Utilities and Airlines

Utilities and airlines have several things in common:  They are highly regulated industries and in many countries still owned and operated by the government.  Structurally they are high fixed and low marginal cost businesses with high barriers to entry. If that’s the case there may be some similarities in how they might evolve. The airlines industry has evolved into a set of characteristics that have been quite controversial.  Deteriorating customer services, lower costs, and constant acrimony; yet there is no clear view of whether the downward slide can be checked.  Only certain theories exist.  Most recently, the New Yorker argued that the basic services are lowered so that there is deliberate misery created for customers to pay the high fees to avoid it.  This results in airlines earning high profits through fees in other services such as, baggage, drinks, and extra legroom seats. The economist adds

“High-fixed-cost, low-marginal-cost industries are characterized by brutal competition and punishing boom and bust cycles. Which is exactly what we see in the airline industry. Over the last 15 years, the three remaining major airlines—Delta, United and American Airlines—have averaged profit margins of 3 to 8 percent, with periodic dips into deep red. Things aren’t getting more crowded and fees higher because it’s a good way for them to shake a little more off the money tree. Rather, the only way that they can make any money is to schedule more flights, cram more seats into the planes and manage their yield so that the planes fly fuller. The result is unpleasantly reminiscent of cattle walking up the slaughterhouse chute. But unlike the cattle, we have to claim our own share of the responsibility. Ultimately, the reason airlines cram us into tiny seats and upcharge for everything is that we’re out there on Expedia and Kayak, shopping on exactly one dimension: the price of the flight. To win business, airlines have to deliver the absolute lowest fare. And the way to do that is…to cram us into tiny seats and upcharge for everything. If American consumers were willing to pay more for a better experience, they’d deliver it. We’re not, and they don’t.”

I don’t fully agree. In such industries there are major barriers to entry. In international markets, airlines have take different strategies to address different customer segements. There are many low cost players but Singapore airlines have taken a strategy to make customer satisfaction as the differentiator and customers are willing to pay for it. In the US, we dont have a well represented market. All US airlines (apart from low cost Southwest and others) are all playing a “me too” low cost game. We are stuck in a way, since companies like Singapore airlines can’t enter and operate in the US domestic market. This is a shame, especiallly for the bastion of capitalistism.

This makes me wonder. Given the similarities with utilities, if we reduce regulations and oversight, is there a possibility that the base service level actually decreases so that the companies can unbundle and make people pay for what was part of the entire package. For example, everytime we have to set up a new connection, can we start getting DIY kits and have to pay a ransom to get a technician out. It is possible. Hence, deregulation needs propoer foresight. Baly implemented policies can result in degreadation of services and a deadlock situation where the optimal point for ownership profits initiates a race to the bottom for customer services level, since the markets would not function well. Due to high risks and fixed costs, companies are reluctant to take the bet and enter into a new segment.