Although US airline deregulation was initially envisioned as leading to an increased number of carriers whose divergent service concepts, market segments, fleets, and route structures would have produced new competition, stimulated traffic, and lowered fares, it ultimately came full cycle and only resulted in virtual monopoly. Three distinct stages occurred during its evolution.
The regulation itself traces its origin to 1938 when Congress adopted the Civil Aeronautics Act. Its resultant five-member Civil Aeronautics Board (CAB), formed two years later in 1940, regulated fares, authorized routes, awarded subsidies, and approved interline agreements, among other functions.
“Regulation, by definition, substitutes the judgment of the regulator for that of the marketplace,” according to Elizabeth E. Bailey, David R. Graham, and Daniel P. Kaplan in their book, Deregulating the Airlines (The MIT Press, 1985, p. 96).
So regulated had the environment been, in fact, that an airline often had to resort to the purchase of another carrier just to obtain its route authority. Delta Air Lines, for example, long interested in providing nonstop service between New York and Florida, continually petitioned the CAB for the rights. But the regulatory agency felt that Northeast, a small local service carrier often plagued by low traffic, financial loss, and bad weather because of its route system, needed the lucrative Florida route’s revenue potential to boost it back to health and granted it the authority instead.
Undaunted, Delta ultimately resorted to acquiring the regional carrier and subsequently received approval for the merger on April 24, 1972. But these extremes would shortly no longer be needed.
A glimpse of the future could already be had in California and Texas. Devoid of jurisdiction over local air transportation, the CAB could neither exercise fare nor route authority over intrastate airlines and these carriers, usually offering high-frequency, single-class, no-frills service at half the fares the regulated “trunk” airlines were forced to charge, consistently recorded both profit and traffic growth.
Air California and PSA Pacific Southwest Airlines, for example, operating in the Los Angeles-San Francisco market, saw yearly traffic figures increase from 1.5 million passengers in 1960 to 3.2 million in 1965. Texas-based Southwest Airlines similarly provided low-fare service between Dallas and Houston and other Texas points. These airlines demonstrated that true deregulation could yield fares accessible to average-income passengers, provide greater airline and service concept choice, and stimulate traffic.
Passengers and government alike increasingly decried regulation during the mid-1970s, citing the examples set by Air California, PSA, Southwest, and other intrastate airlines as demonstrable proof that deregulation could produce mutual airline- and passenger-benefit. At least that was the theory.
Ultimately conceding to reason and democratic rule, President Jimmy Carter signed the Airline Deregulation Act on October 28, 1978, in the process eliminating the need for CAB approval of route entrance and exit and reducing most of the current fare restrictions. Even those would eventually be eliminated when the Civil Aeronautics Board, in its now famous “sunset,” was disbanded in 1985.
At the time of the event, eleven then-designated “trunk” carriers collectively controlled 87.2 percent of the domestic revenue passenger miles (RPMs), while 12 regionals, 258 commuters, five supplemental, and four intrastates provided the balance of the RPM distribution. Which would still ply the skies when deregulation’s dust settled?
Stage One: New Generation Airlines:
Like the California and Texas intrastate airlines, an increasing number of nontraditional, deregulation-spawned carriers initially infiltrated the US market. The first of these, Midway Airlines, was the first to receive certification after the passage of the Airline Deregulation Act and the first to actually inaugurate service, in 1979.
Founded three years earlier by Irwing Tague, a former Hughes Airwest executive, Midway inaugurated low-fare, high-frequency, no-frills “Rainbow Jet” service in November of that year from Chicago’s underutilized Midway Airport-which was once the city’s only airfield until O’Hare was built and which Midway hoped to resurrect the same way Southwest had at Dallas’s Love Field–with five single-class, 86-passenger, former TWA DC-9-10s, initially to Cleveland, Detroit, and Kansas City. Its low fare structure fostered rapid growth and it strategically hoped to penetrate the Chicago market without attracting O’Hare competition from the established carriers.
