Aviation Advisory Committee Objectives: Government or Market Solutions?

by: Vaughn Cordle, CFA

May 12th the DOT released the Mission Statement and Objectives of Secretary Lahood's Advisory Committee. It looks like a great group, and the objectives of the Commission appear to be perfectly politically correct; Obama should be happy.

Labor has a seat at the table, which is good. As they say in Washington, if you are not at the table, you are on the menu. A fair question to ask is how much influence unions have in Washington, and whether their views will prevail in the final report of the commission.

Balancing competitiveness and viability will be the toughest nut to crack for the group. Our recent industry structure work provides an analytical framework for figuring out the right concentration or number of airlines that would allow the industry to break even on capital costs over a full business cycle. This is how viability should be defined and a full business cycle provides the time horizon that matters most.

A "world class" workforce means different things to the consumer, shareholder, and unions. I find this somewhat amusing since the voice of the labor will be loud given the current political slant in Washington. World class implies the best-trained and highest compensated employees accompanied by the best work rules. This "objective" is not consistent with an industry that is so fragmented (too many airlines). Without further consolidation, the industry cannot satisfy the labor, let alone the most important stakeholder - the shareholder.

Viability also means that the business provides the required rate of return for the investors in the business. Without that required return, the shareholders withdraw their enthusiasm and dump the stock, which in turn drives up the cost of debt and the odds of bankruptcy.

In the final analysis, the industry cannot produce a world-class workforce - whatever that means - given the nature of its destructive fare competition, which is a function of a market concentration that is too low. The solution, of course, is less competition and fewer airlines. This will not be viewed favorably by consumer advocates who understand that fares will increase with higher concentration. However, a strong case can be made that the consumer has captured almost all of the value produced by the industry over the last decade - $70 billion in losses. Labor and fuel account for 50% of the costs.

I had an interesting debate recently about mergers with one of the Commission members, Berkeley's Professor Severin Borenstein (Merger Debate: UC Berkeley'sBorenstein & Cordle / May 4, 2010 Point-to-Point KCRW). Borenstein is a strong opponent of mergers and believes the airlines want to merge so they can raise fares, not improve efficiency. His views would quickly change if he were responsible, and accountable, to the key stakeholders of an airline.

This is not rocket science, but it does require a good understanding of what it takes for the industry to meet the strategic tests of consistency and fit, as it relates to the objectives of the Commission.

The Simple Equation

World class workforce + balance between competitiveness and viability + carbon taxes + funding for ATC and aircraft technology = higher government taxes/fees, security costs, airport charges, ADS-B technology costs, and labor costs for the airlines.

These higher costs must be viewed within the context of a $1.4 to $2 trillion budget deficit and Obama's need to reduce government spending in later years.


The solution is to allow consolidations and mergers, which will allow the industry to pass the increased costs on to consumers of the air transportation system.

Airports and manufacturers will not like consolidation because it results in less traffic and demand. National unions will favor big mergers because it enhances negotiating power. Low-cost airlines will not want to be constrained in terms of their ability to grow, which of course gets to the heart of why the industry prices its product below capital costs. Airline executives and analysts understand what that required return must be and that destructive fare competition - a byproduct of excess capacity - makes the airlines unfit for long term investment.

Commission Objectives

Safety: This and more money is typically the only way to improve safety.

World-class aviation workforce: Skill set or in terms of wages/benefits?

Balancing competitiveness and viability: Without mergers, the networks are not viable and will continue a slow liquidation.

Securing funding: Charge the airlines or taxpayers, with airlines likely paying for technology that helps the airlines.

Addressing environmental challenges and solutions: Carbon taxes are coming and airline passengers will have to pay their fair share.

It's easy to see where the Commission's final conclusions are headed before the first meeting is even held. The Commission is a political means to provide cover for Lahood and Obama, who really don't have a clue about how to fix the industry. In the final analysis it's about shifting costs, and those costs will ultimately be absorbed by the shareholders and the consumer.

The good news is that the logic of why airlines must merge is overwhelmingly solid. More mergers provide relief for the industry and the most important stakeholder, the shareholder, at least for a few years.

Former DOT Assistant Secretary Andrew B. Steinberg says it best:

Completing the work of deregulation – the centerpiece of our policy – means better understanding the role that applying our competition laws has played, if any, in impeding market forces that may benefit the public interest. In this context, it is important to emphasize that the Department of Transportation must fulfill a broader set of statutory policy objectives than does competition law.

We just need DOT to focus on its EXISTING statutory mandates under 49 USC 40101 which nowhere say that the only goal should be below-cost pricing for passengers.

Andy provided testimony where he talked about this and has been like a broken record on this key issue, i.e., "they dont need a new solution, they just need to follow the statute:"

While protecting the interest of US consumers in having access to low airfares remains paramount, Congress has also instructed the Secretary of Transportation, in carrying out the Department’s responsibilities to consider other important goals: including the use of marketplace forces to encourage efficient and well-managed air carriers to earn adequate profits and attract capital, to ensure that consumers in all regions of the United States have access to affordable, regularly scheduled air service, to promote a viable, privately-owned United States air transport industry, and to strengthen the competitive position of air carriers to at least ensure equality with foreign air carriers. Our analysis of a proposed merger will necessarily be informed by all these considerations.

Disclosure: No positions