The regulation of deregulation

The regulation of deregulation A comment on the liberalization scheduled airline industry

of the UK’s

B. J. Graham Department of Environmentul Ireland RT52 ISA The

United

Kingdom

policy of liberalization

Studies,

University

of Ulster at Coleruine,

is the only mcmbcr of the EC to have implcmcntcd within

its domestic and international

scheduled

Colemine.

Northern

a rclativcly

long-term

airline

industry.

In this

discussion, the merits and problems of the policy arc cvaluatcd. primarily through an assessment of UK scheduled domcstic air scrviccs. Particular attention is paid to the constraints imposed on implcmcntation characteristic

Govcrnmcnt’s Keywords:

of the policy of liberalization, of the

Liberalization,

of UK airline

Considered ‘route-by-route, the airline incurably oligopolistic’ (Pryke, 1987, characteristic not necessarily incompatible 096~923/93/020125~)7

within the

UK, airlines

As the European Community (EC) enters an era of air-transport liberalization, leading ultimately to the implementation of full internal flying rights by April 1997, the UK remains the only state within the EC which has applied a sustained policy of liberalization to its scheduled airline industry (Graham, 1992). This can be defined as a process of gradual phased change, a recognition that the competition fostered by deregulatory measures such as giving carriers the freedom to enter and leave markets at will, and setting tariffs determined by mtirket forces, requires continued regulatory protection in order to circumvent the natural inclination of incumbents to devise mechanisms which might blunt the effects of actual or potential competition (Button, 1989a). Thus, ultimate control over licensing of UK airlines and their routes has rested with a supervisory agency the Civil Aviation Authority (CAA). The present discussion, having defined the nature of airline competition, seeks to isolate the principal constraints on the effective promotion of this policy of UK liberalization, the domestic scheduled network providing the primary example.

The definition and characteristics competition

occasioned by the imbalance of size and opportunity

UK’s schcdulcd carriers, and by the contradictions inhcrcnt positions on airline and airport competition and privatization.

industry is p. 79), a with vigor-

@ 1993 Butterworth-Heinemann

ous competition. The ‘key point is not how many airline companies serve the market, but rather the degree and nature of the competition which exists between them’ (Button, 1989b, p. 197). Three types of airline competition can be defined. First, there is the comparatively rare condition of head-to-head confrontation between two or more carriers on the same city-pairing, serving the same two airports. In the UK context, a privatized British Airways (BA) continues to operate from the most desirable airport (Heathrow) to other countries as a de facto flagcarrier, agreements on fares, frequencies and timings with the relevant overseas airlines being controlled through ‘double approval’ bilateral agreements between governments (Pelkmans, 1986). Consequently, although all the top 15 European routes out of Heathrow, for example, are served by at least two airlines, only four are actually competitive in terms of business tariff structure (British Midland [BM], 1991).’ It can be argued that the prime objective of aviation policy should be to regulate the industry in order to promote competition and avoid such interdependent duopolies (Wheatcroft, 1988). The major example of head-to-head competition in the UK domestic market is provided by the BA/BM duopoly on trunk routes connecting Heathrow to Edinburgh, ’ Paris, Dublin. Amsterdam and Brussels. Although these data have been compiled by an interested party, there is no reason to doubt their veracity. Ltd

125

Liberalization

of the UK airline industry:

R.J. Graham

Table 1. The distribution of ultimate passenger origins/dcstinations at London Heathrow and Gatwick, 1987 (pcrccntagcs of total domestic passcngcr throughput at each airport) Origin/destination

Heathrow

Gatwick

CL Inner Arca GL Outer Area Other South East Others

32.x 21.5 37.0 08.7

13.1 2o.w 62.0“ 04.0

.‘Y.7% from Bromlcy and Croydon alone. “54.3% from Sussex, Kent and Surrey. Sowcc: CAA. 198’).

