There's No Conspiracy for High Airfares
The only thing worse than a crowded airplane is the idea that an airline is making a profit off of it. That, at least, appears to be the conclusion of the U.S. Department of Justice, which last week announced it had opened an investigation into whether U.S. airlines are colluding to limit seats on busy routes, and thereby enhance their pricing power.
For passengers who have grown weary of paying more for what feels like less, that might seem like justice. In reality, it’s overreach.
The Department of Justice investigation focuses on the four major U.S. carriers that control over 80 percent of the seats on domestic U.S. routes: American, Delta, Southwest, and United. According to U.S. Department of Transportation data, those routes are more packed than they used to be. Between 2002 and 2014, as airlines became more efficient at apportioning planes and seats to routes, the load factor (a measurement of how full a plane is) on U.S. passenger planes to U.S. airports went from 71.78 percent to 83.43 percent. Fuller planes allow airline to charge higher fares (while flying fewer empty seats), and are widely acknowledged to be a major factor in why U.S. airlines have recently posted record profits.
Many airline critics look at this phenomenon and see cause for alarm. But on its face, there's nothing nefarious going on. Airlines, like any other business, have simply focused on matching their supply with demand (and thereby eliminated losses due to excess inventory).
The Department of Justice raises two red flags about the airlines' business practices. First, U.S. airlines seem to have discovered "capacity discipline" at roughly the same time. And second, airline executives have, in recent years, been very vocal in their public statements -- at investor conferences, Wall Street and at trade shows -- about their commitment to their new business model (and their hopes that competing airlines will adopt it). During last month’s annual meeting of the International Air Transport Association, the world’s leading trade association for airlines, airlines executives offered independent, but seemingly unanimous, endorsements of "capacity discipline." To cite just two examples, Delta’s President claimed that his airline "is continuing with the discipline the market is expecting," while American Airlines CEO Doug Parker assured the assembled that the airlines had learned their lessons from past price wars.
For the Department of Justice, the question of criminal collusion comes down to whether all of this open talk about restraining the growth of seating capacity qualifies as a knowing wink between competitors (perhaps backed up by discussions out of the public's sight).
But there’s a big hole in the collusion theory. At the very time that the Department of Justice is looking into the possibility that the airlines are cooperating to have fewer available seats, seating capacity at the airlines in question has been growing, leading to downward fluctuations in airfares. In other words, if airlines are colluding with one another to eliminate seats and thereby raise ticket prices, they're doing a poor job of carrying out the plan.
Last week Bloomberg News reported that seating capacity had grown 2 percent in 2014, and was growing at a 5 percent clip in 2015. Southwest Airlines, for example, increased capacity by 7.6 percent in May, as passenger traffic increased 8.6 percent. But when the airline noticed that its revenue was declining per passenger, it did the natural thing and announced further capacity cuts in June. In theory, those cuts could have been made in tacit collusion with its competitors; more likely, they were just the result of smart observations by executives at Southwest about supply and demand.
Of course, the Department of Justice's case will probably be built on data dating back much further than this summer. But it’s difficult to see an argument for collusion there, either. For example, the average domestic U.S. airfare grew a modest 7 percent between the fourth quarter of 2004 and 2014 in inflation-adjusted terms, from $366.82 to $392.66, according to the Department of Transportation, and only 2.3 percent from the fourth quarter of 2011. To be sure, some markets where competition has been eliminated because of extensive airline mergers have seen larger fare growth. (Omaha, for example.) Airlines have also learned to wring additional revenue from passengers by layering baggage and other fees atop fares -- fees, it’s worth noting, that the airlines have fought to conceal. But even so, there’s no escaping the fact that today’s average airfare is still cheaper, in inflation-adjusted terms, than average prices during the early 2000s.
In fact, if there’s anything mysterious in the Department of Justice's interest in these issues, it’s the timing. The problems identified by prosecutors trace back to the consolidation of the U.S. airline industry into a handful of carriers over the past decade -- a process that consistently won the approval of the Department of Justice's antitrust division. As long as there are only four major airlines, any business model that generates profits is likely to be adopted by a competitor. That’s not necessarily collusion. In a market where competition has been grounded, it’s just good business practice.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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