Fares will soar, Senate hears

Aloha Airlines' CEO tells a committee that round trips to Hawaii will go up by $200
By Dave Segal dsegal@starbulletin.com

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The average fare from the mainland to Hawaii could rise by $200 per round trip due to the shutdowns of Aloha Airlines and ATA Airlines, the chief executive of the Hawaii-based carrier testified yesterday at a U.S. Senate committee hearing in Washington, D.C.
Decrease in supply- price increases. Another factor leading to the increase in price may be that there will be fewer airline firms and hence the price elasticity of demand for air transport by these remaining firms will decrease, therefore the firms can increase the fares to increase revenue.

David Banmiller also told the Senate Committee on Commerce, Science and Transportation that interisland fares "certainly" will escalate to the levels where they were before Mesa Air Group's go! entered the Hawaii market in June 2006. Those fares were about $172 per round trip, almost double what they are now for the lowest fares.
In a hearing to assess Hawaii's air-service market, Banmiller testified that "predatory pricing" by Mesa Air Group's go!, along with record-high fuel prices, forced Aloha to cease passenger operations after no potential buyers could be found.
The practice of predatory pricing- selling below cost to drive out competitors.
Cross elasticity of demand- a positive cross elasticity of demand exists between air transport services provided by Mesa and Aloha since the two are substitutes. Hence a decrease in the fare charged by Mesa brought about a decrease in the quantity demanded of Aloha’s services.

Banmiller said he continues to hold out hope that investors would look at resurrecting Aloha's passenger operations, but he is not optimistic. He said there are 40 interested parties, including five that are serious, for the company's profitable cargo business.
Risk-bearing economies- diversification into cargo business apart from passenger airline services, such that the firm may still survive when demand for passenger airline services decrease as this may be offset by higher demand in cargo business.

If mainland-Hawaii tickets do rise by $200, it will not happen right away, said Rick Seaney, CEO of ticket-pricing Web site FareCompare.com.
"I think what happens is in a few months you'll see a shakeout where they will start to creep up, and you won't see any competitive pressure to pull them down," Seaney said. "Two weeks from now, airlines aren't going to raise their price $200 to Hawaii. But it could happen over the next two years if you don't see somebody jumping in to fly those routes. It could be a sticker shock two years from now."
Market structure of monopoly/oligopoly after shutdown of 2 airline companies- lack of competition, demand becomes less price elastic and producers can raise the price of air tickets to increase revenue since consumers are unable to turn to other alternatives.

Banmiller said that although the Airline Deregulation Act of 1978 opened the playing field of competition, deregulation has proved to be potentially harmful in achieving stable air transportation service for smaller regional markets like Hawaii.
Banmiller cited the collapse of Hawaii-based airlines Mid-Pacific, Mahalo and Discovery, and two bankruptcy filings each by Hawaiian Airlines and Aloha.

"Deregulation only (affected) the revenue side of the business, not the cost side," Banmiller said. "And despite deregulation 30 years ago, the airline industry continues to be one of the most heavily regulated and taxed businesses in America."
Deregulation: process by which governments remove, reduce, or simplify restrictions on business and individuals with the intention of encouraging the efficient operation of markets (source: www. wikipedia.org)
Taxation is viewed as an increase in the cost of production by producers.

U.S. Sen. Gordon Smith of Oregon, a Republican, asked Banmiller whether he thought the airline industry should be re-regulated, but Banmiller said it was too late for that.
"I don't think toothpaste can be put back in the tube," Banmiller said. "I think for the state of Hawaii it was a problem because it wasn't geographically considered."

Democratic U.S. Sen. Daniel Inouye of Hawaii, who chairs the committee, asked Banmiller whether the U.S. Department of Transportation was aware of Aloha's concerns about predatory pricing. Banmiller said he had spoken to two directors at the DOT, as well as attorneys for the Department of Justice.
"And what was their action or response?" Inouye asked.
"'We'll look into it,' and that's all l heard," Banmiller said. "When we followed up ... the comment back ... was that predatory pricing is very hard to define, and our interest is for the consumer and low fares."

Michael Reynolds, the DOT's acting assistant secretary of transportation for Aviation and International Affairs, said Aloha's claim was different from past predatory-pricing claims by other airlines because it usually is the new entrant coming into the market that complains about the incumbent carrier lowering prices and dumping capacity.

"At least initially, it didn't have the look of the traditional case we've seen in the past," Reynolds said.
Jonathan Ornstein, chairman and CEO of Mesa, said in an interview last night that "the DOT had it right."
"We entered the market with 7 percent of the capacity, offered low fares, and the incumbent carriers did exactly what the definition of predatory pricing is, and added significant capacity to push us out of the market."

Charles Willis, owner and chairman of Hawaii-based Island Air, testified that his airline has lost $5 million and seen a 30 percent drop in revenue since go! entered the market. Willis said Island Air was forced to cease nonstop service to eight neighbor island markets, cut scheduled flights by 38 percent and lay off 40 percent of its work force.

He said Island Air intends to restart service to the eight city pairs it eliminated, hire laid-off Island Air and Aloha employees and add more routes. He also said Island Air plans to bring in up to three de Havilland Dash 8s for the summer, as well as bring back Q-400s by mid- to late summer if warranted.

The airline industry involves high set-up costs due to the capital and technology involved, hence there is great potential for reducing the average cost of production. There is significant internal economies of scale and the LRAC falls over a large range of output.

Expansion of the firm to enjoy internal EOS:
-Technical Economies: indivisibilities of capital- the firm can spread the fixed costs of aircrafts over larger output levels, lowering unit costs.
-Marketing Economies: bulk purchase of in-flight meals, fuel for engines. Large-scale advertising to differentiate air travel services such that demand becomes less price elastic. The advertising cost per unit per be lower for a firm producing at a higher output.
-Financial Economies: with higher sales volume and more assets to offer as collateral, it will be deemed to be more credit-worthy by lenders. It will also enjoy lower interest rates when it borrows a large sum of money.
-Risk-bearing Economies: with a larger market share, the company can predict the demand for air travel more accurately.
-Administrative and Managerial Economies: with higher output, the cost of administration, which generally does not rise with level of output, will be much reduced per unit of output.

Willis said Island Air needs the committee's support in getting the Hawaii Legislature to pass bills that exempt airlines from the fuel tax and provide loan guarantees.

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Yanjun :)