The US Airline Industry: an Atypical Oligopoly
Op-Ed: Deregulation can be seen as the turning point conducive to the airline industry becoming an atypical oligopoly.
Op-Ed: Deregulation can be seen as the turning point conducive to the airline industry becoming an atypical oligopoly.
DALLAS — Before we claim that the US airline industry resembles an oligopoly, we must first understand what the term means.
An oligopoly is a market structure in which a small number of large companies work to dominate a specific market segment, either explicitly or implicitly. This is normally done through collusion, and due to the limited competition between these firms, each firm can influence the others through their actions.
Firms in oligopolistic markets set prices but do not compete on price; however, they use advertising to ensure that their products are uniquely identifiable (oligopolies are known for having undifferentiated products).
Products in an oligopoly typically provide the same benefit to consumers. Other characteristics of oligopolies include increased barriers to entry and maximized revenue. Economic and legal factors can create or destroy oligopolies.
In terms of the aviation sector, deregulation policies can be seen as the turning point for the industry and the precise point where the industry became an atypical oligopoly.
The federal government took control of the economic underpinnings of the US airline industry in 1938, and thus the industry was considered a public utility, much like electric power companies.
The Civil Aeronautics Board (CAB) was established at the time as a governing agency responsible for regulating the economic aspects of airline operations. The CAB had five members with six-year terms, appointed by the president (with the consent of the Senate). With its 750 employees (on average), the CAB conducted its duties until its dissolution in 1984, after the deregulation act was passed.
On October 24, 1978, the Airline Deregulation Act of 1978 (ADA) was passed, and air travel in the United States was thus revolutionized.
The law did not completely erase regulatory measures in the industry. It reduced the regulatory blanket gradually over the years until 1984. By then, CAB’s standing functions had been transferred to the Department of Transportation (DOT).
In its reign, the CAB decided how many airlines and which airlines would conduct operations on a particular route. To enter the market, airlines had to gain certification from CAB outlining the routes that must be followed. The exit was also controlled, and it required the carrier to receive CAB approval before cutting services to a city.
This massive shift in the industry was mostly contained in the US, but by the mid-1980s, Canada and Western Europe began adapting these deregulation policies; the rest of the world joined this movement in the mid-1990s, but not without resistance by various governments and foreign airlines.
Despite the fact that the airlines were not subject to stringent government regulations, they faced the same financial and economic challenges as any other business. They include, among other things, managing staffing issues, cost analyses, leveraging financing instruments, and maintaining brand loyalty, which must still be considered.
As one example, apart from suffering from repeated instances of financial mismanagement, TWA failed because the airline couldn’t effectively compete with new competitors after the airline deregulation act of 1978. These new airlines would reside in a special economic environment, and these characteristics would end up labeling the industry as an atypical oligopoly.
[wlm_private "Airways Premium"]
Airlines offer what is known as an "undifferentiated product"—meaning passengers typically cannot distinguish between the services they offer. Modern aircraft are very similar; the speed, safety, legroom, and overall comfort are likely to be similar on Delta (DL), American Airlines (AA), United Airlines (UA), or any other carrier a passenger chooses.
This is where advertising becomes paramount, airlines will promote any amenity or element that is uniquely different from their competitors to separate themselves and maintain or grow their brand loyalty.
For example, JetBlue (B6) is not the only airline to offer free snacks on board, but they provide the most variety, including their branded Terra Blues potato chips. This allows B6 to stand out as the snack-friendly airline or the “blue chips airline,” making it easily identifiable, which leads to sustained passenger demand.
Other differentiating tactics may be much bigger and more costly than offering free chips, carriers will spend a lot of money, time, and research curating a unique business-class experience whether it's through the menu options or the luxury amenities. In a more realistic model, a passenger selects a flight based on departure and arrival times rather than their preference for one airline over another.
For instance, an excited traveler booking a trip to Jamaica would most likely select the flight that lands at Sangster’s International Airport at 8 a.m. versus the one that lands at 11 p.m. at night. Therefore, we could poise that airlines compete in departure and landing slots.
Airlines must also consider the product's high perishability—the seats on each flight. An unfilled seat on that flight to Jamaica cannot be stored and resold later, the second the cabin crew closes the door, the unfilled seat is recorded as a dead loss. In order to combat the threat of dead losses, airline analysts developed complex pricing and revenue management strategies.
So far, we have discussed the undifferentiated product and its highly perishable nature. But there is also some contraction between two other characteristics of the airline market structure—ease of entry, and tendency to monopoly or oligopoly.
Entering the airline market or even expanding into a new one is, for our purposes, relatively easy. To understand this point, we must oversimplify what it entails to start an airline—that is, we should first ignore the high price tag on aircraft, taxes, legal requirements, hiring and training staff, and advertising, among other elements.
If we stripped these variables away, we could see how entry into the market is easy; all a newcomer would need is to buy or lease an airplane (which is no big task as most investors in a new airline are infused with high capital).
