Sunday, November 23, 2003

Curse of high fares has economic upside

Cincinnati airport is regional dynamo

By James Pilcher
The Cincinnati Enquirer

[IMAGE] Nearing the 25th anniversary of deregulation of the airline industry, the Cincinnati/Northern Kentucky International Airport is thriving as a Delta hub.
(Michael E. Keating photo)
| ZOOM |
Looking for a culprit for Cincinnati's high air fares?

On the surface, it would appear to be the pricing policies of Delta Air Lines, the hub tenant here at Cincinnati/Northern Kentucky International Airport. But to trace the roots of air fare angst, you have to rewind 25 years to perhaps the most important event for airlines and their passengers since the Wright brothers flew 100 years ago.

In an act designed to make air travel more affordable to the average American, Congress in 1978 deregulated the airline industry, lifting long-standing price controls that kept air fares artificially high.

To a great extent, the plan worked. As the nation heads into the busiest travel season of the year, more people are flying more inexpensively than ever, with fares at all-time lows. But at Cincinnati's airport, one of those most drastically affected by deregulation, the changes of 25 years ago still play out, especially with regard to the price of flying.

It has gotten to the point where more than one in four Tristate travelers doesn't even use this airport, choosing to drive one or two hours to escape what have become the highest fares in the country.

Yet the airport is a major hub, creating tens of thousands of jobs and billions of dollars in annual economic impact. And local residents can fly just about anywhere in North America nonstop, or worldwide in two flights.

"Cincinnati is definitely a community sitting on a double-edged sword," says Aaron Taylor, an airline specialist for Eclat Consulting in Alexandria, Va. "You've got tremendous service to numerous cities, but you also have an environment that discourages competitive carriers entering the market.

"Delta is not pricing the market abnormally, because the hub is an expensive but necessary part of the network to operate. But if all of a sudden, low-cost carriers all came in and provided great leisure service, Delta might pull out and you'd lose all that connectivity. It's a tough place for Cincinnati to be in," Taylor says.

Glass half-full

Despite a decline in service levels from the days of three-course steak dinners and free liquor in coach class, most people in the industry say deregulation has been an overwhelming success for the nation.

"Our goal from the outset was to make air travel available to everyone," says Alfred Kahn, the Cornell University economics professor who masterminded deregulation. "Just look at the billions and billions that travelers have saved and how many more people have flown who ordinarily would not have."

Kahn took over the Civil Aeronautics Board soon after President Carter took office in the mid-1970s. He immediately set out on a campaign to dismantle the agency, which set fares and approved or rejected price increases or new interstate routes proposed by airlines. Kahn succeeded on Oct. 28, 1978, with the passage of the Airline Deregulation Act.

Fares immediately plummeted, new airlines popped up, and old ones failed. Now, passengers generally have more choices at lower cost than they did before deregulation. "The value that is now delivered to the consumer is on par with just two other industries, those being telecommunications and computing power," says Delta president and chief operating officer Fred Reid.

Another huge impact was expansion of the hub-and-spoke system.

Carriers accustomed to artificially supported fares looked for efficiency, yet still wanted to serve the biggest number of destinations and passengers. The hub system seemed to be the answer.

After winning the war for dominance in Atlanta with the demise of Eastern Airlines, Delta opened a hub in Cincinnati in the mid-1980s.

Since then, the Cincinnati airport has evolved into an economic engine. Its bragging rights include:

• An estimated $4 billion annual economic impact for the region.

• Support of at least 16,000 jobs.

• Attraction of big names in the global marketplace, all of whom acknowledge the importance of being located at an airline hub. The companies include Toyota Motor Manufacturing North America, which put its U.S. headquarters in Erlanger near the airport in 1996; Ashland Inc., which moved to downtown Covington in 1998, and Citibank, which built a major expansion to its customer service center in Florence in 2001, adding 2,000 jobs.

"The airport is a tremendous draw for new business and existing business to expand on," says Danny Fore, president of Tri-Ed, the Northern Kentucky economic development corporation that helps recruit new business and is in part funded by the success of the airport through a rental car fee.

Comair helped fill it

Deregulation also helped spawn Erlanger-based Comair. The company, which revolutionized the regional airline industry, employs 4,000 people and is the area's only locally based carrier.

Launching its first flight the year before deregulation, Comair found itself picking up the scraps left behind by major airlines. After deregulation, those carriers could not afford to fly large jets to smaller cities. That left smaller, nimbler airlines such as Comair to fill the gaps.

But by 1984, Comair needed to team up with a large airline partner at a hub. According to company founder David Mueller, the first choice was Piedmont, which had started a medium-sized hub in Dayton. "But then Delta asked us to wait 30 days before making our final decision, and then they came back ... they were starting a hub in Cincinnati and wanted to partner with us," Mueller says.

Partly because of that partnership, cemented by Comair's introduction of regional jet service in 1993, Cincinnati remains one of the only hubs created after deregulation that has remained a hub.

