You either love hubs or hate them. A government department has accused the US majors of continuing to use their hubs to raise fares and keep out new entrants. At the same time, an investment bank has emphasised how important hubs are to the major carriers by producing a comprehensive guide to which of the US majors are using their hubs most effectively, and which hubs have the most growth potential.
To the American travelling public, the hub and spoke system is as much a way of life as fast food. It has become an almost unquestioned way of travelling; the airlines argue that the system offers convenience and access to city-pairs that might not otherwise be viable markets.
To the major US carriers, hub and spoke operation offers not just convenience, but also control. An airline can focus its routes and maintenance operations on its chosen hub airports at the same time as greatly multiplying the number of cities and people it serves. A good hub and spoke operation feeds itself by capturing nearly all of the the local market and diverting one-stop traffic from other hubs and airlines.
Given that the majors have closed down their smaller hub operations and become entrenched in a few major hubs, most of them are now replying heavily on these so-called fortress hubs for their future prosperity. But the General Accounting Office is recommending regulatory action to curb hub power, in a report which brands the hub-and-spoke system as anti-competitive, saying that it is one of the main barriers to competition in several key domestic markets. Moreover, the congressional watchdog points out that at major airports where one carrier accounts for more than 75 per cent of embarkations, fares tend to be higher - in some cases, much higher.
In a study of the 43 airports falling under the Federal Aviation Administration's 'large hub' classification, the GAO found fares to be generally 'much higher' in 1995 at the ten airports which are either affected by operational constraints or where one airline accounts for the vast majority of emplanements.
At Charlotte/Douglas, for instance, where USAir accounts for more than 90 per cent of seats sold, the GAO says the average fare is 88 per cent higher than those at the other 33 airports which are listed as large hubs. Cincinnati, a Delta-controlled hub, has average fares 84 per cent higher, while Pittsburgh, another USAir-controlled hub, has average fares 72 per cent higher (see chart).
Such figures are not new. PaineWebber's Sam Buttrick comments: 'High fares at fortress hubs have been well documented; the solutions are less well documented.' The GAO's proposed solutions are new, however, and include compulsory lotteries of slots and financial inducements to airports to make gates available to non-incumbent carriers.
While such measures may stand little chance of being implemented, any regulatory threat to the majors' hub structures will concern both the major airlines and their investors.
The importance of fortress hubs to the majors has been thrown into sharp relief by a a review of 24 hubs and eight major hub and spoke airlines by New York investment bank Lehman Brothers. The firm says that, with the US airline industry entering a mature phase and restructuring largely complete, the primary investment determinant of these carriers will be the relative strengths and weaknesses of their hub operations.
The Lehman report acknowledges that hubs are the backbone of major carrier's operations, but points out that they do not signal automatic financial success. Local market growth potential, catchment area growth potential, seat market share, gate control and gate utilisation are the five aspects of hub operations that Lehman identifies as indicators of a hub's current and potential future success. Most hubs are strong in one or more of these areas and weaker in others.
For instance, the report finds that Delta and TWA have the best catchment areas in the industry, while Continental has the most significant untapped potential for adding connecting traffic.
Northwest displays the greatest dominance of its hub markets in terms of seats flown - it wins an average of 79.2 per cent of the available seats out of its hubs at Detroit, Memphis, and Minneapolis-St Paul. Northwest also controls the largest percentage of gates at its hubs - an average of 72.2 per cent. United Airlines, meanwhile, controls an average of only 33.4 per cent of gates at its hubs at its Chicago/O'Hare, Denver, Los Angeles and San Francisco hubs, but has the highest average gate utilisation of 8.03 jet departures per gate.
The two reports have different purposes - one is to identify future investment potential for a carrier by the projected success of its hubs; the other to highlight how strongly dominated hubs are blocking competition - but they each contain facts which are worthy of comparison and which bear out each other's arguments.
For example, the Lehman report lists four airports where a single carrier controls a very high percentage - over 80 per cent - of available seats. Not surprisingly, those same airports - Charlotte/Douglas, Cincinnati, Minneapolis-St Paul and Pittsburgh - also top the GAO's list of where fares are highest.
The only non-hub airport in the GAO's top five is Washington National, which is constrained by slot shortages and the federal perimeter rules that limit the number of hourly operations and prevent nonstop flights exceeding 1,250 miles.
The GAO is recommending that the Department of Transportation should create a pool of available slots at airports that have not experienced lower fares since deregulation. This could be done, suggests the GAO, by periodically withdrawing some slots that have been grandfathered to major incumbents, taking into account the investments made by those airlines, and holding a lottery to distribute them in a way that would increase competition.
Further, the GAO wants the Federal Aviation Administration to encourage airports to make gates available to non-incumbents by taking such policies into consideration when the FAA is deciding whether to make federal grants available to airports.
Naturally, this is welcome news to those airlines trying to nibble their way into the most popular hubs. 'The real issue here is that you have a very close relationship between the tenants of the airports and the airport authorities. Often, in fact, the tenants dictate the terms,' says Jeffrey Bair, chief executive officer at Philadelphia-based JetTrain. In January, this low-fare airline was launched with a Newark-Orlando service using a single McDonnell Douglas DC-9-31. The airline now has three DC-9s, but by September felt compelled to withdraw from Newark, where its only option to secure access to gates was through a sublease from United Airlines. Effectively, this forced the airline to operate at inconvenient, off-peak times.
