Deregulation Countdown Pt Ill

The example of the unregulated Californian market has parallels in the deregulated Australian situation. Population is similar although the size of the state is smaller. Their route structures became more cost efficient which is, consequently reflected in lower fares. Pricing was used as a means of distributing loads away from peak periods and to encourage early booking and flexibility by the rapidly growing market of leisure travellers.

The Treasury believes these economic benefits will flow to Australia under deregulation, even though there may be a period of instability. Therefore, even though there are difficulties in transferring the US experience with deregulation to the Australian market, there are many lessons we can profit from.

Public Expectations

The short term perception of airline deregulation will be ‘overwhelmingly favourable’ by regular travellers. Over the longer term support will depend on the balancing reaction of passengers on long and thin routes which may suffer in service and pricing.

The dramatic changes in the US have induced a ground swell of expectation in Australia which may be impossible to match given our financial and limited population infrastructure. For example, the US has fifteen times our population yet there is thirty eight times the passenger kilometers flown (a measure of output computed by multiplying the total of paying passengers by the distance of the flight). Clearly there is an immense gap of anticipation which may not be possible to breach.

State Government Cooperation

A distinction between the US and Australia is that our deregulation of aviation will require cooperative action by all States. Only the federal government had to act in the US.

Australian Airlines will be severely disadvantaged under deregulation unless the state governments allow it to compete on intrastate routes. Otherwise, competing companies can use earnings from higher yield intrastate routes to subsidise their high volume interstate routes.

Since 1981 the IAFC fare setting arrangements have favoured long haul routes at the expense of short haul commuters. This was politically motivated because of pressure on the then government from its West Australian backbenchers.

After deregulation, market forces will radically reverse that formula because of ‘economies of density’. Service to virtually all existing ports will be maintained although there will often be a deterioration in quality, particularly in aircraft type. The long and thin routes will incur price rises and some service deterioration. The less populated extremes of Australia will quickly forget their favoured treatment over the last seven years and the Western Australian, Queensland and Northern Territory governments can thus be expected to create some political backlash.

Therefore, the scenario of state governments interfering in the market is politically likely.

Government Ownership Of Airlines

The whole point of going as far as complete deregulation in Australia is so that any losers in the readjustment of the industry do not have the option to lobby the regulatory agencies to protect them again. The government has played virtually all its cards in the short term and if the domestic industry goes awry it can only allow in foreign competition. This option may not be politically acceptable which would leave the government with no device to re-establish stability in the deregulated industry, save for an embarrassing reintroduction of some form of regulation.

Therefore, the fly in the Australian ointment is the continuing relationship between the Commonwealth and its two airlines. Surely, if they are the losers, there will be immense political and economic pressure to defend a public asset. This will defeat the initial step of abandoning the regulatory role. Thus, the anomaly of two government airlines brings a wild card into deregulation.

The political process also introduces instability. For example, the previous Minister for Transport and Communications, Senator Gareth Evans, at one time ruled out a merger between Australian Airlines and Qantas yet, less than six months later, amalgamation was being actively pursued by the government.

Opportunities For New Airlines

The Bureau of Transport and Communications Economics estimates that the airline sector will grow by between a pessimistic 37% to an optimistic 85% by the year 2000. Even the larger estimate represents less than the growth recorded in Australia up until 1976.

The magnitude of the differences between the US and Australian airline businesses suggests there is considerable room for expanding the size of the market. For example, 19% of the Australian population has never flown while only 5% do not like air travel.

The battle to increase airline markets will be at the expense of other means of transport. For instance, the majority of people using cheap East-West flights were going to travel anyway. Most have diverted from another mode of transport or alternative airline.

However, the high cost of air travel has restricted its use according to the May Report. Only 27% of Australian travellers use discount fares while fully 80% of US travellers avail themselves of some reduction. Meanwhile, the proportion of business travellers in the two countries is much the same which suggests even business flyers are flexible when price is involved.

The May Report found there was a lack of awareness of discount fares and thus advertising will be a major means of competition after deregulation.