Cincinnati now provides more than 600 flights a day nonstop to 128 destinations, including three in Europe. More are on the way next year, with the addition of Rome and Amsterdam. A direct flight to Honolulu was added this month. Compare that with fewer than 30 destinations and just over 100 flights in 1977, the year before deregulation.

"We would not have international service if not for the hub, and we'd probably have just a little more than we did back in the 1970s, because we're not that big a market by ourselves," says airport aviation director Bob Holscher.

Piedmont no longer exists, swallowed up by US Airways long ago, while Dayton became a minor destination.

Glass half-empty

Cincinnati has paid for the right to call itself a hub city.

Average air fares were 56 percent more than the national average when comparing similar flights and markets in the second quarter of this year. That's tied for the highest premium in the country, according to the Transportation Department, with only White Plains, N.Y., passengers paying as much.

Based on local ridership and average fare figures, that disparity equates to about a $100 million surcharge that Cincinnati area passengers pay annually to help the region keep the hub, which provides Delta control over 92 percent of the seats on planes leaving here. The fare disparity has gotten so great that more than a quarter of Tristate travelers use other airports.

According to a new study commissioned by Cincinnati airport officials, about 2,500 local residents a day choose to drive one or two hours to the five other airports that ring the area and offer low-cost competition. From there, they usually have to take a connecting flight - and many times they travel back through Cincinnati.

"That's what irritates me most, is driving all the way to Columbus or Dayton and then having to fly back through here to save as much as 600 bucks," says Robert Diehl, a Springdale software salesman, who flies at least once a month.

The report says only 72 percent of Cincinnati-area travelers use the local airport. Delta officials argue that number could be higher. They cite the study's methodology, also saying direct connections draw travelers from other regions.

But Delta acknowledges that "leakage" is an issue, especially to Dayton, which collects 12 percent of the local market, according to the airport's report.

"Cincinnati is in a little bit of a unique situation with all those airports surrounding it," says Subodh Karnik, Delta's senior vice president for network and revenue management. "Dayton is an especially large number, and it troubles us."

Yet citing the Citi/Smith Barney 2003 Hub Factbook, Karnik points out that Delta charged 9.5 percent less per ticket originating in Cincinnati than competitors in the 12 months ending March 2002. Even though that report includes the disclaimer that the numbers were skewed lower because of the spring 2001 Comair pilot strike, Karnik argues that this shows that the airline "is competitive" at the local airport. He also says Cincinnati fares have dropped 7 percent to 8 percent overall during the past four years.

Still, Delta defends its turf vigorously. In the past 13 years, 10 low-cost airlines have tried to establish service here. None has survived.

Delta's strategy against low-fare newcomers typically was to cut fares to match or beat the competition, and perhaps add flights. That would entice more local travelers, lured by the ability to pick from six flights a day compared with two, and get frequent flier miles to boot.

Now, low-cost carriers such as JetBlue, Southwest and AirTran are taking a bigger share of the market nationwide, and a bigger share of the Cincinnati market at airports such as Dayton (AirTran) or Louisville and Columbus (Southwest).

But experts such as Eclat's Taylor say part of Cincinnati's problem is that with only 3.2 million people flying annually in this market, and with Delta's dominance, there aren't enough passengers to go around to make the market profitable for low-fare carriers.

That contrasts starkly with Cleveland, which has a small Continental hub but also has Southwest to drive down fares, primarily because nearly 8 million people start trips there each year, more than double Cincinnati's market.

Debate continues

Everyone has an opinion about what should be done about air fares. And the debate about whether Cincinnati's hub is worth the cost stirs strong emotions.

Many area officials are closely watching St. Louis, where this month American Airlines cut the size of the former TWA hub in half, and Pittsburgh, where US Airways is threatening to pull out its hub, putting 10,000 jobs at risk.

They see local jobs, connectivity and the economic impact of travelers passing through Cincinnati who spend money here if they stay overnight. But many local residents can't look beyond the high fares, and continue to shake their fists at Delta.

Even Kahn says one of his few disappointments with deregulation was the creation of "fortress hubs" such as Cincinnati.

"It's the price you pay for superior convenience, but it certainly is a monopoly," Kahn says. "And that creates predatory pricing, and that is why I've been one of the most vociferous people arguing that cities such as Cincinnati should have some protection.

"Antitrust laws are the answer, and it has been a tremendous disappointment to me that the regulators and the judges don't seem to feel that there is such a thing as predatory pricing," Kahn says.

That sparks a heated response from Delta president Reid, who says the only other choice is to take away the hub and replace its economic impact and jobs with low fares but limited travel choices.

"Alfred Kahn cannot pick and choose," Reid says. "Either he understands that networks operate as a single organism or he must say that we have to go back to the regulated days.

"I would also respectfully say to Mr. Kahn to look at the ancillary effect of the hub on the city, the state and the region's economy, the message there being that the airline brings at least a 10-to-1 benefit."


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