Glasgow and Belfast International, the country’s most important internal airport-pairings. Second, two or more carriers may serve the same city-pairing but use different airports at one or both ends, the condition which defines the bulk of what might be termed competitive UK domestic and international city-pairings. However, this is to assume that the airports are competing on an equal basis, a supposition which cannot be vindicated in the case of the UK’s two most important terminals - London Heathrow and Gatwick. In terms of scheduled domestic services, for example, it can be argued that Gatwick operates as a large regional airport, serving Kent, Sussex and the southern boroughs of Greater London. The third London terminal at Stansted provides a similar localized role for a catchment of 7-8 million people living to the north of the capital. Such patterns of localization are far less pronounced at Heathrow, the primary airport for Inner London, the principal destination for domestic business and leisure passengers alike (Table 1) (CAA, 1989). Clearly, consumer preference favours Heathrow and, in 1991, the Government abandoned the legally binding Traffic Distribution Rules preventing new airline entrants there. Finally, if somewhat more obtusely, the introduction of deregulatory policies can sponsor an increase in the number of carriers, thereby permitting the development of additional services out of previously under-utilized airports. Again, the encouragement of new airlines may permit carrier substitution by a regulatory agency in the interests of consumer choice. One example was the CAA’s 1991 award of a Heathrow-Tokyo Narita licence to Virgin Atlantic, using UK slots taken from BA which, in turn, vehemently denies that such a process constitutes competition at all (CAA, 1985-92 [Decisions on Air Transport Licensing Applications, l/91 and 10/91]).

The UK policy of scheduled passenger air transport liberalization Clearly, the policy of air transport liberalization pursued by the UK’s Conservative Government since 1980, together with the concomitant emphasis on privatization, is part and parcel of the ideological 126

baggage of the economics of the New Right (Farrington, 1985). Nevertheless, the Government has failed to develop a coherent empirical policy. either for airlines or airports. Although it has sought to promote competition of all types amongst UK carriers in order to achieve the consumer benefits which do stem - at least in the short term - from deregulatory policies, its several conflicting goals have contributed to the creation of a significant set of constraints on competition in the UK airline industry. Thus, on one hand, for example, BM became the government-sanctioned competitor to BA on domestic services out of Heathrow, while a number of liberalized bilateral agreements have been negotiated with other states (Abbot and Thompson, 1990). Conversely, it can be argued that the government’s priority of commitment was to the 1987 privatizations of BA and British Airports Authority (BAA), both of which were inherently anti-competitive. Divestment of state control of BA demanded that the airline’s international competitive strength remain largely undamaged so that it would appeal to investors. This protection of RA’s position, and the reconstruction of its finances ahead of privatization. not only exacerbated the problem ol the carrier’s dominance of the UK airline industry but, simply, were incompatible with the stimulation of competition. BAA merely became BAA plc. controlling Heathrow, Gatwick, Stansted and several other airports. The ensuing near-monopoly in the London area ensured that these terminals could not be marketed as competing airports; rather they have remained complementary. The actual implementation of this inherently flawed policy has fallen to the CAA which has continued to regulate carriers throu h mechanisms 8 such as route licensing (CAA, 1988).-The Authority is typical of the agencies administering ‘the cmergence of extensive re-regulation of economic activity’. which has been one of the most remarkable features ‘in a period supposedly typified by drastic dcregulation’ (Thompson, 1990, p. 135). The primary aim of the CAA is to provide the consumer with its central and unequivocal better air services, priority being the sponsorship of competition. In seeking to fulfil this objective, it has used the regulatory structure to promote more effective competition to BA which it has treated far less sympathetically than has the Department of Transport. Domestically and internationally, the CAA has consistently favoured some form of multi-airline policy, not as an end in itself, but rather as a means of achieving those long-term user interests to which it is committed (CAA, 1985-92 [Decisions. 7/9!)]). Prior to commenting on the application of this policy

’ The agency will continue to administer UK domestic aviation until lYY7 but. as from I January 1993, UK airlines can commence services to EC destinations without regulatory approval.

Liberalization

to UK domestic specific factors implementation.

air services, we must isolate the which compromise its effective

The constraints liberalization

on the policy of UK

The constraints on liberalization derive both from the nature of the airline market in general and particular UK circumstances. The academic theory of airline deregulation was constructed on the concept of the contestable market - one in which entry and exit is totally free, partly because there are no economies of scale - and the concomitant assumption that sunk costs are comparatively negligible, permitting airlines to enter and leave markets at will (Button, 1991). However, while the existence of economies of scale may be debatable, immense economic advantages continue to accrue to the largest incumbent carriers through economies of density and scope (Levine, 1987; Humphreys, 1989). In particular, these emanate from control of information derived through ownership of Computer Reservation Systems, intra-lining possibilities offered by complex cross-subsidized networks, and the ability to control hub airports. In turn, such economies ensure that there are highly significant sunk costs for any putative competitor wishing to enter a particular market.

of the UK airline

industry:

B.J.