Some of the newer airlines in the US market used other basic strategies to win market share and obtain profitability. Simple shuttle networks developed, often using secondary airports. Simple fare structures were maintained with higher seating density and a schedule closely reflecting peak demands. Off peak fares were used to obtain high load factors out of these times. Part time staff were used to meet traffic peaks while more junior staff meant lower rates of pay. Older aircraft were flown to reduce capital costs.

Only Melbourne has a secondary airport (Essendon) which can handle commercial jet transports, so it will be a favourite with the new entrants if operating restrictions at Essendon are modified. Other capital city secondary airports can cope with larger propjet aircraft so shuttle services may develop which link, say, the western suburbs of Sydney (Bankstown) with the southern suburbs of Melbourne (Moorabbin). The political capability of achieving this though is doubtful at best.

Single economy class seating is the easiest way to increase seat density, so new airlines will most likely dispense with business and first class and concentrate on the budget end of the market. Given that new airlines are not necessarily aiming at the business market, off-peak fares will logically please their leisure travellers. Note however, that East-West abandoned off peak fares after a trial period.

Flight frequency is still the major competitive device in the US.

Deregulation was supposed to achieve better utilisation of facilities and equipment, but the law of peak demand has dictated the industry supply. Therefore, Australia will see a similar emphasis on peak time travel with only limited profitability coming from off-peak fares.

Thus, the congestion and resultant needs of the airways system will also have to be addressed in Australia. In the US, deregulation was not matched by a financial commitment by government to the overtaxed airports and airways systems. The Australian airways system and the airports infrastructure must be properly funded so that deregulation may work without artificial constraints as have occurred in the USA.

Already the CAA is raising charges under the user pays philosophy and this will continue with loadings for peak periods. These charges will become a limiting factor in the growth of the deregulated industry, with subsequent calls for the government to carry the burden of infrastructure “in the public interest”. Older and cheaper aircraft are readily available overseas but must still meet the stringent safety standards of the CAA. Therefore, there will be no drop in equipment quality after deregulation, but there may be a comfort tradeoff. There is theoretically a vast untapped pool of commercial and airline pilots in Australia: there are for instance, 6,394 commercial licences current, but only 2,200 of these are valid airline licences, so obviously not all make a living via their piloting skill. It costs many tens of thousand of dollars to be trained to that standard and most would leap at the opportunity to work in an airline. This pool of latent Biggies would take off after deregulation on enthusiasm alone.

However, because they have not so far been selected for an airline suggests that perhaps present criteria are inflated. Thus, human error will be a danger during the transition phase, but will subside once all airlines have had the opportunity to stabilise their training. As with aircraft, the Commonwealth government will maintain safety standards, but Australia’s long standing premier position in world safety ranking cannot be guaranteed.

The May Report concludes that three factors determine the likelihood of new airlines eventuating: market size, the presence of a dominant carrier and infrastructure limitations. Australia is a sparse market except for the concentrations of Melbourne and Sydney. There are two dominant carriers, one of which will remain in government control at least in the short term. There are capacity restrictions and curfews at major airports in Australia, while most terminals are usually dedicated to a single operator. Therefore, the May Report concludes that there will be limited new entrants into the Australian industry.

Bob Ansett of the Budget Corporation has previously announced that his company will list on the stock exchange, as a means of acquiring capital, to “position Budget . . . to exploit opportunities arising from the deregulation of the airline industry”. Two of Australia’s largest companies, Brambles and Mayne Nickless, also could logically extend their businesses into the airline industry. The former Chairman of East-West, Bryan Grey, is also intending to compete with his new company, Compass Airlines. Air New Zealand could offer cheap fares linking east coast ports via a stop in New Zealand, while under an expanding CER Agreement, that carrier could well find itself with some form of an Australian domestic route structure.

Thus, at this stage it seems that a natural monopoly will not evolve, at least on the trunk routes and the government has stated that it will allow foreign airlines to enter the market if domestic operators allow an oligopoly to stifle a competitive environment. The Leader of the Federal Opposition, John Howard, stated in 1987 that interlining by foreign airlines was desirable. However, the danger here is that Australia would lose potential bargaining power for access to overseas markets in bilateral agreements and would expose the domestic market to predatory pricing by airlines that are often owned and funded by foreign governments.

