Aloha’s departure leaves interisland market muddled

Higher fares, fewer flights among the possible outcomes

By HARRY EAGAR Staff Writer
The islands continued adjusting furiously Wednesday to the failure of Aloha Airlines.

The 500 or so suddenly unemployed Aloha workers on Maui are invited to a combination job fair and unemployment seminar today at the Grand Wailea Resort Hotel & Spa, while Hawaiian Airlines on Wednesday announced immediate openings for 12 pilots, 35 flight attendants and seven mechanics as it expands to capture Aloha’s business.

For the longer term, Bank of Hawaii Chief Economist Paul Brewbaker said the new interisland air traffic regime could come to a new equilibrium at any one of several levels, including one that provides less service and higher prices than before go! airlines entered the field in mid-2006.

Brewbaker said that outcome is not inevitable.

Another possibility is that a major Mainland airline might enter the interisland market, where it could have a cost advantage over Hawaiian Airlines and its smaller local competitors, such as Island Air.

In comments Brewbaker sent to The Maui News, he said the departure of Aloha presents a different set of alternatives for economists to analyze than in earlier events when Mahalo or Discovery airlines failed. It is not only because Aloha is a much bigger airline, accounting for about 40 percent of the market before Tuesday.

Aloha and Hawaiian were “near perfect substitutes” for each other, Brewbaker said.

They flew similar planes, on similar routes from similar terminals.

State decisions reinforced their special status. The Department of Transportation, which owns the airports, provided them with adjacent terminals with (in Honolulu) parking nearby and elevators providing direct access to the ticket counters and baggage claim areas. Competitors got less attractive digs.

They were such twins that, back in the days when interisland customers could buy coupons, the two would sometimes accept each other’s coupons and settle the accounts in the back office later.

In that environment, which Brewbaker calls a “noncollusive duopoly,” they reached a pricing “kernel” at $60 as an average price for a passenger’s flight segment.

Because they were not collusive, they cooperated not by fixing prices but by arranging schedules that did not unduly aggravate each other.

But after Sept. 11, 2001, Sen. Dan Inouye arranged an antitrust exemption for Aloha and Hawaiian, and that allowed them to reach a new equilibrium, because it made it less likely that a new third, outside threat would arise.

The new equilibrium settled at $90 a trip.

Mesa Air Group’s Chairman Jonathan Ornstein decided he saw an opportunity, and he said his cash-rich airline had $500 million on hand and he was ready to spend all of it to establish a low-fare interisland airline.

Ornstein also said it was not his intention to drive anybody else out of business, although it seemed unlikely he could succeed without doing so.

Leroy Laney, professor of business and finance at Hawaii Pacific University, said Tuesday that it was obvious that Hawaii could not support three interisland airlines and that it might not even support two. The market is so small (and has been shrinking) that fixed overhead costs made it difficult for either of two airlines to get enough business to get into profitable territory.

Both Hawaiian and Aloha had been in bankruptcy before go! arrived, and they claim that Mesa used information disclosed in the prior bankruptcy filings to plan its entry.

Confronted with what looked like a long-term decline in overall interisland business with an increase in direct flights to each of the islands — and particularly to Maui — both Hawaiian and Aloha developed long-haul business to the West Coast and to Pacific regional markets.

Hawaiian already had been doing business outside the state, but Aloha had not. Hawaiian chose to expand into bigger West Coast airports, Aloha into smaller ones.

Before it closed up, Aloha had earned about 5 percent of the business between Hawaii and the western states.

Ornstein upset the apple cart, or what Brewbaker calls the Cournot-Nash equilibrium.

The Cournot-Nash equilibrium is now dead, and the interisland airline business has become what economists call a Stackelberg game. Instead of two equally matched contenders warily circling each other, the remaining unevenly matched contenders will try to exploit their differences.

In this Stackelberg game, Hawaiian enjoys some market power — it’s bigger and neither go! nor Island Air can exactly duplicate the vanished service — either in quantity or quality — with which Aloha always threatened Hawaiian.

Island Air and go! fly much smaller planes, for example, and Mesa took a hit Wednesday when Delta Air Lines canceled a Mainland connection contract with Mesa’s Freedom Airlines. Mesa stock dropped 6.3 percent in trading Wednesday.

The exit of Aloha “removes the principal source of rivalry that disciplined Hawaiian by undermining the market power it otherwise has from product differentiation,” said Brewbaker. “The game is afoot, literally, and we should not be surprised by outcomes perverse and otherwise.”

Economic theory allows for a number of balancing points, which include:

• Higher fares and fewer seats.

• Similar or somewhat higher fares, with the entry of a major carrier in the Hawaii interisland market. The majors could enjoy a slightly lower cost structure, because they already have a lot of support services that would not have to be duplicated.

The only way this temporarily unstable condition could have been avoided would have been to merge Hawaiian and Aloha, likely freezing out go!

The two had tried to merge and failed at least three times in the past. Brewbaker said that “a more creative leadership environment” might have managed it for them, as the Federal Reserve did recently by sponsoring the shotgun marriage of Bear Stearns with J.P. Morgan.

Guarantees (loan or debt) might have been required, but the state Legislature finally accepted the idea of loan guarantees, although a day late and about $120 million short.

Meanwhile, Hawaiian pulled a backup Boeing 767 into line to provide hundreds of seats on six daily Oahu-Maui trips, Island Air added flights between Maui and Hilo and go! nearly doubled its daily legs.

The state Department of Labor and Industrial Relations revved up its Rapid Response Team for sessions for displaced workers.

JoAnn Inamasu of the county Office of Economic Development said she was searching for businesses that wanted workers. They were not too hard to find, since Maui has long been short of labor, especially skilled and experienced labor.

Employers, big and small, such as First Hawaiian Bank, also were contacting Inamasu for help in setting up recruiting tables. The Maui Chamber of Commerce will lend a hand.

Inamasu said it is important for the suddenly jobless employees to get a clear idea of the steps they can take to get unemployment benefits, preserve insurance coverage and to take other steps to ease the landing.

• Harry Eagar can be reached at heagar@mauinews.com.