Airline Management - Coursework Example

Airline Management Assignment Introduction According to Deardoff and Stern (2008), the international air transport system has undergone substantialtransformation in the past three decades. Since the Second World War, networks of bilateral air service agreements (ASAs) dominated the air transport scene with their tight regulations of market entry, capacity and fares. Since the late 1970s, there has been deregulation and liberalization of many air transport markets. This liberalization has assumed either bilateral or multilateral regional patterns (Hanlon, 2006). The liberalization started in the USA with the US government signing liberal bilateral ASAs with various trading partners (Open skies arrangements), while there was liberalization of the intra-EU air transport services beginning 1997. This air transport liberalization did not stop in the two major air transport markets consisting of the USA and EU, it spread to other parts of the world with the trend tending towards intra-regional multilateral liberalization. Examples of other regions that have embraced market liberalization include South America (Fontaleza Agreement, 1997); South East Asia region (CLMV Agreement, 1998); Africa (Banjul Accord, 1997 and COMESA, 1999); The Caribbean Community (1998); and the Middle East (Arab Civil Aviation Commission, 1998). This paper examined regulation and why it was necessary in the air transport industry including the reasons why it continues to be necessary in many air transport markets particularly in the developing world. The paper also examines deregulation and liberalization in the American and European markets before discussing their outcomes and examining modern regulations and airline alliances that now dominate most skies in the industry. Regulation With increase in global competition, most businesses have had the luxury of being able to choose their strategies as they wish with regard to mergers and consolidations, however for a long time the air transport industry has been quite different. In this industry, airlines have had to deal with rigid regulatory frameworks that have been particularly designed to dissuade freedom of movement in the market (Gonenc and NIcoletti, 2000). Regulation mainly involved state intervention in the airline industry to protect the interests of domestic airlines and ensure their survival. There are two theories that effectively explain state intervention in the airline transport industry; the economic theory of regulation and the public interest theory. The economic theory of regulation considers political and economical issues in industry regulation by the state and argues that regulation benefits only a small group with economic or political interests, for example the government and the people controlling it (Findlay and Round, 2006). The small group can also be the monopolistic company that dominates an industry or a group of firms controlling a market. In the airline industry regulation has been largely seen as favoring small groups consisting either of national carriers or groups of local airlines (Schipper et al. 2002). A good example is the airline industry in Europe and the USA where regulation benefits a small group consisting of flag carriers of each of the member states while the larger group consisting of consumers and entrepreneurs are harmed by the regulations (Gilber and Wong, 2002). This is mainly because giving benefits to the airlines also benefits the state itself as the flag carrier acts as an ambassador to the country and a symbol of national pride. On the other hand the public interest theory indicates that regulation is mainly aimed at correction of market failures (Hubner and Sauve, 2001). It is argued that regulation corrects malfunctions of the market including increasing uncertainty, concentrations of power, adverse distribution effects and performance failures that the market cannot be able to correct by itself (Hummels, 2007). It also argues that regulation is important for promotion of public interests which cannot be promoted by market-oriented measure (Barret, 2004). This theory has been applied in justification of regulation of the airline transport industry in the USA and other countries. The underlying argument is that the governments favor strict regulation of the industry so as to ensure that there is adequate service and safety in air transport thus promoting public interest (Hummels, 2007). Airline regulation has evolved over the years since World War I mainly through international agreements and conventions; The Paris Convention This convention is also referred to as the Convention for the Regulation of Aerial Navigation (Chang and Williams, 2001). It was signed as far much back as 1919 and is famous as the pre-eminent multilateral agreement for international aviation. This agreement originated from the Paris Peace Conference of 1919 and set the foundations for regulation of the international airline industry (Balfour, 2004). This convention was based on the need for recognition of the sovereignty of the airspace above every country, it underlies all aviation negotiations globally today (Chang and Williams, 2001). The Chicago Convention on International Civil Aviation This convention is commonly referred to as the Chicago Convention and was signed in 1944 by 52 states (Hansjochen, 2001). While the convention still awaited ratification by 26 states, an interim organization called the Provisional International Civil Aviation Organization (PICAO) was formed. In March 1947 after all the ratifications had been received, the organization officially became the International Civil Aviation