off, all will be well - - but, if it does not, the airline will not be allowed to collapse. Conversations with executives from private enterprise carriers show how widespread is the view that they must pursue conservative, low-risk solutions, whereas the security enjoyed by their state-owned rivals often allows them to be more flexible or innovative. The final aspect of price competition relates to the reasons why airlines operate in a market, and the levels of cost which they apportion to it. Some airlines will regard a given market as one of the core routes in their network. To ensure their overall profitability, they will require the route to cover not only its direct operating costs, but also to make a substantial contribution to overhead expenses. However, other airlines may see it differently; viewed in isolation, it may be a small part of their total operations. However, it may bring other benefits which are not easily quantified (eg feeding traffic into the main network). For such airlines, costing for the route will be different, with a continuing presence justified providing only the marginal costs of operating are covered. An airline may also be on a route for reasons which transcend the concerns of profit or loss - - eg an airline which felt that a route brought gains in prestige and corporate identity, which were essential for success in the rest of its network. The North Atlantic illustrates this well. Several carriers operate the route largely for prestige reasons, while different views are to be expected between a carrier to whom North Atlantic operations are a large part of the total network and, say, a US trunkline carrier which is offering only a small proportion of its total output in this market. Given competitive pricing and the tendency for prices to gravitate to the lowest pricing airline, these different reasons for being in markets take on great importance. Liberalization poses the risk that profit-based airlines will find the profitability of their core routes disappearing, as route after route sees yields fall as airlines which perceive the route differently introduce lower fares. As this happens, there is a risk that sectors of the industry made up by relatively small airlines will tend towards inherent unprofitability for reasons which have little to do with differences in operating costs or efficiency. There is no doubting the difficult financial position of the world's airlines at the moment. Although cost escalations and recession are major reasons for this, it seems that reducing regulation has exacerbated the situation. Given the links between aviation and
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tourism, and the importance of a financially sound airline industry for the future of tourism, is it thus sensible for the tourism industry to oppose regulatory liberalization? In short, the answer is no. Regulatory liberalization also brings important opportunities and other benefits.
Gains of reducing regulation Reducing regulation has not only been accompanied by a decline in the overall profitability of the airline industry, but has also brought a divergence between the financial performance of carriers. Many have made serious losses in 1980 and the first half of 1981. Yet to take the example of the now almost totally deregulated US domestic market, not all airlines have shared in this loss-making, the traditionally profitable Delta has kept on being profitable. Financial performance of regional carriers has been much better than that of trunklines, with US Air and Piedmont outstanding (see Table 4). Of course, these airlines may have been fortunate; they may not have faced the same problems as the airlines which have suffered the most (eg Braniff and Pan American). Yet, given the importance of recession and fuel price increases to all airlines, it is difficult to argue this case. Evidence from the US domestic industry does not support the view that profits have been impossible, even for efficient, well managed airlines. Increased f r e e d o m a n d opportunities
The point about some carriers having remained profitable leads us to the appreciation by carriers of the opportunities for profitable operations, brought about by reduced regulation. For example, airlines operating under regulated conditions have complained that regulated prices have handicapped them, by imposing delays on the rate at which fares can be increased to match cost escalations. Increases in costs, such as those for fuel or airport landing fees, have to be paid immediately. However, under regulation airlines have had to seek government approval before raising fares, which has commonly taken several months, with serious financial implications. With freedom to adjust fares in deregulated markets, carders have been able to respond to cost changes much more quickly. Reducing regulation has also provided airline managements with freedom to change the scope and scale of their operations. Under regulated conditions, airlines have always faced problems in making these adjustments. Government control of entry and exit meant that Table 4.
Financial performance 1 9 7 8 - 8 0 , Delta Airlines, US Air, Piedmont (SUS millions) Delta
US Air
Piedmont
Year
Operating revenues
Net profits
Operating revenues
Net profits
Operating revenues
1978
2241 479
137
563 319
34
205 597
6
1979
2 672 068
104
728 710 -
33
296 800
11
1980
3 301 918
130
971 825
60
408 040
16
Net profits
Source." Airline Executive and Air Transport Worm Statistics.
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Airline deregulation and the tourist industry airlines have tended to remain with a fixed route network over long periods, even though markets show varying growth rates (some increasing in relative importance, others decreasing). Under regulation, airline managements are forced to continue with declining routes they might wish to abandon, while being denied access to growing markets. With reducing regulation, the question of the route network becomes a crucial decision area, as it allows opportunities for skilled and innovative management to plan the network free from government interference. Indeed, in the US domestic industry, it has been interesting to watch the response of airlines to this freedom; United Airlines has abandoned some of its short haul network, feeling that its large fleet of wide-bodied aircraft are best suited to trunkline service between major centres, while American Airlines is taking the opposite view, of building up both short haul and trunkline service out of a relatively small number of airports, to produce 'hubs' which it can defend against competition, s Points about freedom to adjust faces and networks allow us to reach a conclusion about the impact of deregulation. If it is in the long-term interests of tourism that the airline industry should show satisfactory levels of profitability, then it is possible to make out a case which says that, in some respects, reducing regulation has adversely affected profits. However, in other ways, it may help airlines towards profitability, especially those which are well managed. There is clear evidence that these advantages are becoming more and more important, as the managements of the most innovative airlines adjust to a situation where positive action is possible, unlike in regulated days where delay and compromise were inescapable.
8. See for example "American adds new service points", Aviation Week and Space Technology, 2 March 1981, page 31; "American Airlines intends to be one of the survivors", Air Transport World, July 1981, pages 22-29. 9. See Shaw, reference I, chapter 8 for a description of this controversy, and further references to it.
