Air Genius Gary Leff on market power for airlines

Read the whole post, but are is an excerpt:

With oil hovering around $100 a barrel we did see airfares rise 2011-2014 but then return to long run trend, and indeed real airfares inclusive of fees were lower 2016-2018 than in 2010…

Indeed the drivers of increased airline profits are:

  • lower fuel prices
  • richer co-brand credit card deals.

As I’ve pointed out in many recent quarters the entirety of American Airlines profit has been accounted for by its co-brand credit card deals and not flying. The richness of these deals for airlines has grown markedly. This may be partly attributable to industry consolidation (fewer airlines for banks to negotiate with) and partly due to American Express losing its deal with Costco which set off a chain of renegotiations at higher price points.

Consolidation has improved airlines’ bargaining position vis-a-vis banks more so than consumers. And indeed with fuel prices up from three and four years ago profits are down…

Moreover it’s the ultra low cost carriers – Spirit, Frontier, and to a lesser extent Allegiant – that have been the driving forces in the U.S. airline industry.

Do read the whole thing.

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If carbon taxes (among other schemes) are being proposed for automobiles and ground transport, why do we hear no one as loudly proposing "ozone taxes" (whether upon jet manufacturers, commercial airlines, the jet-setting public, or all three) to combat ozone depletion where it occurs at varying altitudes in our thin atmosphere?

https://en.wikipedia.org/wiki/Ozone_depletion

(Wikipedia's account seems to offer little data on "ozone replenishment", the natural rates at which that can occur barring technogenic contributions, or what technologies promise to assist.)

If an informed economist like Tyler Cowen (himself a frequent flyer) has little to no idea how much ozone he himself has helped destroy across the tens of thousands of his accumulated air miles, why has he not studied the problem to understand his own contributions?

--or does TC have an understanding of how much ozone he himself has helped destroy but prefers for good reasons not to advertise it?

Don't worry, carbon taxes will fix everything, which means rich people will flay all over and poor people can breathe the exhaust. Meanwhile, having bought their indulgences, the wealthy can fly in pursuit of the perfect taco guilt free, while it will be even more difficult for poor folk to take that once in a decade trip to visit family.

Odd that the biggest warmunists among my FB "friends", those constantly posting the latest scare story from the MSM, post the most inter-continental vacation pics. They seem to love SE Asia and the down under Asian Anglosphere.

New Zealand is a favorite go-to spot for those virtue signallers. Why not Africa or Central America, or Mexico?

Not one sentence without some cant/jargon/talking point. You sound like a Fox news word salad. Jesus, man, think for yourself for once.

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Edward, there was an international agreement to ban the worst ozone depleting chemicals. As a result of this regulation the ozone layer has started to gradually recover from depletion.

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How does AA make a profit by selling frequent flyer miles to banks? Is it because AA is selling more miles than are ever redeemed? Is AA essentially in the finance business, flying passengers in order to facilitate the finance business?

Based on my experience with American Airlines' Citi-related card, the answer to your first question is "Yes."

When American sells miles to third parties (mostly banks, its two major partners are Citibank and Barclays) the revenue is split into two components:

* Liability for providing future travel
* Marketing revenue which is recognized right away rather than being deferred to cover future redemptions. American defines this as "use of intellectual property including the American brand and access to loyalty program member lists, which is the predominant element in the agreements, as well as advertising (collectively, the marketing component)"

They are currently recognizing about $2.5 billion per year in marketing revenue from the sale of miles.

This doesn't count the revenue recognized when miles are redeemed for travel [and an accounting rules change American adopted 1/1/18 gave them over a quarter billion dollar bump related to this].

"This doesn't count the revenue recognized when miles are redeemed for travel [and an accounting rules change American adopted 1/1/18 gave them over a quarter billion dollar bump related to this]." Are you saying what I think you are saying: the liability for future travel is discounted (it is the future) and the revenue for current travel when miles are redeemed isn't. None of this is reflected in the financial statements available online at the SEC. Are the financial statements an accurate reflection of the results of operation and the financial condition of AA? Cowen?

No, I go into some detail on this here: https://viewfromthewing.boardingarea.com/2018/10/28/american-isnt-making-money-flying-customers-without-one-accounting-rule-things-would-be-worse/

However -- are there accounting games going on here? Absolutely!

