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Travel News

Crandall looks at the airline industry, doesn’t like what he sees

Written by editor

Former AMR and American Airlines chief Robert L. Crandall spoke Tuesday night to the Wings Club in New York, and had some interesting ideas.

Former AMR and American Airlines chief Robert L. Crandall spoke Tuesday night to the Wings Club in New York, and had some interesting ideas.

The government should reregulate the industry a little bit. He suggests that airlines be forced to charge fares that add up the legs of a trip, an idea that would penalize connecting hubs like the big ones he championed at D/FW Airport, Chicago and elsewhere.

For example, if an airline charges $200 to fly from Albuquerque to DFW and $400 to fly from D/FW to New York, it would have to charge $600 to fly from Albuquerque to New York through D/FW.

“To my mind, a ‘sum of the locals’ rule would likely reduce the ability and motivation of airlines to preserve connecting complexes now being sustained by operating small, relatively inefficient aircraft, or by pricing connecting itineraries far below actual costs or – in far too many cases – doing both!!!!” Mr. Crandall said.

If that’s not the solution, he welcomes another, but urges that something be done.

He urges the developing of a better train system as part of a national transportation policy, action on improving the air traffic control system

Says Mr. Crandall:

In addition to producing huge losses, current pricing and operating practices have produced many negative side effects. In an effort to ameliorate losses, airlines have driven load factors much higher than can comfortably be managed, have outsourced much of their labor to firms employing marginally capable personnel, have introduced hundred of small, inefficient aircraft, have eliminated amenities once considered normal and are imposing a wide range of fees to supplement revenue.
The proliferation of fees irritates already unhappy customers, and some – notably baggage checking fees – slow up the check-in process and encourage passengers to carry aboard even more than they have in the past.

Fuel isn’t the issue, he says, although it is exposing problems now.

These are just snippets. For the whole speech, keep reading.

Robert L. Crandall, Wings Club speech, June 10, 2008:

Many years ago, I gave a talk here during which I used a naval analogy to urge the industry to find new approaches to its problems. The story involved a battleship captain who perceived his ship as the most powerful vessel afloat and who sent an ever more preemptory series of signals directing an approaching ship to change course. In the end, the other ship signaled back that it was a lighthouse.
Looking back on the industry’s experience during the years since, I am forced to the conclusion that the captain – sure of himself despite the obvious perils ahead – went full steam ahead onto the rocks.

The consequences have been very adverse. Our airlines, once world leaders, are now laggards in every category, including fleet age, service quality and international reputation. Fewer and fewer flights are on time. Airport congestion has become a staple of late-night comedy shows. An ever higher percentage of bags are lost or misplaced. Last-minute seats are harder and harder to find. Passenger complaints have skyrocketed. Airline service, by any standard, has become unacceptable.

Meanwhile, the financial health of the industry, and of the individual carriers, has become ever more precarious. Most have been through the bankruptcy process at least once, and some have passed through on multiple occasions.

An analyst from Mars, just arrived and knowing nothing of the industry’s background, might be forgiven for believing that the entire problem can be laid at OPEC’s doorstep. If only fuel prices were lower, the Martian might conclude, the industry would have no problem. Looking around the room, I see no Martians – but lots of folks who can remember – as I do – when the industry lost money while paying far less for fuel than it does today. While the price of fuel – and particularly the rapid rate at which it has risen – has certainly complicated the management challenge, it is clear that fuel prices are not the core of the problem.

Nor is inadequate scale. These days, the solution de jure seems to be mergers, and many voices clamor that consolidation is both inevitable and imperative. In my view, the arguments in favor of consolidation are unpersuasive. Mergers will not lower fuel prices. They will not increase economies of scale for already sizable major airlines. They will require major capital expenditures and are likely to increase labor costs. Finally, they will disadvantage many employees, whose incentive to provide good service will be further reduced.

If consolidation were really the answer, it is conceivable that the system could be run by a single efficient operator. However, consumers clearly benefit from the existence of multiple airlines; the absence of alternatives does not encourage good customer service. Thus, our goal should be to harness competition and regulation to create a system responsive to both the imperative of efficiency and the desirability of decent service.

As is always the case, “victory has many fathers, but failure is an orphan” and no one wants to take credit for the sad state of our aviation industry. Fortunately, there is plenty of blame to go around. In my view, the industry’s problems reflect several shortcomings:

• First and foremost, we have failed to confront the reality that unfettered competition just doesn’t work very well in certain industries, as amply demonstrated by our airline experience and by the adverse outcomes associated with various state efforts to deregulate electricity rates. In my view, it is time to acknowledge that airlines look and are more like utilities than ordinary businesses.

