Background
The airline industry is one of the most fascinating in the world, with roots going back to the earliest years of the 20th century. Not long after the Wright brothers flew successfully for the first time in 1903, interest in aviation for military and commercial purposes began. Following World War I, the U.S. government began offering potentially lucrative airmail contracts to start-up air carriers, who competed vigorously for them often with disastrous results. Given the crude aircraft, lack of navigation and weather forecasting services, and poor pilot training, crashes became the rule rather than the exception. Despite the rocky start, the carriers persevered and by the 1930s were beginning to look like the companies we see today. In fact, competition in the United States became so severe that the government created the Civil Aeronautics Board (CAB) in 1938 to regulate the business of domestic air travel. The industry worldwide got a tremendous boost after World War II, with the availability of inexpensive military surplus aircraft and a plethora of airfields that could easily be converted to civilian use.
Commercial aviation, both in the United States and abroad, continued to grow during the 1950s, 1960s, and 1970s. By the mid-1970s, Congress decided that economic regulation was no longer necessary and began the process of deregulation by freeing the all-cargo carriers from most CAB oversight in 1977. In 1978, for better or worse, the passenger airlines were deregulated as well.
Deregulation transformed the U.S. airline industry forever. New carriers entered the marketplace, while old ones failed. As the demand for international travel increased, airlines in other countries began to grow as they found ways to successfully compete against what had been an industry largely dominated by U.S. firms. Competition forced managers to adopt cost control measures that seriously degraded service, while more recently rising fuel prices have made profitability even more elusive. Indeed, the carriers well regarded by passengers today are not based in Los Angeles or New York, but rather in Dubai, Singapore, or Germany.
In order to provide insight into the nature of the airlines and why companies promulgate the strategies they do, the history of commercial air services will be examined, with an initial focus on the United States. After this background, airline operations around the world will be compared and the different types of carriers that comprise the industry will be discussed. Next, the reader will learn about important uncontrollable outside forces (fuel costs, terrorism, economic conditions, etc.) that can have dramatic and potentially devastating impacts on an airline. A discussion of economic regulation and deregulation will follow, to help the reader understand the impact of both legislative actions on the carriers operating today. Finally, in the face of expected increases in the demand for the global movement of passengers and cargo, future opportunities and challenges facing the airline industry will be presented.
The Early Years: 1918 to 1938
Commercial aviation in America began in 1918 with the transport of airmail, first by the U.S. Army Air Service and then by the U.S. Post Office, which carried the mail for nine years using its own pilots and airplanes. To say that flying at that time was fraught with danger is an understatement. Thirty-one of the first 40 airmail pilots hired by the government died in crashes.1 There were no airways, navigational aids, or emergency landing fields; no federal agencies that dealt with civilian flying and no federal laws to regulate it; no standards for aircraft maintenance; and no mechanism for licensing pilots.2
Similar developments were occurring in Europe. For many months after the war, normal rail travel in Europe remained problematic and irregular because of the shortage of passenger equipment and the destruction of tracks and bridges. In addition, chaotic political conditions in Central and Eastern Europe often disrupted schedules. The situation opened many possibilities for launching airline routes. Although few airfields existed, aircraft of the postwar era could and did use relatively short sod runways for years, meaning that locating suitable airports near most cities was not the formidable engineering challenge that emerged in subsequent decades. Another factor that emerged as a driver of airline development in Europe was the ongoing need to tie far-flung empires to their respective mother countries. Great Britain, France, and the Netherlands all had colonies around the world; while in the nascent Union of Soviet Socialist Republics (USSR), air transport emerged as an indispensable medium for rapid transportation and a visible means of knitting together sprawling, divergent regions.3 In fact, the oldest continuously operating airline in the world is the Dutch carrier KLM, which was founded in 1919.4
A significant difference between the United States and the rest of the world was that the former relied on the private sector to develop its airlines while virtually every other nation created and operated its own national carrier(s), a fact that continues to impact global commercial aviation to this day.
