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Remarks of
JEFFREY N. SHANE
UNDER SECRETARY FOR POLICY
U.S DEPARTMENT OF TRANSPORTATION
American Bar Association 2004 Annual Meeting
Aircraft Financing Subcommittee
Atlanta
August 6, 2004
For a lawyer who was told to check his legal credentials at the door upon
re-entering government service a few years ago – if the word “policy” is in your
title in the bureaucracy, you had better not be caught rendering a legal opinion
about anything -- it is a rare pleasure to be able to pay even a fleeting visit
to the American Bar Association’s Annual Meeting. Each year, the ABA wins the
prize for conducting the world’s most complicated meeting. So many sections,
divisions, committees, subcommittees, and forums! You have to have a legal
education just to be able to figure out the program. According to my quick
estimate, more than a thousand meetings will be conducted during this five-day
affair. Apparently there is a lot to talk about. It’s reassuring to know that
the bar is keeping busy.
To be serious, I am very grateful for Jim Tussing’s gracious invitation to speak
with you today. I want to talk about the profound changes sweeping through the
airline business. For government policy makers, as you can probably imagine, it
is a time of great challenge. I also want to talk about what the Bush
Administration and Secretary Norm Mineta have been doing to provide leadership
for the future of the aviation sector, including some things that haven’t
received much public notice. I also want to give you my impressions of where the
industry is headed. Finally, I hope we can engage in some dialogue; I came to
Atlanta as much to hear what practitioners in this sector are seeing and
thinking as to offer pronouncements on aviation policy.
An Industry in Transition
As you are all well aware, the airline industry is going through a period of
profound transformation. A fundamental restructuring is under way, attributable
to three simultaneous phenomena: first, the shrinkage of high-end demand for air
travel that began in late 2000; second, the emergence of a new cadre of low-cost
carriers; and third, the increased transparency of alternative airline offerings
and less expensive itineraries made possible by the internet and other
technologies.
DOT’s analysts believe that the collapse of high-end demand at the end of 2000
was not simply another cyclical change, but rather an important structural
change driven by a powerful combination of economics and technology. While
leisure travelers have always chosen an airline primarily based on price, there
is growing evidence that business travelers have become significantly more price
sensitive. For many, the change is likely to be permanent. Together, the
economic downturn beginning in the latter half of 2000 and 9/11 engendered some
major changes in business travel purchasing habits. Because cutting travel
budgets became a corporate imperative, businesses embraced lower cost travel
alternatives, including low-cost air carriers. Many trips that would have been
routine just a few years ago simply weren’t taken. Consider how many fewer trips
you take today during the course of a major transaction than even a few years
ago. That’s because your clients are more attentive to such costs and because it
is so easy to exchange redlined documents electronically. Businesses in every
sector made similar changes in their travel patterns, substituting web
conferencing and other technologies for face-to-face meetings.
Second, the new generation of U.S. low-cost carriers – like JetBlue, AirTran,
and Frontier – are bigger and better than the previous generation of LCCs, most
of whom ultimately failed. Flying on a low-cost carrier generally used to mean
infrequent service on aging airplanes across a limited network. No longer. LCCs
now offer convenient schedules, state-of-the art aircraft, and amenities that
meet or exceed those offered by the “full service” airlines. This competitive
challenge has forced pre-deregulation airlines – we now call them “legacy”
carriers -- to take a hard look at their business strategies and reduce costs
wherever possible.
A third factor underlying the structural changes in the industry is the internet
– not as a substitute for travel but as a perfect purveyor of information about
travel. Carriers everywhere have embraced online ticket sales as a means of
reducing distribution costs. Low-cost carriers were often in a better position
to take the greatest advantage of internet distribution channels because they
were unburdened by the legacy of existing distribution systems and technologies.
Travelers now have the wherewithal to compare price and service offerings of all
airlines quickly and efficiently, and to act on those comparisons instantly with
only a few keystrokes.
