The Competitive Status of the U.S. Civil Aviation Manufacturing Industry: A Study of the Influences of Technology in Determining International Industrial Competitive Advantage (1985)

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THE PRESENT ENVIRONMENT 30 fleet. Because of CAB regulation the major airlines engaged in almost no fare competition to achieve lower costs through modifications in service or economies in airline operation. They did little to probe customer preferences by experimentation in fares or levels of service. The major airlines, not surprisingly, resisted both the entry of new airlines and attempts of smaller commuters to expand routes and service, even though they themselves were not aggressive in serving low-density locations that did not provide an attractive basis for profitable operations. Lack of competition in fares and service, combined with pressure of smaller operators to expand, is credited with creating an environment that fostered demands for deregulation. Airline Restructuring—Deregulation The rapid increase in fuel costs after the Organization of Petroleum Exporting Countries (OPEC) crisis in 1973 was a jarring note to the financial performance of the airlines. These escalating fuel costs changed the cost structure and operating characteristics of the industry. In the early 1970 the cost of fuel as a percent of total operating expenses was 12.7 percent. The cost began to escalate in 1974, reaching 30 percent in the early 1980s (Table 2-1 ). A second major perturbation was created by deregulation. The termination of airline economic regulation in 1978 removed the TABLE 2-1 Jet Fuel Costs, 1970–1982 Year Cost Index (1972 = 100) As Percent of Cash Operating Expenses 1970 93.7 12.7 1971 97.0 12.6 1972 100.0 12.0 1973 109.3 12.2 1974 208.0 17.4 1975 249.7 19.1 1976 271.6 19.5 1977 310.6 20.5 1978 336.8 20.1 1979 496.0 25.1 1980 766.1 30.5 1981 892.7 30.3 1982 841.6 28.1 SOURCE: Air Transport Association of America, Inc., Aerospace Facts and Figures, 1983/1984, p. 98. 

THE PRESENT ENVIRONMENT 31 barriers to entry and opened the door to new routes, new carriers, and unprecedented competition and flexibility in fares and services. Experience soon demonstrated that fare levels were more important to many people than service amenities. It is not yet clear, however, how many new passengers have been attracted as a result of lower fares because passenger statistics of this nature are limited and subject to various interpretations. The situation is further beclouded by the coincidence of a major recession. During the era of regulation, short-range jet transport operation was traditionally subsidized by longer routes, with the level and degree of subsidization controlled by the CAB. Furthermore, the CAB provided direct subsidies for many short routes. These regulatory policies had the effect of creating an artificial marketplace in the domestic United States, which distorted operating efficiency and equipment selection to the disadvantage of some consumers—i.e., frequency of service was low to smaller localities; fares tended to be artificially high on the longer, more heavily traveled routes in order to subsidize the short, lower-density operations; and little was available in the way of specialized equipment to serve the commuter market because it did not appear attractive enough to stimulate the interest of aircraft manufacturers. As the impact of deregulation began to be felt, the large carriers responded by abandoning their less productive, low-density markets. Commuter airlines, many of them new, expanded to fill the void. The number of certificated scheduled carriers offering passenger service has expanded from 36 to 98 (Figure 2-1). In addition, service in terms of number of flights and passenger seat-miles available has been increased for more thinly populated areas.1 Perhaps more important, the structure of air travel service has changed markedly. The regional/commuter airlines have expanded the number of airports served, while the major national airlines have markedly reduced the number of airports served (Table 2-2). The trunk airlines have instead concentrated their attention on the largest hubs, where they offer competing service with majors already entrenched. Table 2-2 shows a 79 percent reduction in airports served exclusively by the majors and a 58 percent increase in airports served exclusively by regionals. Table 2-3 shows that in March 1983) 15 major carriers were serving only 42.8 percent of the city-pairs they had served in March 1978. The pairs dropped were replaced by joining other majors at a few major hubs. Figure 2-2 indicates the concentration of the major carriers on the large hubs. The sharp shift to the right of the lined bars indicates the dramatic concentration of major carriers at major hubs. At deregulation the average major hub was served by seven major carriers, by 1983 it was served by 10. 

