What is the history of the domestic airline industry under regulation?


The Paper is about Information systems in the Airline systems. My part in the paper is the following
Description of the industry structure;
The dominant competitive strategy within that
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Journal of Aviation/Aerospace
Education & Research
Volume 7
Number 1 JAAER Fall 1996
Article 1
Fall 1996
A Review of History, Structure, and Competition in
the U.S. Airline Industry
Gerald N. Cook
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Cook, G. N. (1996). A Review of History, Structure, and Competition in the U.S. Airline Industry. Journal of Aviation/Aerospace
Education & Research, 7(1). Retrieved from http://commons.erau.edu/jaaer/vol7/iss1/1
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Cook: A Review of History, Structure, and Competition in the U.S. Airli
Gerald N. Cook
The airline industry has evolved~intwo profoundly different eras, first under the protective hand of federal
economic regulation and, following the Airline Deregulation Act of 1978, subjected to the full force of the
free market. This history has proved a fertile testing ground for economic theories and predictions of market
behavior. This paper first provides a brief history of the domestic airline industry under regulation. Next, the
post-deregulation transformation is reviewed. Attention is then focused on a survey of the extensive airline
economic literature. Finally, several current trends that promise to further shape the industry are examined.
Birth of the Airline Industry
The U.S. airline industry was born and reared in a
time of regulation and subsidy. In 1918, the Post Office
began administering airmail routes operated by U.S.
Army pilots and aircraft. A rudimentary transcontinental
infrastructure of navigational lights and airfields
developed to support the nascent airmail service. In 1925,
Congress passed the Contract Air Mail Act, popularly
known as the Kelly Act after its principal congressional
sponsor, authorizing the Post Office to award routes and
payments to private air carriers. Over the following
decade, cost overruns, inefficiencies, and political scandal
led to frequent and somewhat chaotic changes in the
system of route awards and subsidies, even including a
brief and disastrous return to all-Army service in 1934.
Despite the turbulence of the period, the “Big Fourw
airlines, United, American, Trans World, and Eastern,
trace their origins to this time (Bailey, Graham, &
Kaplan, 1985; Heppenheimer, 1995; Meyer & Oster,
1981; Petzinger, 1995). Although the others survive,
Eastern eventually liquidated following industry
Limited aircraft performance and spartan
accommodations doomed most early attempts at
passenger service offered in conjunction with airmail
delivery. Introduction of new twin-engine airplanes, most
notably the Douglas DC-2 and later the ubiquitous DC-3,
enabled the fledgling airlines to offer reliable passenger
service with an acceptable level of comfort. With the
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growth of passenger service, airline regulation was
transferred to the Interstate Commerce Commission
(ICC) in 1935. The ICC’s governance, however, proved
unenlightened and disruptive as a revised policy caused
many carriers to bid below cost for new route awards,
debilitating the industry (Button, 1991).
The Civil Aeronautics Act of 1938 transferred
regulatory authority over air commerce to the Civil
Aviation Authority, reorganized two years later as the
Civil Aeronautics Board (CAB). In part a reaction to the
Great Depression, the 1938 Act directed the CAB to
enact policies to promote and develop an economical,
safe, and efficient air transportation system free of “unfair
or destructive competitive practices” (Meyer & Oster,
1981, p. 18). This mandate provided the basis for CAB
regulatory actions over the next 40 years. Though
certainly successful and probably necessary for the early
development of the airline industry and the air
transportation infrastructure, the CAB’S aversion to
competition eventually led to its demise.
Four Decades of Regulation under the CAB
World War I1 supported a period of sustained
profitability as much of the airline fleet was diverted to
military transport. At the war’s end, hundreds of surplus
DC-3’s and DC-4’s entered airline service. New nonscheduled airlines, followed shortly by the trunk carriers,
introduced high-density seating and coach fares,
foreshadowing the development of today’s complex
discount fare system. Low fares spurred demand; traffic
doubled over a five-year period (Heppenheimer, 1995).
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Journal of Aviation/Aerospace Education & Research, Vol. 7, No. 1 [1996], Art. 1
History, Structure, and Competition
Also with the conclusion of the war, the CAB
responded to political pressure for more local air service
by awarding certificates and routes to newly founded local
service airlines (LSA). These carriers were to provide
connections from smaller cities to those destinations
served by the trunk carriers. The CAB was careful to
prevent the LSA’s from competing directly with lhe
trunks, generally requiring an intermediate stop on any
route connecting cities already served by established
carriers (Button, 1991).
During the 1950’s and 1%0’s, subsidization of most
local service and many trunk routes continued. Local
subsidy cost, exacerbated by fares deliberately set below
marginal cost in accordance with the CAB formula,
escalated rapidly as the LSA’s added routes and replaced
their original DC-3 aircraft with larger equipment. In an
effort to reduce subsidy costs, the CAB at first shifted
some low-density trunk routes to the LSA’s. When this
approach failed, longer and potentially more profitable
routes, often in direct competition with the trunk
carriers, were awarded (Bailey, Graham, & Kaplan, 1985).
Despite this overlap of local service and trunk carrier
routes, the CAB largely maintained its vision of a bi-level
industry. Trunk airlines served long-distance routes
between major cities and local-service carriers provided
connecting service from smaller cities to trunk
destinations. Consequently, many itineraries required a
change of airlines. Because of poorly coordinated flight
schedules, significant delays awaiting a connecting flight
were common.
Despite these problems, the industry grew rapidly,
enjoying more than a tenfold growth in passengers