One factor that quickly became apparent in the United States was that the demand for military aircraft alone could not sustain aircraft manufacturing, which prior to 1917 was virtually nonexistent.5 After the war, the government was buying fewer planes while commercial flying was virtually nonexistent.6 As a result, there was no civilian market for planes. The government’s decision to sell its surplus aircraft to civilians at cheap rates made an impossible situation even worse. The availability of inexpensive planes did lure many people into the air transport business, but those enterprises proved too precarious either to provide reliable transport service or to serve as a market for planes. For example, in the United States, there were 88 airline operators in 1921 and 129 in 1923, yet the latter figure included only 17 of the original 88. While some companies managed to eke out a thin existence with a plane or two, as late as 1924 the nation still did not have a single regularly scheduled air transport line.7
Structure Emerges
The event that brought order to the chaos was the passage of the Air Commerce Act of 1926. Championed by then-Secretary of Commerce Herbert Hoover, the act’s impact was enormous. During the period from 1922 to 1926, the nation added only 369 miles of regular air service operated by private enterprise and 3,000 miles of airmail lines run by the post office that did not carry passengers or express. By 1929, there were 25,000 miles of government-improved airways of which 14,000 were lighted with beacons; 1,000 airports built and 1,200 in progress; 6,400 licensed planes making 25,000,000 miles in regular flights annually; and a manufacturing output of 7,500 planes a year.8 In fact, the act paved the way for the formation of three of today’s four largest U.S. airlines: Delta, which started as a crop-dusting operation in 1924 and carried its first domestic passengers in 1929; United Airlines which began in 1931; and American in 1930. Of course, there were many others as well (Northwest, 1926; Pan American, 1927; Eastern, 1927; Trans World Airlines [TWA], 1930; Braniff, 1931; Continental, 1934; National, 1934), although these have all failed or been assimilated by other carriers.9 Perhaps the greatest impact of the act was to establish a model of private industry and public promotion working together to establish a strong U.S. airline industry responsive to the needs of the nation.
Naturally, all these new airlines were trying to compete with each other during one of the worst depressions ever to occur in the United States. Recall that there was no government oversight of the industry, so managers were free to make whatever business decisions they thought best, with little regard for the stability of the industry. Congress had established a precedent of imposing economic regulation on the railroad, pipeline, and trucking industries engaged in interstate commerce because they viewed such a move as being in the public interest. The airlines were brought under that regulatory umbrella in 1938. While the topic of economic regulation will be covered in a later chapter, the CAB was created to stabilize the fledgling airline industry by controlling prices and limiting competition. One goal at the time was to encourage the spread of commercial air services across the nation. Of course, the airlines only wanted to serve routes that they knew would be profitable, so the agency utilized the award of operating authorities (i.e., permission) to ensure the public need for air services would be met. Essentially, carriers were forced to serve both money-making and money-losing routes, with the earnings from the former offsetting the losses of the latter so that overall the carrier made a profit. By limiting the number of certificates awarded to serve profitable or high-demand routes and increasing those for unprofitable or low-demand ones, the CAB limited competition on the former and increased it on the latter. The impact on fares was predictable: higher prices where competition was restricted and lower where it was forced.
