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How the Airlines Became Abusive Cartels

The New York Times logo The New York Times 2017-04-17 By ROBERT KUTTNER
Travelers at O’Hare International Airport in Chicago, on Wednesday. © Joshua Lott/Agence France-Presse — Getty Images Travelers at O’Hare International Airport in Chicago, on Wednesday.

The recent United Airlines bumping debacle has prompted calls for reforms in the system of auctions that reward fliers for voluntarily giving up seats. Delta Airlines has now authorized payments as high as $9,950 to induce passengers to give up seats on overbooked flights.

But no refinement of voluntary market remedies will fix the deeper mess of the airline industry. For air travel is far from a free market.

When the airlines were deregulated in 1978, economists led by Alfred Kahn, then chairman of the Civil Aeronautics Board, argued that airlines and airline tickets were really like any other free-market product. He called them “marginal costs with wings.” Nearly 40 years of deregulation have disproved that premise.

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Previously, the C.A.B. had ever since the 1930s regulated both fares and routes and guaranteed the airlines a decent but not exorbitant profit. The airlines, in turn, had the predictability to invest in new generations of more fuel-efficient aircraft, which allowed fares to drop over time. Prices actually dropped at a faster rate in the decades before deregulation than afterward.

Kahn believed that if new competitors could enter markets and charge whatever prices they liked, fares would drop even faster and more people would fly. But airlines do in fact have fixed costs in the form of expensive capital equipment. And one seat is pretty much like another — as economists say, there is little product differentiation — so in a competitive free-for-all, everyone goes broke.

In the first years of deregulation, there was too much competition and the airlines collectively lost a fortune. Their strategy was to consolidate. All 21 of the proposed mergers presented to Reagan administration antitrust officials in the 1980s were approved, and some 20 more have been approved in the years since.

The airlines devised frequent flier programs and “fortress hubs” to maximize their pricing power. Carriers knew to stay out of each other’s hubs. By 1988, 85 percent of airline markets had only two airlines competing, and they closely monitored each other’s fares, so that true price competition was rare.

An industry that is not naturally competitive went from being a regulated cartel, to a brief period of ruinous competition, and then to an unregulated cartel — with predictable effects on the quality of service. This restored profitability, but at awful costs both to customer convenience and to economic efficiency as well.

With the hub-and-spoke system used to defend airlines’ pricing power, there are fewer nonstops. Passengers waste time and often miss connections, while airlines waste fuel.

Flying more miles than necessary to reach a destination is known in the industry as circuity. All of these profit-gouging strategies add up to a false brand of “efficiency” that actually increases the system’s costs at passenger expense.

Today’s auction system on oversold flights, ironically, is the stepchild of a 1976 Supreme Court case, Nader vs. Allegheny, in which the late and little lamented Allegheny Airlines (known to its long suffering passengers as Agony Airlines) picked the wrong passenger to bump. Ralph Nader sued and the case went all the way to the Supreme Court.

The high Court, in a 9-0 ruling, held that if a passenger had a confirmed ticket, the airline was committing a fraudulent act by bumping him. (Allegheny, fittingly, became USAir, which was merged into American.) After a search for remedies, the industry eventually came up with — what else — a wondrous market solution: the auction.

But in an industry that is not naturally competitive, tweaking market incentives will not fix what’s broken. For starters, planes should not be permitted to fly so full. That leaves no room for contingencies.

When weather or mechanical problems or crew delays cause cancellations, the airlines have great difficulty accommodating passengers because there is not enough slack in the system. Leaving a few empty seats would increase the system’s efficiency overall.

Also, we need rules limiting penalties for changing flights. In life, it’s normal for plans to sometimes change. The airlines disparage this as “no-shows,” but in fact these are bona fide needs to revise travel times, usually hours or days in advance. Few passengers are literal no-shows.

There should also be rules on how many passengers an airline can cram into a plane, and what extras it can charge for. And there should be limits on price gouging. It makes no sense to allow airlines to charge an astronomical fare just because a flight is nearly full, and a dirt-cheap fare for an advance booking.

Would rules like these destroy the airlines’ business model? Ask Amtrak, which hauls three times the passengers between New York and Washington as all airlines combined, and doesn’t punish you for canceling a ticket. Or ask Southwest Airlines, which never charges a fee for changing flights and has no hidden extra charges.

The current business model used by the big airlines is not the only one consistent with reasonable profit and good service. It simply reflects the sheer arrogance that comes with monopoly power.

Beyond that, there is too much concentration in the industry. The Federal Trade Commission or the Justice Department’s Antitrust Division should take a close look, and if rules like these don’t do the trick, the biggest carriers should be broken up.

Elsewhere in the travel industry — hotels and car rental agencies, for example — these abuses do not exist because there is actual competition. But airlines are simply not naturally competitive.

There is a middle ground between an abusive cartel and a ruinous free-for-all in the skies. It’s known as regulated competition.

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Correction: April 17, 2017

This article has been revised to reflect the following correction: An earlier version of this article misstated the merger history of USAir. It merged into American Airlines, not into United.

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