Post Deregulation Act of 1978 - Term Paper Example

The Airline Industry Post Deregulation Act of 1978 Table of Contents Introduction 3 Deregulation of the US Aviation Industry 3 Reasons leading toDeregulation of the US Airlines Industry 4 Situation of the Airlines Industry post deregulation 6 Market Forces 7 Economic Model followed by the Government 7 Conclusion and Recommendations 8 References 10 Kwong, K. (1988) Towards open skies and uncongested airports: an opportunity for Hong Kong. Hong Kong: The Chinese University of Hong Kong. 10 Severin, B. (1989) Hubs and High Fares: Dominance and Market Power in the U.S. The Rand Journal of Economics, 20 (5), 344-365. 10 Siddiqi, A. (No Date) Deregulation and Its Consequences. U.S. Centennial of Flight Commission. Retrieved October 4, 2010 from 10 Bibliography 10 Kasper, D. M. (1988) Deregulation and globalization: Liberalizing international trade in air services. USA: Ballinger. 10 Yosef, E. (2005). The evolution of the US airline industry: theory, strategy and policy. The Netherlands: Springer. 10 Introduction United States has proved itself to be a big player in the aviation industry from time to time. With the domestic industry having gained a momentum following the World War II, it earned the highest revenue per passenger miles (RPM); records for the year 1996 put the figures at 3.3 billion which comprised of almost 33 percent of total scheduled passengers in the global airlines sector. Though the industry had reached an epitome of success during its very early years, it came across better prospects, following the deregulation move initiated in the industry in 1978 by the Congress through the Airlines Deregulation Act. A strategic repositioning from being fundamentally controlled by the government to that of being guided by private market players resulted to a reduction in the costs of operations as well as a hike in the RPM. This was in fact, the primary objective that the US national authorities had in their mind while submitting to the demands of the Civil Aeronautics Board (CAB), for privatisation. Privatisation flooded the industry with new entrants each of whom aimed at capturing the largest possible share of the market. Such a mindset posed by most of the players led to the creation of a highly competitive market constitution, with the players striving hard on the basis of price. The outcome of such a stance was cost-efficient techniques of production, which again were mirrored through lower air fares. Given the intensive controls imposed by the government in this arena, such a development could not be envisaged, prior to deregulation. The present study reflects upon the purpose along with the causes which led the US government to submit itself to the demands for deregulation. Furthermore, it also analyses the impact that the move created over the industry and the economy. Deregulation of the US Aviation Industry The proposal for deregulating the US airlines industry came to the forefront following widespread demands made by the domestic airlines companies, when they comprehended a clear picture of being treated unfairly. Housing the largest number of airlines consumers in the world, the nation was clearly identified as one with immense potentials. The primary reasons which led to deregulation of the US airlines industry can thus, be illustrated in the following section. Reasons leading to Deregulation of the US Airlines Industry The US Airlines industry was primarily a highly controlled one, with heavy regulations imposed upon the air fares, air routes as well as the air schedules. Prevalence of such restrictions within the airlines arena had serious implications upon market demand. The Civil Aeronautics Board (CAB) restricted the entry of new players within the industry, depending upon the approval provided by the Department of Transportation (DOT). Prior to deregulation, unless the DOT endorsed any indigenous airlines company as fit and able to commute passengers within the national premises, they could not operate within the domestic territory (Siddiqi, n.d., par. 1). The outcome of creating such a highly constrictive environment of operation had serious drawbacks upon the cost structure of the companies which were active in the business. Though initially, the profit margin earned by the US airlines industry was quite high, viz., 14%, the situation worsened following the restrictions inflicted by the board upon the margin. According to the guidelines being implemented, the profits earned upon stockholder’s equity could not be exceeded beyond a certain ceiling, so that the players who were already present in the market could not increase the air fares above a particular point (Kwong, 1988, p. 14). Though, a low air fare was considered as an advantage for the customers who availed the service, the companies suffered from bottlenecks as their avenues for procuring capital was approaching a standstill. Given a low dividend-earnings ratio, no investor considered the airlines industry as a lucrative ground for pouring their resources. Hence, the industry went through a retarded growth phase nurtured only by an immense volume of retained earnings. However, given their restricted operational activities, the industry could not perform to its utmost potentials so that even their profit margin could not shoot up. A major area of concern for the service providers was that they were not even allowed by the CAB to leave the sector at any cost (Kwong, 1988, p. 14). Another major reason behind the craving for deregulation was that the airlines could only operate along predefined routes, which rarely were revised. Moreover, they were not allowed to ply across international boundaries, so that the sector experienced from severe resentment coming from potential customers. In fact, the customers who wanted to travel