Threat Of Competition

There is a difference between US markets that are actually contested and those that are served by a single airline. Where there is no competition, the threat of entry has not induced the established airline to lower fares to discourage entry. However, discounts are suddenly offered when competition appears.

Market niches are available in Australia for new entrants where service or cost has not been competitive in the past. However, the threat of competition may not be enough to control fares given the financial hurdles, lack of return on capital and restriction on foreign entry.

Network Hubs

The congestion of hub and spoke networks makes it difficult for two large airlines to hub at the same airport. Thus, Ansett Airlines and Australian Airlines can be expected to fight over Tullamarine and Sydney. Qantas, naturally, demands that Sydney remain as its base. All three have significant expansion plans for Sydney. However, Tullamarine has no curfew. The new facilities at Brisbane have no curfew either and are thus perhaps the premier hub location for any new entrant.

Because Melbourne and Brisbane will gain commercially from 24 hour operations, there will be enormous business pressure on Sydney to allow further relaxation of the curfew. Only then will the decision to start a second runway be forced because the Badgery’s Creek airport will be too far down the track, both temporally and physically.

Terminal Facilities

Recent new leases signed by the two major airlines at domestic terminals include a clause that space must be made available for new airlines after deregulation.

Meanwhile, the May Report found in a specially commissioned study that only Brisbane, Perth and Townsville had facilities which could cope with new entrants, provided their operations were less than half the size of either of the existing airlines and they do not require the same ‘style’ of operation. The other airports would have to make alternative arrangements. A situation where new entrants had ‘off airport’ terminals similar to EastWest in Brisbane during 1987 could well eventuate as ‘on airport’ terminal facilities become unavailable.

However, in the US, terminal limitations have meant competition is thwarted and the same situation is likely in Australia.

Reservation Systems

The unfair reservation practices in the US will not occur in Australia because of the independent Travel Industry Automated System. A company jointly owned by Qantas, Ansett Airlines and Australian Airlines operates the service which I presume will also be commercially available to new companies. There is also the option to use an overseas based service as East-West did until its takeover. Ansett’s association with the Galileo Network though could change this.

The TIAS system is available to all travel agents for a fee.

Because the agent must first specify an airline, the screen cannot be unfairly formatted as happened in the US.

However, overseas business is increasingly won or lost on the international computer reservations screens and it is essential for domestic airlines to buy into these systems. British Airways, for instance, recently bought a share in the Apollo reservation system in the United States for a price of $150m.

Qantas is negotiating with Japan Airlines to establish an Asian regional booking system but a group of major Asian airlines is racing to set up a rival network. The competition is intense because the experts all predict that the Asian region will be the major growth area in the next decade. Without access to the winning reservation system, domestic airlines may find themselves losing control of their own tourist market.

Discount Fares

Established airlines in the US did not match the lower prices of new entrants because selling more discount fares meant that profit would fall. Instead, they were able to segment the market by using their computer reservation statistics to discriminate between groups on the basis of strength of demand. Thus, they increased their load factor by offering selective discount seats without decreasing their revenue. That’s good business.

Today in the US, ticketing is an auction process, with the price rising as the departure date approaches. To get a discount, you have to get in early. Therefore the established airlines will have little incentive to supply enough discount seats for the market. The availability of discounts will create a demand which will not be met – other than by new entrants.

Note that the May Report found Australia actually has lower regular economy fares, but the United States has lower and much more readily available discount fares. Therefore, the leisure traveller and the business traveller will mutually gain from deregulation where competition is increased. New markets of discount travellers will create an increase in frequency for regular flyers.

Predatory Marketing

Although the distortion of Frequent Flyer Bonus Plans in the US will be avoided in Australia, the infinite number of marketing permutations cannot be adequately outlawed. Thus, airlines will find ways to bribe the business traveller (who is not paying the fare) to maintain brand loyalty in return for personal gain.

The difficulty of monitoring or proving the intent of such predatory actions and the inherent delay in getting government agencies to react may mean that violators will escape discipline.

Cost Recovery

The policy of cost recovery established by the Bosch Inquiry will see that the industry is not distorted by cross-subsidisation and covert subsidies.