But, having been employed by Midway, the author can attest that it quickly learned three vital lessons, which indicated that it would have to remain tremendously flexible in order to survive under prevailing competitive market conditions:
Although it served a secondary Chicago-area airport, it first and foremost still competed in the Chicago market.
Secondly, once the incumbent airlines lowered their fares, its load factors declined.
Finally, the high-density, low-fare strategy, which had become the principle characteristics of deregulation-spawned upstarts, was ineffective when an airline attempted to cater to a specific market segment, such as the higher yield business one, where increased comfort and service were expected.
Resultantly, Midway modified its strategy by introducing a conservative cream-colored livery; single-class, four-abreast business cabin seating with increased legroom; additional carry-on luggage space; and upgraded, complimentary-wine in-flight service in exchange for higher than Rainbow Jet fares, but those which were still below the major carriers’ unrestricted coach tariffs.
The newly implemented strategy, dubbed “Midway Metrolink,” significantly reduced the number of seats per aircraft. While its DC-9-10s and -30s had respectively accommodated 86 and 115 passengers, for example, they were reconfigured for only 60 and 84 under the new Metrolink strategy.
Apparently successful, it sparked explosive growth, from an initial 56,040 passengers in 1979 to almost 1.2 million in 1983.
Capitol Air, another deregulation-transformed carrier of which the author had equally been a part, also experienced initial, rapid expansion. Formed in 1946 as Capitol Airways, it had commenced domestic charter service with Curtiss C-46 Commandos and DC-4s, eventually acquiring larger L-049 Constellations, and by 1950 became the fifth largest US supplemental carrier after World Airways, Overseas National (ONA), Trans International (TIA), and Universal. It acquired the first of what was to become one of the largest used-Super Constellation fleets in January of 1960, eventually operating 17 L-749s, L-1049Gs, and L-1049Hs during the 14-year period from 1955 to 1968.
Redesignated Capitol International Airways, the charter airline took delivery of its first pure-jet in September of 1963, a DC-8-30, and subsequently operated four versions of the McDonnell-Douglas design, inclusive of the -30, -50, -61, and -63 series, which replaced the Lockheed Constellation as the workhorse of its fleet.
Receiving scheduled authority in September of 1978, Capitol inaugurated New York-Brussels service on May 5 of the following year and a second, Chicago/Boston-Brussels transatlantic sector on June 19. Like PSA and Southwest, Capitol Air, a former supplemental carrier, was not regulated by the CAB and therefore conducted its own “deregulation experiment” by sublimating proven charter economics of single-class, high-density, low unrestricted and even standby fares to scheduled service in order to attain low seat-mile costs and profitability.
The scheduled concept, branded “Sky Saver Service,” consistently attracted capacity-exceeding demand and sparked considerable fleet and route system expansion. Operating six DC-8-61s, five DC-8-63s, and five DC-10-10s to seven US domestic, three Caribbean, and three European destinations from a New York-JFK hub by 1982, it attracted an ever-increasing passenger base: 611,400 passengers in 1980, 1,150,000 in 1981, and 1,824,000 in 1982.
Passengers, unaware of deregulation-molded carriers whose low fares could only attain profitability with used aircraft, high-density seating, and lower-wage nonunion employees, often voiced criticism about Capitol Air’s non-interline policy and refusal to provide meals and hotel rooms during delays and compensation during missed, other-airline connections. Nevertheless, its fares in the New York-Los Angeles market ranged from an unrestricted $149 based upon a round-trip purchase to a one-way $189, while the majors’ unrestricted tariffs in the market hovered at the $450 mark. As a result, Capitol Air’s load factors exceeded 90 percent.
By September of 1981 ten new carriers received operating certificates and inaugurated service.
“The first effects of deregulation were dramatic,” wrote Anthony Sampson in Empires of the Sky: The Politics, Contests, and Cartels of World Airlines (Random House, 1984, p. 136). “A new breed of air entrepreneurs saw the chance to expand small companies or to establish ‘instant airlines’ which could undercut fares on local routes; they could dispense with much of the superstructure and bureaucracy of the big airlines and could use their flexibility to hit the giants at their weakest points where they could make quick returns.”