Expansion Abroad
Global expansion on any meaningful level was constrained by the lack of suitable aircraft and infrastructure. Pan American established itself as an international carrier with a short-lived passenger service from Key West to Havana in 1927. The carrier proved so adept at winning federal airmail contracts that services throughout the Caribbean quickly followed.10 However, crossing the Atlantic and the Pacific Oceans proved much more challenging. The Atlantic routes had to be via intermediate points, either by the northern countries, or via island hopping points in the Central Atlantic. The problem thus became one of territorial sovereignty. Great Britain, for example, through its Commonwealth connection to Canada stood in the way of the initial segment of the Great Circle route eastwards from New York. The British were not anxious to allow the Americans to start a service before they were ready themselves. Similarly, France had secured exclusive landing rights to the Azores, the vital halfway point in the middle of the Atlantic, by an agreement with Portugal, which controlled the islands. Denmark still extended its political domain to the Faröe Islands, Iceland, and Greenland, and thus controlled the northern perimeter.11
There were actually fewer operational and political problems growing across the Pacific. Initial efforts focused on securing a Great Circle route from New York to Tokyo via Canada, Alaska, and the Soviet Union, but the Soviets refused to allow U.S. carriers to transit its airspace because America continued to withhold diplomatic recognition. All interest then shifted to the Central Pacific. The weather was better, but more importantly, the United States controlled vital territories like Hawaii, Midway and Wake Islands, Guam, and the Philippines, which meant that trans-Pacific air services could be stitched together without asking for permission from any foreign government. One big problem remained, aside from the challenge of developing an aircraft capable of profitably flying between San Francisco and Honolulu: the lack of infrastructure between Hawaii and Manila. Pan American faced the challenge head-on and built these resources itself. It leased a ship, organized supplies and equipment, and dispatched it with 44 airline technicians and 74 construction staff. The cargo included enough material to construct two complete villages and five air bases (including hotel accommodations for passengers and crew), the most important of which were at Midway and Wake Islands, tiny specks of U.S. territory in the middle of the Pacific where two flying boat bases were blasted out of the coral. All this work was completed in mid-1935, with scheduled airmail service starting in November of that year and passenger service a year later.12 A few statistics on the first flight from San Francisco to Manila: one-way fare was $799, the equivalent of $13,895 in 2014; total flight time was 59 hours, 48 minutes (21 hours from San Francisco to Honolulu alone); total elapsed time was seven days.13
World War II and the Postwar Years: 1939 to 1958
Unfortunately, as the 1930s wore on, the threat of war in both Europe and the Pacific became more acute, slowing further developments in the industry. Pan American started transatlantic services in 1939, only to curtail them a few months later. By the time the United States actually entered the conflict in December of 1941, international commercial flights had virtually ceased as did casual air travel within the United States. The Army’s Air Transport Command was formed in 1942 to coordinate the transport of aircraft, cargo, and personnel throughout the country and around the world. The Air Transport Command contracted with airlines to fly wherever they were needed. Pan American’s vast overseas experience became an especially valuable asset. Unfortunately, other airlines also received overseas routes, only to become Pan American’s postwar competitors: Northwest flew to Alaska and the Pacific; United to Hawaii and the Pacific; Eastern and Braniff to Latin America; TWA across the Atlantic; and American to Africa, India, and China.14
By 1944, the outcome of the war was ordained as was the future of air transportation. The allied nations of the world gathered in Chicago to lay the groundwork for postwar international commercial air transport. Fifty-two countries signed the Convention on International Civil Aviation on (ironically) December 7, 1944, an agreement that continues to form the basis for the exchange of air rights between nations to this day.15 With the plethora of surplus aircraft available and military air bases ripe for conversion to civilian use, the stage was set for international air transportation to grow once the global economy recovered.
The 1950s saw unprecedented growth in the demand for both domestic and overseas air travel. Regulation by the CAB in the United States limited new entrants and pretty much ensured prosperity for what have come to be known as the legacy carriers. There were several systemic events that occurred during this period as well. First, the Civil Reserve Air Fleet (CRAF) was created in 1954 to augment Department of Defense (DOD) airlift requirements when emergency needs exceed the capability of military aircraft. This program, which is still in place today, eliminates the need for a huge investment in military aircraft that (hopefully) will never be needed. The airlines contractually pledge aircraft to the various segments of CRAF, ready for activation when needed. To provide incentives for civil carriers to commit aircraft to the CRAF program and to assure the United States of adequate airlift reserves, the government makes peacetime DOD airlift business (passengers and cargo) available to civilian airlines that offer aircraft to the CRAF.16 Two other noteworthy events that both occurred in 1958 were the introduction of the first jet-powered transports into scheduled service and the creation of what is known today as the Federal Aviation Administration (FAA) to oversee air traffic control and flight safety issues.
The Calm Before the Storm: 1959 to 1978
This period was one of domestic stability and international growth. Recall that the CAB continued to regulate domestic U.S. competition and fares such that both new entrants and failures of existing airlines were equally rare. Internationally, airlines were still primarily government owned and thus more concerned with expanding their nation’s global presence than with profitability (Pan American was also used in this role by the U.S. government, though without any direct support). Thus many countries, even those with no domestic markets, operated subsidized airlines in competition with U.S. carriers, a situation that still exists.