Thus, costs are already rising with the advent of the Civil Aviation Authority in July 1988. It is reported that charges within Australia could rise by 618% (sic) to ensure full cost recovery. Meanwhile, the Federal Airports Corporation is mooting rises of 17. 9% in landing charges to pay for new terminals and infrastructure.

Profitability

Profits in the Australian industry have been high by international standards. After deregulation, increased demand will maintain revenue although there is a real risk that losses will be encountered in the short term. After an unstable transition period, profit levels will be below industry averages. Investment will decline in airlines and there will be a rationalisation of surviving operators. In the longer term, profits in the industry will not be as attractive, so diminished returns will affect investment.

Ansett appears to be starting from a stronger position than Australian Airlines. Jim Thorn, editor of Australian Aviation says that Ansett “. . . with its enormous cash reserves (via TNT and News Ltd) would overwhelm any competitor”. There is a risk that Ansett will win so much market share that effective competition will be stifled. Further, the cost structure of Australian Airlines is higher and their market share is presently sustained by regulation.

Ansett also has a strong network of regional airlines feeding into the main trunk routes. Unhappily, Australian has been forced to close its Air Queensland operations in most of the State because of its dismal performance.

Ansett will be able to concentrate on the lucrative business market, while its subsidiary East-West will be geared up into a full sized carrier dedicated to low cost, no frills service. This will tap the new and vast leisure travel market, particularly in the expanding and wealthy 45 plus age category.

Thus, there is the danger that the government will be abandoning the two airline policy to end up with a one and a half airline industry. Already, the General Manager of Australian Airlines states that it must now operate with “not what it would like but what it can afford”. Thus they are containing costs while profits are rising. However, in the run up to deregulation their position is greatly improving.

The implications for the government airlines suggest some political reaction. The debate over privatisation is stalled until 1990, providing the present government remains in power until then. The question will develop into a financial one of picking the best time to float the airlines. The window of opportunity wilt be small and increasingly it will seem advantageous to sell before deregulation takes place. The government of the day will face intense temptation to gather windfall profits regardless of the merits of the idea.

Industrial Relations

Industrial relations in the deregulated industry must diverge from the US experience. Collective Bargaining and the low union membership (about 18% compared to 60% in Australia) meant that new US airlines and those declaring Chapter 11 Bankruptcy could save substantially on labour costs. The US experience has been of increased productivity in non union carriers, two separate wage structures for identical jobs and a major lessening of restrictive work practices. It would be impossible to introduce viable non union carriers into Australia and it would contravene the union’s principles to have two employees being paid different rates when working side by side.

Labour cost reductions must then be made in productivity and work practices. Happily there is room for improvement, as the May Report found that labour productivity in Australia is low because the regulatory framework fosters an efficient use of capital (ie aircraft) but merely compensates for labour costs. Under regulation, costs are simply passed on to the consumer if they occur in both airlines. For example, we are the only nation to fly new generation Boeing 767 aircraft (Ansett) with three crew; the manufacturers had to design and install special cockpits at extra cost.

Comparisons with overseas airlines also show that our airlines are substantially over manned. Therefore, the airline which realises staff rationalisation and productivity will reap the profits. However, in their submissions to the May Inquiry both airlines negated this scenario: Australian Airlines stated it “. . . could not contemplate substantial cuts in either the workforce or pay scales”, while Ansett said that the severe drop in wages and conditions in the US” . . . would not be acceptable in the Australian environment”.

It went on to argue that even a 25% drop in wages would only grant 8% relief in air fares, so it sees little incentive to act. However, it did take on the unions at Easter, 1985 and won. It is difficult for Australian Airlines to act against the unions although the government does encourage negotiated productivity agreements.

The ACTU believes that deregulation would be against the public interest. They see a scenario where Ansett Airlines would be able to sustain a prolonged price war but the government would not be able to back its airline with new capital to compete. With Australia’s centralised industrial relations system and enforced award wages, many of the US options will therefore not be available in Australia.

Further, given the shift to productivity as the determinant in wage increases, then the airline industry faces the anomaly of paying out substantially more in wages than other sectors if the efficiency advantages of deregulation are realised in Australia. Because costs are brought down, wages will go up!

