C. R. SMITH

WHY AIRLINES ARE IN T R O U B L E

otrrsmF_~ to the airline industry recently escribed the economic problems facing

the airlines today. A survey team, employed by the Bell Telephone System to consider progress in regulated and unregulated indus- try, made this comment on the airlines:

"Looking beyond the iets, more innovations will come. The country will make new de- mands on the industry. The question is what kind of industry it will be that meets these de- mands. If the industry is strong it will be able to meet the demands of the future as it has the demands of the past.

"But ff regulation restricts, instead of stim- ulating the airlines, the future may be dark. Unless industry profits are kept at healthy levels, the airlines could start down the path the railroads have traveled.

"Up to now the story of the airlines sounds very much like the history of the railroads. It began with subsidies. Then regulations

Mr. Smith is President of American Airlines.

stepped in. Competition and regulation made a tangle which greatly restricted the freedom of the companies. For the good of everyone, the airlines must not end up where the rail- roads are today. ''x

Earnings reports for the first half of 1960 tend to justify this concern for the economic state of the airlines. Although traffic in the trunk-line industry for this period was 7.6 per cent over that for 1959, the industry had a net loss of $7.4 million. Compared to the same period for 1959, when the industry made a net profit of $29.4 million, this decline amounts to $36.8 million, not all of it due to the bad weather of 1960. Further evidence of the eco- nomic condition of the industry was brought to the attention of the Civil Aeronautics Board recently, when one of the trunk lines filed an

1 From "Profit, Performance, and Progress: A Study. of Regulated and Non-Regulated Industry," a booklet pub- lished in May, 1959, by the Bell Telephone System (pp. 78-79).

38

WHY AmLm-ES ARE IN TI~OtmLE 3 9

application stating that it could not continue to operate without subsidy.

For the past three years, the trunk-line in- dustry as a whole has earned 5.1 per cent on its investment. Considering the economic haz- ards of the business, this rate of return is not sufficient. The examiner in the current gen- eral passenger fare investigation recommend- ed a 10-12 per cent rate of return. The Civil Aeronautics Board recently accepted the rec- ommendation, and granted the domestic trunk-line industry the new rate of return, but, under existing conditions, it will be difficult to find a way to earn this rate, It is often over- looked that in a business like ours, with con- stantly expanding demands for capital, it is not enough just to earn as much money as last year. For example, the total assets of Ameri- can Airlines have more than. doubled since 1955, but our earnings have gone up only about 10 per cent. On the basis of perform- ances like this, investors will be slow to trust their funds to the air transport industry.

Why do the airlines not make more money? This failure has not resulted from an inability to expand; the airlines have recorded a spec- tacular growth in business.

Before World War II, our best airliner was the DC-3, carrying twenty-one passengers and flying at a speed of 180 miles per hour. Today, our jet machines carry five times as many passengers and fly them three times as fast. In between the DC-3 and the jet, many new airplanes have been developed, used, and in part retired, all within postwar years. The short careers of these fine airplanes, in and out of service within so brief a time, is un- mistakable proof that the airlines can adapt successfully to change.

The airlines have continued to exhibit both technical and financial courage in the opera- tion of their business. Their ability to do so in the future, in view of the enormous costs of modern equipment, will depend on solid businesslike plans; the barnstorming days of aviation are over.

If the solution to the economic problem does

not lie within the industry's operations, what, then, needs to be done? Here are some recom- mendations on the subjects of subsidy, route competition, aeronautical research, and devel- opment of supersonic transports-subjects that do have a direct bearing on the problem.

S U B S I D Y

The United States airlines are regulated by the Civil Aeronautics Board, an agency of the federal government. This regulatory agency was created in 1938 by the Civil Aeronautics Act. The air transportation act was, in many respects, patterned after earlier national legis- lation for the regulation of other forms of transportation. Most of the provisions of the 1938 act were carried over intact into the Federal Aviation Act of 1958, which now gov- erns air transportation.

The act regulating aviation differs in one notable feature from the legislation now in effect for rail and highway carriers-the Civil Aeronautics Board was given authority, by both the 1938 act and its successor, to provide economic aid to the airlines through what is generally known as the "need" section. The only other existing transportation legislation providing for subsidies is the Merchant Ma- rine Act, and this aid is limited to foreign ship- ping. Domestic shipping lines, like the rail- roads and motor carriers, are not eligible for subsidies.