abroad took international flights to serve their purpose so that the latter earned a fortune in lieu of the former. A third area of aversion coming from a section of the service providers was that they were not allowed to fly through profitable routes. Despite the fact that the routes chalked out by the CAB were rather few, they were segregated into those which were subsidised and those which were not. The players, who were not allowed to ply across the subsidised ones, were the sufferers and felt the government’s decision to be a one-sided and an unfair one. Furthermore there were a large number of intrastate carriers plying across the US states, but which were not directly under the jurisdiction of the CAB. The ticket prices of these carriers were quite lower compared to the national ones. Moreover, they also provided a regular premium quality service so that the customers preferred to hire them in contrast to their counterparts operating within the national circle. Hence, the airlines service providers who were directly under the command of the CAB were the ones who felt a partial treatment in vogue. Their area of operation was low enough for them to even think of a sectoral expansion. Moreover, it was also felt by the CAB that a restriction to the number of entrants in the market resulted to a fall in quality of the service so provided. The market for airlines service providers had essentially taken the form of an oligopolistic structure with a very few number of players. However, unlike that of an oligopoly, the players were constrained from competing with one another on the basis of a price. The ones operating within the market could earn a fortune (though not optimum), but the number of entries within the market was highly restricted. An unrevised and pre-charted route of plying added with their inability to reduce the cost of operations resulted to a fall in the profit margins of the operators, who were also being continually drained out of their potentials to expand. With poor scopes of earning profit, there were little ways to make improvements in the quality of customer service, though air fares were kept low enough. This led the customers to shift their preference from the domestic to the international airlines companies. When the US government perceived a downfall in the aviation industry, they decided to give the widespread demand for deregulation a serious thought, which the CAB finally approved in the year 1978 (Kwong, 1988, p. 14). Situation of the Airlines Industry post deregulation The scenario following deregulation of the airlines industry was a positive one giving the impression of a well-decided move. There were clear indications of the industry to be expanding significantly. The profit trends of the airlines industry post deregulation were found to be moving upward as well. The initial years were found to be moving quite slowly, but steadily till the year 1988. However, the profit figures became turbulent soon after 1991, with the initiation of the Gulf War that led to a hike in fuel prices. The profit margin had reached the level of almost US$ 1 billion in the year 1986, after which it met with a downfall that sharpened further post 1991 (Hansman, 2003, p. 11). Since then, the airlines industry had seen immense discrepancies in its business, which was mirrored through its profit figures. The prime reason behind such profit-loss cycles was that the industry became highly sensitive to fluctuations in the GDP following deregulation. With the government no longer backing the service providers, there were no channels to shield them from the brunt of economic recessions. Research recently conducted upon the area reveals that a downfall in GDP of UK is positively associated with the revenue earned per passenger mile (RPM), so that the recessions the nation faced during the years 1983, 1992 and 2001 resulted to a fall in RPM as well. Prior to deregulation, the picture had been a reverse one, however (Hansman, 2003, p. 4). Hence, a recession must also indicate a fall in the revenue being earned by the industry. This indeed is a clear sign of being a part of a perfectly competitive market, which now is partially regulated by the government in certain aspects (Severin, 1989, p. 355). Though left unguarded in the face of economic downturns, which coincidentally became quite common in USA following the Gulf War of 1991, there was a remarkable rise in the Scheduled Revenue earned per Passenger Mile (RPM) post deregulation; average RPM was recorded at 8.35 billion per year before 1978, but leaped to 19.4 billion after the event (Hansman, 2003, p. 6). RPM indicates the number of passengers in an aircraft who have paid for their tickets, multiplied by the total distance travelled. A rise in this RPM thus, clearly indicates a growth being experienced by the industry post deregulation. Market Forces The situation in the US aviation industry evolved out to be a rather pathetic one, with the post-deregulation realisation that the industry had been suffering from excess capacity throughout its period of pact with the US government. The national government had allowed a large number of companies in the industry initially, which were later identified to be excessive. The obvious outcome of the same was that the industry was characterised by a large number of acquisitions and mergers (Kohl & Lehn, 1999, p. 84). Gradually there were only few players left in the market, whose activities however were unrestricted, unlike the situation prior to deregulation. Market forces became quite active following the deregulation of US aviation industry. Though the government no longer objected to the entry of new market players, the big names in the industry created virtual barriers in the same, since they already had a faithful circle of customers. The market demand