between 1950 and 1970. Technological advances first
embodied in the long-range DC-6 and Constellation
aircraft and then in the first-generation commercial jet
transports provided steady improvements in productivity.
Airfares, though high, remained nominally stable but
declined in real terms throughout the period (Bailey,
Graham, & Kaplan, 1985). High fares, however, limited
air travel to business and affluent passengers (Petzinger,
Calls for Change
The impetus for regulatory change first appeared in
the early 1970’s. Prohibited from competing on fares and
Page 34
routes, carriers responded by increasing flight frequency,
lowering seating density, and adding ever more
extravagant in-flight senice. Anticipating continued rapid
traffic growth that accompanied the introduction of jet
aircraft, the major carriers placed new wide-body aircraft
in senice, exacerbating existing overcapacity. Load factors
fell from 70 percent in 1950 to 50 percent by 1970. With
the transition to jet aircraft complete, productivity gains
that had cushioned the economic consequences of falling
load factors slowed. The industry’s financial health
The CAB responded to the deteriorating financial
conditions by increasing its regulatory interventions. In
addition to the ongoing denial of new carrier
applications, it imposed a new route moratorium on
existing carriers, approved a 20 percent fare increase in
1974, and sanctioned capacity limitation agreements
among the major carriers (Borenstein, 1992, Button,
1991). These actions raised alarm outside the CAB,
resulting in a consensus in government and academia that
regulato~ydistortions imposed unacceptable burdens on
the economy and society (Levine, 1987).
Sensing a winning issue, Senator Edward Kennedy
held congressional hearings in 1975 sharply critical of
CAB policies. Studies comparing intrastate airlines
operating outside CAB control with the trunk carriers
projected fares 50 percent to 70 percent lower if the
industry was deregulated.
Deregulation Act
In response to the criticism, the CAB reversed its
policies, beginning with the approval of new route
applications. In 1977, it consented to American Airlines’
request for Super Saver discounts some 45 percent below
existing coach fares. When American’s traffic swelled as
much as 60 percent in response, the solution to
overcapacity seemed at hand. Other carriers quickly filed
and received CAB approval for similar discounts. De
facto deregulation was under way (Meyer & Oster, 1981).
In 1978, now with the active encouragement of new
CAB Chairman Alfred Kahn, Congress passed the Airline
Deregulation Act (ADA). It mandated that the CAB
phase out its route approval authority over three years,
the regulation of fares over five, and pass its remaining
functions to the Department of Transportation. The CAB
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History, Smcture, and Competition
ceased operation at the end of 1984 (Bailey, Graham, &
Kaplan, 1985).
Proponents of deregulation unanimously predicted
improved consumer welfare with the elimination of price
and entry control. Regulation, it was argued, caused
carriers to resort to non-price competition, which led
directly to the overcapacity and low-load factors of the
1970’s. Less agreement existed on the likely effect of
deregulation on industry structure. Asserting that the
industry benefits from little or no returns to scale, some
observers felt equilibrium would lead to many new
carriers. Conversely, others contended that without
regulatory restraint large carriers would crush any daring
new entrants with an attendant growth in concentration
(Borenstein, 1992, Gaynor & Trapani, 1994). Within the
industry, most feared that the subsequent upheaval,
though unpredictable, would prove extremely painful.
History offers some support for all positions.
Growth and Consolidation
The years immediately following deregulation were
marked by rapid expansion of existing carriers, including
entry into former trunk routes by local service and intrastate airlines. New-entrant carriers proliferated. Bates
(19%) lists 24 jet carriers that started flying between the
passage of the ADA and 1985, People Express being
perhaps the best known. Most provided basic air
transportation but, in confirmation of the deregulation
proponents, offered bargain fares as well.
The difficulties of the early 1980’s, however,
including intense competition, the oil embargo, the air
traffic controllers’ strike, and recession, reversed the
trend. By 1988, consolidation, acquisition, and bankruptcy
reduced the 24 early postderegulation airlines to just
two, Midwest Express and America West. Nor were
major carriers exempted from the turmoil as Braniff,
Eastern, and fabled Pan American World Airways
succumbed in bankruptcy.
By the end of the decade, the percent of traffic
carried by the largest airlines returned to pre-ADA levels.
The eight biggest carriers accounted for 78 percent of the
total traffic in both 1978 and 1988. System expansion,
however, boosted the number of routes each carrier
served from approximately 200 to nearly 500 so that
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route level concentration actually declined. In a
continuation of past trends, traffic more than doubled
(Borenstein, 1992, Button, 1991; Evans & Kessides,
Structural and Marketing Changes
Many aspects of the industry transformation caught
observers by surprise. The deregulation debate focused on
fare levels. Proponents pointed to intrastate carriers PSA
and Southwest as exemplar airlines combining a simple
fare structure with low peak and off-peak pricing and a
linear route system. The result is vastly different. Alfred
Kahn (1988), Michael Levine (1987), and others list
several “surprising” outcomes. Among these are: (a) the
dominance of hub-and-spoke route systems resulting from
internal growth, merger, and vertical integration; (b) the
pervasive role of computer reservations systems (CRS’s);
(c) an exceedingly complex fare structure controlled by
sophisticated yield management software; (d) rebate
programs of frequent flier awards and travel agency
override commissions; and (e) the persistence of
predation and high casualty rate among new airline
entrants. These developments led Levine to conclude that
large carriers exercise a degree of market power which,
despite relative ease of entry, new carriers cannot
Hub-and-Spoke Systems
Largely unanticipated in the deregulation debate but
arguably the most important change is the development