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Pressures on m a n a g e m e n t s Overall, therefore, reducing regulation is giving opportunities for the managements of the best airlines. However, equally important for the future of tourism, liberalization is putting tough pressures on the managements of all airlines in deregulated markets. Scheduled airlines have often been criticized as inefficient - - overstaffed, with excessive costs, and failing to innovate sufficiently quickly with new services or lower fares? The airlines have disputed these accusations, ascribing cost variations to unavoidable operating differences, and any lack of innovation to government resistance. Until now, this argument has been hard to resolve, because there has been no way of proving which side was correct. Reducing regulation provides answers from the market. Under reduced regulation, it will be a diagnostic feature of efficiency of an existing airline that it can identify, seize, and exploit successfully the opportunities presented to it. If an inefficient airline cannot change its ways, deregulation offers a certainty that, if it is private, it will disappear (either by bankruptcy, or merger with an existing efficient airline). For a state-owned carrier, bankruptcy or merger may not be realistic, but deregulation is showing that some inefficient state-owned airlines are not secure: their market share will decline drastically during the next _decade. Increasing innovation Now we reach the crucial area as far as defining a policy for the tourism industry on deregulation is concerned. An important feature Tourism Management March 1982
Airline deregulation and the tourist industr3'
of the present-day air transport industry is the pace of airline innovation, a pace which is faster than at any other recent time. Innovation is now perceptibly quicker in those markets where reduced regulation has come. Also, the changes in both the structure and operations of the aviation industry resulting from these innovations are almost entirely to the benefit of tourism. To describe these innovations, it is best to distinguish between the products offered by airlines, and innovations in airline management. Product innovations. It is a feature of the airline industry that most product innovations which have resulted in gains to tourism have come in markets where gaps have appeared in the regulatory framework. In the immediate postwar years, almost all airline service was based on the scheduled principle. Airlines offered high flight frequencies, a ready availability of capacity relative to demand, and extravagant standards of in-flight service. This was of little relevance to mass tourism; its high production costs meant that fares had to be high, and it entailed paying for features which the tourist did not need (or would forgo for lower fares). For example, with the holidaymaker's normal ability to book well ahead, he did not need to be able to book and alter reservations near to flight departure time. Also, although the traveller may have enjoyed high quality in-flight service, the scheduled product did not offer him the option to sacrifice this to gain cheaper fares. Since the days of the domination of the scheduled service principle, the link between the introduction of a variety of services to meet the spectrum of needs of the tourist industry, and regulatory liberalization, has been remarkable. First came the idea of charter service, where airlines base their operations on intensive use of capacity, and low seat-mile costs. The scheduled airlines responded with lower-cost concepts of their own. In 1977, the Laker Skytrain began on the North Atlantic, and was accompanied by much low fare innovation by other airlines. Finally, and crucially, the scheduled carriers have come to compete not only with the charter airlines for low fare traffic, but between themselves for the whole market. Again, one is struck by the acceleration in the pace of innovation, with airlines moving over to a three-class concept of cabin service on longhaul routes, and also making many innovations in short-haul markets. ~° It is certain that the successful airlines of the coming decade will be those adopting an innovative, market-orientated philosophy. There are no arguments to suggest that forcing airlines to be innovative is anything but in the long-term interests of the tourism industry.
10. See Shaw, reference 1, pages 128-136.
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Innovations in management. Important though arguments about airline innovation are in themselves, they become even more so when considering airline management; deregulation is focusing attention on the ability of airline managements to control costs. We have noted that the past two years have seen airlines facing a major cost inflation, much of it coming in areas which are outside airlines' direct control (particularly in fuel, landing fees, and navigation charges). While there is scope for airlines to act efficiently on fuel costs, by using fuel carefully, they are largely at the mercy of markets over which they have no control. However, this provides an incentive to act efficiently when costs can be controlled,
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Airline deregulation and the tourist industry
11. For descriptions of the operations of some of these airlines, see for example: "New York Air studying expansion for Newark", Aviation Week and Space Technolog3, 1 June 1981; "'People
Express slashes its way into market with cheaper than driving fares", Air Transport World, June 1981; "Air Florida is on the prowl, and no market is safe from its competition", Air Transport World, May 1981. 12. See for example, "Eastern battles for the productivity gap", Airline Executive, May 1981.
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the most notable instances being travel agents' commissions ( 7 - 8 % of typical scheduled airline costs), and labour ( 3 0 - 3 5 % of costs). Airline managements would argue that it has always been necessary to keep a close watch on such costs - - but deregulation is giving a new urgency to what has always been a vital management task (perhaps the single most important feature of deregulation). All airlines face increases in uncontrollable costs. Equally, competing carriers are often flying identical aircraft, so few opportunities for lower costs arise in flight equipment. Overwhelmingly, such opportunities will come for airlines which can make efficient use of labour. Such efficiency will depend on the unit price paid for labour, and on labour productivity. Traditionally, the airline industry has had high labour costs. They have paid skilled labour - - particularly pilots - - a great deal, while generally paying well above going rates for unskilled labour. There have been criticisms of the poor productivity of airline labour, particularly within Europe, but to a lesser extent in North America as well. If airlines were using labour efficiently under regulated conditions, we would expect them to be continuing with the same practices under deregulation. Deregulation does not show the old patterns of labour usage. There are now several new airlines in the US domestic industry (eg New York Air, People Express and Muse Air) as well as rapidly expanding older airlines (eg Air Florida, now with a wide domestic and international network compared with its former role as a purely intrastate carrier); their use of labour as a resource is totally different from that of traditional airlines. T h e y are non-unionized, place emphasis on job flexibility and staff productivity, pay wage rates which are believed to be much nearer standard industry wages, and contract out many labour-intensive activities (thus making them a variable cost), on a 'quantity used' basis, tt W e are also beginning to see real change in incumbent airlines. Some have been making attempts to solve their labour problems for a number of years, but deregulation has made a more efficient use of labour into a necessity. A good example is Eastern Airlines: it has traditionally been one of the weaker of the large US trunklines. However, recent accounts t-" suggest that major changes in staff productivity are an attempt to match the carrier's newer and more flexible rivals, and form the cornerstone of the airline's plans for the future. In Europe, British Airways has had an overmanning problem since its creation, but now, unless BA achieves its planned reduction down to 43 000 stafffrom its m a x i m u m 58 000, its future in marketshare terms is bleak.