Organization (ICAO). The main function of the Chicago convention was to provide a regulatory framework for global air transport and standardize the industry; ICAO was created to perform this function (Balfour, 2004). The convention had a number of fundamental outcomes after its formation; first, it ensured the standardization of different operations in terms of various ‘freedoms of air’. The various degrees of freedom to utilize airspace over different territories has formed the basis for how much lee-way a country can give another country in operating their airspace (Barret, 2006). There are a number of freedoms that were set up by ICAO, the first example is the freedom or right to fly and carry traffic non-stop over the territory of the state granting the freedom. In this case a carrier from a particular state has the right to carry traffic and fly non-stop over the territory of the state granting the rights as illustrated by figure 1 (Grosso, 2008). Figure 1: First freedom Another example of freedom is the right to carry traffic and fly over the territory of the state granting the right and to make one or more stops in the country for non-traffic purposes (Grosso, 2008). This was very useful in the times before introduction of long-range aircraft because flights needed to make refueling stops (Grosso, 2008). This is demonstrated by figure 2. Figure 2: Second Freedom Deregulation Deregulation is a term that is mainly associated with the US air transport industry, in other parts of the world the terms liberalization or regulatory reformed are used to describe the deregulation (Hindley, 2004). Regulation in the US originated from the Airline Deregulation Act (ADA) which came into action in October 1978. The Act was mainly intended to minimize government control over the airline industry and open the domestic passenger air transport industry to market forces that could make it more competitive (Hanlop, 2006). The ADA was crafted with the main intention that market forces would determine the quantity, quality, and price of domestic air services in the USA thus reducing fares, lowering barriers to entry into the market for new airlines and increase the use of different aircraft for various roles (Hindley, 2004). The result of deregulation of air transport in the country was a free and efficient marketplace that would encourage competition within the market and lift the growth of the air transport industry (Micco and Serebrisky, 2006). The act targeted removal of restriction within a period of four years with the main target being complete elimination of restriction on the domestic US routes by the end of 1981. All domestic fare regulations were supposed to come to an end by the beginning of 1983 (ICAO, 2005). Liberalization Unlike the deregulation of airline transport in the United States, liberalization within the European Union combined into a single market a number of distinct national markets which were previously interlinked by various bilateral agreements (). The decision of liberalization of the EU airline industry was borne out of the move towards a single international market across a large range of economic activities in the continent through the Single European Act (WTO, 2007). The reforms in all economic sectors including airline transport were introduced at a time of recession, high levels of costs among many of the national airlines, and growing congestion in various of the international airports in the EU (Barret, 2004). Before the establishment of the EU single market in 1993, the air transport market across the whole of Europe was made of a collection of national markets in each country. The domestic air services within each of the countries were governed by national regulations that varied enormously in terms of levels of promotion and permission of competition (Gronenc and NIcoletti, 2000). The international air transport industry in Europe was mainly governed by bilateral agreements between pairs of countries (WTO, 2006). It must be noted that although some of the bilateral agreements were significantly liberal, all of them contained traditional ownership and control restrictions and many were faced restriction of market access and capacity. This frequently allowed only one airline from each of the countries to operate services, these were often on a limited number of routes. At that time international fares were generally agreed between airlines under the auspices of IATA, even then, both the international and domestic fares were the subject of government regulations (WTO, 2006). Although there had been earlier efforts in 1987 through two international agreements permitting partial capacity and tariff liberalization, the first concrete steps towards liberalization of the EU airline transport market were taken within the framework of the EU after creation of the common market (Barret, 2004). After the creation of the EU common market in 1993, a process of progressive liberalization in the airline industry did away with the pre-existing institutional barriers to market entry and competition (Grosso, 2008). Liberalization of the air transport market created a genuinely single market for airlines within the EU which has since extended to cover other countries including Norway, Iceland, Liechtenstein and others through creation of the European Economic Area (IATA, 2000). Other countries, including Switzerland are now associated with the market through bilateral agreements. The liberalization of the European Airline industry involved removal of restrictions issues such as market entry, frequency of flights, and pricing. This resulted in greater emphasis on the application of normal competition