of the hub-and-spoke route system (Bailey, Graham, &
Kaplan, 1985; Kahn, 1988, Levine, 1987). This design
routes flights from the origin to a major intermediate
“hub” city where passengers change planes for a
continuing flight to their destination. Because of the
large number of city pairs connected through the hub,
even smaller cities generate enough traffic to warrant
frequent flights with jet aircraft. Economies arise because
higher traffic density allows the use of more efficient
aircraft at higher load factors (Brueckner, Dyer, &
Spiller, l m , Caves, Christensen, & Tretheway, 1984). At
the other extreme of route structure design, cities are
linked in serial fashion, a common structure under CAB
regulation. But with this structure, only large city pairs
generate sufficient traffic to justify jet service.
Freed from restrictions on mergerlacquisition and
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Journal of Aviation/Aerospace Education & Research, Vol. 7, No. 1 [1996], Art. 1
Histoy, Structure, and Competition
routeexpansion following the passage of the ADA, major
carriers moved quickly to develop extensive hub-spoke
networks. In addition to internal expansion, route systems
grew through acquisition of former local senice carriers.
Northwest merged with Republic, TWA merged with
Ozark, Delta acquired Western, American acquired Air
California, USAir acquired PSA and merged with
Piedmont, and Continental grew with the additions of
Frontier and People Express. To serve smaller cities near
the hub, airlines either acquired or entered into
marketing agreements with commuter airlines principally
operating turbopropeller aircraft. These agreements
typically involve code-sharing in which the commuter
flights are listed under the major carrier’s designation in
the CRS’s, frequently leaving passengers unaware of the
change in level of service. The American Airlines’ Eagle
network is the largest example.
Every major airline with the exception of Southwest
relies on a hub-and-spoke system of one or more hub
cities. Although carriers concentrate in specific
geographical areas, the hub system allows the largest
carriers to compete in nearly every major U.S. market.
Each airline attempts to capture the passenger from
origin to destination. Dominance at hub airports has
allowed some carriers to exercise significant control over
gates and other airport facilities, a power which is
occasionally used to restrict access by new entrants
(Levine, 1987).
Computer Reservations Systems
The requirement to store, retrieve, and process data
on thousands of daily flights, many more connections,
and hundred of thousands of passengers lends itself
naturally to the computer application. Airlines were
among the first to employ the technology (Petzinger,
1995). Perhaps less obvious were the marketing
advantages of leasing these computer reservations systems
to travel agents. The four major CRS’s, each owned by a
single or small consortium of airlines, list virtually all
commercial flights, allowing an individual travel agent to
use just one system. American’s Sabre CRS has the
highest penetration; however, the geographically
predominant carrier generally captures most of the local
agency market (Levine, 1987). Booking charges for
reservations made on the systems for competitors’ flights
Page 36
provide additional ownership returns.
From the start, reservation systems stirred
controversy. Early flight displays were highly biased in
favor of the owner airline, listing its flights first.
American’s egregious use of this marketing tactic brought
protests by other carriers and eventual regulatory
restriction on display bias (Petzinger, 1995). As a
byproduct of the CRS, all carriers gain instant access to
competitors’ continually changing fares. Allegations that
the system provided a means of signaling proposed fare
changes and subtle collusion prompted regulations
restricting advance notice of pricing changes.
Complex Fares
Travel demand varies by time of day, day of the
week, and season. If sufficient capacity exists to meet
peak demand, then seats will go unsold on off-peak
flights. Discount fares can smooth traffic patterns by
shifting less time-sensitive passengers to off-peak flights
and inducing price-sensitive consumers to travel. To
avoid diluting all fares, however, advance purchase,
Saturday stay, and other restrictions on discount fares
attempt to segregate passengers by willingness to pay.
Though some cost justification exists for these different
fare levels, classic price discrimination motivates most of
the fare dispersion (Borenstein & Rose, 1994; Oum,
Zhang, & Zhang, 1 m ) .
American’s original Super Saver discount fare and
its competitors’ imitations have grown over the last two
decades into a bewilderingly complex array of discount
fares. To extract the maximum revenue potential, yield
management software controls the availability of fare
levels for each flight on a real-time basis. Beginning with
historical booking data, the yield management software
continuously monitors the booking progress of each flight
as the departure date approaches, adjusting the
availability of discount fares in an attempt to maximize
revenue (Weatherford & Bodily, I=). As ability to
manage fares and discriminate among passengers on
willingness to pay improved, airline marketers widened
the spread between high and low fares much to the
consternation and disadvantage of business travelers who
typically pay the highest prices (Evans & Kessides,
The use and sophistication of yield management
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Hi~tory,Structure, and Competition
software varies considerably among carriers. The latest
advances attempt to maximize revenue across the airline’s
entire route network rather than by flight segment as
earlier versions have done. TWA, in contrast, only
recently installed its first system. Borenstein and Rose
(1994) provide some empirical evidence that airlines with
the best systems extract higher yields.
Airlines employ a somewhat less sophisticated
device, indelicately but accurately termed kickbacks, to
instill brand loyalty. Frequent flier programs (FFP)
provide rewards, generally free travel, to passengers based
o n a scale of miles flown. Travel agency override
commissions (TACO) represent the travel agency analog
to FFP. Agencies typically receive a higher commission
o n sales above a set monthly minimum. The CRS’s
provide reliable sales data necessary to administer these
override commissions.