Graham

If we turn to the UK case in particular, these general constraints on the CAA’s policy of liberalization in the interests of consumer benefits have been further compounded by four specific factors. First, there is the problem - already referred to - of the enormous imbalance of size and inequality of opportunity amongst the UK carriers, a characteristic not radically altered by the years of liberalization. Partly because of the Conservative commitment to privatization, BA has been and remains entirely dominant (Figure l).” Second, the multi-airline policy has been terminally compromised by business failure and consolidation, particularly affecting those carriers favoured by the CAA as second-force scheduled airlines.” Third, with the exception of BM’s operations out of Heathrow, the multi-airline policy has been concerned essentially with fostering a credible UK scheduled carrier serving Gatwick, although, ironically, BA’s 1992 take-over of DanAir appears to offer the best chance yet of developing ’ Apart from BA, Virgin is the only other independent scheduled carrier of any substance. Airlines of Britain (BM, Loganair and Manx) group is now 40% owned by SAS, while KLM has a 14.Y% shareholding in Air UK. ’ Laker Airways collapsed in 1982, partly due to predatory pricing by its much larger international rivals. including BA, a financially terminal British Caledonian was subsumed by BA in lYH7. Air Europe went bankrupt in 1991 and, most recently, the rump of Dan-Air Services was taken over by BA.

U

BA

--W-

B Cal

h

Laker

---I--

Dan -Air

U

Air Europe

---&-

Airlines of Britain*

*

Air UK

+

Virgin

I 1

1980

I

1982

I

I

1

1984

1986

1988

I

British Midland, Loganair and Manx

l

1990

Year Figure 1. Pcrcentagc 198(&91 (in millions) Note: Despite Solrrcr: CAA

of all available

liberalization, the dominance (19X1-X3, lYX&Yl. 1002).

tonne-kilometrcs

(including freight and charter

of BA has marginally

incrcascd,

a trend

exacerbated

carriers)

for scheduled

by its lYY2 take-over

UK airlines. of Dan-Air

127

z .= .-

m

$

60

10000

2 r

50

8000

x

tff % G

2

40

6000 8 4000

30

E ?! k P

20 10

Airline Groups Figure

2. Top

ten

airline

groups world-wide.

Airlines IYYI. in

terms of salts

3. The

Figure from

principal

January

a stable network of routes out of the airport. But, as we have seen, Heathrow is a much more desirable terminal for consumers and airlines alike, though the shortage of slots, especially at peak times, militates against stimulating competition to BA. For example, BM has only been able to achieve sufficient frequency on European routes by abandoning domestic schedules to Liverpool and East Midlands. Finally. there is BA itself. Ranked sixth in the world in 1991 in terms of sales, it is engaged in a global competitive battle (Figure 2). ‘Fortress Heathrow’ is crucial to its success and one of BA’s principal reasons for involvement in unprofitable domestic schedules is intra-lining through this hub (Hanlon. 1989). Arguably, however, BA cannot achieve sufficient control of slots at Heathrow to maximize such connections, and, in comparison to many of its European competitors, it fares badly in terms of control of its principal hub (Jenks, 1990; Figure 3). Consequently, the carrier has claimed consistently and. within its global perspective, logically, that the CAA’s multi-airline policy is hurting its business. Government, and particularly CAA, commitment to UK airline competition is therefore incompatible with BA’s global aspirations, a key reason behind the carrier’s attempts to undermine Virgin .5

128

of

airports

international for

selcctcd

dcparturcs EC

carriers,

199 I

Note: The comparative disadvantages suffered by RA at Hcnthrow arc readily apparent. Sourw: Thr Economist ( 199I ).