Conclusions When one is dealing with a complex area such as airline deregulation. even a long discussion can only skim the surface of the various arguments. However, what conclusions can we reach which are of relevance to those involved with the development of tourism? Here, the following five conclusions are important. First, the reduced role of government regulation is the most fundamental trend now influencing the aviation industry. Few markets are unaffected by it; some have seen a direct move towards greater
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Airline deregulation and the tourist industry
economic freedom, and many others have been affected by 'parallel routes' having been freed from controls, with a consequent effect on the distribution of traffic. Second, given the importance of the trend and the links between aviation and tourism, all tourism-receiving locations must formulate a policy regarding the economic liberalization of air transport. With the significance of the issues involved, the policy should be a selfish one, based on the extent to which economic freedom will lead to the kinds of air transport services which will meet the needs of tourism. For instance, it is unlikely that there would be a commonality of interest between the tourism industry and an inefficient airline which knew that, if liberalization were to come, substantial changes in its method of operation would be necessary. Next, we have seen that reduced airline regulation does pose dangers for the tourism industry. It has added to the difficulties facing airlines in securing profitable operations during a time of recession and rising operating costs. This in turn poses a threat to tourism, because of a short-term risk of instability of service, and a longerterm risk of difficulties of attracting investment capital. However, it is reasonable to expect that the worst of these effects will be alleviated by a period of stability in the world economy, and a resumption of airline traffic growth. We now have sufficient evidence to suggest a further conclusion: that reduced regulation also brings important opportunities to airlines. It can help profitability by allowing faster fare adjustments and the development of networks. It is allowing airlines who wish to be -- and forcing those who do not - - to be innovative in product terms. Airlines in liberalized markets are now better at meeting the spectrum of consumer needs, something which must be to the advantage of the tourism industry. Deregulation is showing evidence of airlines affected by it becoming more efficient in their use of resources, particularly labour. Thus, as an overall policy for tourism, we can preach a doctrine of realism. In a few tourism locations, protection should be retained for an infant, developing airline. From the tourism industry's point of view, the justification for such a policy would be that it was an investment in the certainty of service which a national airline ought to be able to provide. Eleswhere, the tourism industry must now think carefully before opposing a move towards economic freedom. Aviation is not the only industry which is becoming more competitive. Tourism is as well and, given the gains in efficiency which reducing regulation can bring, it will be a crucial advantage to be served by airlines which have gained the discipline of operations in the new tougher, leaner world of deregulation. Spain, Israel, and the U S A are merely three examples of many countries where a liberal attitude to aviation regulation has been accompanied by more service at lower fares from efficient airlines. In each case, the cause of tourism has been furthered. Cyprus is perhaps an example of a country pursuing the opposite policy, of rigid regulation (particularly regarding charter services). Such a policy may be an attractive one in terms of airline protection, but it can only work against the long-term interests of tourism development.
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51
Commercial air transport has always been notable for the system of government regulation which has been imposed on it. Governments have regulated market entry and exit policies of airlines. They have dictated the kinds of service which carriers might offer. Also in many cases they have decided the amounts of capacity which might be provided. Finally, they have commonly regulated prices with the effect of eliminating almost all public price competition. It is not the aim of this article to consider why regulation should have come to be imposed on the industry,' but to concentrate on the changes to the regulatory framework which have occurred recently, and to deal with the implications of these changes for tourism.
Keywords: civil aviation;transport
Changing regulatory policies
economics;deregulation
Stephen Shawis directorof Aviation ContinuingEducationServices,Cityof LondonPolytechnic,Schoolof Business Studies,84 Moorgate,LondonEC2M8SQ, UK.
1. See S. Shaw,Air Transport -- A Marketing Perspective (Pitmans,
London, 1981) pages 90-113. 2. See R. Doganis, "Air transport-a case study in international regulation", Journal of Transport Economics and Policy, 1973, 7, pages 109-33. Also R.M. Smithies, "The changingdemand for air transport -- the North Atlantic case", Journal of Transport Economics and Policy, 1978, 7, pages 231-249.