• Second, our government has failed to develop a national transportation plan of any kind and has thus been indifferent to the continuing decline of our highways, our railroads and our airlines.

• And third, the government has failed to invest in the capabilities and resources which only it can provide, most notably by failing to implement the new air traffic control system that everyone agrees we desperately need.

In my view, it’s time to do something about all three.

I feel little need to argue that deregulation has worked poorly in the airline industry. Three decades of deregulation have demonstrated that airlines have special characteristics incompatible with a completely unregulated environment. To put things bluntly, experience has established that market forces alone cannot and will not produce a satisfactory airline industry, which clearly needs some help to solve its pricing, cost and operating problems.

It must now be clear to all that one of the industry’s fundamental problems is the way in which it prices its product. As you all know, airlines work with a very distorted supply-demand equation. The instant perishability of empty seats, the impossibility of quickly reducing fixed and semi-variable costs when demand falters, the public’s view that all airline seats are interchangeable commodities, the plethora of competitors and the desire to protect the reach of networks all create a great temptation to sustain volume by selling seats too cheaply.

In addition to producing huge losses, current pricing and operating practices have produced many negative side effects. In an effort to ameliorate losses, airlines have driven load factors much higher than can comfortably be managed, have outsourced much of their labor to firms employing marginally capable personnel, have introduced hundred of small, inefficient aircraft, have eliminated amenities once considered normal and are imposing a wide range of fees to supplement revenue. The proliferation of fees irritates already unhappy customers, and some – notably baggage checking fees – slow up the check-in process and encourage passengers to carry aboard even more than they have in the past.

I have heard various proposals for solving the pricing problem. The most aggressive favor government supervised pricing discussions whose goal would be to establish minimum fares sufficient to cover full costs and produce a reasonable return. While I would fully support such an approach, the idea is deeply offensive to those who cling to the belief that the markets can solve everything.

However, I think there may be a less intrusive way for government to help the industry achieve compensatory pricing while simultaneously responding to the increasingly pressing need to increase its fuel efficiency. Suppose for a moment that in a world where every airline set its own prices, a regulatory agency required that any passenger traveling between two points via a connecting point pay the sum of the local fares on his or her itinerary.

As we have all known for many years, the cheapest way to carry a passenger from point a to point b is non stop, and the most efficient way to do it is by using the largest airplane compatible with demand. To my mind, a “sum of the locals” rule would likely reduce the ability and motivation of airlines to preserve connecting complexes now being sustained by operating small, relatively inefficient aircraft, or by pricing connecting itineraries far below actual costs or – in far too many cases – doing both!!!!

Ask yourself this: if the non-stop fare from Detroit to Los Angeles is $450, why should a passenger be able to travel via a connection for the same amount or, as is the case today, for even less?

In a sum of the locals world — or even in a world where the minimum fare was the nonstop price plus a connection premium — there might be fewer flights from Detroit to various hubs because higher through and connecting fares would mute demand. Passengers traveling only from Detroit to one of the hubs would likely have fewer service choices while passengers traveling to Los Angeles or other points beyond the hubs would confront a new paradigm in which the lower price of a non stop journey might make waiting for a non stop more desirable than choosing a higher cost but more convenient departure via a connecting point.

This argument, of course, turns the conventional wisdom about hubs on its head. However, times are very different now than they were when the hub and spoke system was growing rapidly. In those days, the United States gave little thought to either global warming or energy independence; today, the U.S. spends $600 billion per year on petroleum, pines for energy independence and watches the ice caps with increasing trepidation…

Things have changed dramatically and will change even more in the years ahead. In due course, our country’s need for energy conservation and our airline’s need for profitability will inevitably generate an intensive search for new approaches.

As you all know, I am no longer active in airline management, and thus lack the sophisticated analytical tools I so enjoyed in years past. It may be that there are better ways of approaching the pricing dilemma, and if so, I shall look forward to hearing about them. In one way or another, however, I think it’s time for everyone to face up to the need for our airlines to price their products to recapture full costs — and earn the profits needed to sustain the huge investments essential to the industry’s future.