When JetTrain then tried to lease three additional gates from United, it could only watch as another established carrier took up those leases before it could arrange the necessary financing. It is that sort of practice that the GAO wants to see changed. 'Representatives from other airlines that started after deregulation told us that they strongly prefer not to sublease gates because the established airlines typically insist that the sublessee use the established airlines' ground personnel, which artificially raises costs and may reduce efficiency,' observes the GAO. ' The CEO of Southwest Airlines told us that this was a key factor in his decision not to serve Minneapolis.'
Southwest remains the outstanding exception to the rule that hub and spoke is the only way to go. Southwest operates a successful service based on a point-to-point system that is almost unseen anywhere else in the US.
'We don't go into Phoenix or Houston and say we can satisfy any of your needs - that is not us,' acknowledges Southwest's chief financial officer Gary Kelly. 'But if you want to go on a short hop, on time and for a low fare, then that is us. We define city pairs in a narrow way and we think that passengers like jets and like frequency because that gives them choice. So, the only plane we fly is the 737. We look at city pairs that have a high volume of traffic. And we know that our costs are the lowest in the industry, which is top of the list in terms of being successful.'
Kelly takes the view that Southwest can be successful in any market that meets this broad definition of what his airline is about. 'But the speed at which we become financially successful may vary. We can be very successful very quickly in somewhere like Providence, but a hub city, by definition, is over-served so we know there will be an uphill battle and it will take a formidable effort on our part. We have to let those opportunities evolve with time,' says Kelly.
This philosophical view might well be applauded by the majors, which are indignant at the idea that their monopolisation of hub airports should be challenged by something as arbitrary as a government-enforced lottery. Delta, for instance, points to the millions of dollars it has invested in its fortress hubs, including Atlanta and Cincinnati, and argues that it has effectively created the markets it now serves, so why should it now be forced to give them up? And, say the majors, they are giving the market what it wants - the most convenient, flexible way of reaching the largest number of destinations around the country.
Avmark's Barbara Beyer agrees. 'Hub and spoke is something that suits the US public. It lets you get to places that previously were extremely difficult to get to and which involved lots of stops and changes. Now, you can reach almost anywhere with just one stop.' Beyer points out that deregulation was the real driver of the whole hub and spoke concept because it led the carriers to want two things - market dominance and lower cost of operation. 'Using the hub and spoke system you can put far more cities into your system and you capture your passenger - you make it difficult and expensive for them not to use your services,' says Beyer.
The fortress hubs have become more important to the majors since the last recession, which prompted many of the smaller hubs to be wound down. As a consequence, the major hubs have become sacred territory, so it is not surprising that the US majors view the GAO's recommendations with distaste.
Not that they have too much to fear. The GAO's last such survey, in 1990, highlighted almost exactly the same concerns about long-term, exclusive-use gate leases, slot-controlled airports, and their effects on competition.
But there has been little progress since then. 'By the early 1990s, we found that a few carriers had increased their control of slots to such an extent that they could limit access to routes beginning or ending at any of the slot-controlled airports - airports that are crucial to establishing new service in the heavily travelled eastern and midwestern markets,' notes the GAO. 'Since the early 1990s, a few established carriers have continued to build upon the favourable positions they inherited as a result of grandfathering. By contrast, the share held by the airlines that started after deregulation has remained low.'
This has resulted in a seller's market in which slots, when available, have become very expensive. According to FAA officials and the airlines themselves, the price of a slot has risen sharply over the last decade, now exceeding $2 million for the peak period slot and $500,000 for an off-peak slot. 'In order to mount competitive service in a market, an airline generally needs about six slots, with at least three slots falling during the peak periods so that the airline can offer a flight schedule that is attractive to business travellers,' says the GAO. 'As a result, for the airlines that started after deregulation, the cost of purchasing the slots necessary to compete effectively may be prohibitive.'
There is a similar story with gate availability, again unchanged since 1990, says the GAO. 'In 1990, at some airports, every gate was under an exclusive-use lease. We concluded that such leases limited entry because, in order to gain access to the airport, a non-incumbent would generally have to sublease from the incumbent airlines . . .
'Since then, some airports, such as Los Angeles, have sought to regain more control of their facilities by signing less restrictive, shorter-term leases when the exclusive-use leases expire. Nevertheless, senior management at many airlines that started after deregulation told us that long-term, exclusive-use gate leases continue to be a barrier to entry.' The GAO concludes that exclusive-gate leases are making access to certain airports, especially Charlotte, Cincinnati, Detroit, Minneapolis, Newark and Pittsburgh, 'extremely difficult.'
Whether this latest report leads finally to the creation of more inroads into those 'extremely difficult' markets remains to be seen, although early feedback indicates that any changes will be minimal.
The FAA is handing the ball over to the DOT, saying that allocation of gates and slots is 'strictly a DOT issue'. The DOT, meanwhile, is circumspect. 'We are preparing a formal response to the GAO, which is now being formulated and which we hope will be available shortly,' is its only comment to date.
If, as the Lehman report contends, hubs are the key to success in a maturing airline industry, then the GAO's recommendations will receive an icy response from the majors. The indisputable fact remains that hub and spoke in the US is now so deeply established that any fundamental change would be extremely controversial and difficult to bring about.
Source: Airline Business