As Levine (1987), the one-time president of People
Express, points out, the evolution of structure and pricing
methods leads to economies of scope and density
benefiting the largest carriers (scope refers to the extent
of the route system while density is the level of traffic
generated on the system). American’s Super Saver fares
were, in part, a response to low-fare charter operators
who diverted leisure travelers from American and other
scheduled camers (Bailey, Graham, & Kaplan, 1985).
Later, discount fares administered by yield management
systems allowed the largest carriers to better the fares of
low-cost, post-deregulation new entrants while
simultaneously charging much higher prices to less pricesensitive passengers (Evans & Kessides, 1993b). Carriers
with extensive hub-and-spoke systems can aggressively
meet the competitive threat of new entrants in limited
markets before they establish a defensible route system.
FFP and TACO both benefit the predominant
carrier in a geographical market. Each draws its power by
exploiting principal-agent effects that arise when the
agent encounters incentives in conflict with the best
interests of the purchaser. Business travelers, the primary
beneficiaries of the FFP,tend to choose the airline with
the most extensive service in order to enhance their
frequent flier awards even if this choice is not the most
JAAER, Fall 1996
Published by ERAU Scholarly Commons, 1996
cost-effective travel option (Nako, 1992).Similarly, travel
agents will book most flights on the largest carrier in
their area to profit from override commissions. Booking
on another carrier disproportionately decreases override
commissions because the reward system is non-linear. If
the fare on a competitor is less, generally the
circumstance if the competitor is a new entrant, the agent
also earns a smaller regular commission. To compete,
new entrant and smaller carriers often find they must
offer a higher percentage commission than larger carriers.
Other marketing advantages also accrue to carriers with
concentration in a market. Large carriers spread
advertising costs over more product. Including many
destinations in a newspaper ad, for example, is no more
costly than advertising a few (Borenstein, 1991).
Many casualties of deregulation were certainly
victims of their own mismanagement (Bailey, 1992).
Nonetheless, the low operating costs of new entrants
have generally proved inadequate weapons to breach the
barriers of establishing initial customer recognition and
acceptance compounded by the competitive advantages of
scope and density enjoyed by large incumbents.
Economic Research
The airline industry has long been the subject of
concerted economic research. During the decades of CAB
regulation, Board economists attempted to devise and
implement policies to control the industry in the public
interest, a pursuit that required extensive market data.
The Board consequently required all airlines to provide
standardized data on costs and traffic. Following
deregulation, economists were presented with a rare
opportunity to study the transition from strict regulatory
control of product and pricing to relatively unimpeded
competition. For the purpose of review, the literature is
divided into studies of (a) effects on consumer welfare,
(b) evidence of contestability, and (c) concentration and
market power.
Consumer Welfare
Widespread consensus exists that deregulation has
improved consumer welfare. The difficulty in estimating
the actual gains stems first from determining the level of
service and fares that would have existed had regulation
continued (lack of a control group) and, second, from
measuring simultaneous changes in price and quality
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Journal of Aviation/Aerospace Education & Research, Vol. 7, No. 1 [1996], Art. 1
History, Structure, and Competition
(Gaynor & Trapani, 1994).
Economists believed consumers would primarily
benefit from lower airfares with estimates ranging from
2.7 to 6.6 billion dollars annually. Airfares have dropped
dramatically but, as noted earlier, are far more complex
and discriminatory than predicted. Business travelers have
generally been excluded from otherwise available
discounts. In his survey of economic deregulation
predictions and results, Winston (1993) estimates the
consumer gains from lower prices at $6.5 billion but
deducts $3.0 billion for attendant fare restrictions leaving
a net of $3.5 billion annually (in 1990 dollars).
Though complaints about the deterioration in the
quality of air travel are common, the development of hub
and spoke networks greatly multiplied the frequency of
available flights in most markets. Although leisure
travelers have been the primary beneficiaries of airfare
discounts, higher frequency serves the business traveler.
Adjusting for some gain in travel time through the hub,
Winston (1993) places the net gain at $7.5 billion.
Consumer welfare gains from reduced fares and
augmented service total some $11 billion annually.
Proponents argued that a deregulated airline market
would somehow approximate the ideal of perfect
competition. A perfectly competitive market is
characterized by (a) a large number of firms, the output
of any one of which is too small to effect price; (b)
homogeneous product; (c) costless price information; and
(d) unimpeded entry and exit. Although most airline
markets naturally support only a small number of
competitors and differ markedly from the next two
requirements as well, faith was placed in the supposed
ease of entry and exit to discipline the market. Airline
assets, it was argued, are highly mobile and few costs are
sunk in entering and exiting a market. Therefore, high
prices (economic rents) in a market encourage new
entrant competition (Bailey & Baumol, 1984; Borenstein,
The Theory of Contestable Markets, formalized in
1982, sets forth the conditions under which natural
monopolies would approach the efficient pricing and
asset allocation conditions of perfect competition. The
theory requires the availability of potential entrants,
Page 38
freedom of entry, and costless exit so that any entry costs
can be recovered. Under these conditions, the threat of
entry disciplines the pricing of incumbent carriers (Bailey
& Baumol, 1984).
Perhaps not surprisingly, the evidence on the
efficacy of contestability is poor. Aircraft mobility does
not translate to free and costless entry and exit.
Acquiring facilities and support equipment, hiring or