The carriers also need help in curbing labor costs. As everyone here knows, airline efforts to control labor costs have been blunted – since the demise of the mutual aid pact in 1978 — by the dramatic imbalance between the negotiating strength of organized labor and that of the airlines. Unlike industries with a tangible product, airline seats cannot be stockpiled. Thus, an airline has no product to sell during a strike, loses business when a strike is threatened and suffers from reduced traffic for months after a strike is settled. Moreover, airlines are unable to quickly reduce fixed and semi-fixed costs during a strike. Thus, as a practical matter, no airline can endure a strike and will invariably yield to labor’s demands before a strike is actually called.

The result has been labor rates and work rules which are far more generous than those offered for comparable skills in other industries. Since strikes against transportation utilities are illegal in many jurisdictions around the world and are clearly contrary to the public interest, I do not see why the railway labor act should not be amended to require binding arbitration. While organized labor would object to being deprived of its ultimate weapon, it seems likely that the threat of binding arbitration would encourage both labor and management to adopt more moderate positions than has been true in the past while simultaneously moving all airlines closer to labor cost parity.

We would also be well advised to revise our bankruptcy laws to deprive failed carriers of the right to use lower costs to undercut the fares offered by their more prudent rivals. Forcing both management and labor to face the twin spectres of liquidation and unemployment would likely be another step towards less confrontation and more cooperation.

It is also clear that decisive government action is needed to relieve the extreme congestion now being experienced at our busiest airports. As we all know, airlines cannot unilaterally reduce frequencies because doing so would allow another carrier the opportunity to add flights and gain a competitive advantage. In the short term, the only solution is a regulatory mandate that limits the number of flights scheduled to what the runways, terminals and air traffic control facilities at a given airport can handle.

To get there, present schedules should be reduced proportionally to each carrier’s present frequency share. Doing so would create pressure to use the largest feasible aircraft in each slot. Matching capacity and usage would also get flights back on time, reduce both fuel usage and costs, and influence long term fleet planning in ways consistent with both compensatory pricing and energy conservation.

The government should also tighten the financial standards that must be met by new airlines. In the years since deregulation, nearly 200 airlines have come and gone. These inadequately financed carriers, whose principal goal has often seemed limited to either lasting long enough to reap the rewards of an initial public offering or satisfying the ego of yet another would be airline mogul, have consistently cut prices to attract passengers. Such short-term antics have destabilized the pricing structure required by a healthy industry, and have offered no lasting benefit to anyone.

Finally, we should ask ourselves whether using our anti-trust laws to prevent airlines from collaborating to achieve more intensive asset utilization and more efficient operations really makes sense. It is hard to imagine the kind of clean slate productivity gains that are clearly needed without some relaxation of past and present restraints on cooperation.

Modest price regulation, slot controls at congested airports, more stringent standards for new carriers, revised labor laws, amended bankruptcy statutes and a more accommodating stance towards industry collaboration are a far cry from the inclusive regulatory regime of cab days. However, these few steps – in my view – would have a dramatic and favorable impact on the financial health of our airlines, the usefulness of our airline system, service levels in the airline business and the welfare of airline employees.

But regulation alone is not enough. We also need a national transportation plan, including a clearly articulated, widely understood statement of our aviation goals. In my view, our objectives should be:

• first, to strengthen our national economy by encouraging the creation of a cost effective, energy sensitive transportation network which will permit people to move easily from one place to another

• second, to assure safe, courteous and on time service for consumers

• and finally, to improve the financial performance and international competitiveness of America’s airlines.

Unhappily, such a plan does not exist. For many years, the only apparent goal of U.S. Aviation policy has been to secure lower fares for consumers by encouraging competition of any stripe in every market, without regard to any other consequences, including the industry’s viability.

A good first step towards a sensible policy would be to revisit the basis on which we negotiate international aviation agreements. Since the late 1970’s much of our governments effort has been focused on achieving very liberal aviation agreements with governments around the world, for no apparent purpose other than to drive prices ever lower. Since the United States has long been the world’s largest single aviation market, those agreements – over the years – have afforded far more opportunities for foreign airlines than for our own, with predictable consequences.

Currently, a major element of debate surrounds the question of whether foreign airlines should or should not be allowed to own more than 25% of the equity of a U.S. Carrier. Given the deplorable economic record of U.S. Carriers, it seems highly unlikely that foreign airlines have an overwhelming desire to participate in our domestic aviation market. Thus, it seems clear that the objective of those seeking U.S. carrier ownership is primarily directed at using a U.S. base to feed international flights and to discourage the creation of incremental competitive capacity by resurgent U.S. Competitors. Thus, I am mystified by the apparent willingness of U.S. Negotiators to further weaken the domestic system by turning over control to people without any stake in making our domestic system work.