New Realities in Aviation
The conventional wisdom seems to be that demand for air travel remains soft,
that there is too much capacity in the marketplace, and that’s why our
traditional network carriers are still suffering. The truth is that the only
demand that is soft is demand at the high end of the fare structure. The demand
for more affordable air travel is extremely healthy. That the carriers earning
profits in this market are the ones charging the lowest prices is an important
clue to the different kind of structural transformation that is currently under
way.
One important difference is that high-end legacy carrier fares have declined not
merely on routes served by LCCs, but also on routes where there is no current
LCC competition. Very clearly, the fare transparency delivered by the internet
and the expansion of LCC services has increased the price-sensitivity of all
travelers, even business passengers. The airline seat is rapidly becoming a
commodity, and as a result the pressure on legacy carriers to reduce their cost
structures has been enormous.
Despite these difficulties, legacy carriers remain an invaluable part of
commercial aviation in America. They are – and for the foreseeable future will
be – the only airlines that link thousands of city-pair markets across the
nation and often the only service available to small communities. Through the
legacy carriers’ networks and those of their alliance partners, Americans can
reach any corner of the globe, often with just one connection. We should not
underestimate the continued importance of these networks to our economy and to
our nation generally. Nevertheless, it is clear that this time we are witnessing
a true watershed in the development of deregulation, and legacy carriers can no
longer simply follow each other through the ups and downs of the normal business
cycle.
The architects of deregulation predicted that new airlines, unburdened by higher
costs, would enter the market and exert pressure on pre-deregulation carriers
either to compete on cost or fail. The first 25 years of deregulation did not
follow this script, largely because of the unexpected economies of scale and
scope on the revenue side that enabled carriers to pursue a strategy focused on
higher unit revenues rather than on lower unit costs. For years, our large
network carriers were able to avoid cost-side pressures by focusing on a
revenue-side strategy largely centered on high-yield business traveler. The
strategy generally worked because the business traveler, who grew accustomed to
paying high fares, had no attractive alternatives. The airlines also kept tight
control over the number of seats available to discretionary travelers. In a
market now characterized by declining high-end demand and widespread
availability of attractive low-fare options, legacy carriers no longer have the
ability to do that. As a result, revenue-side strategies are no longer
sustainable. While the architects of deregulation were accurate in predicting
how the market would change, they were way off in guessing how long it would
take that change to materialize.
What does all this mean for the future? The “delta” between the legacy carriers
and the LCCs in cost per available seat mile remains very high, even for
carriers that have gone through a round of restructuring. It will be a
continuing challenge for the legacy carriers to further shrink that gap in the
current environment, particularly because low-cost carriers continue to make
improvements and drive costs down still further.
It also seems likely that today’s group of savvy, well-equipped, low-cost
carriers will continue to expand. They are pushing the limits of the traditional
low-cost carrier business model, in which low-fare carriers only operated
successfully in dense, short-haul, point-to-point markets. ATA, AirTran, and
Frontier all operate hub-and-spoke systems to destinations from coast-to-coast.
Furthermore, LCCs are now rapidly expanding into transcontinental markets and
some even into international markets as well. In fact, ATA, based in
Indianapolis, has announced trans-Atlantic service between Chicago and
Cologne/Bonn beginning in May 2005.
International Developments
What is also remarkable about the transformation of this industry are the
striking similarities between the U.S. market and what is happening in Europe
today. Common to both sides is a rapidly changing, dynamic marketplace, with a
demand for affordable air travel that is increasingly robust. In fact, global
passenger growth is exceeding IATA’s expectations, registering a 20 percent jump
for the first six months of 2004.
Although deregulation of the airline industry within the European Union was not
completed until 1997, there has been a rapid convergence of airline business
models on both sides of the Atlantic. The European airline industry, like our
own in the U.S., is characterized by a combination of legacy network carriers
and LCCs. Consumers and our respective economies need both types of service.