American books a liability of around 1 cent per mile when you earn miles flying, but it's about 1/10th that when you earn miles through other activities. That's because new ASC 606 revenue recognition standards applied in the former case (requiring them to book a liability equal to the future value of travel to be provided) but not in the latter. Ultimately from a redemption standpoint though miles are miles, but the airline books the liability differently because the accounting rules allow it.

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They're also selling access to their club lounge programs. Which is worth a lot more than miles to many travelers.

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Citi-AA has been a well-known secret in the churning (CC rewards gaming) community for some time, it's almost a joke how exploitable it is. You can apply for the same card nearly every month and collect ~$750 worth of miles (double that if you fly J international). There are many people who have redeemed tens of thousands in flight, and banked millions of miles on top of that, despite bringing basically 0 profit to the issuer.

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I'd be interested in a more robust analysis of ticket prices, in particular as to composition. It feels (completely unscientifically) like very low prices with stripped down features - now offered by everyone and not just the discount carriers - may be masking higher fairs for the traditional level of service. So maybe there is robust competition for discount vacation travelers but coordination for traditional level of service travelers?

Up through mid-2017 at least there was a convergence of airfares. Airlines that used to sell high priced tickets to business travelers and cheap tickets to leisure travelers lost the ability to 'gate' their tickets through things like Saturday stay and advance purchase requirements. That's because low cost carriers like Spirit and Frontier were offering cheap walkup one way fares and the major carriers were matching. Even less price sensitive business travelers were getting Spirit pricing at the last minute from legacy airlines.

At the same time domestic first class fares have gotten much cheaper. Fifteen years ago 90% of first class cabins on domestic routes were occupied by passengers on awards or upgrades. Airlines were selling many seats. That's in large measure because the seats were very costly, they had one or at most two prices for the forward cabin. Better technology has allowed airlines to price first class more granularly --for instance as a fixed upcharge to whatever the prevailing coach price is at the moment. So instead of $1000 one way, you might see first class at $350 one way. And as a result nearly half of first class is sold on American, about 70% on Delta.

Now, in the past couple of years we've seen basic economy fares used as a way of re-segregating customers into the more traditional business vs leisure bucket. Customers give up pre-assigned seats and the ability to upgrade on these cheapest tickets, and business customers booking through corporate travel tools usually don't even see them as an option. So yes -- 'stripped down features' are more common with the lowest fares than two years ago.

But there's a limit to the stripping down! American Airlines initially prohibited basic economy customers from bringing a full sized carry on bag onto the plane. And they initially limited customers to being able to pay for a seat a couple days prior to flight. They've since eliminated the no carry on rule (they were losing business to Delta, which doesn't have it) and now let customers pay for seat assignments two weeks out (raise more revenue).

The data I present is real airfare inclusive of fees. It accounts for things like having to pay for seats and bags, which used to be included in price. In fairness though it doesn't account for changes in product, both positive (eg availability of high speed internet, streaming video content, better cabin pressurization on newer Boeing 787 and Airbus A350 aircraft) and negative (ceg arry on restriction still in place at United).

Thanks for the additional info, Gary!

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I assume there is not a viable niche for a 12-20 seat per plane first class only premium carrier a grade below private jet? I would think it might work for the top handful of markets. No gates?

I know of one group of former executives from a very successful non-tech startup looked at the idea a few years ago. The fact they didn't go through with it leads me to believe it isn't viable.

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And all we had to sacrifice was our dignity, as we slowly get compressed into a human suitcase in-between seats.

As an aside, does anyone remember the scene in "The Fifth Element" where they are boarding the plan, and everyone gets those coffin type pods and people are put to sleep during the flight? I would be okay with this, we are basically human cargo at this point anyway.

Leeloo Dallas Multipasss?

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Airlines are a terrible business. Pronte to overcapicity.

However I think the story about them making money now has less to do with the exact break down (From value of selling miles versus running airlines) and more to do with investors and management realizing airlines are a terrible business and deciding to compete at a lower level. No one wants to invests in a business that always loses money. So somehow they found an equilibrium where they make money.

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When I started flying (pre-Carter era deregulation days), the fares were higher but the flights seemed (at least to my eye) to run less full than today. It wasn't the every-seat-always-taken experience you have today.

And pre TSA, both passengers and family could freely go right up to the boarding gate. Nice opportunity for little kids to see the planes. Nice for the travelers to not be delayed and frisked by TSA.

It's overall an unpleasant experience now.

"When I started flying (pre-Carter era deregulation days), the fares were higher but the flights seemed (at least to my eye) to run less full than today."

