Deregulation of the Airline Industry

The airline industry has been subject of intense price competition since
it was deregulated, and the result has been a number of new carriers which
specialize in regional service and no-frills operations. These carriers
typically purchase older aircraft and often operate outside the industry-wide
computerized reservations system. In exchange for these inconveniences,
passengers receive low fares relative to the industry as a whole. This research
examines two low fare air carriers, ValuJet and Southwest Airlines. By
investigating these air carriers, we can better understand the economic impacts
of price versus service in the airline industry as a whole, as well as, the
impacts on passenger and investor confidence.
Until 1978, air transport rates were approved by the government, which
meant that price was not a primary competitive factor. Instead, airlines would
compete on service and image. The airline industry was dominated by giants
(American, United, TWA) which offered nationwide and some international service,
and by regional carriers, such as Southwest, which offered short trips between
airports not served by the nationals.
Deregulation of the airline industry brought about in 1978 introduced a
situation in which the national and regional carriers were suddenly able to
compete in an environment that resembled a free market. Rate schedules were
lifted, price fixing was eliminated and route management was removed. The main
factors that affected whether an airline could serve a particular city was
whether or not that city had enough gates for the new carrier, and whether the
carrier was able to afford to purchase them. Companies such as Southwest
recognized potential for low fares, and began building a niche for themselves by
offering low fares with equivalent low levels of service. Southwest\'s success
gave rise to a new generation of low fare airlines, with ValuJet entering the
market in the early 1990\'s. Unfortunately, ValuJet suffered a string of
accidents which brought the future of this air carrier into question.
ValuJet is a low-priced airline that offers inexpensive tickets for
regional travel. Based in Atlanta, the airline serves the Southeastern United
States and competes with Continental Airlines as well as with other small
regional carriers. It serves 31 cities primarily in the southeastern United
States. The airline began its service with flights to Tampa and Orlando from
Atlanta in 1993. The no-frills strategy paid off for the fledgling airline,
which posted half again as many revenue passenger miles in April 1996 as it did
in April 1995. However, the company announced that it was slowing the expansion
of its services, voluntarily, at the same time that it posted this impressive
revenue mark (Cole & Pasztor, 1996, p. A6).
Perhaps due to overexpansion or to poor luck, Valujet experienced a
series of mishaps in its short history. In January 1994, a DC-9 skidded off a
runway in Washington which resulted in the entire airport being shut down. In
June 1995, a ValuJet flight went through an emergency evacuation after an engine
failed and shrapnel flew into the cabin. Additional incidents, including one
where the landing gear collapsed after a particularly forceful landing, led the
FAA to begin an intense review of ValuJet in February 1996. This review found
that ValuJet was in compliance with FAA regulations, but cited concern about
pilot training and aircraft maintenance (Larson, 1996, p.30).
In May 1996, Valujet flight 592 crashed in the Everglades, killing all
aboard and resulting in a shutdown of the carrier for several months. When
ValuJet began flying again, it did so with a reduced schedule, and considerable
speculation about whether the company will be able to continue operations long-
term. The company is also involved in litigation resulting from the crash, and
the long-term prospects for the company are questionable.
The following chart identifies key operating statistics for Southwest
(seat miles are in millions, cost factors are in cents)

(Shammas, 1996, p. 5541P):
1995 1994 1993

Revenue Passenger Miles (RPM) 2,624 941 44
Available Seat Miles (ASM) 3,813 1,471 63
Load Factor 68.8 % 64.0 % 69.7 %
Revenue per RPM 13.4 13.8 13.1
Cost per ASM 6.8 6.8 9.8

Because Southwest\'s flights are generally an hour or less in length, the airline
saves money by not having to serve meals. It has a liberal work rule
arrangement with its unions, so productivity is high, and overall costs are low.
For example, Southwest gets 672 hours per year on average from pilots versus 371
for American Airlines pilots, and 60 percent more passenger miles per flight
attendant (Levinson, 1993, p. 34). These figures enable the company to realize
profits during years in which the industry as a whole was suffering.