Given the high level of congestion at our major airports and our desire to operate a more energy efficient transportation complex, I am similarly mystified as to why we have heard little or nothing about the development of alternative surface transportation systems for short haul journeys. At our major airports, a significant percentage of flights are to destinations less than 300 miles distant, which could readily be replaced by the modern high speed rail systems found in many countries around the world. Similarly, we could increase long haul aviation capacity to and from our major cities by linking near by airports to those cities with high speed rail links.

The East Coast offers easy examples. It would be a relatively simple matter to improve rail service between New York and Washington sufficiently to render airline service unnecessary and thus free the LaGuardia and Reagan slots now allocated for service between the two points for longer flights. We could also link Stewart airport to New York via rail, and thus expand opportunities for service to New York dramatically. And that Detroit to Chicago trip we talked about earlier – which is 283 miles – could be struck from schedules altogether if there was decent rail service.

I’m sure there are many other opportunities in the Midwest, on the west coast, in Florida and elsewhere — and I’m appalled that no one in Washington seems to have given the matter a moment’s thought.

We ought to consider, as well, how aviation related policy positions impact our other national goals. Some years ago, airlines gained permission to have maintenance work done at overseas maintenance facilities. In the years since, a substantial percentage of our aircraft maintenance work has gone abroad – despite the reality that work at those facilities is done under less demanding rules, and with far less FAA oversight – than is true of work done in the United States. Additionally, of course, allowing airlines to export their maintenance work has cost the United States many thousands of high skilled middle class jobs – which seem to be in short supply these days. Thus, it’s a bit hard to know just what national policy goal is met by permitting offshore maintenance.

In recent weeks, the seriousness of this issue has been underscored by controversy about whether the FAA is or is not doing airline oversight adequately. A recent story in the wall street journal alleged that the FAA has failed to perform a number of required 5 year reviews of airline performance, and – quite unbelievably – that the FAA did not know whether the reviews had or had not been performed. According to the article, the FAA has recently developed a new tool that will alert senior officials when five year reviews are overdue!!! While the agency has done a fine job of guiding the industry towards an exemplary safety record, I find it unbelievable that it doesn’t know whether required reviews have been performed – and wonder how that uncertainty impacts work done in countries as remote as china.

Finally, despite the undisputed importance of aviation to the health and vigor of our economy, our government has failed to invest in the facilities and systems needed to assure its continued growth. An effective aviation system depends on the aviation infrastructure, which consists of airports owned and operated by local government agencies and the air traffic control system owned and operated by the FAA.

A comprehensive redesign of the ATC system is a responsibility of the federal government, and has been the subject, since 2003, of an intensive planning effort under the guidance of the joint planning and development office, commonly referred to as the JPDO. Despite the acknowledged importance of the task – the U.S. Chamber of commerce has called our failure to address the problem “devastating” — implementation of the system has been hampered by resistance from the air traffic controllers union, the unwillingness of some in general aviation to invest in needed on board equipment, the unavailability of capital funding, ongoing arguments about who should pay how much to build and use the system, faulty management of various projects by the FAA and by political resistance from congress, which is unwilling to support the facility consolidations essential to realizing the plan’s economic benefits.

Additionally, as I am sure many of you know, the very slow progress we have made towards creating the ATC system we need has been complicated by the continuing struggle between those who would like to introduce a user fee system and those who advocate continued excise tax financing, and between those who favor privatizing the ATC function and those who want it to remain the province of the FAA. Unfortunately, we seem to have lost our political will to resolve conflicts and move towards solutions. Until we regain that will, our antiquated ATC system will continue to inhibit the growth and success of our aviation industry.

I read just recently that the president’s approval rating has dropped to well under 30% — a modern record – and that Congress gets favorable marks from only 18% of citizens. There are certainly many reasons for the widespread dissatisfaction, which for reasons of time I will not enumerate here. But the sad state of our own industry certainly deserves a place on the list of grievances.

The United States used to be good at solving problems. These days, we don’t seem up to the job. I find that discouraging, as I know many of you must. I do hope, however, that whether you agree or disagree with the thoughts I have presented today, you will become an advocate of substantive debate about finding solutions for our commercial airline industry.

There is an old saying that what can’t continue, won’t – and it’s pretty clear we can’t stand much more of what we’ve had in recent years.

As you know from these remarks, I think a dollop of regulation, along with new government policies and appropriate investment, would help the carriers get back on the right track. Although I am not going to hold my breath, I sincerely hope we’ll move in that direction.

Thanks very much for your attention.