The federal government should consider forcing airlines to pay passengers compensation for cancelled or delayed flights, the consumer watchdog has said in a report criticising the industry.

In April nearly 4 per cent of domestic flights were cancelled and close to 30 per cent were late, the Australian Competition and Consumer Commission's (ACCC) latest report, released today, said.

Qantas-owned Jetstar was "notably worse" than other airlines, cancelling just over 8 per cent of its flights in April, the report said.

"After showing signs of improvements earlier in the year, the latest rates of flight cancellations and delays have gotten worse and remain poor compared to long-term industry averages," the report said.

The report also blamed a lack of competition in the domestic market for driving prices up and making services worse for consumers.

Virgin and Qantas flew more than 90 per cent of passengers over the past year, despite the growth of competitors like regional carrier Rex and budget newcomer Bonza.

The "duopoly" has made the domestic airline industry one of the most concentrated in Australia, leading to "underwhelming outcomes" for consumers, the report said.

"There is ineffective competition resulting in higher prices and less customer service than Australian passengers deserve," ACCC chair Gina Cass-Gottlieb said.

Compensation proposal has merit: ACCC

The ACCC has called for measures to improve competition over the long-term, and said the federal government had "several policy options" to improve airline services for customers in the short-term.

"Some advocates have called for the introduction of specific consumer compensation entitlements for delayed or cancelled flights," the report notes. 

"While consultation would be required to assess the impacts of such a scheme on the market and consumers, the ACCC considers there is merit in the government further considering and consulting on this."

It also said there was a "clear need" to introduce a new system for resolving disputes between airlines and customers.

The current Airline Customer Advocate was "ineffective" and should be replaced with an independent ombudsman which had the ability to make binding decisions, the report said.

Under consumer law, passengers are not entitled to any specific compensation if an airline fails to get them to their destination on time, although some companies will offer it in certain circumstances.

Industry group Airlines for Australia and New Zealand (A4ANZ) defended the airlines' performance, saying some of the factors that caused cancellations and delays were outside their control.

A4ANZ chief executive Alison Roberts warned policies to support passengers could have "unintended consequences", saying the cost of schemes overseas has pushed airfare prices higher. 

"If the government wants to look at the one single thing it could do to improve competition in the aviation market more broadly, it would do well to also look at monopoly airports and their charges that make up a big chunk of the cost," Dr Roberts said.

Report warns of big consequences if Rex and Bonza fail

The report said the best way to improve competition would be to help smaller airlines get better access to take-off and landing slots at Sydney Airport.

The slots at Australia's busiest airport are managed by federal laws which "limit the opportunities" for new and expanding airlines to "launch new services and compete".

Both Bonza and Rex have limited access to peak hour slots at major airports, which could make it difficult for them to expand and become effective competitors to Virgin and Qantas.

"Without these slot changes, there will not be any material improvement in domestic airline competition in Australia in the foreseeable future," the report said.

"Should Rex and Bonza not succeed and withdraw from the market, it will not just result in less competition in the near term, but will likely deter new airlines from attempting to enter the domestic industry for many years."

The industry is still recovering from the pandemic, the report said, with airlines operating at a lower capacity and flying fewer passengers than they were in 2019.

Domestic airfares hit historically high levels last December but have started falling in recent months, in part due to fuel costs going down and demand for travel easing.

"It appears that the pent-up demand for leisure travel that characterised much of 2022 is beginning to ease," the report said.

"Increasing cost-of-living pressures have also led to consumers becoming more price sensitive."

Even though discount airfares were getting cheaper, prices in May 2023 were still more expensive than they were in May 2019.

The consumer watchdog has been monitoring domestic airlines for three years after a directive from the federal government in June 2020.

Today's publication was its 12th and final report on the industry.

The federal government is currently working on a new Aviation White Paper which is expected to be released in 2024.