A major factor contributing to the industry’s struggles during the current crisis was the loss of resiliency due to the consolidation of the airlines serving the intercontinental market. Part 1 of 4.
It is difficult to imagine how a stable, efficient, and competitive private sector airline industry could possibly emerge from the staggering post-coronavirus demand collapse. Aviation history provides many examples of far less serious crises triggered by bad corporate decisions (expansion far beyond market demand) and external shocks (major fuel price spikes, recessions, wars, terrorism). Recoveries from these smaller crises were slow and traumatic and depended on a large set of conditions that no longer exist.
In past airline crises, the most serious financial problems were limited to just a portion of the industry, and those carriers had ample liquidity, thanks to healthy demand and temporary debt relief. Legal processes and regulatory institutions were focused on protecting consumers, creditors, and longer-term economic welfare. There were still a large set of better managed/positioned carriers, so that capital markets and the bankruptcy courts could readily restructure still-viable assets. Robust competition rewarded the airlines who had not recklessly over-expanded and could readily cope with cyclical problems.
Over the last 15 years, all of the processes and conditions that had allowed commercial aviation to weather downturns and crises were systematically undermined. The largest, most politically astute carriers successfully captured existing legal processes and regulatory institutions, who abandoned the pro-consumer and pro-competitive policies of the previous 30 years, and worked aggressively to maximize the corporate value of favored incumbents.
In many of the world’s most important markets, robust competition was replaced by an oligopoly/cartel of Too-Big-To-Fail airlines. Freed from competitive pressures, focus shifted from the innovations needed to drive ongoing productivity improvements to maximization of artificial short-term supra-competitive profits.
The owners of the Too-Big-To-Fail airlines aggressively extracted tens of billions of these profits into their own pockets, under the apparent belief that these companies would never ever face a serious downturn.
These changes destroyed industry resiliency. Critical liquidity was extracted, and even the huge taxpayer bailout the airlines requested is far too small to stabilize industry finances. The industry requires much more radical restructuring than anyone has ever considered before. This is not a situation where a handful of airlines need to replace failed management teams and downsize networks.
Since the cataclysmic demand collapse is likely to last for years, every sector of the worldwide industry (including manufacturers, airports, and other suppliers) is economically bankrupt in the Chapter 7 “no longer a viable going concern” sense, and must rapidly shrink to a fraction of its current size.
The needed industry restructuring cannot happen on a private sector basis funded by at-risk capital. Near-term operations and the restructuring process can only be funded and administered by governments. This government role can only be justified if it minimizes the inevitably large number of job losses and service cuts.
Restoring a legitimate private sector industry will require that the restructuring process restores the level of competition that existed twenty years ago and ensures that competition drives the innovation needed for ongoing improvements in consumer welfare and overall industry efficiency.
Unfortunately, airlines and governments appear to be focused on protecting the managers and shareholders who created these problems, under the misguided belief that they can quickly recreating a 2019 status quo that is no longer sustainable. These airline owners and government officials spent the last fifteen years eliminating competition and ensuring that the resulting artificial short-term gains went almost exclusively to a narrow set of private shareholders who had little interest in the industry’s long-term health.
If these owners and officials control the restructuring process, there is a huge danger that it will focus on even deeper competitive cuts, bigger increases in artificial pricing power, creating even more powerful Much-Too-Big-To-Fail-Much-Less-Regulate airlines, and protecting investors from bearing their share of the pain and disruption of industry restructuring.
The Radical Post-2004 Consolidation
The radical post-2004 consolidation of international aviation is critical to understanding the depths of the current crisis, and the obstacles to solving it. None of this consolidation was due to cost efficiencies or other “market forces.” It was entirely the result of government decisions to reduce competition in order to help some of the most powerful incumbents boost near-term profits and stock prices. A major industry with a strong track record of producing significant consumer welfare gains was rapidly converted to a permanent extractive oligopoly.
In the 90s, the transatlantic (North America-Europe) airline market—the largest airline market in the world—was highly profitable and innovative, growing rapidly, and was robustly competitive. Consolidation focused on intercontinental markets because they have been the overwhelmingly largest source of airline profits and growth, and the North Atlantic was the most lucrative of them all.
|Concentration of US-Continental Europe||top 3||67%||97%|
|market (40 million annual pax)||top 5||80%||99%|
|Concentration of total North Atlantic||top 3||54%||96%|
|market (55 million annual pax)||top 5||73%||99%|
|Collusive Alliance share||48%||96%|
|North Atlantic competitors with||>4%||8||3|
|capacity share of at least||>2%||9||3|
Beginning with 2004, the transatlantic market was converted into a permanent 3-player oligopoly/cartel that controlled 96 percent of all traffic. Those three are the collusive alliances led by Lufthansa, Air France, and British Airways, whose US partners are United, Delta, and American.
These alliances go well beyond traditional marketing alliances (where independent carriers link frequent flyer programs and lounge facilities) because the US Department of Transportation (DOT) granted them antitrust immunity (ATI) to fully collude on pricing and capacity. The antitrust immunity granted to these carriers eliminated competition just as a full merger would.
The radical consolidation of the North Atlantic directly (and by design) drove a major consolidation of the domestic US industry (the world’s second-largest market, where 4 of the largest competitors were merged out of existence) and drove ongoing reductions of competition in the Transpacific and Latin American markets.
The idea that balanced competition between just three players could be sustained indefinitely never made any sense, given the industry’s long history of cyclical downturns and market instability. Consolidation eliminated the possibility of significant price competition in international markets and eliminated any remaining possibility of new market entry. The consolidation movement allowed the now Too Big To Fail carriers to capture full control of industry oversight in Washington and Brussels. That control threatens to hugely bias, and perhaps undermine efforts to recover from the coronavirus crisis.
This article summarizes previously published analysis from journal articles and DOT and Congressional testimony that readers interested in more exhaustive documentation of the history and industry economics should refer to.
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