The old joke about how to become a millionaire quickly is to start off with a billion dollars and invest in an airline. The idea that airlines are profit-generating machines, earning unfair rates of return on the backs of consumers, is hard to square with this. Which view is right?
Are Airfares “Too High” or “Just Right”?
The list price on a Boeing 737 is $90 million. No question airlines buy these at a discount, and large orders get big discounts. But American Airlines mainline – not counting regional jets farmed out to affiliated carriers – has over 950 planes. That’s a huge capital investment.
If you have money to invest do you buy stocks, bonds, CDs? Or do you put it to work in a business, because you think you can do even better than you could with a more passive investment?
Airlines have only now started to cover their cost of capital, making enough to justify their investment.
(Source: Financial Times)
At higher fuel prices, of course, airfares would need to be higher as well to cover an airline’s cost of capital.
We now see airlines earning enough where it makes sense to invest in aircraft and all of the other costs necessary to run an airline. That’s why we see growth. And it’s also why we see airfares beginning to fall.
Airfares Aren’t High After All
Airfares, including average fees, are down compared to last year. American Airlines announced that in the second quarter its average revenue per seat mile flown was down nearly 7%.
But in 2014 airfares were high compared with record low fares we’ve come to experience. So airfares feel high. The idea that air travel is ‘expensive’ has a certain truthiness.
Adjusted for inflation airfares inclusive of fees were lower in 2014 than they were 15 years earlier. And those fares were lower than at any point in the past. The long run trend is for lower fares. But with record high fuel prices, more than double what they are today, airfares blipped up. We’re seeing that moderate.
How You Lower Airfares — and How You Don’t
The federal government is pursuing claims of collusion against US airlines, arguing that they conspired to restrict flights in order to raise prices. (It’s an odd claim that airlines are colluding when 80% of their attempts to raise prices fail, and when the investigation proceeds at a time that fares are falling and capacity is growing.)
They’re also pursuing a separate investigation over price gouging in the wake of an Amtrak accident outside Philadelphia.
These moves go after unpopular airlines, and create the illusion that the government is ‘doing something’ (both investigations in response to a complaint from a politician). But they don’t hold out hope of driving down prices.
You can’t claim to care about lowering prices if you don’t favor removing restrictions on competition. There are fewer airlines in the US than there used to be, but it doesn’t have to be that way. The government’s legal arguments against recent large mergers weren’t compelling enough to oppose them, I take the government at their word that the analysis was based on law. But the biggest reason we have fewer airlines is because it’s illegal for most of the world’s airlines to operate inside the United States.
The simple solution to fewer airlines and less competition is to eliminate foreign ownership restrictions on US airlines. Then we could have Singapore Airlines, Lufthansa, British Airways, and Ryanair operating carriers inside the United States.
Competition would be brutal, airfares would be low. I wouldn’t want to invest in the sector. We’d see a return to Warren Buffet’s description of investing in the airlines.
“If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright. He would have saved his progeny money. But seriously, the airline business has been extraordinary. It has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in. You’ve got huge fixed costs, you’ve got strong labor unions and you’ve got commodity pricing. That is not a great recipe for success. I have an 800 (free call) number now that I call if I get the urge to buy an airline stock. I call at two in the morning and I say: ‘My name is Warren and I’m an aeroholic.’ And then they talk me down.”
If you want lower airfares there’s an easy solution, it comes from government, but it’s not bread and circuses.