Low-cost carriers now account for nearly a 30 percent market share in the U.S.
and close to 20 percent in Europe. Like Southwest and JetBlue in the U.S.,
Ryanair and EasyJet are reshaping the nature of air travel in Europe. There is,
perhaps, one important difference – European low-cost carriers face very real
additional competition from Europe’s expanding high-speed rail network.
Legacy carriers on both sides of the Atlantic are responding to mounting
low-cost carrier competition in similar ways. Some, like America West and Aer
Lingus, are transforming themselves into LCCs. Others, like United and SAS have
formed low-fare airline brands. Most legacy carriers on both sides of the
Atlantic are seizing the opportunity to strengthen their trans-Atlantic
alliances to reduce costs, increase revenues, and respond to changes in the
marketplace.
The government’s role in this process is clear: to do all we can to encourage
continued innovation and dynamism within this remarkable and essential industry.
That is why we were disappointed at the European Council of Ministers’ recent
refusal to take the first important step toward a new comprehensive air services
agreement with the U.S. that would have taken aviation liberalization to an
entirely new level. Among a number of important innovations in that accord was
an agreement by the United States to treat EU airlines not as national carriers
allowed to fly to the U.S. only from their individual home countries, but rather
as “EU carriers” eligible to originate flights anywhere in EU territory to any
point in the U.S. and beyond. That single concession would open the door to a
likely rationalization of the European airline industry, with important
dividends for U.S. carriers and their alliances as well. It is a badly overdue
first step, and the U.S. announced its commitment to take that step at the very
outset of the negotiations. I am surprised that our European friends didn’t
attach more value to that commitment.
We have not, of course, let the EU’s refusal to take this first step towards a
fully liberalized market stop us from pushing forward elsewhere. We recently
concluded bilateral agreements with China and Indonesia, expanding liberalized
air service and a more open aviation market to another 1.6 billion people. The
number of commercial and cargo flights between the U.S. and China will increase
successively through 2010 by nearly 200 weekly departures, bringing huge
economic benefits to both countries. Indeed, we estimate that a single new daily
777 roundtrip between the U.S. and China will produce a total annual benefit of
about $158 million to the U.S. economy.
Implications for Competition Policy
It is reasonable to expect the expanding liberalization of aviation markets –
including eventually the trans-Atlantic market -- to facilitate further changes
in the industry’s structure. In a liberalized environment, the industry can look
forward at last to managing itself in keeping with commercial exigencies, not
political ones.
Airline strategies in this environment are increasingly predicated on an array
of joint ventures and alliances. Internationally, these alliances serve as a
surrogate for genuine consolidation, which is artificially impeded today by
national laws everywhere governing the ownership and control of airlines –
another relic of the past that we undertook to revisit with the Congress as part
of a new agreement with the EU. Those strategies appear to be moving in the
direction of more consolidation in this industry, particularly among the legacy
carriers. It appears to be taking two forms. The first involves airlines joining
forces under a holding company structure to deal with the longstanding
restrictions on foreign ownership. This approach was followed by Air France and
KLM and appears to be the strategy of Virgin Express and SN Brussels. The second
form is the further development of the international alliance model. This could
take the form of consolidation of alliances or through the deepening of
cooperation within alliances. European carriers and their U.S. partners in the
major global alliances (e.g., Star, Oneworld, SkyTeam) increasingly see these
alliances as a major component of their business.
Perhaps one of the greatest policy challenges going forward will be for
governments to deal effectively with new consolidation proposals. Changes in
international alliances will have a direct impact on domestic competition, as
current developments already make clear. The Department of Transportation will
actively follow these dynamics, and will consider carefully their impact on the
industry and consumers. While the marketplace, not the government, will
determine which carriers succeed, the government does have a role in protecting
competition by barring anticompetitive behavior.