UK domestic airline services and liberalization The imperfections of the UK experience of domestic liberalization have to be assessed within thcsc constraints. Airlines have wanted liberalization of access to markets but. once incumbent, unsurprisingly, they are inclined to seek protection and/or eradicate competition. The smaller UK airlines have opposed outright deregulation because of the imbalances in size, financial and operational strength which, as we have seen, exist in the UK market and because of their exclusion from Heathrow (CAA, 1984; CAA, 1985-92 [Decisions 12/X5]). Table 2. Competition

on UK

domestic routcs,

1091

No. of

routes UK Mainland/ Northern Ircland/lslc of Man I IO Channel I&md\ 44 Scottish Highlands and Islands (excluding Loganair 15 inter-island scrviccs) Isles of Stilly 2 Total

5 On I I January 1903. BA apologized publicly to Virgin in the London High Court for a series of unethical husincss practices aimed at undermining the smaller carrier’s reputation and customer base.

pcrccntagc hub

I71

Competitive” Monopoly

I

2

71 33

‘1 x

I4 2

I

IZI

IX

32” -1

36

~‘1 = had-to-head competition: 2 = compctitivc airport-pairings. “Three routcs had both head-to-head and airport competition. ‘One route had both forms of competition Source: <‘AA. 1092.

Liherulization

Table 2 relates the UK domestic net to the three forms of competition identified above. In 1991, when almost 20 airlines transported 11.6 million passengers, this amounted to 171 airport-pairings. If routes to the Channel Islands are excluded, because they are not enumerated separately in CAA statistics, 9.3 million passengers were carried. Although only nine routes were characterized by head-to-head competition, these accounted for over 40% of total uplift (Table 3), primarily on the trunk routes from Heathrow on which competition has produced a sustained increase in traffic, much better cabin service, vastly improved frequencies, cheaper Apextype fares but very little variation in tariff structures (CAA, 1987; Barnes, 1988; Graham, 1990). Competition on the remaining routes characterized by head-to-head confrontation can be unbalanced with small regionals occasionally finding themselves in direct confrontation with BA. In such cases, CAA protection may be essential as witnessed by the agency’s decision to cap BA frequencies on Manchester-Edinburgh when the airline appeared to try and force Loganair off the route. At the hearing, it was estimated that the service contributed 15% of Loganair’s total revenue in 1991, compared with a nominal 0.1% of BA’s (CAA, 1985-92 [Decisions, l/92]). In the interests of competition, it might have been better to exclude a privatized BA from such domestic operations, for the carrier has yet to develop a consistent strategy to deal with these, while its presence in the market accentuates the problem of making that competitive.” Second, no less than 75% of 1991 domestic uplift was carried on city-pairings characterized by the far less dynamic dimension of competing airports. With the exception of Belfast, the only UK city with two actively competing airports, this total derives from services into the four London area terminals (including Luton). In the case of Heathrow and Gatwick, however, the former dominated in terms of London

Table 3. Passenger uplift on UK Mainland/Northern of Man routes, IYYI

Head-to-head competition Trunk routes Others Airport competition Monopoly Sourw:

CAA,

lreland/Isle

Uplift (millions)

Percentage total (9.329 million)

3.772 3.524 0.247 7.OSY I .x77

40.36 37.71 02.65 75.54 20.09

of Trunsport

Geogruphy

199.3 Volume

I Numhrr

industry:

R.J.

Gruhum

area domestic uplift (Table 4). In reality it is perhaps best not to see the two airports as direct competitors, Air UK for example regarding Gatwick as the end of a spoke radiating from its Scottish services. By contrast, the juxtaposition of Belfast’s City and International airports does underline the potential benefits which consumers can derive from directly competing terminals. For once, small carriers are able to compete effectively with the majors because they can offer a different product, a downtown and highly accessible commuter airport (Graham, 1990). The final dimension of competition identified earlier posited that liberalization might sponsor the development of further services out of previously under-utilized airports. In the context of UK domestic services, and also those between provincial airports and European destinations, this constitutes one conspicuous success for the CAA’s liberalization policy. Particularly through the medium of licensing, the CAA has allowed smaller carriers to build up the network synergies and critical mass essential to survival, and many regional airports now possess miniature hub-spoke networks operated by one of the smaller carriers.’ Although this has increased consumer choice through an elaboration of the UK domestic net, a wider range of possible routeings, and many more connections with Europe, these services are often monopolies and fares are high. In practice, a substantial residue of monopoly does remain although many routes so defined have small pasenger uplift totals and would be incapable of supporting more than one carrier. Nevertheless, in 1991, no less than six (now seven) of the top 20 UK domestic routes (excluding those to the Channel Islands) were monopolies although it must be

Table 4. Passenger uplift on domestic and Gatwick, IYYI”

city-pairings

at Heathrow

City-pairing

Gatwick as percentage of Heathrow total

Channel Islands Manchester Newcastle Aberdeen Glasgow Edinburgh Plymouth” Belfast International” Tecsidch

53.50 25.70 22.63 22.43 14.40 12.44 03.73 01 .hS 01.20

“The Channel Island routes arc anomalous in that they are Icisure-dominated. “Gatwick services suspcndcd during IYYI. Jcrscv European is to restart a Belfast (City) to Gatwick schedule during 1003. So[rrce: CAA, lYY2.

lYY2.