laws so as to safeguard against abuse of market power and uncompetitive behavior among market players (WTO, 2007). Some rules which had already been in place from 1987 helped the EU in applying competition regulations to the EU Treaty, these particularly included Articles 81 and 82. According to Article 81, there can be no agreements between firms which prevent, distort or restrict competition unless such agreements can be proven to promote technical or economic development that will bring benefits that consumers can also enjoy a share of. Article 82 on the other hand prohibits the abuse of a dominant position. Outcomes of Regulation The regulative environment that prevailed before liberalization provided an environment that had many negative outcomes for the airline industry although it had its benefits, particularly in protection of national carriers. The environment was mainly characterized by bilateral agreements that tried to take advantage of regulations or tried to lessen the economic impacts of regulation to their operations (Barbot, 2006). The agreements and regulations controlled air traffic flow between partner countries through designation of air carries that served routes through control of market access (ICAO, 2005). In that environment, markets were determined in advance in terms of shares in relation to total market size while new entrants were suppressed. Some of the effects of the bilateral agreements on the industry included high airfares especially in the European region which was dominated by bilateral agreements; there was inadequate attention to the costs of airlines both internally in their countries and internationally; increase in airline costs were passed in to passengers by airlines because competition was not based on price; and the industry has low profit margins because most airlines were government-owned (Micco and Serebrisky, 2006). Outcomes of Deregulation and Liberalization Deregulation in the USA and liberalization in the EU and other countries had various outcomes on the global airline industry. Just in the first decade after deregulation in the US (1978 to 1987), various impacts were evident in the airline transport industry. First, passenger enplanements had increased by to 55%, secondly, employment in the industry had risen by over 150 000 jobs (ICAO, 2005). Other impacts included increase in scheduled passenger revenue miles by about 62%, availability of seats on airplanes had increased by 65%, and in terms of fares the deregulation had allowed discount fares that were ion use by over 90% of travelers by 1990 (ICAO, 2005). Deregulation has largely transformed the aviation industry in the US from a public utility to a modern business which makes the industry much more competitive, efficient, and profitable (Deardorff and Stern, 2008). It is evident that the free market has boosted business because airlines now make more money by flying longer journeys. On the other hand, in terms of operating costs, more destinations for an aircraft implies greater revenue for the airline and the running costs for the aircraft can be spread over its design life (Chang and Williams, 2001). Another effect of deregulation is that it has allowed aircraft to fly to several destinations thus enabling favorable competition along specific routes, particularly if the passenger demand is high enough (Buttle, 2004). In Europe, liberalization of the air transport industry has resulted to a number of impacts to the industry. Although the total number of airlines based in the UE that provide scheduled services have not changed a lot, the rate of entry and exit from the market is very high with many airlines coming in while other leave, collapse due to cut-throat competition, or become full franchisees of other airlines (Hansjochen, 2001). The lowering of barriers to entry in the market as a result of liberalization has encouraged innovation and entrepreneurship in the EU airline market. This has encouraged the establishment of many new airlines that operate totally within the liberalized area, a situation that has resulted to growth in competition, particularly on the domestic routes (Barret, 2004). One of the greatest benefits of airline liberalization has been the coming up of low-fare no frills airlines that have now assumed about 10% of the total domestic market in the EU and are continuing to expand rapidly (Barbot, 2006). For example, the no-frills airlines transported 25% of the passenger traffic on the routes between the UK and other EU member states in 2001 alone (ICAO, 2005). There has also been an increase in the number of schedules intra-EU routes that has resulted to passengers benefiting from an increased number of direct flights (Grosso, 2008). Figure 3 shows a chart illustrating air transport service trends after liberalization of the market. Figure 3: Air transport services after liberalization (ICAO, 2013) Deregulation has also come with negative impacts. As indicated by Grosso (2008), the move away from restrictive bilateral agreements towards liberalization means that member countries cannot be able to unilaterally negotiate commitments to open specific service sectors foreign competition thus allowing them the same treatment as domestic businesses. Liberalization has also resulted to lack of ability by countries to control the progressive liberalization of access of their own markets (Hindley, 2004). Finally, liberalization has also allowed for trade-offs between all the products and services, forms of trading and even between all the countries. This represents a disadvantage because bilateral international airline agreements were sector specific and country-specific thus