Providing Capacity to Facilitate Growth
In addition to the various responsibilities governments have in supporting
competition and ensuring safety and security, we also must provide adequate
aviation infrastructure so that the industry can continue to serve as an engine
of economic growth and prosperity. Passengers are returning to the system in a
big way as demand returns to pre-9/11 levels, and as a result we are facing
significant delays at some of our most congested airports. While increasing
capacity will typically be our preferred response, there will be some situations
where we will have to take action to alleviate delays, at least on a temporary
basis.
One such example is the current situation we face at O’Hare International
Airport in Chicago. Over the last two days, the FAA has been meeting with the
carriers that serve O’Hare, where a substantial increase in operations over the
last few years has strained the airport’s capacity and caused record delays. We
hope ultimately to achieve schedule reductions from the carriers on a voluntary
basis, but have made it clear that we will take unilateral action if we must to
ensure that passengers at O’Hare do not continue to suffer through intolerable
delays. In doing so, however, we will leave room for some limited new entry and
keep a close eye on the competitive environment at O’Hare going forward. In the
interim, we will also be working closely with the City of Chicago on their
proposals for modernizing and ultimately expanding O’Hare.
Other airports, like New York’s LaGuardia, are a different challenge in that
there is little room for additional capacity. As they did for O’Hare in 2002,
Congress has eliminated the limit on operations at LaGuardia as of January 1,
2007. We are working closely to explore options available to us to better manage
demand there, including market-based mechanisms. Just last week, I chaired a
discussion with our airport and airline stakeholders to discuss the pros and
cons of such market-based mechanisms. It was a very open and productive dialogue
– one that we plan to continue in the months ahead.
These efforts, of course, are not a comprehensive or long-term solution to the
growing demand for air travel. We need to take a hard look at what we expect of
the entire system in the longer term. To that end, Secretary Mineta has
announced an historic new initiative that will take our aviation system to a
wholly different level of efficiency and capacity. No matter what the future
market for air transportation will look like, we know we will have to handle a
great many more aircraft operations than we do today. Secretary Mineta therefore
has called for a tripling of system capacity over the next two decades. As part
of his Next Generation Air Transportation System Initiative we have established
a new Joint Planning and Development Office within the FAA that is staffed by
representatives of a number of participating agencies, including NASA and the
Departments of Defense, Homeland Security, and Commerce. The program is being
guided by a Senior Policy Committee chaired by Secretary Mineta, with high-level
participation from each of the participating agencies. That committee has met
twice now, and is well on its way to developing the first edition of a National
Plan that will lay out the long-term plan for ensuring the continued vitality of
our air transportation system, and ensuring its wherewithal to accommodate
whatever increases in demand our growing and robust economy places on it..
Conclusion
I’ve been talking about our policy toward the economics of the airline business
– it’s largely “hands-off” – as well as our efforts to instill greater
competition in international aviation markets, to preserve competition in the
face of a growing pressure to consolidate, and to grow the capacity of our
aviation system so that it continues to support America’s economic growth. I
hope I have left you in no doubt that I am bullish on this industry. There is an
abundance of creativity in the airline business here and abroad and none of us
can predict with any confidence what the next important innovation will be.
But my bullishness is predicated in turn on my optimism about the direction of
government policy. It is critically important that government continue to place
its trust in market forces to the greatest possible extent and to address
impediments to competition – both here and abroad -- in a way that ensures
healthy competition but that does not unreasonably impede the continued
evolution of the industry. Finally, it is government’s job to ensure that the
aviation system has the wherewithal to accommodate whatever the market may
deliver in the future.
I am pleased to tell you that the Bush Administration has understood all this.
Secretary Mineta and the DOT/FAA team have addressed these issues and many
others – safety, security, war risk insurance, compensation for 9/11-related
losses, liability for accidents on international flights, the Cape Town
Convention on interests in mobile assets – in an aggressive and clear-eyed way.
Regardless of the particular prism through which you look at the aviation
industry, it is endlessly fascinating. I don’t think you need to be concerned
about your practices drying up any time soon.
Thank you for allowing me to share these thoughts with you this afternoon.
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