40
Moves towards less regulation have a long history in some aviation markets. For example, the growth in charter services which took place in Europe and on the North Atlantic during the 1960s and early 1970s was a first development of less regulated services outside the highly controlled scheduled service environment. 2 However, since the mid-1970s, the pace of development has accelerated, and one can list the following examples of aviation markets which are now significantly less controlled: • The US domestic market has been freed from a large amount of economic regulation under the Airline De-regulation Act of 197 8. • In some other countries, although developments have stopped short of those in the USA, there has been a progressive liberalization of domestic air services. Canada and the UK provide illustrations. • In international service, the North Atlantic has seen a relaxation of controls, with more direct routes, more airlines allowed entry, and greater freedom on pricing. • Also in international service, a number of other routes to and from the U S A have been liberalized as the USA has negotiated bilateral agreements allowing for freer entry and flexible pricing. In particular, the agreements negotiated by the Carter administration between 1976 and 1980 (eg with Israel and Singapore) have left a strong mark on the industry. • There has been a change in the rate-making role of the International Air Transport Association (IATA). During the postwar period, I A T A has provided a forum within which airlines meet and attempt to agree fares and rates, subject to the approval of governments. Following criticisms of both the ineffectiveness and the anticonsumer connotations of IATA, the Association has been reformed so that member airlines can innovate with low
0261-5"177/82/010040-12503.00 © 1982 Butterworth & Co (Publishers) Ltd
Airline deregulation and the tourist industry
fares outside the confines of traffic conference agreements. Such flexibility in publicly available fares is being strengthened by the willingness of airlines to engage in price competition even where agreed fares exist, by the offer of cheap fares through discount travel agencies. • Within Europe, a move towards liberalization of scheduled services has been restricted by a number of intransigent governments. However, the development of basically unregulated charter services has continued. • Finally, on routes to the Far East, the U K government has initiated an experiment by its liberalization of services on the L o n d o n - H o n g Kong route. Three airlines are now operating this route, in contrast to one previously, with intense competition in price and service. This development has been important for consumers in the L o n d o n - H o n g Kong market; it has also had "parallel route" implications, of sucking in demand from routes between Europe and South-east Asia, where a freer economic regime has not yet come. This is forcing innovation on governments and airlines which may be opposed to greater freedom, but which cannot ignore the effect of a less regulated route on their traffic. This phenomenon is observable in other similar situations, eg intense price competition in the London-Miami market has affected the Caribbean and Central and South American routes. More examples could be cited, 3 but they all indicate that regulatory conditions are now easier than they were a few years ago. Although in most markets this easing has stopped short of'deregulation', there has been a pronounced softening of the hand of government.
N e e d for a tourism policy towards aviation liberalization
3. These developments are covered in detail in Shaw, reference 1, pages 102-112.
Moves towards economic liberality have shown that the old regime was a distorting factor on the operations of the airline industry, with the need to overcome these distortions the most important challenge facing airline managers today. Before pursuing this theme, it is worth examining the broader question of policies for the tourism industry towards aviation liberalization. First, it is essential for the tourism industry to have such a policy. Aviation operations in less regulated markets will be different from those in regulated ones, in ways which cannot fail to have important implications for tourism. Also, the economic importance of tourism means that, in many countries, the tourist industry has an effective lobbying power, which must be exercised in the correct direction. The need for a policy then begs two questions. First, what are the features of aviation services which will meet the needs of the tourist industry? Second, will a less regulated environment help in securing the provision of services which show these features? Regarding the needs of tourism, it is wrong to expect that all sections of the tourism industry will have identical requirements. Needs will vary and will, to some extent, be conflicting. Even if it is possible to define a set of all-embracing needs, there may be conflicts within the needs themselves, where one feature (say, expensive service provision) excludes another (eg low prices). Therefore, even if we can set down the features which a tourism-orientated aviation
Tourism Management March 1982
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Airline deregulation and the tourist indust~
service should show, it will still be necessary to strike a difficult balance between many features. Having said this, it is possible to argue that the tourism industry of a country will be supported by aviation services which show as many as possible of the following characteristics: • safety of service - - a basic requirement; • broad route networks, allowing tourism to draw its clientele from as wide an area as possible; • consistency of service, allowing the tourism industry to plan with confidence the provision of infrastructure; • adequate capacity - - especially important to a tourist destination facing peaking in demand; • provision of service by efficient airlines - - prices of air service to tourism destinations have always been a difficult issue. Some destinations (perhaps Kenya is an example) have seemed to be seeking high air fares, to remain a location patronized only by wealthy visitors. Other destinations (eg Spain) have gone for low air fares, often founded on a liberal attitude to charter services. We take the view that air fares may need to be coordinated between tourism and airline authorities when defining strategies. For example, an airline should operate its services with basic standards, if the accommodation sector is offering large quantities of budgetpriced accommodation. Conversely, expensive accommodation indicates high standards (and prices) from the airline. Although prices are a difficult question, a clear criterion for policy can be set down. We argue that liberalization should be supported if it enhances the probability of services being provided by efficient airlines. Services by inefficient airlines will require additional resources to be devoted to the airline sector; as most tourism destinations will encounter resource shortages (particularly of capital), inefficient airlines are an unjustifiable luxury.
Implications of liberalization for tourism Debates about air transport regulation have a long history, and are continuing today? In evaluating the arguments, we are now in the fortunate position of having several markets where greater economic freedom has arrived, and where several years have elapsed to allow the new regime to settle down. Equally, there are markets where liberality has been resisted (eg in Africa, the Middle East, South America and, for European scheduled services). Therefore, to evaluate how far liberalization is favouring tourism, we must take the criteria given above, and examine the extent to which they are being met by liberalized markets. The conclusions we reach will be reinforced if we can show that trends in regulated markets have been different. Financial performance
At first sight, the prospects for being able to conclude that liberalization is working in the interests of tourism are remote. The period from 4. For asummaryofthese arguments, 1978 until 1981 has been notable for the biggest ever financial turnsee Civil Aviation Authority, around in the aviation industry. 1978 was one of the few years to Domestic Air Services -- A Review show reasonable profits. Since then, many carriers have been making of Regulatory Polic). CAP 420 (London, 1978), pages 6-I 1. serious losses (see Table 1 ). Furthermore, those airlines which have
42
Tourism Management March 1982
Airline deregulation and the tourist industry Table 1.
Operating and net r e s u l t s -
scheduled airlines of ICAO Contracting States, 1 9 7 5 - 1 9 8 0 . a Operating result
Year
Operating revenues US$ (millions)
Operating expenses US$ (millions)
1975 1976 1977 1978 1979 1980
38 43 50 58 70 87
37 41 47 55 70 88
309 400 344 769 755 500
579 244 715 669 019 000
Amount US$ (millions) 730 2 156 2 628 3 100 736 --500
% of operating revenues 1.9 5.0 5.2 5.3 1.0 --0.6
Net result
Amount US$ (millions) --67 825 1 656 2 412 588
% of operating revenues
Direct subsidies US$ (millions)
Income taxes US$ (millions)
--0.2 1.9 3.3 4.1 0.8
167 132 127 116 69
--50 --610 --631 --540 --145
aEstimates for 1980 are preliminary; USSR domestic operations not included.