Who Gets Subsidies?

There are three principal categories of a.ir- lines: domestic trunk lines, domestic local service carriers, and international carriers. In the earlier days of air transportation, all of the airlines, in all of the categories, received some form of economic aid from the federal govern- ment. This has not been true in recent years. Most of the trunk lines have received no sub- sidy since 1951 and, with one exception, none

40 BUSINESS HORIZONS

of the tnmk lines has received any subsidy since 1956. None of the international carriers has received subsidy since 1958.

However, all of the local service carriers receive subsidy, and it is likely that they will continue to need subsidy for some time to come. These carriers usually serve communi- ties of limited population and limited traffic potential, and do not have the opportunity to attain self-sufficiency that is available to the trunk lines.

Payments to these carriers, which are al- most wholly noncompetitive, is subsidy in its classical foam according to the Columbia En- cyclopedia: "Financial assistance granted by the government to a private person or associa- tion for the purpose of promoting some enter- prise considered to be for the good of the country or its people." The local service car- riers perform a necessary public selwice, and subsidy is justified on the basis that this es- sential service could not be provided without aid from the government.

The airline industry is unique among busi- ness enterprises. During the twenty-two years since the passage of the Civil Aeronautics Act, no airline certificated for passenger and mail carriage has ever "gone broke." Some of the carriers have had economic difficulties, but critical situations have usually been remedied by subsidy from the government. To students of both business enterprise and government policy this is an interesting situation. One of the basic criteria of the private enterprise system is that the risks of the business will be borne by the private investor. He is entitled to the profits of the business if there is success, but he is also expected to pay for the losses if hopes cannot be realized. The merit of this system is that it impartially prunes the weak limbs, leaving the hardier stock a better chance to develop a strong structure. Yet the air transportation policy of the government, as defined in the acts goveroAng aviation, has shielded the participants in the industry from the principal penalty of the private enterprise system-potential bankruptcy. What brought

about this policy? Is it a good policy, and should it be continued?

Philosophy of Subsidy

For more than one hundred years, it has been accepted as a matter of principle that the fed- era] government, on behalf of the people, has a direct interest in and responsibility for assur- ing that the nation has an adequate system of transportation. Certain areas often need improvements in transportation services be- fore they can provide enough traffic to pay for the cost of operating the services. Land grants and advantageous government loans to the railroaqls in their early days are examples of government aid to pioneering transporta- tion. This government program worked well; it did provide the rail lines to the West. But when the railroads could be self-sustaining, direct government aid was no longer given.

A later generation of statesmen saw that the airplane would become a tremendously useful vehicle of transportation, although the airplanes at the time were primitive machines that could not operate at a profit. After the fuel for the journey had been put aboard, there was neither lift capacity nor physical space remaining for sufficient pay load to cover operating costs. Air transportation, like the transcontinental railroads, would have been long delayed in making its contribution to bet- ter transportation had the government not been willing to assist during its pioneering days.

I am sure that the philosophy of those who created the early airmail legislation, and those later responsible for the creation of the Civil Aeronautics Act of 1938, must have followed, in principle, the philosophy that apparently guided aid for the early railroad enterprises:

We will aid air transportation during its pioneering days, but it is not our intention to subsidize air transportation ad infinitum.

We will expect air transportation to be self- supporting when the ability of the airplane

and the tra~c potential provide a reasonable opportunity for profitable operation.

The question then is this: Has air trans- portation attained a stature that affords a rea- sonable opportunity for self-support without direct economic aid?

Recommendations

The "need" section of the act, insofar as it applies to trunk-line carriers, should be re- pealed, so that no trunk-line operator will be eligible for subsidy. Until the time of such repeal, the federal go venmaent should estab- lish and enforce the policy of not paying sub- sidy for operation over any specific route if there are one or more other carriers on the same route that are willing and able to pro- vide an adequate service without subsidy. There is no essential economic need for sub- sidy amo.ng the domestic trunk carriers trader modern conditions, and recourse to this out- moded crutch would serve to undermine pub- lic confidence in the integrity of air trans- portation at a time when investor support has never been more necessary.

