Legal Commentary

The Decline of Airline Service-Becker

By becker

The increase in flight delays is just one aspect of a general decline in airline service. A few prominent examples of this decline are the elimination of meals in economy on domestic flights, more lost baggage, and dirtier seats and toilets. Posner gives several reasons why service has declined, with concentration on flight delays. I will add one reason to those he mentions that has been very important but is usually overlooked; namely, that the decline in service is an integral part of the substantial fall in the cost of airline travel after the airline industry was deregulated.

The crucial point is that the lower income and leisure flyers, and families with children that now make up the vast majority of customers on domestic routes, and a substantial fraction on international flights, prefer lower prices to better quality service and higher prices. On this interpretation it is no surprise that Southwest Airlines achieved remarkable success by offering low prices with no meals, and only non-reserved economy seats. The revealed preference of the majority of flyers has been that they prefer lower prices to meals and many other amenities that were once standard on flights in the United States. American Airlines and other more traditional airlines have been forced to react to the competition from the no frills airlines by, for example, eliminating meals, and sometimes eliminating first class seats and even reserved seats, so that they too can offer lower prices.

The same considerations explain the greater crowding on flights since airlines can offer much cheaper seats with average loads of 80 percent rather than say 50 percent. The reason is that the cost of handling the additional 30 percent of passengers is very low compared to the high cost of owning and operating planes, and compared even to the reduced revenue they receive from these passengers. Most persons who now fly prefer lower prices with more crowded planes and greater delays in boarding to the high prices and low occupancy rates that prevailed prior to deregulation.

The same trade off between price and service applies to the flight delays discussed by Posner. These delays are stochastic in that they vary from day to day according to different probability distributions of delay times. When delays persist, airlines are forced by the regulatory authorities to increase their scheduled flight times to recognize that typical travel times are longer. Airlines can cut down their delays by having greater amounts of deicing equipment during winter in the event of unexpected icing of planes, greater reserves of crews in case some crew members call in sick or get stranded, a larger number of backup aircraft in case some aircraft develop mechanical problems, and so on for other determinants of delays.

I am arguing that many passengers prefer the combination of low fares and greater delays on average to higher fares and fewer delays because it is cheaper to operate planes when inventories of people and equipment are smaller. Consider as an analogy a clothing store that has a large inventory of merchandise. It charges customers a lot for the suits and dresses it sells partly to help finance the convenience to customers of having many types of clothing to choose from. More generally, sellers often offer customers goods that have at least two dimensions: price and size of inventories. Prices generally are higher when inventories are greater so that delays in buying particular merchandise due to unexpected surges in demand are shorter because of the greater inventory of goods.

Of course, not all passengers are identical, and some of them prefer shorter delays and higher prices to the present situation. A number of airlines have been started in order to cater to these customers by providing exclusively first class or business class seats. These airlines have generally not been successful, probably because there are not enough of these customers to support commercial airlines that only offer first class service. Instead more affluent flyers have opted to buy shares in or outright ownership of private planes where service is far better and delays are much shorter. Private planes even have shorter delays from air traffic congestion because they frequently use less crowded airports.

Air traffic delays at major airports can be reduced through varying pricing of take offs and landings with time of day and the density of traffic, as discussed by Posner. Implementation of such sophisticated pricing is always difficult with publicly owned resources like airports and roads. So the privatization of airports could make possible greater flexibility in pricing the use of airports to take account of congestion.

The high fixed cost and low variable cost of airlines do not imply that airlines must be unprofitable in a competitive environment. Southwest and Jet Blue are two examples of airlines that have done quite well by offering low prices and limited service. Airlines made considerable profits in the latter part of the 1990s, but then the industry was hit first by 9/11, and then by the sharp run up in the cost of their fuel. Fuel costs have become more important to airlines than labor costs.

The hotel industry offers insights into the airline industry. This industry is more competitive than the airline industry since entry into the hotel industry is even easier than into the airline industry, and hotels also have high fixed costs of operations and relatively low variable cost of servicing individuals who occupy their rooms. Hotel prices adjust in the short run to the level of demand, but there are times when it is hard to get rooms, and people with reservations are denied rooms because of overbooking. Yet hotels have on average been quite profitable, which has stimulated various booms in the building of new hotels. To be sure, airlines have been exposed to major shocks, such as deregulation, terrorism attacks, and expensive fuel, but there is no intrinsic structural reason why the airline industry should be less profitable than the hotel industry.

Full post as published by Becker-Posner Blog on April 21, 2008 (boomark / email).