Four types of airline types emerged and exerted considerable initial impact on the traditionally regulated airline industry.
The first were the deregulation-spawned upstarts, such as Air Atlanta, Air Florida, Air One, Altair, America West, Best, Carnival, Empire, Florida Express, Frontier Horizon, Jet America, Midway, Midwest Express, MGM Grand Air, Morris Air, Muse Air, New York Air, Northeastern International, Pacific East Air, Pacific Express, PEOPLExpress, Presidential, Reno Air, SunJet International, The Hawaii Express, and ValuJet.
The second were the deregulation-matured local service carriers, including Allegheny, Frontier, Hughes Airwest, North Central, Ozark, Piedmont, Southern, and Texas International, which quickly outgrew their former, regulation-imposed geographic concentrations.
The third, the boundary-crossing intrastate airlines, encompassed companies such as Air California (later AirCal), Alaska, Aloha, Hawaiian, PSA, Southwest, and Wien Air Alaska.
The fourth were the deregulation-transformed charters, such as Capitol Air, Trans International (later Transamerica), and World Airways.
Although some of these carriers, particularly Air One and MGM Grand Air, targeted very specific market niches by offering premium seating and service, the vast majority, whether spawned, raised, or matured by deregulative parenting, attained (or attempted to attain) profitability by means of several core operating characteristics, including, of course, low, unrestricted fares, single-hub, short- to medium-range route systems, high-density seating, limited onboard service, lower wage nonunion work forces, and medium-range, medium-capacity trijets, such as the 727, and short-range, low-capacity twinjets, such as the BAC-111, the DC-9, the 737, and the F.28.
All achieved high load factors, generated tremendous traffic in existing and emerging markets, and created considerable competition.
“In this respect,” wrote Barbara Sturken Peterson and James Glab in their book, Rapid Descent: Deregulation and the Shakeout in the Airlines (Simon and Schuster, 1994, p. 307), “deregulation worked like a charm.”
Stage Two: Monopoly:
Although the established, traditionally regulated major carriers temporarily lowered their fares in selected high deregulation airline-concentrated markets in order to retain their passenger bases, the established airlines, long nurtured and protected by regulation, were not structured for profitable operation with them. Yet even in those cases where they managed to eliminate competition from the market, another low-fare upstart seemed waiting in the wings to fill the void.
The incumbent carriers were thus faced with the choice of relinquishing painstakingly developed markets or dwindle financial resources to retain passengers until they themselves slipped into bankruptcy. It quickly became apparent that the deregulation-sparked fare reductions would become permanent elements of the “new” unregulated airline industry and the major carriers eventually discovered that they had to fundamentally restructure themselves or succumb to the new breed of airlines. Almost every aspect of their operations would, in the end, be transformed.
The first aspect targeted was the route system. Traditionally comprised of point-to-point, nonstop service, which had its origins in 1940 and 1950 CAB route authorizations, these route systems actually contained no inherent “system” at all, and consisted instead of unbalanced geographical encompassments that resulted in lost revenue to other carriers and inefficient, uneconomical use of existing fleets. What was really needed was a centralized “collecting point” for self-feed.
Because of bilateral agreements, European carriers actually operated the first “hubs,” channeling passengers from, say, Copenhagen to Athens by means of an intermediate connecting point such as Dusseldorf. Any passenger flying either the Copenhagen-Dusseldorf or Athens-Dusseldorf sector could theoretically transfer to any of the airline’s outward-radiating flight spokes, vastly increasing the number of markets potentially served. These European capital hubs also demonstrated increased aircraft utilization, improved traffic flow, a larger market base than traditional point-to-point service relying only on origin-and-destination traffic could have supported, and retention of the connecting passenger.