’ BA’s latest scheme is British Airways Regional, a lower cost carrier, set up in lYY2. using turbo-prop ATPs and old, noisy B737-200s displaced from Heathrow by the arrival of more modern aircraft, to opcratc scrviccs out of Manchester. Birmingham and in Scotland; two small subsidiaries, Brymon and Birmingham European, have been amalgamated as Brymon European. Journul

of the UK airline

2

’ Examples include Air UK at Stanstcd. Manx at Isle of Man and Cardiff. Jersey European at Belfast City and Brymon European at Birmingham and Bristol.

129

Tsble 5.

Top 20 UK domestic

I 2 3 .l 5 6 7 X Y IO II I2 I.7 13 15 16 I7 I8 19 20

IYYI.

in terms of paswngcr uplilt

Route

Passenger (millions)

LHR-EDI LHR-GLA LHR-BFS LHR-MAN LHR-ABZ LHR-NCI LGW-MAN LHR-I,BA LGW-GLA LTN-BFS LHR-MME” LGW-EDI BHX-EDI LHR-INV BHX-GLA BFS-MAN IOM-LPL LHR-IOM BFS-BHX LGW-ABZ

I .22x l.IXX I.107 0.7X8 0.420 0.327 0.702 0.1x4 0.171 0. I70 0. IhX 0. I53 O.IJl 0. I11 0. I37 0. I26 0. I IS 0. I05 0. IO3 O.OY‘l

“I = head-to-head competition: “LHR-MME is now a monopoly ‘Now BA. ABZ BFS BHX ED1 G1.A

Source:

routes.

2 = airport route.

Abcrdecn Bclfnst International Birmingham Edinburgh Glasgow

that many (Table 5).

were

Monopoly

I

2

BA. BD BA. BD BA. BD BA BA BA DA’ BD UK BY BD UK BA DA‘ BA BA .I E JE VU DA’

subject

to

IOM INV I.BA LGW I.HR

lslc of Man Invcrncss Leeds-Bradford Gatwick Heathrow

.IE UK VB

Manx Air UK Birmingham

railway

Conclusions Thus, within the constraints outlined earlier, liberalization has promoted a considerable amount of competition in the UK domestic market. Nor should it be thought that profit ensues from the survival of monopoly, and the attenuation of competition brought about by inconsistent government policy on airlines and airports exacerbating the constraints identified earlier. No airline is making an adequate return from the UK domestic market; generally, operating profits are nil. Conversely, there is no doubt that consumers have benefited from CAA policy, particularly in the range, quality and availability of air services if not in their price. The recent history of the US industry has demonstrated that deregulation of the airline industry -if left to market forces alone - will lead to an attenuation of competition through consolidation and bankruptcy. The UK example - modest as it is - illustrates that, compared with deregulation, the retention of a 130

Competition” Carriers

competition.

BA British Airways BD British Midland DA Dan-Air CAA. IYY2

remembered competition

uplift

I.PI. I .TN MAN MMF NCI.

Liverpool Luton Manchcater Tcculde Ncwcatlc

European

measure of regulation in a liberalized regime. partly to offset large-scale imbalances of size and opportunity amongst airlines, offers some prospect ol stability, both for suppliers and consumers. and a prolongation of user benefits. A multi-airline policy is essential to liberalization. As the European industry continues to consolidate into a handful ol very large airline groups, the UK example demonstrates that competition at the local or regional lcvcl will survive only if artificially sponsored and then protected. Particular carriers (those most likely to survive?) have to be favourcd: probably the best that can be hoped for is a sanctioned oligopoly - usually a duopoly. The altcrnativc is clear: in an industry uncontrolled by such proscription, the eradication 01 but competition ~ and the often quite modest tangible consumer bcncfits which that brings ~ is inevitable.