A startup airline does not need to own the airspace and terminals, unlike a railroad where you must build the track and purchase the right-of-way. Therefore, we can classify the economic barriers to entry as minimal, especially when we compare them to other industries such as manufacturing.
Even though we can classify that entry is relatively easy in the airline industry, there is an element that contradicts this trait—airlines tend to eliminate new competitors, which leads to an oligopolistic structure or even a monopolistic structure in some instances.
This trait has been the basis for the need for government regulation in the market. To clear up the contradiction, it is crucial that we separate the short-run experiences from the long run; it is one thing for a new airline to enter the market but it’s a totally different playfield for it to survive and strive in the long run. Where deregulation allowed entry of many new airlines, only a few have survived the forces of the industry.
This is what gives the airline industry its atypical oligopoly status: while in our oversimplified model entry, it was easy to flat out, in a more realistic model, the requirements will discourage potential entrants. For example, when the incumbents’ large economies of scale are enough to halt entry, this makes for the US airline industry to become a prime example of an atypical oligopoly.
We could argue that the US domestic airline industry represents an oligopoly where four carriers' combined market share totals two-thirds of the domestic market (in aggregate), but no carrier exceeds 20% of the market share.
According to Statistica.com, the big four in 2021 include AA, Southwest Airlines (WN), DL, and UA, with market shares of 19.5%, 17.4%, 16.3%, and 12.9% respectively, totaling a combined market share of 66.1% of the domestic market.
Some think the industry is currently viewed as unfair by consumers because of its high ticket prices, which are often assumed to have been achieved through collusion or other tactics, and its poor service when compared to European air travel offerings.
Before the pandemic, major US carriers ceased unprofitable flights, increased their load factors, and slowed capacity growth to gain higher airfare. It has also been argued that these airlines would avoid certain routes to give the other a monopoly on that market, which enables the power to dictate prices without competition interfering.
In short, economists have accused the US industry of colluding but there has never been any hard evidence to propel these claims. However, it is believed that through tacit collaboration, the aforementioned carriers have created market power that benefits them and negatively impacts consumers whose taxes are used to fund major airline bailouts of the past. Let's recall that the COVID-19 pandemic led the industry to receive a US$25bn bailout from the US government.
Coming back to deregulation, it also created more consolidation, such as DL and Northwest Airlines (2008), UA and Continental Airlines (2010), WN and AirTran (2011), and AA and US Airways (2013).
Here we see that the Big Four have all conducted mergers, and while the US Department of Justice tried to block AA’s merger with US Airways by suing the airlines, the matter was settled, and AA was granted the green light to proceed after agreeing to divest some slots and gates.
More recently, The Department of Justice attempted to block AA and B6’s Northeast Alliance code-sharing agreement, stating that the deal would negatively impact passengers and eliminate competition at New York and Boston airports. The carriers continued their expansion and requested that the pending suit be dropped.
The DoJ states in its 2021 suit that the "alliance eliminates competition in New York and Boston and harms air travelers nationwide." The airlines countered, saying that the codeshare "will give customers access to the largest flight schedule on the most connected network" in the country.
In the end, we read in the Federal Register that the "DOT's review of the NEA under section 41720 was not designed to approve or disapprove the alliance. During the Department's review, American and JetBlue entered into negotiations with DOT. These negotiations culminated in the DOT Agreement with American and JetBlue on January 10, 2021, in which the carriers agreed to take actions to address several Departmental concerns about anticompetitive harms arising out of the NEA."
In conclusion, the US airline sector is, to some extent, a good example of an atypical oligopoly. No one airline has a dominant market share, but a few airlines provide services to the majority of passengers nationwide.
Competition on some routes is limited but some analysts have simply credited geography for this occurrence. There have been mergers and acquisitions that pundits have also criticized, mostly in regard to high ticket prices; however, even with the high barriers to entry and increased consolidations, ticket prices are still lower since deregulation took hold of US skies.
The fact is that The US aviation industry has faced many challenges since deregulation in 1978: oil and energy crises, 9/11, and climate change. Now, as it begins to recover from the fallout of the pandemic, the industry faces even broader economic challenges that need its own strategies, experts, and solutions.
The airline industry is resilient and knows how to adapt, even taking heavy losses in the process. Therefore, it is almost impossible to explicitly classify the US airline industry, and global commercial aviation as a whole as an oligopoly when the industry’s behavior continues to contradict itself.
[/wlm_private]
Featured image: A United Airlines Boeing 737-9 MAX, American Airlines and Southwest Airlines Boeing 737-8 MAX sit in Renton. Photo: Brandon Farris/Airways
.webp)
David H. Stringer, the History Editor for AIRWAYS Magazine, has chronicled the story of the commercial aviation industry with his airline history articles that have appeared in AIRWAYS over two decades. Here, for the first time, is a compilation of those articles.
Subjects A through C are presented in this first of three volumes. Covering topics such as the airlines of Alaska at the time of statehood and Canada's regional airlines of the 1960s, the individual histories of such carriers as Allegheny, American, Braniff, and Continental are also included in Volume One. Get your copy today!
