Air travel Is Set to be Improved by New Competition

Bill Hogan is a giant of a man, physically and intellectually. For 30 years he has been teaching economics, statistics and, most important, good common sense at Harvard’s John F Kennedy School of Government. Years ago, when I was a colleague of his, and puzzling over how to regulate where necessary and deregulate where possible, he solved most of my problem. “Get the incentives right,” he said, “and much of the rest will take care of itself.” Add to that any business’s need to control the totality of its customers’ experience and you can begin to understand what’s going on in the airline industry.

Let’s start with the problems at London’s Heathrow, Washington’s Dulles, and other airports. If lines lengthen at security checkpoints, nobody has an incentive to add staff or open more lanes. By contrast, such a situation at Tesco immediately results in the opening of more tills to relieve congestion. Tesco’s managers have an incentive to prevent customers from taking their business elsewhere; airport managers don’t, or think they don’t. Indeed, they have every incentive to keep costs down and profits up, even if that means providing a miserable service. Imagine what life would be like in an airport where security personnel, or at least the managers, had their pay cut every time lines lengthened beyond a target limit, and had the power to correct the situation.

Now consider British Airways. For a long time it controlled enough slots and gates at Heathrow to have significant monopoly power on important routes, most notably those across the Atlantic, which provide an estimated 60% of the airline’s profits.

But the airline and BAA, the airports operator, may not be able to count on sheer market power to keep their revenues flowing. BAA is under investigation by the Competition Commission, which will be unimpressed with the argument that service cannot be improved because the money is needed to cover the cost of the debt incurred when Grupo Ferrovial acquired BAA. Equally important, competition is rearing its beautiful head, although not from the other six UK airports that BAA also controls.

First, there is the new fast train service from St Pancras to Paris, Brussels and other destinations on the Continent; and in America, Amtrak trains on the Washington-New York-Boston corridor. Second, more and more passengers are recasting their itineraries to avoid Heathrow by using connecting points other than London, and to avoid the most congested of the American airports.

BA also faces new competition, and not only from faster trains to Europe. New carriers are wooing BA’s business-class customers with lower fares and terminal service that avoids the nightmare of Heathrow.

But those limited-capacity lines are nowhere near as great a threat as the liberalised regime that will come into force in March. Any airline will be free to fly anywhere between America and Europe. Delta and Air France have already announced a deal for the Atlanta-based carrier to get three of Air France’s Heathrow slots. The two carriers will offer 19 flights a day from America to Britain and France.

BA is preparing to respond with a state-of-the-art Terminal 5 at Heathrow, and a fleet of new aircraft. But the history of former monopolies in other industries suggests that they are not uniformly successful in a more competitive environment. BA enters the newly competitive era after a period in which it has been antagonising its customers. Management seemed unable to ensure that passengers and their baggage arrived at the same destination, and to prevent monstrous queues from becoming the norm at the carrier’s understaffed check-in counters.

As they decide on optimal service levels, BA’s chief executive Willie Walsh and colleagues might recall the observation of Gordon Bethune, a former boss of Continental Airlines: “You can take so much cheese off the pizza that nobody will eat it.” Especially if the store down the road is offering pizzas with all the toppings – Singapore Airlines now has bedroom suites on its new A380s, and Virgin is creating a dedicated drop-off, check-in and security facility at Terminal 3, bypassing the horror show run by BAA.

That gives the perennially innovative Branson team control of the entire customer experience – no more outsourcing control of that experience to the likes of BAA.

Whether all this competitive jockeying will in the end find its way to the bottom line is uncertain. American airlines made money in the face of delays and horrible service because they cut capacity, reducing the intensity of competition for customers. A wave of bankruptcies brought capacity more into line with demand, reducing the scramble to peddle empty seats, and even allowed airlines to increase fares. This past summer, carriers operated at 86% load factors (percent of seats filled), and racked up profits even as oil prices rose. United, Delta, American Airlines and Jet Blue all reported hefty increases in profits.

All this black ink is due to the elimination of excess capacity on most routes. With the number of bums about equal to the number of available seats, competitive pressures have eased, and passengers in America have no choice but to accept rotten service.

BA might not be so lucky. Capacity on its overseas routes is about to move in the opposite direction. With the economic outlook uncertain, and potential American travellers watching the purchasing power of their dollars shrivel, BA might find itself in increasingly competitive markets, with fewer bums and more seats, and headed for that most fraught of things – interesting times.