Source: ICAO Annual Report 1980.
been operating in liberalized markets have fared badly; total losses sustained by airlines in the US domestic market and on the North Atlantic have been large. Those in the tourism industry might think that poor financial performance should merely be the concern of airlines and their managements. Unfortunately, this is not so. In the liberalized markets, instability of service is becoming significant, with route withdrawals a common feature, especially in the US domestic industry. Also, the spectre of airline bankruptcies.is beginning to emerge. For private enterprise airlines, profit-making is the cornerstone of continued existence. However, already one US airline (Braniff) is in serious financial difficulties. Indeed, liberalization is raising the possibility of f'mancial instability affecting the development of the private enterprise sector in the same way as happened in the highly liberalized European air charter market during the 1960s and early 1970s. For publicly owned airlines, the threat of lossmaking leading to a cessation of services is presumably less severe; they will usually be bolstered by their governments. However, sustaining loss-making airlines should be of even greater concern to tourism; such carriers are in direct competition for scarce resources. Even where loss-making is not so severe as to bring withdrawal of services or a need for subsidy, poor financial performance should still concern the tourism industry, because such airlines are surviving only by drawing on depreciation reserves, or by failing to make adequate provision for depreciation out of current income. Such actions stave offshort-term problems, but at a penalty of threatening the airline's ability to replace and expand capacity with new aircraft. Thus financial problems today may affect tourism in the future by causing an under-supply of service. If we can then proceed to a further conclusion, that the twin developments of regulatory liberality and worsening financial performance have a causal connection, then the tourism industry should lobby government to end liberal policies. This article argues that this would be an untenable conclusion. Instead, we must look in more detail at the present situation, to isolate the broader effects of regulatory liberalization. We then see that its effects have been mixed, and that some have been highly beneficial for tourism.
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Airline deregulation and the tourist indust~
It is clear there is no simple causal relationship between regulatory liberalization and worsening financial performance. Instead, during the past two years, aviation (and its profits) have been influenced by three developments - - of which liberalization is one. Cost escalations. The first factor has been cost escalations (see Table 2). 5 The period from early 1979 until mid-1981 has seen the price of aviation fuel rise by 250%. Fuel now accounts for 30% or more of operating costs; such increases have had a major impact on airline unit costs. Airport landing fees and charges for air traffic control and air navigation services have also risen steeply. Payments in travel agent's commissions have been increasing quickly, too. A typical scheduled airline is now paying 7-8% of its costs in commissions. Commission payments are of course, an example of a 'controllable' cost, potentially within the control of airline management, in contrast to fuel and landing charges which are 'uncontrollable', in that airlines have no choice but to pay the prices demanded by outside suppliers. This is an important destinction, to which we return later. Given that aviation has traditionally had falling costs (in real terms), it is not unreasonable to suggest that cost escalation will have had a significant impact on financial performance.
5. These cost escalations are discussed in detail in Shaw, reference 1, pages 44-56.
Economic recession. The second factor influencing financial performance has been recession in the world economy affecting aviation especially severely. The amount of business travel has been reduced, while a slowing of real income growth has affected the leisure travel market. Table 3 shows the extent of the stagnation in the markets available to airlines. For the aviation industry, the seriousness of traffic stagnation cannot be overemphasized. Airlines normally make fleet planning decisions several years before capacity comes into their fleets, when they have no real idea what economic conditions will be. Also there is a tendency to take a hopeful view of the future, partly out of optimism, but also because of the promise of lower seat-mile costs which large aircraft bring. Traffic stagnation or decline therefore almost always finds airlines with excess capacity, together with a range of costs which cannot easily be avoided. There is no possibility of storing output until market conditions improve, and so traffic decline is usually accompanied by a deterioration in financial performance, often hastened by discount pricing to sell surplus seats. Although such practices may have short-term cash flow advantages, in the long-term they will worsen financial results further, because of their effect on revenue yields. Table 2.
Source: International Civil Aviation Organization, Annual Reports.
44
Airline unit costs, 1 9 7 6 - 1 9 8 0
Year
Average unit cost, scheduled airlines reporting tolCAO(UScentsperavailable tonneokilometre)
% change on previous year
1976 1977 1978 1979 1980
25.2 27.5 30.3 35.1 41.0
+ 1.2 + 9.1 -t-10.2 +15.8 -Jr16.8
Tourism Management March 1982
Airline deregulation and the tourist industD' Table 3. World aviation industry: growth in passengers carried, and growth in passenger-kilometres, 1 9 7 5 - 8 0 (scheduled services, including USSR).
Source: I C A O Annual Reports.
Year
Billion pass-km performed
Growth rate (%)
Passengers carried (millions)
Growth rate (%)
1975 1976 1977 1978 1979 1980
691 000 765000 813000 934 000 1 057000 1 071 000
+10.7% +10.6% +14.9% +13.1% + 1.3%
536 578 607 685 747 734
+ 7.8% + 5.0% +12.8% + 9.1% -- 1.8%
Annual average growth rate
+10.1%
+ 6.6%
Those who link financial performance with regulatory liberalization are presumably aware of the relationships between cost escalation, recession, and declining profitability. Thus proponents of this strong linkage6 must feel that reducing regulation has had sufficient impact to outweigh the other factors. What evidence can be found to support them?
Financial impacts of liberalization
6. For example Adam Thomson, Chairman of British Caledonian Airways, as reported in Aviation Week and Space Technology, 27 April 1981, page 42. 7. For an extreme illustration of this trend see "The US trancon r o u t e deregulation's battered child", Air Transport World, December 1980.