We must, however, continue to subsidize the local service carriers for some time in the future, but in this area also we look forward to the time when tlaey can be self-sustaining. There can be no such thing as a sound com- petitive industry, partly subsidized and partly self-suflqcient.

The international carriers have already demonstrated an ability to be self-sustaining; they have no need for government subsidy today. Whether or not they will need govern- ment subsidy at some time in the future may depend on the competit ion they encounter from the foreign-flag airlines; the extent to which foreign governments will be willing to subsidize their own national carriers; and the ultimate effect of the lower labor costs avail- able to the foreign-flag airlines.

While there is no justification for subsidy to our overseas lines at this time, it would not

w i l Y AIRLINES ARE IN TROUBLE 41

be good judgment to repeal the legislation that makes subsidy available if needed.

R O U T E C O M P E T I T I O N

Competit ion as an economic force is good, but competit ion must be at the "right level" if it is not to become wasteful. The right level of competition for the airlines is one that pro- vides each of the efficient carriers on the route with reasonable opportunity to operate at a profit.

But tmneeessary duplication causes the total traffic to be shared among so man.y airlines that there is insufficient business to provide a profit for even the most efficient of the opera- tors. When competition has that effect, it has become wasteful - i t has eliminated both the opporttmity for profit and the hope for sub- sequent fare reductions. The customer, in ad- dition to the airlhle investor, has been forced to pay for a level of competition far beyond "the extent necessary to assttre the sound development of an air transportation system," the standard laid down by Congress. This was a thoughtfully worded provision. Congress recognized that it is possible to have too little competition, and that it is also possible to have too much competition. The right level of com- petition is, healthful, providing incentive for better service and for potential reductions in charges.

It is not my intention to discuss details of the local service area or of the international area. Instead, I want to focus on the area of the domestic trunk lines. On this, I should like to offer a basic opinion.

I doubt that any stndent of transportation, or any other competent person who examines the facts of the situation, would disagree with the conclusion that the total domestic trunk- line market today is of the extent and kind that should permit profitable operation with- out subsidy. With the right number of com- peting domestic trunk-lines, there is enough

42 BUSINESS HORIZONS

total business to assure a reasonable profit for each efficient operator.

The Civil Aeronautics Board is responsible for determining the number of carriers to be permitted on any route, and some of the board's decisions have been difficult to make. The backbone of the existing system is a basic route pattern inherited outright from the air mail system. To this there has been added route after route, often in piecemeal fashion, over a period of more than twenty years.

In earlier days, often one airline, and less often two or three airlines, was responsible for operation over a specific route. Today, four or as many as eight airlines may be operating on the same route, all seeking to maintain their services and make a living from a total traffic not big enough to divide among them with profit. This burdening of the airlines with more and more competition is not a new devel- opment. Year by year and route by route, the CAB has been piling up parallel services, de- spite continued warnings that the economic integrity of the airlines would be endangered.

Whatever may have been the motivations that influenced the members of the board in years past, the board must now deal with changed and changing conditions, all of which dictate a re-evaluation of the level of com- petition on some of the routes. At the same time, the "state of the art" in the design and construction of airplanes has changed, altering the original function of some of the routes and rendering obsolete the principles underlying the establishment of others. This re-evaluation can be made without the sacrifice of useful and necessary competition, and it can be done without any requirement that the trunk-line services be subsidized by the government.

Recommendations

The federal government, through the caB, should assume responsibility for a realignment of the route structure to provide for the eco- nomically sound air transportation system con- ternplated by Congress. This can best begin

by the encouragement of mergers that will effect economies, and mergers that will reme- dy existing inefl[iciencies in the route structure through the redistribution of competition or, when necessary, the reduction of competition that exceeds the limit needed for the sound development of the segment concerned.

If these approaches do not produce the re- sult desired, the board should consider use of the full range of its powers under existing legislation and, ff these prove inadequate, should ask Congress for whatever additional powers may be needed to rid the industry of the danger spots in some of the jerry-built route systems.

Rates are.too low and, under present condi- tions, they should be increased. But increases will never be a panacea for all the ills of the business. I believe that if we had the right level of competition on the trunk l ines- the level prescribed by the Federal Aviation Act - w e would need no rate increase today. In- stead, if action is taken to provide the right level of competition on the trunk-line routes, I am hopeful that in the future we can sponsor a rate reduction rather than a rate increase.