transferring personnel, advertising new service, and, most
importantly, building traffic in a new market requires
time and money. When an incumbent can immediately
adjust fares to meet new competition, there is little
incentive to respond in advance. Several studies have
shown that only actual competition significantly lowers
prices (Bailey, Graham, & Kaplan, 1985; Borenstein,
1989, 1990, 1992; Evans & Kessides, 1993b; Joesch &
Zick, 1994; Whinston & Collins, 1992). Although
estimates vary widely among studies, Borenstein (1992)
estimates prices in 1990 on routes with two competitors
averaged 8 percent less than monopoly routes; a third
competitor produced another 8 percent drop.
Concentration and Market Power
As a consequence of the growth of the hub-andspoke networks, the airline maintaining a hub provides
the most service and carries the highest percentage of
local traffic (Borenstein, 1991). Many studies confirm this
concentration confers a degree of market power that
raises local fares at the hub by as much as 20 percent.
Much of this premium results from higher fares paid by
business passengers traveling on the hub carrier (Berry,
1990, Borenstein, 1989, 1990, Evans & Kessides, 1993a;
Peteraf & Reed, 1994). Reasons for this seemingly anticompetitive behavior have been debated. Critics conclude
that dominant carriers at individual hub airports exercise
market power through their CRS’s, FFP, TACO’S, and
control of airport facilities that blocks entry o r expansion
of rivals. Other contend that passengers willingly pay a
premium for the frequency and quality of service a
dominant hub carrier provides (Berry, 1990).
The results of two controversial airline mergers that
concluded in 1986 — Northwest’s merger with Republic
and TWA’s purchase of Ozark — provided ideal tests of
market power. Both mergers significantly increased hub
airport concentrations and reduced competition on routes
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History,Structure, and Competition
where the consolidated carriers once competed. Fares at
Minneapolis-St. Paul, home of Northwest, rose
substantially following the merger. At St. Louis, in
contrast, TWA’s post-acquisition fares showed little
change relative to the industry and remained near the
national average. TWA’s local fares, however, remained
higher than its competitors (Borenstein, 1990).
The failures and consolidations of the mid-1980’s
and evidence of localized market power at hub airports
raised congressional ire and even short-lived calls for reregulation (Morrison & Winston, 1990). Yet a decline in
the number of large national carriers does not translate
into greater concentration at the route level. In fact, the
growth of the large hub-and-spoke networks provided for
more competition in most longer markets which are
serviced across several competing hubs. Brueckner, Dyer,
and Spiller (1992) show that network growth reduces
fares in city pair markets connected through the hub.
Stability and equilibrium do not yet reign in the
domestic airline industry. Despite the well-known risks of
forecasting, several recent developments seem likely to
shape the industry.
Role of the Travel Agent
Travel agents provide about 80 percent of airline
reservation and ticket sales. At an average of 10 percent
of ticket price, commissions provide an attractive target
for cost savings. Last year most major carriers engaged in
a direct assault by capping commissions at $50 per ticket.
Subsequent defections leave the result in question. All
carriers attempt to encourage direct bookings through
owned sales offices, ticket by mail, and other marketing
programs; nonetheless, most carriers support and
encourage sales through the agency network. A few,
however, attempt to bypass the agencies entirely.
Southwest’s flights are listed in the CRS’s but agents
must book flights directly with Southwest. Before its
tragic crash, ValuJet supported its rapid growth primarily
through direct marketing with little agency support.
High information costs generated by thousands of
constantly changing fares and restrictions as well as the
requirement for a hard-copy ticket have, to this point,
allowed the travel agency industry to dominate the retail
market channels. This position is under attack by recent
industry initiatives. Ticketless travel, first introduced by
Morris Air (now acquired by Southwest), is spreading
across the industry and receiving growing customer
acceptance. Reno Air recently announced an agreement
with Ticketmaster for sales in the Los Angeles basin.
Ticketmaster will book directly into Reno Air’s
reservation system. Finally, direct passenger access to
schedules, fares, and reservations through online services
may represent the greatest threat to the travel agent as
consumers invade the agents’ previously exclusive domain
(Ott, 1995; Underwood, 1995).
The outcome of these changes is ambiguous. A
restructuring of sales distribution with less travel agency
involvement offers significant savings potential for major
carriers, eroding some of the cost advantage of their
smaller rivals. On the other hand, improvements in
passenger access to schedules and fares would benefit
smaller airlines.
Low-Cost Carriers
Southwest Airlines continues to expand its low-frills,
low-fare service, most recently with service from existing
markets in the Midwest and Northeast to Florida.
Southwest’s growth, customer acceptance, and consistent
profitability have attracted the adulation, envy, and
strategic attention of every segment of the industry.
United’s West Coast Shuttle represents the most
significant effort to defend markets with service designed
specifically to compete with Southwest. Carefully planned
and well-financed, the Shuttle at first met with limited
success, having to withdraw from some initial markets
(McCartney & McCarthy, 1996). More recent reports
show stronger traffic. Although the West Coast markets
will remain intensely competitive, nothing on the horizon
would seem to limit Southwest’s ultimate expansion to
the entire domestic market.
The last few years also have witnessed a resurgence
of low-cost, new-entrant carriers reminiscent of the
immediate post-deregulation period. A recent
Department of Transportation study concludes that
consumers save some $4 billion annually from this
renewed competition covering routes that account for 37
percent of domestic passenger traffic (Gruley &
McCartney, 1995). Frequent comparison with Southwest
masks the diverse marketing strategies employed by these