There are two areas where reducing regulation may be affecting airline finances adversely. In the markets where liberalization has proceeded furthest (principally, the US domestic market and on the North Atlantic), considerable freedom in market entry is possible. The effect has been that incumbent airlines have faced greater competition than before. When competition is not accompanied by traffic growth, the effect on an incumbent carrier is exactly like that of recession: traffic will not come forward in the forecast amounts, and airlines are left with excess capacity. The second impact of liberalization has been more widely based. It has been present on the North Atlantic and in the US domestic market, where greater freedom of entry has arrived. However, it has also been important in a number of markets where a tight control of entry has been retained by govemments, but where airlines have exercised greater flexibility over pricing. Before the mid-1970s, pricing in aviation was a simple affair. Regulation prevented almost all price competition; airlines and governments set the fares to be charged. Inevitably, fare levels tended to gravitate to the cost levels of higher-cost airlines, given a natural reluctance on the part of high-cost operators to agree to fares based on the costs of low-cost competitors. Liberalization has changed this. Almost always, new carriers have arrived on 'free entry' routes with innovative low fares, which have been matched by incumbent airlines. Where there has not been new entry, but incumbent airlines have begun to engage in price competition, the same process of fares moving downwards to the price level of the cheapest airlines has been clearly visible. 7 These tendencies have serious implications for airline finances. Airlines with high costs are placed in a difficult position, as low-cost airlines can price competitively against them and remain profitable. Serious though this might be for the management of such an airline, it is a less than vital problem. However, price competition does raise
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Airline deregulation and the tourist indust~
issues which are important to all airlines which are operating in markets where general price levels of discount fares are being set by one, or a few, low pricing carriers. The managements of all privately owned carriers are concerned that this situation may be brought about by state-owned national flag-carrying airlines. Accusations have been made that such airlines may cut prices, not because they have low costs, but because they are required to meet non-profit objectives by their governments. Should a low fare policy aimed at these objectives lead to losses, the airline will be s u b s i d i z e d - an option not available to private enterprise airlines with which the carrier is competing. Even more worrying for private airlines is the view that a state-owned carrier can always engage in high-risk solutions to its problems, of which discount pricing is a common example. A state-owned carrier is believed to know that, if such a risk pays off, all will be well - - but, if it does not, the airline will not be allowed to collapse. Conversations with executives from private enterprise carriers show how widespread is the view that they must pursue conservative, low-risk solutions, whereas the security enjoyed by their state-owned rivals often allows them to be more flexible or innovative. The final aspect of price competition relates to the reasons why airlines operate in a market, and the levels of cost which they apportion to it. Some airlines will regard a given market as one of the core routes in their network. To ensure their overall profitability, they will require the route to cover not only its direct operating costs, but also to make a substantial contribution to overhead expenses. However, other airlines may see it differently; viewed in isolation, it may be a small part of their total operations. However, it may bring other benefits which are not easily quantified (eg feeding traffic into the main network). For such airlines, costing for the route will be different, with a continuing presence justified providing only the marginal costs of operating are covered. An airline may also be on a route for reasons which transcend the concerns of profit or loss - - eg an airline which felt that a route brought gains in prestige and corporate identity, which were essential for success in the rest of its network. The North Atlantic illustrates this well. Several carriers operate the route largely for prestige reasons, while different views are to be expected between a carrier to whom North Atlantic operations are a large part of the total network and, say, a US trunkline carrier which is offering only a small proportion of its total output in this market. Given competitive pricing and the tendency for prices to gravitate to the lowest pricing airline, these different reasons for being in markets take on great importance. Liberalization poses the risk that profit-based airlines will find the profitability of their core routes disappearing, as route after route sees yields fall as airlines which perceive the route differently introduce lower fares. As this happens, there is a risk that sectors of the industry made up by relatively small airlines will tend towards inherent unprofitability for reasons which have little to do with differences in operating costs or efficiency. There is no doubting the difficult financial position of the world's airlines at the moment. Although cost escalations and recession are major reasons for this, it seems that reducing regulation has exacerbated the situation. Given the links between aviation and
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Tourism Management March t982
Airline deregulation and the tourist industry
tourism, and the importance of a financially sound airline industry for the future of tourism, is it thus sensible for the tourism industry to oppose regulatory liberalization? In short, the answer is no. Regulatory liberalization also brings important opportunities and other benefits.
Gains of reducing regulation Reducing regulation has not only been accompanied by a decline in the overall profitability of the airline industry, but has also brought a divergence between the financial performance of carriers. Many have made serious losses in 1980 and the first half of 1981. Yet to take the example of the now almost totally deregulated US domestic market, not all airlines have shared in this loss-making, the traditionally profitable Delta has kept on being profitable. Financial performance of regional carriers has been much better than that of trunklines, with US Air and Piedmont outstanding (see Table 4). Of course, these airlines may have been fortunate; they may not have faced the same problems as the airlines which have suffered the most (eg Braniff and Pan American). Yet, given the importance of recession and fuel price increases to all airlines, it is difficult to argue this case. Evidence from the US domestic industry does not support the view that profits have been impossible, even for efficient, well managed airlines. Increased f r e e d o m a n d opportunities
The point about some carriers having remained profitable leads us to the appreciation by carriers of the opportunities for profitable operations, brought about by reduced regulation. For example, airlines operating under regulated conditions have complained that regulated prices have handicapped them, by imposing delays on the rate at which fares can be increased to match cost escalations. Increases in costs, such as those for fuel or airport landing fees, have to be paid immediately. However, under regulation airlines have had to seek government approval before raising fares, which has commonly taken several months, with serious financial implications. With freedom to adjust fares in deregulated markets, carders have been able to respond to cost changes much more quickly. Reducing regulation has also provided airline managements with freedom to change the scope and scale of their operations. Under regulated conditions, airlines have always faced problems in making these adjustments. Government control of entry and exit meant that Table 4.