THE PRESENT ENVIRONMENT 32 Figure 2-1 Number of Certificated Carriers Before and After Deregulation (Civil Aeronautics Board documentation of air carrier traffic statistics for September of each year) Source: Civil Aeronautics Board. One study of airline productivity before and after deregulation found that average annual improvement for 10 trunk airlines increased from 2.6 percent between 1972–1975 to 4.9 percent for 1975–1980. Improvements for regional carriers increased from 4.0 percent in 1970–1975 to 6.3 percent in 1975–1980. The two categories combined showed an improvement from 2.8 percent to 5.1 percent. These numbers indicated a substantial improvement in productivity in the period including deregulation.2 It should be noted that evaluation of productivity for a service such as air travel where convenience and time saved are important ingredients for many users, is exceedingly difficult. The study cited does not attempt to incorporate these variables. The airlines have responded to deregulation by revising their strategies for designing routes. The earlier emphasis on nonstop city-pair routes is being supplanted by an expanded hub-and-spoke strategy. This strategy seeks to improve load factor by strengthening market positions in selected hub cities where airlines already have strong positions by funneling increased traffic in from other cities. Consequently, the number of major airlines serving major hubs has tended to increase significantly, while 

THE PRESENT ENVIRONMENT 33 service to lower-traffic airports is increasingly being left to regional airlines; however, the number of nonstop flights between long-distance city-pairs is being reduced. Figure 2-2 shows the significant increase in service being offered by the 11 major airlines at the 25 largest hubs. Many of the major airports are now serving as key transfer points for passengers.3 TABLE 2-2 Airports Served by Regional and Major Airlines, 1978 Versus 1982 1978 1981 1982 % Change 1978–1982 Airports served Regional/ 630 766 817 +30 Commuters Major/Nationals 673 389 323 -52 Exclusive airports served Regional/ 359 504 566 +58 Commuters Major/Nationals 230 80 49 -79 SOURCE: Fairchild Industries, Inc. Evaluation of the consequences of deregulation for the passenger depends very much on one's point of view, and both advocates and opponents have strongly held views. The panel has TABLE 2-3 Major Airline Service Reductions Since Deregulation Carrier City-Pairs Served In Both March 1978 Percent of City-Pairs March 1983 and March 1983 Served in March 1978 Which Were Also Served in March 1983 Northwest 284 165 58.1 Pan American 109 62 56.9 Eastern 503 273 54.3 Delta 645 335 51.9 Trans World 237 120 50.6 USAIr 566 282 49.8 United 472 226 47.9 Piedmont 383 164 42.8 Ozark 208 83 39.9 Frontier 231 90 39.0 American 343 129 37.6 Western 253 86 34.0 Republic 945 305 32.3 Continental 384 59 15.4 Braniff 0 0 0.0 Total 5,563 2,379 42.8 SOURCE: Official Airline Guide, March 1, 1978 and March 1, 1983. 

THE PRESENT ENVIRONMENT 34 not attempted a comprehensive evaluation—it is beyond the scope of the study. The panel's perception of the various points of view is that for the frequent business traveler, chaotic fare structures and frequent changes have been unsettling; at the same time special incentive plans have offered him fare reduction. Furthermore, his interest in frequent point-to-point service between city-pairs is now sometimes less well served, (especially for longer-distance pairs) and in-flight amenities such as food and space have deteriorated. For the traveler who seeks the lowest possible cost and is willing to accept some inconvenience and minimal amenities, the result has been dramatic improvement. Travelers, both business and nonbusiness, in smaller communities face a mixed picture. For some, service is improved; for others, service is less convenient or nonexistent—commuter airlines, usually with propfan equipment, have expanded coverage; the trunk airlines have reduced it severely. Figure 2-2 Concentration of Major Airlines at Large Hubs Before and After Deregulation Source: Official Airline Guide. 