The winds of change began to blow in the mid-1970s when Congress started to question the efficacy of transportation regulation. The feeling was that the time had come to allow market forces to allocate transportation services. With regard to the air transport industry, there was concern that passengers were paying more than they should be and that the carriers were constrained from responding to the changing demands of a mature marketplace. Congress dipped a legislative toe in the water in 1977 by freeing the cargo-only airlines from domestic economic regulation, then committed completely in 1978 by passing the Airline Deregulation Act, which did the same for the passenger carriers as well. The industry has never been the same.
Adapting to the Free Market: 1979 to 1998
Deregulation put the business of air transportation back into the hands of carrier managers. “Normal” corporate decisions related to issues like where to fly, what services to offer, and fares, which since 1938 required CAB vetting, were now (with the exception of some initial limitations on pricing freedom) left up to management. The relaxation of barriers to entry encouraged new carriers to initiate services in competition with the legacy carriers. In other words, airlines were given the ability to succeed or fail without interference from the federal government. Two important caveats must be made before proceeding. First, deregulation applied only to business matters. The government was and still is very much involved in air traffic control, safety, labor, environmental, and antitrust issues pertaining to the airline industry. Second, deregulation was strictly a U.S. phenomenon that only applied to domestic airlines and services; international aviation continued to be strictly controlled.
Competition
Because government barriers to entry were eliminated, there was a dramatic influx of new airlines virtually all of which were competing with the established carriers on the basis of price. In fact, as a group, these new entrants came to be known as no-frills airlines because the low price bought only a seat; everything else was a “frill” that either cost additional money or was eliminated altogether. Pretty much every aspect of flying that passengers were used to fell into this category: complimentary in-flight meals and drinks, pillows and blankets, advance seat selection, and even the ability to book a flight were all viewed as extras. Perhaps the best known of these carriers was People Express, which began service on April 30, 1981 with the strategy of short flights, small fares, no frills, and indirect competition (operating at lesser used airports in the vicinity of large airline hubs).17 Passengers arrived at the terminal without a reservation and paid onboard the aircraft. There were no assigned seats; if and when the aircraft filled up, those waiting either caught the next flight or made other arrangements. By the end of 1981, over 950,000 passengers had flown on a People Express flight, many of whom had never flown before. The reality was that the fares were often lower than driving or taking the bus. To say their strategy was a success is an understatement. In fact, the airline grew at an astounding rate and, at one point, was the fastest growing company in the nation.18 Unfortunately, that growth ultimately contributed to their demise, but not before they spawned many imitators who collectively redefined airline competition in the United States.
While People Express instituted a London service as a part of their failed growth strategy, low-fare or low-service air transport was not strictly a U.S. phenomenon. Icelandair began offering transatlantic low-budget flights with single-class seating in the mid-1950s, connecting the United States with Luxembourg via Reykjavik.19 Laker Airways, a private British carrier that started as an ad-hoc charter airline in 1966, began no-frills scheduled services between London and New York in 1977. Despite the carrier’s efforts to expand with similar flights to Australia, Hong Kong, and other U.S. destinations, British regulatory impediments and the recession in early 1980 conspired to push the company into bankruptcy in February 1982.20
Fares and Yield Management
A study by the Government Accounting Office (GAO) in 1996 stated that domestic fares overall fell between 1979 and 1994, although the impact across specific airports was not even. For example, of the 112 airports in the study, eight experienced fare increases of more than 20 percent while 14 saw decreases in excess of 20 percent, with the remainder falling somewhere in between.21 Much of this variation can be attributed to the fact that fares now reflected actual demand such that prices on high-demand routes fell as additional carriers began serving them while those on low-demand routes rose as competition declined, a complete reversal from the situation under regulation. Distance per se became largely irrelevant to the pricing equation, so passengers often realized they were paying higher fares to fly fewer miles, which intuitively seemed wrong even if economic theory says otherwise. In other words, airlines began charging fares based on where and when passengers wanted to travel, thus applying the concept of price elasticity (how sensitive people are to changes in price) to the demand for air travel. A passenger who wants or needs to fly today will be willing pay a very high fare (e.g., a business person), while a leisure traveler will book well in advance to get a lower one. Understanding passengers’ demand elasticity allowed the airlines to develop a myriad of fares intended to maximize the revenue on every flight, a practice known as yield or revenue management. Obviously, such a system requires a tremendous amount of historical data, which the legacy airlines had been capturing for years via their proprietary reservations systems. This capability enabled them to compete with the new low-price carriers by selectively lowering fares to match them on the routes where the two competed while continuing to offer their higher service levels.