Financial performance 1 9 7 8 - 8 0 , Delta Airlines, US Air, Piedmont (SUS millions) Delta
US Air
Piedmont
Year
Operating revenues
Net profits
Operating revenues
Net profits
Operating revenues
1978
2241 479
137
563 319
34
205 597
6
1979
2 672 068
104
728 710 -
33
296 800
11
1980
3 301 918
130
971 825
60
408 040
16
Net profits
Source." Airline Executive and Air Transport Worm Statistics.
Tourism ManagementMarch 1982
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Airline deregulation and the tourist industry airlines have tended to remain with a fixed route network over long periods, even though markets show varying growth rates (some increasing in relative importance, others decreasing). Under regulation, airline managements are forced to continue with declining routes they might wish to abandon, while being denied access to growing markets. With reducing regulation, the question of the route network becomes a crucial decision area, as it allows opportunities for skilled and innovative management to plan the network free from government interference. Indeed, in the US domestic industry, it has been interesting to watch the response of airlines to this freedom; United Airlines has abandoned some of its short haul network, feeling that its large fleet of wide-bodied aircraft are best suited to trunkline service between major centres, while American Airlines is taking the opposite view, of building up both short haul and trunkline service out of a relatively small number of airports, to produce 'hubs' which it can defend against competition, s Points about freedom to adjust faces and networks allow us to reach a conclusion about the impact of deregulation. If it is in the long-term interests of tourism that the airline industry should show satisfactory levels of profitability, then it is possible to make out a case which says that, in some respects, reducing regulation has adversely affected profits. However, in other ways, it may help airlines towards profitability, especially those which are well managed. There is clear evidence that these advantages are becoming more and more important, as the managements of the most innovative airlines adjust to a situation where positive action is possible, unlike in regulated days where delay and compromise were inescapable.
8. See for example "American adds new service points", Aviation Week and Space Technology, 2 March 1981, page 31; "American Airlines intends to be one of the survivors", Air Transport World, July 1981, pages 22-29. 9. See Shaw, reference I, chapter 8 for a description of this controversy, and further references to it.
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Pressures on m a n a g e m e n t s Overall, therefore, reducing regulation is giving opportunities for the managements of the best airlines. However, equally important for the future of tourism, liberalization is putting tough pressures on the managements of all airlines in deregulated markets. Scheduled airlines have often been criticized as inefficient - - overstaffed, with excessive costs, and failing to innovate sufficiently quickly with new services or lower fares? The airlines have disputed these accusations, ascribing cost variations to unavoidable operating differences, and any lack of innovation to government resistance. Until now, this argument has been hard to resolve, because there has been no way of proving which side was correct. Reducing regulation provides answers from the market. Under reduced regulation, it will be a diagnostic feature of efficiency of an existing airline that it can identify, seize, and exploit successfully the opportunities presented to it. If an inefficient airline cannot change its ways, deregulation offers a certainty that, if it is private, it will disappear (either by bankruptcy, or merger with an existing efficient airline). For a state-owned carrier, bankruptcy or merger may not be realistic, but deregulation is showing that some inefficient state-owned airlines are not secure: their market share will decline drastically during the next _decade. Increasing innovation Now we reach the crucial area as far as defining a policy for the tourism industry on deregulation is concerned. An important feature Tourism Management March 1982
Airline deregulation and the tourist industr3'
of the present-day air transport industry is the pace of airline innovation, a pace which is faster than at any other recent time. Innovation is now perceptibly quicker in those markets where reduced regulation has come. Also, the changes in both the structure and operations of the aviation industry resulting from these innovations are almost entirely to the benefit of tourism. To describe these innovations, it is best to distinguish between the products offered by airlines, and innovations in airline management. Product innovations. It is a feature of the airline industry that most product innovations which have resulted in gains to tourism have come in markets where gaps have appeared in the regulatory framework. In the immediate postwar years, almost all airline service was based on the scheduled principle. Airlines offered high flight frequencies, a ready availability of capacity relative to demand, and extravagant standards of in-flight service. This was of little relevance to mass tourism; its high production costs meant that fares had to be high, and it entailed paying for features which the tourist did not need (or would forgo for lower fares). For example, with the holidaymaker's normal ability to book well ahead, he did not need to be able to book and alter reservations near to flight departure time. Also, although the traveller may have enjoyed high quality in-flight service, the scheduled product did not offer him the option to sacrifice this to gain cheaper fares. Since the days of the domination of the scheduled service principle, the link between the introduction of a variety of services to meet the spectrum of needs of the tourist industry, and regulatory liberalization, has been remarkable. First came the idea of charter service, where airlines base their operations on intensive use of capacity, and low seat-mile costs. The scheduled airlines responded with lower-cost concepts of their own. In 1977, the Laker Skytrain began on the North Atlantic, and was accompanied by much low fare innovation by other airlines. Finally, and crucially, the scheduled carriers have come to compete not only with the charter airlines for low fare traffic, but between themselves for the whole market. Again, one is struck by the acceleration in the pace of innovation, with airlines moving over to a three-class concept of cabin service on longhaul routes, and also making many innovations in short-haul markets. ~° It is certain that the successful airlines of the coming decade will be those adopting an innovative, market-orientated philosophy. There are no arguments to suggest that forcing airlines to be innovative is anything but in the long-term interests of the tourism industry.