Fortunately, there are indications that both the CaB and the industry are beginning to recognize that if the airlines are not to wind up like the railroads, an intelligent realign- ment of route structure is essential.

A E R O N A U T I C A L R E S E A R C H

It is our good fortune that aviation had its beginnings in this country. We realized very early that aerodynamics was a complicated subject, and that we had much to learn about it. Our interest brought about the creation of the National Advisory Committee for Aero- nautics, an agency that assisted the United States in gaining leadership in aviation.

The NACA has been a respected name in world aviation since it was founded in 1915. Its basic mission was a simple one: to "solve the problems of flight." The great progress

toward achieving this goal has stemmed large- ly from programs undertaken by NACA, but even so, the latest of our products demon- strate that we lack the full knowledge for best design.

Aeronautical research and space technology have now been combined. The new agency, the National Aeronautics and Space Adminis- tration, has taken over the duties and respon- sibilities formerly assigned to NACA. This merger has produced some beneficial results and has also raised some questions about the best course for the future.

The emphasis in NASA is on missiles and satellites, and the role of aeronautical re- search is now a secondary concern. This rela- tive lack of attention to aeronautical research has discouraged some of our talented and de- voted aeronautical scientists. Some of them have moved over to the space department; others are leaving NASA to seek more congen- ial employment in private industry.

It is ol~vious that we must be well equipped with missiles, because we live in the kind of world that demands such equipment. It is also obvious that there are similarities between the problems of high-speed flight and of mis- siles, and that there is no reason why both problems cannot be tackled in the same shop. But ff they are to be done in the same shop, efforts must be balanced between the two projects, and each must command the human and economic resources that axe necessary to get the job done. To devote our attention ex- clusively to rockets and missiles, with relative neglect for aeronautical research, would be a policy that would produce tragic disappoint- ments.

Recommendations

We do lead the world in aviation, but, if our interest in aeronautical research continues to decline, we are certain to falter. There is nei- ther need nor excuse to do so. This country can afford the expenditures necessary to keep us out in front, but cannot afford the penalty that

WHY AmLIN~.S ABE IN Ta O tmLE 4 3

will be ours ff we rest content with the knowl- edge gained to date. Knowledge in the aero- nautical sciences represents a field in which many of the potentially profitable areas re- main unexplored. It is foolish to believe that other nations of the world will abandon their aeronautical research. If we abandon such re- search, our position of world leadership in aviation will rest on an unstable basis.

Since we are far from knowing all the an- swers about the art and science of flight, the federal government must renew its active in- terest in aeronautical research. There should be a redivision of duties and emphasis within NASa, and aeronautical research should not be neglected when this redivision is made. The more we know the more we find we need to discover. We might, for example, work on problems connected with:

Noise (causes, effects, and control) Airplane control and stability over the total

speed and operational ranges Low speed take-off and landing, including

cross-wind p~oblems Materials and structures (weight, strength,

and fatigue resistance) Meteorology, including clear air turbulence Aerodynamics, including boundary layer

control Propulsion characteristics and efllciencies Safety in all of its ramifications VTOL/STOL problems (efflciency, economy,

safety, and performance)

We are not doing well in aeronautical re- search, and the course we appear to be taking for the future is not encouraging.

T H E S U P E R S O N I C T R A N S P O R T

Pure aeronautical research is not the only area in which the federal government has a major stake. Serious consideration must be given to the challenge of supersonic trans- portation. No supersonic, passenger-carrying transport has yet been designed or built; none, to the best of our knowledge, is now under

44 BUSINESS HORIZONS

way. Newspaper stories indicate that the Brit- ish or French may be considering the author- ization of a supersonic transport program, and there are rumors that the Russians also have such a program in mind.

A project of this magnitude and complexity must, of course, be approached with suitable caution. It will be both difficult and expensive to build a transport with a speed of Mach 3 (three times the speed of sound). Conse- quently, the decision to build or not to build it is an economic decision of the highest order. We must first overcome a tendency to be satis- fied with what we have, to conclude that speeds of 600 miles an hour are sufllcient for the time being, and to postpone making the decision because the decision is difllcult.