Therefore, alternative arrangements such as staff shareholdings to replace unionism may occur among the new entrants. However, a change of government with a new industrial relations mandate could see a substantial loosening of labour market rigidities. Meanwhile, the latest national wage case decision points to a change in direction with a shift to award rationalisation which will possibly assist the airlines.

It is naive to assume that the present industrial relations situation will continue after deregulation. Changes will be dictated by market forces. Therefore, the best the unions can hope for is that the increase in the size of the market compensates for the shakeout which will occur.

But even though it may be a zero sum game in the long run, the short-term is bound to see confrontation – especially with two of the seven state governments now having essential services legislation. In fact, the May Report warns that deregulation carries with it “. . . the distinct risk of industrial opposition and disruption”.

The trend to smaller but more densely packed aircraft will also result in congestion on the airways system and lead to a worsening of delays at peak times. The Air Traffic Controllers and Flight Service Officers will be forced to press for improved equipment, conditions and wages. The CAA must address its equipment shortages and staff morale problems before this occurs, or risk a breakdown of the system.

Current Account Deficit

The implications of deregulation on the current account deficit are enormous. The government is abandoning control over the importation of aircraft with each new 767 class aircraft costing over $A1000m with spares. Therefore, any import surge by the domestics will have devastating effects on our balance of payments with market forces controlling our national prosperity.

However, the trend to leasing aircraft may mitigate the trade repercussions. The irony here is that Ansett may be leasing aircraft to competitors through its international leasing subsidiary Ansett Worldwide Aviation Services.

Qantas, meanwhile, makes the point that the balance of payments difficulties in Australia mean it would be detrimental to increase domestic competition with foreign carriers.

A Self-fulfilling Prophecy?

Deregulation is usually a device advocated by economic supply siders. They contend that increasing incentives will lead to a growth in demand which will match and support the increase in output. However, the argument is based on unproven assumptions about how the capitalist economy works and there is no guarantee that deregulation of itself will deliver an improved airline industry or enhance the efficiency of our economy. The divided opinions about the outcome of US deregulation suggest the benefits may not be as cogent as these economists argue.

There is also a degree of myopia about deregulation. For example, the Treasury submission to the May Inquiry glamourIses the evidence; it lists an impressive selection of the benefits of deregulation without revealing the many negative factors.

They note the creation of new employment and development of new route structures. These at best do not reveal the whole picture. The 300,000 people who lost jobs in the five years after US deregulation became effectice and the travellers who suffer the inconvenience of the overloaded hub and spoke system instead of flying direct may offer diverging opinions. Such deception may win the argument but will ruin the debate. However, they at least contribute to the information available on the Australian industry.

At a conference in 1984, a policy adviser to the then Minister for Aviation made a plea for more research to be done into the Australian aviation industry. He wanted researches to provide some guidance to those making decisions about the best course for the industry. He asked for a framework to be developed to end the uncertainty and lack of information about the Australian industry.

There is a monopoly on information by the Bureau of Transport and Communications Economics and less than a handful of independent researchers provide little balance to the official view. There is hardly enough material to build a description of the Australian industry let alone any prescriptive framework.

Thus, one side benefit of airline deregulation is that the industry may become more interesting to researchers – or at least marketers – and lead to a burgeoning of information. Without that, we are never likely to be able to adequately assess the changes that deregulation brings.

This series has examined the likely impact of deregulation on the Australian airline industry. This has been structured around the results of the US experience, with adaption for the peculiarities of the local environment. Thus, it has built up a reference system to assess the manoeuvrings of officials, airline executives, unionists and consumer groups as the industry positions itself prior to 1990.

The ground swell of expectation will carry the airlines into deregulation. The newly created leisure travellers

will establish market niches for existing and new operators. However, complete overall competition in the Australian airline industry is highly unlikely given the size of the market and the vast geographic spread of the population.

After the honeymoon period, general disenchantment with deregulation will surface in all but the major cities. The unintended consequences will loom large as politicians choose to forget the many advantages compared to the regulated industry of today.

However, the government which introduced deregulation does not have the luxury of such comparison. From the current perspective, airline deregulation is a Bicentennial Project which seems like a good idea . . . at the time.