This same principle has been applied to air freight charges as well. FedEx was originally an overnight service that guaranteed delivery by 10:00 a.m. the next morning and was priced accordingly. In other words, by calling FedEx, customers communicated their urgency of need and consequent willingness to pay the high price. Gradually, FedEx (and, later, UPS) began offering cheaper second- and third-day services, in addition to next-day. This strategy allows the carrier to capture more price-sensitive buyers while, at the same time, better managing their aircraft loads. For example, freight that is identified for three-day service may actually move overnight if the airplane has room, though it will not be delivered until the date paid for by the customer. By the same token, FedEx will even accept cargo for same-day delivery, although in most cases this freight will be put on a scheduled passenger flight. Needless to say, this service is extremely expensive.
Networks
One of the early results of deregulation was the abandonment of unprofitable routes to primarily small communities that the carriers had been forced by the CAB to serve. Many of these towns had enjoyed scheduled, if relatively infrequent, service for decades, so the loss was very traumatic. During the first 10 years of deregulation (the 1980s), the major airlines shifted dramatically from point-to-point to hub-and-spoke route systems. Following the example of prederegulation Delta, which pioneered the concept at Atlanta, the major airlines built up major connecting hubs at what had been principally origin-and-destination airports, such as Charlotte, Dallas, Detroit, Minneapolis, Pittsburgh, and St. Louis. Hubs made possible huge increases in service for two categories of air traveler. First, those living in the hub-airport city gained access to a many more destinations and flights. Second, residents of small cities on the spokes of the hub, who may have lost some point-to-point service, gained access to potentially hundreds of destinations via the hub.22 In fact, many of these locales actually ended up having better (i.e., more frequent) service then they did prior to 1978. Of course, the major advantage of the hub-and-spoke accrued to the airline because support activities such as catering, maintenance, and fueling could be concentrated at the hub rather than scattered throughout a point-to-point system, thereby lowering costs. In addition, the carrier could operate full but smaller aircraft into and out of the hub, minimizing empty seats.
Operating Costs
The thread running through the discussion about deregulation so far is cost reduction, a topic largely unfamiliar to airline managers used to economic regulation. The rapid market inroads made by innovative low-cost competitors forced a complete overhaul in the way the business was run. The move to hub-and-spoke networks was very much cost driven, as was the elimination of unprofitable routes. The 1980s and 1990s saw the paring of employees and passenger services as labor contracts were renegotiated to lower costs. Many of these changes had a direct and largely negative impact on the in-flight customer experience as passengers still expected prederegulation service and postderegulation fares. Aircraft technology emphasized cost savings as well, offering new airliners with better fuel economy (while generating less pollution) and sophisticated flight systems that allowed two pilots to safely operate even the largest and longest-range planes. Yield management systems allowed the airlines to minimize the number of empty seats on every flight, an essential goal when fares are low.
This period was a very tumultuous one for the airline industry as firms adjusted to the new reality of deregulation. Unfortunately, some major carriers simply could not adapt: Braniff failed in 1982, Western in 1986, Eastern and Pan Am in 1991.23 Of the eight local service airlines that served various regional markets in 1978, only one, US Airways, survived into the 90s while Southwest was all that remained of the four intrastate airlines operating in California, Florida, and Texas. Most telling of all is that out of 119 airlines that started service between 1979 and 1998, 76 failed during the same period.24 Some airlines simply went bankrupt while others were bought or merged with a larger carrier, but all disappeared one way or the other from the industry.