THE PRESENT ENVIRONMENT 35 This change in route structure also changes the comparative demand for large versus small airplanes. For smaller route segments, the carriers need smaller aircraft. Consequently, there is a surplus of large aircraft (747, DC-10, L-1011) and increased demand for commuter airlines and fuel-efficient, 100- to 175-seat equipment. In fact, there is still considerable uncertainty regarding what mix of equipment will best serve future markets. Depressed airline earnings and reduced demand for travel have created a pool of unused or underused aircrafts not necessarily with the lowest operating costs, but available at rock-bottom prices. Free entry and the absence of fare regulation make it possible for new operators to buy or lease such aircraft, select a high-density route, lease the operating infrastructure (ticket sales, baggage handling, maintenance), and hire otherwise unemployed flight and cabin crews at less than the salary scales of established major and national carriers. These new carriers obviously have very low costs in their selective route operations and can price their seats to be profitable at the margin for less than the established carriers, which have a large infrastructure, union salary scales and work rules, and the loan payments on highly efficient modern aircraft. There are several consequences: • Ticket prices stay low, driven by the lower costs of the new entrants, so that some established carriers continue to incur losses or nominal profits even as traffic grows. • Operators find it more difficult to justify paying the high price of new and more efficient aircraft since the improvement in aircraft productivity may not outweigh the economic benefit of old, inefficient aircraft bought at discount prices and operated with low-cost labor. • As new aircraft are bought by foreign, state-owned airlines, their used aircraft are taken in trade and frequently appear on the U.S. market. The present period is one of transition, aggravated by the recent recession that further beclouds the future. The character of the eventual new equilibrium— assuming one ensues—is uncertain. More time will be required for the full effects of deregulation to become clear. Despite the pressure for improved efficiency in operations, the lower fares, and the improved service to some smaller communities that deregulation generated, one cannot yet conclude that the present arrangement is optimal. In assessing results, it is important for consideration to be given to all the significant effects, including safety and the impact on the aircraft manufacturers. 

THE PRESENT ENVIRONMENT 36 Irrespective of the details of the outcome, high priority must continue to be placed on safety. Even though the commitment to safe operations of all interested parties is continuously reaffirmed, it is important to reexamine all the institutional arrangements for insuring safety in the light of the changing character of the air transportation industry. There is little question that the airworthiness of aircraft is subject to continuing careful scrutiny. During the era of controlled entry the professionalism, operating competence, and experience of the airlines with respect to such matters as flight crew training and monitoring, maintenance standards, replacement schedules, training and monitoring of maintenance crews, and depth and experience of engineering staffs were well established. The airlines then operating had been in business for many years and level of safety and reliability of schedules were major elements of the airlines competitive stature. However, with barriers to access removed it is important for the FAA inspection process to take into account such factors as the changed character of the industry, the many new entrants, the comparative lack of extensive operating experience and the variety of equipment utilized by given operations. For example, it is important to insure that severe cost pressures and the more heterogeneous fleets —with some flight and operating crews having to adjust to different instrumentation, flight deck layouts in aircraft, and work rules—do not lead to deteriorating standards of quality and safety. Accumulating experience has led to increased government attention to this situation. Deregulation, depressed economic conditions, and growth of foreign competition are having profound effects on the U.S. manufacturers of aircraft. The subject is complex and multidimensional. One potentially disturbing effect concerns the continued capability of U.S. aircraft manufacturers to launch new aircraft. Depressed traffic and earnings of the airline industry have caused a severe reduction in new orders, deferment of deliveries, and in a number of cases, inability to take delivery of firm-order aircraft. The prospect of continued instability in route structure shortens the time frame over which forecasts can be relied upon for decisions on capital investment. It is difficult to make a decision based on a calculation of the return on investment of a new aircraft with a service life of 20 years when routes and traffic can not be forecast credibly for the next 12 months. Although it is premature to make such a dire prediction, these adverse conditions could persist long enough to prevent the launch of new programs, cause the termination of current development and production programs, and lead to the disbanding of the teams performing advanced development. Such an eventuality would lead to a deterioration of aircraft design, development, and