The military implications, however, cannot be ignored. The United States is the world leader in aviation, and it is important that we maintain this position. We should make no decision until all of the pertinent facts are in hand, but we should be diligent in accumu- lating these facts and in weighing their sig- nificance. There are already too many areas for which the United States has no national policy, and this should not be another.

The specifications for the B-70 bomber are our best source of knowledge concerning the potential performance of a supersonic airliner. The B-70--the first attempt to give a large air- plane a speed potential of Mach 3- is designed to cruise at 2,000 miles per hour and to fly nonstop for 7,000 miles. It can be operated at 80,000 feet; at that altitude it should do 33 miles per minute. Using existing B-52 bases, the B-70 could reach any part of the world in six hottrs. Most of its potential targets could be reached in two and one-half hours. For a flight of that distance, the B-70 should have a pay load of 20 tons.

A supersonic airliner might be slightly slow- er because its fuselage would be larger, but the Mach 3 transport should be able to go from New York to Paris or London in about two hours. If the B-70 can carry 40,0~)0 pounds for a journey of two and one-half hours, the trans-

port would certainly do no less for a shorter journey. A 20-ton pay load should permit the transportation of two hundred passengers, or a smaller number with residual capacity for mail and cargo.

Whether or not the B-70 program will go forward will be decided by Congressional ap- propriation of funds. The position of the Air Force is, I believe, that military necessity dic- tates the completion of the program. As of now, a single prototype is authorized.

Recommendations

A Maeh 3 transport will not be built until the ability to operate at Mach 3 has been proved. That, of course, could be done by starting such a transport from scratch. The more usual way, and the better way, would be to develop a Mach 3 military machine first, and the best opportunity to do that lies in the completion of the B-70 program. Experience to date with the B-58 and the B-70 design projects demon- strates, we believe, that a supersonic transport is technically feasible.

The very high capital cost for a Mach 3 development program places that project be- yond the ability of the private airplane manu- facturer; he does not have the capital required, and he cannot afford to take so great an eco- nomic risk. If the Mach 3 airplane is to be built in the United States, then the United States must be behind the project. It will have to be justified and authorized on the basis of the national interest, and the project will have to be sponsored by the federal government. It is probable that it would cost no more to be the leader in the introduction of supersonic air transportation than to try to catch up at some later date. In fact, it probably would cost less to lead, provided the technical solutions are produced in the B-70 program.

Assuming that the operation of the super- sonic transport should prove to be economic (that is, could produce and sell air transporta- tion at a price the customer would pay), the

WHY A m L t N ~ S APE IN TROUBLE 4 5

use of a supersonic transport would revolution- ize the transportation services of the world. The nation that introduces such an airplane will dominate international flying, just as our country has dominated international routes since World War II.

In addition, the pioneering of supersonic air transportation-being the first to have the ability to go half-way around the world in six hours-will have great propaganda and prestige value. It should be remembered that the gloss has been worn off the launching of satellites. Better opportunity for propaganda may be found in other areas, and supersonic air transportation may be one of these. The implications of world leadership in aviation, with its effect on foreign relations, makes it essential that the government face this issue

and come to some decision. Nothing is to be gained by continuing to drift.

FoR Trm sake of our aviation and, indeed, for

the sake of the prestige and economy of our

nation, I hope that we will embark on a devel-

opment program for the supersonic trar~sport.

I hope, too, that steps will be taken to ensure

the economic stability of this important in-

dustry. The existence of the individual carriers in the industry and, indeed, of the industry'it- self depends on the continued sound develop- ment that Congress visualized. It would be a great disservice to the country if, at this crit- ical point, our policy were not carefully re- viewed to make certain that a sound basis is being established for future operations.

• . . ff a power to convey himself from place to place, like a bird, would have been good for [man], his Maker would have formed him with such a capacity. . . . . it is easy to prognosticate a thousand evils which the project must necessarily bring after it; amounting at last to the confusion of all order, the annihilation of all authority, with dangers both to prope.rty and person and impunity to the offenders. Were I an absolute legislater, I would therefore make it death for a man to be convicted of flying, the moment he could be caught; and to bring him down from his altitudes by a bullet sent through his head or his carriage, should be no murder.

-William Cowper LEI-I1~I~ TO THE REV. JOHN NEWTON (15 DECEMBER, 1783)