More Upheaval: 1999 to 2014
This period was very much defined by environmental events: September 11, 2001 and the use of commercial airliners as terrorist weapons; the ensuing war in the Mideast; rising fuel prices; and a global recession, just to name a few. When you add to this turmoil the rise of a new generation of “no-frills” competitors now known as low-cost carriers (LCCs), increasing global competition, declining revenues, and the continued contraction of the industry, the challenges become even more apparent.
9/11 and Its Aftermath
The attacks on the World Trade Center in New York forced airlines, passengers, and governments around the world to redefine their respective views of security. The United States immediately strengthened passenger screenings as did many other nations. The Transportation Security Administration (TSA) was established on November 19, 2001 and assumed responsibility for all civil aviation security functions from the FAA. In March 2003, TSA transferred from the Department of Transportation to the Department of Homeland Security, which was created in November 2002 to unify the nation’s response to threats to the homeland.25 The new procedures were more intrusive, restrictive, and time consuming, necessitating preplanning on the part of passengers to ensure they allowed sufficient time for the process. In other words, the days of dashing into the airport 30 minutes prior to departure and making the flight were gone forever. As time passed, procedures had to be modified as new threats arose and were handled. Items that used to be allowed in carry-on bags are now prohibited (nail files, pocket knives, and later on, liquids and gels over three ounces), adding to the confusion and processing time. Taken in sum, the impact on the passenger experience of heightened security, while necessary, was largely negative.
Fuel Costs
Fuel, which globally comprised 14 percent of a carrier’s operating costs in 2003 when the average price per barrel of crude was $28.80, accounted for 30 percent 10 years later as the price per barrel rose to $108.26 By the middle of 2013, oil prices began to fall and have continued to do so to the point that the airlines paid an average of $2.05 per gallon in June 2015.27 The attendant reduction in operating costs from the streamlining of routes and the increased use of highly efficient aircraft means the cheaper fuel is even more impactful to the company’s bottom line.28
Financial Recovery
Beginning in 2007, deteriorating consumer confidence and economic uncertainty due to the European debt crisis and the growing likelihood of a protracted period of slow growth in developed economies combined to plunge the world into a recession that persisted into 2011.29 However, this situation exacerbated an already untenable situation. For most of the 2000s, U.S. passenger airlines were struggling to post operating profits. In 2008 alone, they lost $5.6 billion,30 but things began to improve as operating profits rose to more than $5 billion in 201231 and almost $200 billion in 2013.32 One reason credited for the industry’s soaring profits is that carriers are not adding more capacity than demand can support. And to a large extent, they are trying to add capacity without adding airplanes by ensuring every flight is full.33 In addition, companies are reaping billions by charging for everything from checking a bag to extra legroom. United, for instance, said that its revenue from such extra charges increased 16 percent in the third quarter, to more than $20 per passenger, compared with the same period in 2012.34 Another factor is the wave of mergers that occurred among the nation’s largest carriers at the turn of the decade: in 2008, Northwest Airlines merged with Delta,35 while United and Continental did the same in 2010,36 and American and US Airways in 2014.37 This concentration of market power facilitated the stability necessary to implement many of the policies just discussed.
Low-Cost Carriers
The public interest in low-cost or low-service air transportation became a global phenomenon in the 2000s. Southwest, which started as an intra-Texas carrier in 1971, was the first of the second-generation LCCs in the United States, to be followed by others like JetBlue, Spirit, Allegiant, and a newer incarnation of Frontier. Similar airlines can be found in virtually every area of the world, all promoting lower cost flights and fewer (if any) free amenities than their full-service competition. Succeeding in this segment remains challenging, however, as profitability can remain just as elusive as it did for those firms following the same strategy in the 1980s.
Summary
This chapter has presented the high points of the industry’s development from the beginnings of powered flight in 1904, through two world wars and a like number of major economic downturns, as well as other environmental events that have collectively shaped this global transportation system into the one we rely on today. In addition, the transition from economic regulation to deregulation completely transformed the way the airlines operated, and necessitated such a dramatic change in management skills that many carriers failed because their leaders could not make the transition to a free-market business model.