all the entitlements that accrued were restricted to the countries (WTO, 2007). Modern Regulation and Airline Alliances Even though deregulation and liberalization of the airline transport industry in the USA and Europe has come with many benefits for the industry as well as the economies of the countries involved, some level of regulation still goes on various airline markets in the world. Airlines from developing countries particularly benefit from some level of modern regulation because most of them are still infant and underdeveloped and thus require protection from the cut-throat competition of airlines from the developed world (Micro and Serebrisky, 2006). Such regulation is implemented both directly and indirectly through regulations and trade agreements. Modern regulation is however largely implemented through bilateral and multilateral agreements that are largely controlled by government; these enable domestic airlines to work in bilateral or multilateral collaboration with other more developed airlines in alliances (Balfour, 2004). The agreements largely allow sharing of customers and routes between local flag carriers and major international airlines with the domestic airlines being left to local carriers (Hubner and Sauve, 2001). Airline alliances are defined as agreements between different airlines to share codes, routes, and slots in international airports as a way to break into different air transport markets (Chang and Williams, 2001). These alliances have come up as being very useful particularly in markets which are still controlled by levels of regulation to protect weak national carriers, particularly in developing markets. In alliances, the airlines do not have to originate from the same region or country in order to form the alliance. According to Barret (2004), alliances between airlines are important for expanding and strengthening globalization. Most of the alliances that have been created by now have provided a way for the carriers to mitigate the limitations of bilateral agreements, licensing and control regulations, and ownership restrictions (Balfour, 2004). As such, alliances can be viewed as a measure of removing or reducing barriers between countries which still serve to a degree as market regulations. According to Grosso (2008), the last decade has witnessed the emergence of an increasing number of strategic alliances between airlines from all over the world. These coordinate a number of aspects of their operations including the building of integrated route networks that are operated by the members of a particular alliance of partner airlines (WTO, 2006). From an economic point of view, alliances enable airlines to expand their networks with the advantage of higher traffic density resulting to higher load factors in the different markets of the network (Gronenc and Nicoletti, 2000). Another advantage of alliances is that they ensure lesser duplication of capital investments, particularly fixed costs associated with new stations (Hummels, 2007). Some examples of alliances in the global airline industry include the Star Alliance and the Sky team. Conclusion Regulation of airlines is a process that started over a century ago with the sole aim of helping countries to protect their airspace at a time of great suspicion between major world powers. With time, as commercialization of airlines increased with viability of expansion in air transport national carriers became the pride and image of states and were therefore highly protected through regulation. This protection however also aimed to reduce competition that could disadvantage not only national carries but also domestic airlines in their markets. With time airlines started utilizing bilateral agreements to increase the economic value of their operations and access markets that were previously accessible. Due to the many disadvantages associated with regulative protection of markets, deregulation started in the USA with airlines getting greater leeway to operate freely in different routes and work in a competitive environment. It is evident that this resulted to immediate impacts with growth of profits and employment figures in the industry. Deregulation efforts in the EU followed shortly in the late 1980s with the main terms used being liberalization of the market. Even though the efforts were slow at first, the creation of the EU common market in 1993 quickened the process leading to a common liberalized air transport market in the EU. The market has produced great benefits both to economies and airlines but it has not been without disadvantages. The main disadvantage has been high rate of turnover of airlines because of competition. There is still some level of regulation in the airline industry particularly in the developing markets where governments still need to protect their infant air industries to encourage growth. However, air alliances have come in as a beneficial strategy to improve performance and maximize profits through economies of scale. Some weaker airlines are utilizing the alliances to their advantage in pursuing growth and profitability. References Balfour, J., 2004. EC competition law and airline alliances, Journal of Air Transport Management, 10, pp. 81-85. Barbot, C., 2006. Low-cost airlines, secondary airports, and state aid: an economic assessment of the Ryanair–Charleroi airport agreement, Journal of Air Transport Management, 12(4), pp. 197-203. Barrett, S.D., 2004. How do the demands for airport services differ between full-service carriers and low-cost carriers?, Journal of Air Transport Management, 10(1), pp. 33-39. Barrett, S.D., 2006. 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