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Journal of Aviation/Aerospace Education & Research, Vol. 7, No. 1 [1996], Art. 1
History, Structure, and Competition
newest entrants. Unlike Southwest, most operate huband-spoke systems. Leading examples include Reno Air,
Midway, Western Pacific, and, before its June grounding,
highly profitable, rapidly expanding Valdet. Reno Air
and Midway operate on opposite coasts in markets
abandoned by American. Each provides traditional fullservice with CRS listing, reservations that include
advanced seat assignment, and interline ticketing and
baggage with other carriers. AirTran offers a different
example with its low-frequency, low-fare service between
smaller Midwest and Northeast markets to Orlando. In
its Southeast and Florida routes, Air South, in contrast,
attempted to replicate Southwest’s linear, high-frequency,
no-frills service.
Encouraged by the success of Valdet’s initial public
stock offering, Frontier, Western Pacific, and Vanguard
also have gone public, raising funds that ensure at least
short-term survival. While the long-term prospects for
Reno Air seem assured, most new carriers struggle. Air
South, initially supported with ample initial public
financing from South Carolina, failed to develop a
profitable level of traffic. This spring, Air South changed
to a “hub bypass” strategy by linking New York with midsized Southeast cities. Frontier largely abandoned its
early emphasis of linking Denver to markets in the
northern mountain and plains states and now
concentrates on easthest markets across its Denver hub.
MarkAir entered bankruptcy and ceased operation in the
fall of 1995 (Alexander, 19%). The publicity following
ValuJet’s May crash and the FAA investigation that led
t o its grounding on June 17 heightened concerns for the
viability of the current wave of low-cost camers.
No matter the outcome for individual new-entrant
carriers, low-cost carriers promise to fulfill the
predictions of deregulation proponents by providing lowfare air travel alternatives. As a result, major old-line
carriers will face continuing pressure to lower costs,
particularly in short-haul markets that connect to their
hub cities. Routes once served by the major airlines but
now entrusted to their commuter subsidiaries operating
turboprop aircraft seem particularly vulnerable. The
commuters have responded by adding pure jet aircraft to
their inventory. On the other hand, American and Delta,
following United’s lead, are in discussions with their
Page 40
pilots aimed at forming effective, low-cost competitive
service. Which carriers eventuallysucceed in serving these
markets is an open question (Bender, 1995).
In long-haul routes, the major carriers appear better
positioned to compete. These markets are hardly immune
to competition, however. Western Pacific, after less than
a year in business, operates a coast-to-coast route system
through its hub in Colorado Springs. Southwest has on
order new 737 models well-suited for long, thin routes.
And Pan American World Airways, perhaps the best
known name in aviation history, has announced plans to
resurrect itself as a low-cost carrier with non-stop, coastto-coast domestic service.
For 40 years before 1978, the Civil Aeronautics
Board protected the domestic airline industry from the
vagaries of the free market, controlling entry and exit,
awarding routes, and dictating price by formula. Prices
remained uniform, simple, stable, and high. Rare
corporate business failures resulted in CAB-sanctioned
acquisition by a stronger airline. Unionized labor wages
rose above comparable levels in other industries.
Inefficiencies, particularly low-load factors, resulted from
non-price competition in service frequency and inflight
amenities. During the regulated era, the industry matured
to replace rail as the predominant mode of public
intercity transportation.
The Airline Deregulation Act of 1978 unleashed the
full power of market forces and transformed many of the
fundamental characteristics of the industry. Expansive
hub-and-spoke delivery systems, complex pricing schemes,
hub airport dominance by a single carrier, and brand
loyalty-inducing devices did not exist in the regulated
environment. Almost 20 years after the ADA, it would
seem that all results should be fully known and, indeed,
the vision of the proponents of deregulation has been
largely vindicated. Consumers in general have benefited
but not without great cost to many within the industry
who endured the transition. Although the pace of change
has slowed, evolution continues, shaped by yet another
wave of new entrant carriers and by new information and
marketing technology that promise to reduce the role of
the travel agent.O
JAAER, Fall 19%
Cook: A Review of History, Structure, and Competition in the U.S. Airli
History, Structure, and Competition
Gerald N. Cook earned an M.S. in Management and a B.S. in Aviation Technology, both from Purdue University. He
is Vice President of Flight Operations for Sun Jet, St. Petersburg, Florida.
Alexander, K. L. (19%, February 12). Start-ups fly into financial head wind. USA Today, pp. B1-3.
Bailey, E. E. (1992). Airline deregulation: Confronting the paradoxes. Regulation, 15(3), 18-25.
Bailey, E. E., & Baumol, W. J. (1984). Deregulation and the theory of contestable markets. Yale Journal of Regulation,
1(111), 111-137.
Bailey, E. E., Graham, D. R., & Kaplan, D. P. (1985). Deregulating the airlines. Cambridge: MIT Press.
Bates, D. (19%, April). Debunking the myth of the start-up juggernaut. Flightline, 3-13.
Bender, A R. (1995), Battle 2000. The new jet entrants versus the regional partners. The Journal ofAviationlAerospace
Education and Research, 6(1), 7-17.
Berry, S. T. (1990). Airport presence as product differentiation. American Economic Review, 80(2), 394-399.
Borenstein, S. (1989). Hubs and high fares: Dominance and market power in the U.S. airline industry. RAND Journal
of Economics, 20(3), 344-365.
Borenstein, S. (1990). Airline mergers, airport dominance, and market power. American Economic Review, 80(2), 400-
Borenstein, S. (1991, November). The dominant-firm advantage in multiproduct industries: Evidence from the U.S.
airlines. The Barterly Journal of Economics, 1237-1266.
Borenstein, S. (1992). The evolution of U.S. airline competition. Journal of Economic Perspectives, 6(2), 45-73.
Borenstein, S., & Rose, N. (1994). Competition and price dispersion in the U.S. airline industry. Journal of Political
Economy, 102(4), 653683.
Brueckner, J. K,Dyer, N. N., & Spiller, P. T. (1992). Fare determination in airline hub-and-spoke networks. RAND
Journal of Economics, 23(3), 309-333.
Button, K (1991). Airline deregulation: International experiences. New York: New York University Press.
Caves, W. C., Christensen, L. R., & Tretheway, M. W. (1984). Economies of density versus economies of scale: Why
trunk and local service airline costs differ. RAND Joumal of Economics, 15(4), 471-489.
Evans, W. N., & Kessides, L N. (1993a). Localized market power in the U.S. airline industry. Review of Economics and
Stathtics, 75(1), 66-75.
Evans, W. N., & Kessides, I. N. (1993b). Structure, conduct, and performance in the deregulated airline industry.
Southern Economic Joumal, 59(3), 450-467.
Gaynor, M., & Trapani, J. M. 111. (1994). Quantity, quality and the welfare effects of U.S. airline deregulation. Applied
Economics, 26, 543-550.
Gruley, B., & McCartney, S. (1995, November 2). Flock of new low-fare carriers means savings for consumers, U.S.
study says. The Wall Street Journal, p. A4.
Heppenheimer, T. A (1995). Turbulent skies: The history of commercial aviation. New York: John Wiley & Sons.
Joesch, J. M., & Zick, C. D. (1994). Evidence of changing contestability in commercial airline markets during the
1980’s. The Journal of Consumer Afairs, 28(1), 1-24.
Kahn, A E. (1988). Surprises of airline deregulation. American Economic Review, 78(2), 316-322.
Levine, M. E. (1987). Airline competition in deregulated markets: Theory, firm strategy, and public policy. Yale Journal
on Regulation, 4, 393-494.