and supply conditions in the airlines sector showed an oligopolistic trait where the air fares were decided through an intersection between the market demand and market supply schedules. Though the market players have to operate in an oligopolistic environment which is prone to price competitions, the airlines players rarely do so due to the high costs involved in the same. The extent to which that price might be reduced is bounded by a floor owing to the costs of operation of airlines. On the other hand, a fall in air fares might lead to the entry of new entrants in the market, which could prove harmful for the existing ones in the long run. Hence, the price elasticity of demand in the US airlines market cannot be considered to be greater than 1 or even equal to it. This implies that given a constant supply of airlines service providers, a rise in the demand for air tickets by 1 unit leads to a fall in the air fares by less than 1 unit. A similar trait is also reflected through the price elasticity if supply. Economic Model followed by the Government Previously, the US government had followed a strictly regulated regime for the domestic airlines service providers or companies, where the latter had to operate across a few pre-planned routes and also keep their prices low. In short, the initial situation had been anything but one able to invoke a sectoral growth. However, following the deregulation move, the government relaxed its areas of restriction largely. The airlines industry is characterised by the use of scarce resources which must be rationed for use; leaving market forces to take care of the same would lead to a sharp depreciation in these endowments. Moreover, given the oligopolistic structure of the industry, the US government also needs to implement anti-trust policies which bar the component market players from forming agreements between themselves. Since such tacit collusions will change the market structure from being oligopolistic to that of being a monopolistic one, the government plays a significant role in preventing the same. A third point that the government or rather Department of Transportation (DOT) takes care of is that whether the airlines companies, whether domestic or foreign which provide their service in USA, comply with the safety and security rules maintained by the national administration. In short, the government of the nation follows a lightly regulated economic model, which has room for competitive forces as well as external regulations (Gowrisankaran, 2002, p. 4). Conclusion and Recommendations The US airlines industry is one that had been through immense turbulences throughout its history. It is one with high profit potentials as has become evident now, but which had been heftily regulated till 1978. Though, the sector experienced a downfall following the terrorist attacks of 9/11, it soon revived from its dilapidated state following certain effective government policies, which included added security measures. In addition, there had been many other instances of recession in the US economy like the one following fuel price hikes invoked by the Gulf War of 1991. US airlines industry had also been found to be highly sensitive towards GDP fluctuations in the economy, so that every time that a recession hit it, the industry suffered a setback. This overtly susceptible structure is one of the worst drawbacks of privatisation, since some parts of the cost have to be borne by the consumers as well. The companies need to maintain their competitive prices simultaneously so as to hold back their customers. On the other hand, the government of the nation remains in the better part of the deal given that it no longer needs to incur the entire cost of shielding the industry from the brunt of recession. There also was created a ruckus among the airlines companies almost all of whom believed that they were treated rather in an unfair manner. Moreover, the industry also could not sustain in competition before their foreign rivals. This restricted environment was taking a toll on the industry’s abilities to perform and thus came the decision to deregulate or privatise the same. This deregulation move led to the formation of an oligopolistic market, though partially regulated by the national government. Extent of this regulation though did not go beyond the limit of taking a toll upon the future of the companies, there are a number of areas that the government must remove its hands from. For instance, the government is still keeps itself responsible for regulating the market for certain airport subsidiary industries, e.g., the airport boarding gates. If the authorities leave these industries to operate on the basis of market forces as well, the operation would be a more effective one. References Gowrisankaran, G. (2002). Competition and regulation in the airline industry. FRBSF Economic Letter, 2002-01. Hansman, R. J. (No Date) Overview of recent trends in the airlines industry. MIT Department of Aeronautics and Astronautics. Kole, S. R. & Lehn, K. M. (1999). Deregulation and the adaptation of governance structure: The case of the U.S. airline industry. Journal of Financial Economics, 52, 79-117. Kwong, K. (1988) Towards open skies and uncongested airports: an opportunity for Hong Kong. Hong Kong: The Chinese University of Hong Kong. Severin, B. (1989) Hubs and High Fares: Dominance and Market Power in the U.S. The Rand Journal of Economics, 20 (5), 344-365. Siddiqi, A. (No Date) Deregulation and Its Consequences. U.S. Centennial of Flight Commission. Retrieved October 4, 2010 from Bibliography Kasper, D. M. (1988) Deregulation and globalization: Liberalizing international trade in air services. USA: Ballinger. Yosef, E. (2005). The evolution of the US airline industry: theory, strategy and policy. The Netherlands: Springer. Read More