Last week, the Department of Justice (DOJ) apparently sent letters to American, Delta, Southwest, and United asking for information about communications between the airlines and Wall St analysts, shareholders, and other airlines. What is DOJ looking for? Proof that the airlines are colluding to keep capacity down and fares up. This doesn’t seem to jibe with reality, but that’s never stopped DOJ before. It’s possible that DOJ has a smoking gun somewhere that it’s waiting to show the world. It just seems unlikely.
The two evil words that DOJ is investigating are “capacity discipline.” Uh oh. I just wrote it myself. Now I’ll probably get a subpoena. Capacity discipline is something that better management teams have preached for the past few years. This strategy is the complete opposite of how airlines have traditionally operated.
Historically, airlines craved market share. So they would pour a bunch of capacity into a market to try to build up a presence. The end result was a capacity glut that made everyone lose money. Airlines are really good at that. So when some management teams started actually practicing capacity discipline, it was a foreign concept.
The idea behind capacity discipline is to NOT chase market share. Instead, some airlines have decided to be more conservative, focus on their strengths, and actually aim for maximum profitability instead of flooding the market with cheap seats. Of course, this became easier with consolidation because the airlines now have fewer shiny objects they want to chase in the first place.
The result of this strategy was pretty much as you’d expect under the basic laws of supply and demand. With capacity not growing as fast, airlines could fill those fewer seats with higher fares. While in the past airlines hadn’t been considered great long term investments, that began to change as they began acting like smarter businesses. Airlines began to string together a series financial results that almost looked like companies in a normal industry. Investors began to pay closer attention.
Despite what you might expect, the airline industry is actually pretty transparent when it comes to data. Fares are published for everyone to see and schedules are in the market nearly a year in advance for most airlines. Regular updates are provided to investors around revenue and capacity expectations. Today, Wall St has whole-heartedly embraced capacity discipline because it creates a more sustainable long-term business, one worth investing in.
This, however, doesn’t mean airlines have simply fallen into line with what Wall St wants entirely. This is still a competitive industry. Delta has been pouring capacity into Seattle. American is trying to strategically grow LA. And Southwest has been bumping up its growth. That alone caused something of a panic.
Southwest CFO Tammy Romo said the airline was going to grow faster than originally expected. That combined with Delta’s bump in capacity plans as well as the fact that the big airlines were seeing falling unit revenue sent Wall St into a panic. Airline stocks lost a lot of value. It didn’t take long before Southwest scaled back its growth plans to the lower side of expectations.
While this was going on, the political machine was ramping up. Sen Richard Blumenthal (D-Conn.) wrote a letter to DOJ asking for an investigation into airline collusion. He used this Southwest example as proof. In his mind, Southwest had put out its growth plans and then the other airlines signaled to Southwest at the annual IATA general meeting that this was unacceptable. Southwest immediately pulled back.
The idea that Southwest would be scared of other airlines and reduce capacity because of them is laughable. The reality here is that the airline’s investors didn’t like the growth plan, and that’s why Southwest pulled back. It wasn’t due to signaling from other airlines.
I really hope that DOJ has more than this to stand on if it decides to pursue a case. Maybe there is some smoking gun that it hasn’t released to the world. (I kind of hope so, because it would be a lot of fun to watch.) Or maybe it’s just giving in to political pressure and going through the motions, hoping to uncover something before the investigation fizzles.
Even if it does have something, what can it really do? As one person suggested, it’s not like DOJ can make airlines grow. Sure, it can fine the airlines, but my guess is that the fine will be less costly than adding a ton of new capacity just because DOJ thinks that’s how things should work. But we won’t get to that stage anytime soon. This will be a long process.
In the meantime, you’ll see all kinds of skewed numbers thrown out there to support this accusation. I think my favorite so far is the stat looking at the big fare increases since 2009. Remember 2009? That was the depths of the recession and airlines had seen fares tank from just a year earlier.
So yes, if you compare airfares today to 2009, it’s going to look like a big increase… but only because it had fallen just before that. Fares remain historically affordable, even when you factor in fees.
The reality is that we’re in an industry that continues to put out more capacity than many think is sustainable and declining unit revenues certainly show that. If DOJ has a smoking gun, let’s just see it. Until that, I remain pretty skeptical that this will amount to anything.