Acknowledgements The support of a Charitable Trust connected with the University of Ulster is most gratefully acknowledged. I am also indcbtcd to the following for their

Liberalization

time and patience in discussing some of the issues raised in this comment: Dr Barry Humphreys, CAA, London; Mr Richard Venables, Lane and Partners, London; Mr D. A. Cox, Britannia Airways, Luton; Mr B. P. Chapman, Air UK, Stansted. Opinions expressed remain my own responsibility.

References Abbot, K. and Thompson D. (1990) Deregulating European aviation ~ the impact of bilateral liberalisation, Working Paper 73, London: Ccntrc for Business Strategy. London Business School Barnes, F. (1988) ‘The impact of partial deregulation in the United Kingdom domestic air transport market’ in Deregulation and airline competition, Paris: OECD, Annex 111 British Midland (1991) A fair deal?, Castle Donington: British Midland Airways Button, K. (lY8Ya) ‘Liberalising the Canadian civil aviation market’, Fiscal Studies, 10, pp. 19-52 Button, K. (19XYb) ‘The dcrcgulation of US interstate aviation: an assessment of causes and conscquenccs’, Transport Reviews, 9. pp. 99-l 18. 189-125 Button, K. (ed) (1991) Airline deregulation: international experiences, London: David Fulton CAA (1981-83) Annual statistics 1980, 1981, 1982 (CAP 436, CAP 449. CAP 484), London: CAA CAA (lY84-91) UK airports: monthly statements of movements, passengers and cargo, 1984, 1985, 1986, 1987, 1988, 1989, 1990, 1991 (CAP 492. CAP 504, CAP 521, CAP 529, CAP 538. CAP 558, CAP 568, CAP 506) London: CAA CAA (1984) Airline competition policy (CAP 500). London: CAA CAA (1985-92) Decisions on air transport licence applications, 12/X5. 7/YO, l/91, 10/91. l/02, London: CAA CAA (1987) Competition on the main domestic routes (CAA 87OOS), London: CAA

Journal of Transport Geography 1993Volume I Number 2

of the UK airline industry:

R.J. Graham

CAA (1988) Statement of policies on air transport licensing (CAP 539). London: CAA CAA (1989) Passengers at the London Area Airports and Manchester Airport in 1987 (CAP 560). London: CAA CAA (1992) UK airports: monthly Statements oj” movements, passengers and cargo, 1991 (CAP 606). London: CAA Farrington, J.H. (1985) ‘Transport geography and policy: deregulation and privatisation’. Transactions of the Institute of Rritish Geographers. IO. pp. IOY-I IY Flight International (lYY2). l&l6 June, p. 36. Graham, B.J. (1990) ‘Deregulation of domestic passenger air transport services in the United Kingdom, 198&X9: a case study of Northern Ireland’. Environment and Planning: C, 8. pp. 327-346 Graham, B.J. (1992) ‘A conflict of interests: the European Commission’s proposals for competition in the scheduled airline industry’. Area, 24, pp. 245-252 Hanlon, J.P. (1989) ‘Hub operations and airline compctition’, Tourism Management, 10. pp. 1 I I-124 Humphrcys, B.K. (lY8Y) ‘Economics of density. scale and scope’, Avmark Aviation Economist, 6(6). pp. I&l I Jenks. C. (1900) ‘Can Europe rcplicatc US hubbbing?‘, Avmark Aviation Economist, 7( IO). pp. I(&12 Levine. M. (1987) ‘Airline competition in deregulated markets: theory, firm strategy and public policy’, Yale Journal of Regulation, 4. pp. 393-494 Pclkmans, J. (1986) ‘Dcrcgulation of European air transport’ in dc Jong, H.W. and Shepherd, W.G. (cds) Mainstreams in industrial organization. Dordrccht: Martinus Nijhoff, pp. 347-385 Prykc, R. ( 1987) Competition among international airlines, London: Trade Policy Research Ccntrc The Economist (1991) ‘Making competition take off’, 19 October, p. IlY Thompson, G. (1990) The political economy of the New Right, London: Pinter Wheatcroft. S. (1988) ‘European air transport in the 1YYOs’. Tourism Management, 9, pp. 187-198

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