– –

JAAER, Fall 19%
Published by ERAU Scholarly Commons, 1996
Journal of Aviation/Aerospace Education & Research, Vol. 7, No. 1 [1996], Art. 1
Histoty, Structure, and Competition
McCartney, S., & McCarthy, M. J. (19%, February 20). Southwest flies circles around United’s Shuttle. The Wall Street
Joumal, pp. B1, B5.
Meyer, J. R., & Oster, C. V. (Eds.). (1981). Airline deregulation: The early erperience. Boston: Auburn House.
Morrison, S. A, & Winston, C. (1990). The dynamics of airline pricing and competition. American Economic Review,
78(2), 389-393.
Nako, S. M. (1992).Frequent flier programs and business travel. Promest Dzksertation Abstracts, (University Microfilms
AAC 9308634).
Ott, J. (1995, January 23). New technologies change ticket sales. Aviation Week and Space Technology, pp. 40-41.
Oum, T. H., Zhang, A, & Zhang, Y. (1993). Inter-firm rivalry and firm-specific price elasticities in deregulated airline
markets. Joumal of Transport Economics and Policy, 27(2), 171-192.
Peteraf, M. A, & Reed, R. (1994). Pricing and performance in monopoly airline markets. Joumal of Law and
Economics, 37, 193-213.
Petzinger, T. (1995). Hard landing. New York: Random House.
Underwood, E. (1995, August 21). Are travel agents dinosaurs? Brandweek, pp. 30-35.
Weatherford, L. R., & Bodily, S. E. (1992). A taxonomy and research overview of perishable-asset revenue
management: Yield management, overbooking, and pricing. Operations Research, 40(5), 831-844.
Whinston, M. D., & Collins, S. C. (1992). Entry and competitive structure in deregulated airline markets: An event
study analysis of People Express. RAND Journal of Economics, 23(4), 445-462.
Winston, C. (1993). Economic deregulation: Days of reckoning for microeconomists. Joumal of Economic Literature,
31, 1263-1289.
Page 42
JAAER, Fall 1996


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I. Introduction
II. Description of the Industry Structure

I. Introduction:
The airline industry has undergone significant changes since its inception, from being tightly regulated to a free-market system. The industry has also seen a range of strategies implemented by airlines to remain competitive. In this paper, we will be exploring the industry structure and the dominant competitive strategies used by airlines.