10. See Shaw, reference 1, pages 128-136.
Tourism Management March 1982
Innovations in management. Important though arguments about airline innovation are in themselves, they become even more so when considering airline management; deregulation is focusing attention on the ability of airline managements to control costs. We have noted that the past two years have seen airlines facing a major cost inflation, much of it coming in areas which are outside airlines' direct control (particularly in fuel, landing fees, and navigation charges). While there is scope for airlines to act efficiently on fuel costs, by using fuel carefully, they are largely at the mercy of markets over which they have no control. However, this provides an incentive to act efficiently when costs can be controlled,
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Airline deregulation and the tourist industry
11. For descriptions of the operations of some of these airlines, see for example: "New York Air studying expansion for Newark", Aviation Week and Space Technolog3, 1 June 1981; "'People
Express slashes its way into market with cheaper than driving fares", Air Transport World, June 1981; "Air Florida is on the prowl, and no market is safe from its competition", Air Transport World, May 1981. 12. See for example, "Eastern battles for the productivity gap", Airline Executive, May 1981.
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the most notable instances being travel agents' commissions ( 7 - 8 % of typical scheduled airline costs), and labour ( 3 0 - 3 5 % of costs). Airline managements would argue that it has always been necessary to keep a close watch on such costs - - but deregulation is giving a new urgency to what has always been a vital management task (perhaps the single most important feature of deregulation). All airlines face increases in uncontrollable costs. Equally, competing carriers are often flying identical aircraft, so few opportunities for lower costs arise in flight equipment. Overwhelmingly, such opportunities will come for airlines which can make efficient use of labour. Such efficiency will depend on the unit price paid for labour, and on labour productivity. Traditionally, the airline industry has had high labour costs. They have paid skilled labour - - particularly pilots - - a great deal, while generally paying well above going rates for unskilled labour. There have been criticisms of the poor productivity of airline labour, particularly within Europe, but to a lesser extent in North America as well. If airlines were using labour efficiently under regulated conditions, we would expect them to be continuing with the same practices under deregulation. Deregulation does not show the old patterns of labour usage. There are now several new airlines in the US domestic industry (eg New York Air, People Express and Muse Air) as well as rapidly expanding older airlines (eg Air Florida, now with a wide domestic and international network compared with its former role as a purely intrastate carrier); their use of labour as a resource is totally different from that of traditional airlines. T h e y are non-unionized, place emphasis on job flexibility and staff productivity, pay wage rates which are believed to be much nearer standard industry wages, and contract out many labour-intensive activities (thus making them a variable cost), on a 'quantity used' basis, tt W e are also beginning to see real change in incumbent airlines. Some have been making attempts to solve their labour problems for a number of years, but deregulation has made a more efficient use of labour into a necessity. A good example is Eastern Airlines: it has traditionally been one of the weaker of the large US trunklines. However, recent accounts t-" suggest that major changes in staff productivity are an attempt to match the carrier's newer and more flexible rivals, and form the cornerstone of the airline's plans for the future. In Europe, British Airways has had an overmanning problem since its creation, but now, unless BA achieves its planned reduction down to 43 000 stafffrom its m a x i m u m 58 000, its future in marketshare terms is bleak.
Conclusions When one is dealing with a complex area such as airline deregulation. even a long discussion can only skim the surface of the various arguments. However, what conclusions can we reach which are of relevance to those involved with the development of tourism? Here, the following five conclusions are important. First, the reduced role of government regulation is the most fundamental trend now influencing the aviation industry. Few markets are unaffected by it; some have seen a direct move towards greater
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economic freedom, and many others have been affected by 'parallel routes' having been freed from controls, with a consequent effect on the distribution of traffic. Second, given the importance of the trend and the links between aviation and tourism, all tourism-receiving locations must formulate a policy regarding the economic liberalization of air transport. With the significance of the issues involved, the policy should be a selfish one, based on the extent to which economic freedom will lead to the kinds of air transport services which will meet the needs of tourism. For instance, it is unlikely that there would be a commonality of interest between the tourism industry and an inefficient airline which knew that, if liberalization were to come, substantial changes in its method of operation would be necessary. Next, we have seen that reduced airline regulation does pose dangers for the tourism industry. It has added to the difficulties facing airlines in securing profitable operations during a time of recession and rising operating costs. This in turn poses a threat to tourism, because of a short-term risk of instability of service, and a longerterm risk of difficulties of attracting investment capital. However, it is reasonable to expect that the worst of these effects will be alleviated by a period of stability in the world economy, and a resumption of airline traffic growth. We now have sufficient evidence to suggest a further conclusion: that reduced regulation also brings important opportunities to airlines. It can help profitability by allowing faster fare adjustments and the development of networks. It is allowing airlines who wish to be -- and forcing those who do not - - to be innovative in product terms. Airlines in liberalized markets are now better at meeting the spectrum of consumer needs, something which must be to the advantage of the tourism industry. Deregulation is showing evidence of airlines affected by it becoming more efficient in their use of resources, particularly labour. Thus, as an overall policy for tourism, we can preach a doctrine of realism. In a few tourism locations, protection should be retained for an infant, developing airline. From the tourism industry's point of view, the justification for such a policy would be that it was an investment in the certainty of service which a national airline ought to be able to provide. Eleswhere, the tourism industry must now think carefully before opposing a move towards economic freedom. Aviation is not the only industry which is becoming more competitive. Tourism is as well and, given the gains in efficiency which reducing regulation can bring, it will be a crucial advantage to be served by airlines which have gained the discipline of operations in the new tougher, leaner world of deregulation. Spain, Israel, and the U S A are merely three examples of many countries where a liberal attitude to aviation regulation has been accompanied by more service at lower fares from efficient airlines. In each case, the cause of tourism has been furthered. Cyprus is perhaps an example of a country pursuing the opposite policy, of rigid regulation (particularly regarding charter services). Such a policy may be an attractive one in terms of airline protection, but it can only work against the long-term interests of tourism development.
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