“Although passengers prefer frequent nonstop service, such service can be quite costly,” according to Bailey, Graham, and Kaplan (p. 74). “Airlines thus face strong incentives to establish hub-and-spoke operations… By combining passengers with different origins and destinations, a carrier can increase the average number of passengers per flight and thereby reduce costs. Essentially the broader scope of operation lets the carrier take advantage of the economies of scale in aircraft. At the same time a hub-and-spoke operation provides more convenient service for travelers in less heavily traveled markets.”
The first US hub had its origins in the 1940s when the government, attempting to develop the south, awarded Delta some profitable, long-range routes in exchange for its agreement to serve several small communities from Atlanta.
“All of these routes became the ‘spokes’ leading into a Delta ‘hub’ at Atlanta,” said Peterson and Glab (p. 120). “With it came the compelling benefit of passenger retention.”
Allegheny, formerly a Pittsburgh-based local service carrier without a distinctive long-range development plan, recorded considerable success on its eastern and mid-Atlantic state route network, which had progressively “evolved” because of its Pennsylvania funneling point. Increasing the balance of its predominantly business and small community route system with longer-range sectors to leisure-oriented destinations, it was further able to nurture this evolution and by 1978 73 percent of its passengers connected. By 1981 this figure rose to 89 percent-meaning that 89 percent of those flying to Philadelphia and Pittsburgh were not flying to Philadelphia and Pittsburgh.
The Delta and Allegheny hubs were only the beginning of the phenomenon, since the concept did more than create airline concentration in a particular city. Instead, it resulted in an ultimate monopolistic strangulation that precluded any competition.
At four of the major US hubs (Atlanta, Chicago-O’Hare, Dallas-Ft. Worth, and Denver), for example, “the two largest carriers have simply squeezed out or have made it virtually impossible for other airlines to expand and gain market share,” wrote Julius Maldutis in Airline Competition at the 50 Largest US Airports since Deregulation (Salomon Brothers, Inc., 1987, p. 4).
In Atlanta, where both Delta and Eastern once had hubs, the possibility of any significant third-carrier competition was eliminated. In 1978, for instance, Delta’s and Eastern’s hub traffic percentages were respectively 49.65- and 39.17-percent, while nine years later these figures had increased to 52.51- and 42.24-percent.
Analysis of the 50 largest airports (which represented 81.1 percent of US scheduled passenger enplanements) indicated that only ten of these airports could have been considered less than highly concentrated. On the other hand, 40 (or 80 percent) of the airports had excessive amounts of concentration. The ten most concentrated airports had one airline that had more than a 66-percent market share of passenger enplanements.
In St. Louis, where both TWA and Ozark operated hubs, the former enjoyed a 39.06- percent market share, while the latter had a 20.21-percent of it in 1978. In 1986 these corresponding figures respectively increased to 63.16 and 19.68 percent. The following year, after TWA acquired Ozark, its only other significant competitor, it parlayed this share into 82.34 percent with nine other US domestic airlines sharing the remaining 17.66 percent. An airline computer listing, reflecting all carriers operating between New York’s three major airports and St. Louis on December 1, 1995, revealed 27 flights on this day. Not one of them was operated by a carrier other than TWA! This was power.
Similarly, deregulation-matured Piedmont, which only captured a 10.19-percent market share in Charlotte, North Carolina, in 1977, parlayed this into a monopolistic 87.87-percent a decade later after having established a hub there. The same transformation occurred in Pittsburgh with Allegheny/USAir/US Airways-43.65 percent in 1977 and 82.83 percent in 1987.
“Since a large proportion of city-pair markets cannot support convenient nonstop service, hub-and-spoke operations have proved to be the dominant strategy of air carriers since deregulation,” wrote Bailey, Graham, and Kaplan (p. 196). “There has been a significant shift away from the regulatory vision of linear systems and toward sunbursts of routes.”
Aside from the hubbing concept, the major carriers experienced several other fundamental changes. Aircraft, for example, were reconfigured for higher-density-and, in some cases, single-class-seating, while business cabins augmented first class and coach sections on selected routes; first class cabins were later altogether replaced by those of business class in a trend-following pattern sparked by some special-niche deregulation airlines.