II. Description of the Industry Structure:
The airline industry has a complex structure that has evolved over time. In the early days of the industry, the US government regulated and subsidized the airline industry. This led to the birth of major airlines such as United, American, Trans World, and Eastern. However, with the Airline Deregulation Act of 1978, the industry shifted towards a free-market model. This shift led to a transformation in the airline industry and an increase in competition.

In a competitive landscape, airlines have employed various strategies to differentiate from their competitors. One of the dominant strategies used by airlines is a low-cost carrier model. This model is used by airlines such as Southwest, which offers low fares and no-frills services to attract price-sensitive customers. Other airlines have chosen to differentiate by offering premium services and experiences.

Another competitive strategy employed by airlines is the use of technology and information systems. These systems are used to streamline processes, enable efficient scheduling and planning, improve customer service, and maintain a competitive edge. Airlines are also investing in data analytics to gain insights into customer behavior and preferences, allowing for personalized offers and targeted marketing.

In conclusion, the airline industry’s structure has changed significantly over the years, from regulated to a free-market model, leading to an increase in competition. Airlines have adopted various strategies to remain competitive, including a low-cost carrier model, premium services, and technology and information systems. It’s clear that airlines that adopt innovative strategies will be better positioned to succeed in a highly competitive marketplace.

The objective of this section is to provide a detailed description of the structure of the airline industry. This will involve an analysis of the regulatory history and the evolution of the industry from a regulated to a free market.

Learning Outcomes:
1. Understand the regulatory history of the airline industry and its impact on the evolution of the industry.
2. Analyze the structure of the airline industry, including the dominant competitive strategy within the industry.
3. Evaluate the industry literature on the airline sector, including current trends shaping the industry.
4. Develop an understanding of the key factors that influence the success of airlines, including pricing strategies and customer service.

Description of the Industry Structure:
The airline industry has undergone significant changes over the years, transitioning from a regulated industry to a free market. The regulatory history of the industry began in 1918 when the Post Office started administering airmail routes. The 1925 Contract Air Mail Act gave the Post Office the power to award routes and payments to private air carriers. However, the industry was plagued by inefficiencies, cost overruns, and political scandals.

The dominant competitive strategy within the industry is characterized by low-cost carriers offering no-frills services, while full-service carriers focus on customer service and quality. Pricing strategies, customer satisfaction, and fleet modernization are some of the factors that influence their success. The industry literature reflects the challenges and opportunities within this sector, including deregulation of the industry, the impact of technology, and the emergence of new business models.

– Bailey, E. E., Graham, D. A., & Kaplan, D. P. (1985). Deregulating the airlines. Brookings Institution Press.
– Cook, G. N. (1996). A Review of History, Structure, and Competition in the U.S. Airline Industry. Journal of Aviation/Aerospace Education & Research, 7(1).
– Heppenheimer, T. A. (1995). Turbulent skies: The history of commercial aviation. John Wiley & Sons.
– Meyer, J. R., & Oster, C. V. (1981). Airline deregulation: The early experience. Journal of Law and Economics, 24(2), 313-328.
– Petzinger, T. (1995). Hard landing: The epic contest for power and profits that plunged the airlines into chaos. Three Rivers Press.

Solution 1: Industry Structure

The airline industry is a dynamic, complex and evolving industry. It can be categorised under the service industry and is characterised by high fixed costs and intensive capital investments. The airline industry is made up of several key players. These players are airlines, regulators, suppliers, labour unions, airports and travellers. Airlines are the primary focus of this industry as they provide air transportation services. Regulators are the entities responsible for establishing rules and regulations that govern the airline industry. Suppliers provide the airline industry with products such as fuel, aircraft, insurance and maintenance services. Labour unions are the organisations that represent airline employees. Airports are the facilities that provide the infrastructure necessary for air travel, including runway, terminals, and aircraft support services. Lastly, travellers are the individuals who use airlines to travel to different locations for business or leisure.

Solution 2: Competitive Strategy

In the airline industry, the dominant competitive strategy is a pricing strategy. The intense competition in this market is largely driven by price and airlines must constantly adapt to changing market conditions to remain competitive. The airline industry’s pricing strategies include discount pricing, promotional pricing, and loyalty pricing. Discount pricing involves reducing ticket prices to attract a large volume of customers, while promotional pricing involves offering discounts or freebies for a limited period as an incentive to purchase. Loyalty pricing, on the other hand, involves offering rewards to frequent flyers or providing incentives to customers who book directly with the airline.

In conclusion, the airline industry is highly competitive, and airlines must continually adapt their strategies to remain relevant. This paper used primary sources such as scholarly articles and websites to describe the structure of the industry and the dominant competitive strategy within that industry. It is important for industry players to understand this information to effectively innovate in the industry.

Suggested Resources/Books:
1. Airline Industry: Strategies, Operations and Safety by Connor M. Krizanic
2. Airline Operations and Management: A Management Textbook by Gerald N. Cook
3. The Economics and Politics of the Airline Industry by Volodymyr Bilotkach

Similar asked questions:
1. What is the history of the airline industry and how has it evolved over time?
2. What is the impact of government regulation on the airline industry?
3. How has deregulation affected the competitive strategy within the airline industry?
4. What are the dominant competitive strategies used by airlines today?
5. What are the current trends shaping the airline industry?

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