Isn't this basically what we should expect?

Yep. For the vast majority of passengers, it’s a undifferentiated commodity purchase, and lowest price and/or best schedule wins.

It’s sort of all McDonalds all the time.

Plus we are running 2x or 3x people through the same airports.

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I hate the airlines, all of them. They should be investigated for price fixing.

DOJ investigated US airlines for price fixing for ~ 18 months starting in mid-2015 and closed the investigation.

A private lawsuit, however, has extracted settlements from Southwest and American Airlines. Internally American refers to this as 'extortion'.

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Oh, Mr. Cowen, what transgressions have you exposed by big business.

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Gary Leff in the house! My god, he's almost famous! I'm looking at a book in my library as I type this, by Petzinger "Hard Landing" (1995) about the airline industry, and it's driven by egos, with the slightest difference in revenue making a big deal in profits. For example American Airlines' Sabre reservation system pioneered by Max Hopper, as well as seemingly minor labor disputes, was the basis between success and failure for AA and others.

And this: The Economics of Airline Class, at https://www.youtube.com/watch?v=BzB5xtGGsTc - at the 1:50 mark, the example that the 14 passengers in first class in a jumbo make more money for the airline than the 122 passengers at the back of the plane.

The Petzinger book is what first channelled my passion for this industry. I stumbled onto it browsing the shelves of the Borders in Fairfax, Virginia and couldn't put it down. Then I bought amd read every book in the author's bibliography. I was already a frequent traveler since I was a young child but it was with that book that I was hooked.

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"richer co-brand credit card deals"

Is the idea here that flights purchased through credit card miles are more profitable for the airline (expensive from the flyer's perspective) than flights purchased for cash? That actually would make sense. Search engines make the market for flights purchased with cash very transparent and competitive. In contrast, many consumers probably think they get miles "for free" from credit card purchases rather than paying for them through higher prices, fees, interest, etc. Also, because miles can only be used on a specific airline, the flyer can't shop for the lowest fare on different routes.

If so, then American is still making money by flying passengers. They just make the money by flying passengers that buy tickets through credit card miles rather than through cash purchases. Hasn't price discrimination always been an essential contributor to airline profits? (For example, in the past, maybe they made most of their money flying business and first-class passengers and little or no money flying tourists in coach?) Still, it's surprising to me that credit card miles customers are so profitable that American can actually fly cash customers at a loss and still be profitable. How many credit card miles customers are there?

Alternatively, is Leff saying that credit card miles customers aren't really that profitable, and it's just an accounting anomaly, i.e., American is realizing revenue from those customers now but will pay the price later when those customers redeem miles for flights? I thought, though, that the whole point of booking a liability for frequent flyer miles was to match in the same time period the revenue from selling the miles with the expense of providing a future flight.

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"This may be partly attributable to industry consolidation"

This would seem to imply that market power matters more than Tyler is inclined to believe.

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More proof that American business is mostly about financial engineering, not making widgets. One will recall that the financial sides of car companies and GE dominated the industrial sides. In case one might question the behavior of Boeing, financing the sale of aircraft is a large component of Boeing's business: Boeing makes aircraft so it can finance them. The financialization of the American economy partially explains the lack of investment in productive capital (although we are often told that the financialization of the economy is a myth).

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In your earlier post, you wrote that output restriction was "the sine qua non" of market power. Indeed, that's just what the big three airlines have focused on, under the term "capacity discipline." John, a commenter on Gary Leff's post, points to exactly this phenomenon. John writes:

"The airline industry is an oligopoly not a monopoly. Market power ( a better term than monopoly power) is concentrated in three large carriers. The Big 3 use their market power to affect price by controlling capacity.

"A major problem for airlines before mergers was excess capacity. Airlines tried to increase market share by increasing capacity and lowering prices to levels at or below cost to fill planes. With only three major airlines, maintaining capacity discipline and a healthy (and seemingly ever widening) spread between cost and price is now doable.

"Airlines are recording absurd load factors. In the three months ending 6/30/19 American’s load factor was 87.5%. Thanks to capacity discipline, airlines are making record profits even though prices are said to be falling. Tacit capacity collusion is working very well for the airlines."

Along these lines, I'm sure you have seen this study: https://www.ftc.gov/system/files/documents/public_events/1349883/aryalcilibertoleyden.pdf

Is capacity discipline analogous to output restriction? If so, would you deny there is market power in the airline industry?

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