[Senate Hearing 105-936]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 105-936


 
                          AIRLINE COMPETITION

=======================================================================

                                HEARINGS

                                before a

                          SUBCOMMITTEE OF THE

            COMMITTEE ON APPROPRIATIONS UNITED STATES SENATE

                       ONE HUNDRED FIFTH CONGRESS

                       FIRST AND SECOND SESSIONS

                               __________

                            SPECIAL HEARINGS

                               __________

         Printed for the use of the Committee on Appropriations


                               



 Available via the World Wide Web: http://www.access.gpo.gov/congress/senate

                                 ______

                       U.S. GOVERNMENT PRINTING OFFICE
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_______________________________________________________________________
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                           ISBN 0-16-058362-4



                      COMMITTEE ON APPROPRIATIONS

                     TED STEVENS, Alaska, Chairman
THAD COCHRAN, Mississippi            ROBERT C. BYRD, West Virginia
ARLEN SPECTER, Pennsylvania          DANIEL K. INOUYE, Hawaii
PETE V. DOMENICI, New Mexico         ERNEST F. HOLLINGS, South Carolina
CHRISTOPHER S. BOND, Missouri        PATRICK J. LEAHY, Vermont
SLADE GORTON, Washington             DALE BUMPERS, Arkansas
MITCH McCONNELL, Kentucky            FRANK R. LAUTENBERG, New Jersey
CONRAD BURNS, Montana                TOM HARKIN, Iowa
RICHARD C. SHELBY, Alabama           BARBARA A. MIKULSKI, Maryland
JUDD GREGG, New Hampshire            HARRY REID, Nevada
ROBERT F. BENNETT, Utah              HERB KOHL, Wisconsin
BEN NIGHTHORSE CAMPBELL, Colorado    PATTY MURRAY, Washington
LARRY CRAIG, Idaho                   BYRON DORGAN, North Dakota
LAUCH FAIRCLOTH, North Carolina      BARBARA BOXER, California
KAY BAILEY HUTCHISON, Texas
                   Steven J. Cortese, Staff Director
                 Lisa Sutherland, Deputy Staff Director
               James H. English, Minority Staff Director
                                 ------                                

          Subcommittee on Transportation and Related Agencies

                  RICHARD C. SHELBY, Alabama, Chairman
PETE V. DOMENICI, New Mexico         FRANK R. LAUTENBERG, New Jersey
ARLEN SPECTER, Pennsylvania          ROBERT C. BYRD, West Virginia
CHRISTOPHER S. BOND, Missouri        BARBARA A. MIKULSKI, Maryland
SLADE GORTON, Washington             HARRY REID, Nevada
ROBERT F. BENNETT, Utah              HERB KOHL, Wisconsin
LAUCH FAIRCLOTH, North Carolina      PATTY MURRAY, Washington
TED STEVENS, Alaska
  ex officio
                           Professional Staff
                             Wally Burnett
                             Anne M. Miano
                             Joyce C. Rose
                        Peter Rogoff (Minority)



                            C O N T E N T S

                              ----------                              

                       Tuesday, October 21, 1997
                the implications of airport deregulation

                                                                   Page
Statement of Dr. Steven A. Morrison, Department of Economics, 
  Northwestern University........................................     1
    Prepared statement...........................................     6
Statement of Jay U. Sterling, Ph.D., C.P.A., associate professor 
  of marketing and logistics, University of Alabama..............    14
    Prepared statement...........................................    17
Statement of Dr. Fred C. Allvine, professor of marketing, Georgia 
  Institute of Technology........................................    23
    Prepared statement...........................................    26
Statement of Patrick V. Murphy, Deputy Assistant Secretary, 
  Aviation and International Affairs, Department of 
  Transportation.................................................    35
Restricted airports..............................................    35
Wright amendment.................................................    36
DOT position on airport restrictions.............................    36
Prepared statement of Patrick V. Murphy..........................    37
Statement of Jeff Griffith, Planning Director, Air Traffic 
  Operations, Federal Aviation Administration....................    39
Airspace management..............................................    39
Economic impact of airport restrictions..........................    40
Fares at airports with capacity or operating restrictions........    41
Safety in the DFW airport metroplex..............................    41
DOT study of slot-controlled airports............................    42
DOT's efforts to enhance competition.............................    42
Questions submitted by Senator Shelby............................    43

                        Thursday, March 5, 1998
                    barriers to airline competition

Statement of Paul Dempsey, vice chairman, Board of Directors, 
  University of Denver/College of Law............................    49
Prepared statement of Senator Shelby.............................    50
Statement of Senator Lautenberg..................................    51
Statement of Senator Gorton......................................    53
Statement of Senator Faircloth...................................    54
Prepared statement of Paul Dempsey...............................    57
Statement of Mark Kahan, executive vice president and general 
  counsel, Spirit Airlines.......................................   111
    Prepared statement...........................................   113
Statement of Michael J. Boyd, the Boyd Group.....................   124
    Prepared statement...........................................   126
Statement of Senator Reid........................................   139
Statement of John Anderson, Director, Transportation Issues, 
  Resources, Community and Economic Development Division, General 
  Accounting Office..............................................   153
    Prepared statement...........................................   155
Statement of Patrick V. Murphy, Deputy Assistant Secretary, 
  Aviation and International Affairs, Department of 
  Transportation.................................................   162
    Prepared statement...........................................   164
Gate constraints and fares.......................................   166
Airline competition..............................................   167
Improving aviation competition and service.......................   167
Unfair competitive practices.....................................   168
Enforcement actions..............................................   169
Airline laws and rules...........................................   170
Routine studies of fares.........................................   171

                          Tuesday, May 5, 1998
         airline ticketing practices and antitrust enforcement

Statement of Alfred Kahn, professor emeritus, Cornell University.   173
Reasons for concern..............................................   175
Problems with reregulation.......................................   176
Signs of predation...............................................   178
Dangers of airline alliances.....................................   179
Deregulation versus antitrust law................................   180
Closer scrutiny for predation....................................   181
Preserving competition...........................................   184
Profit margins and competition...................................   186
Prepared statement of Alfred E. Kahn.............................   188
Statement of Professor Jenkins, director of the Aviation 
  Institute, George Washington University........................   191
Pricing and yield revenue management.............................   191
Reasons for new entrant failure..................................   192
Statement of Borden Burr, president, All Seasons Travel Agency...   193
    Prepared statement...........................................   196
Letter from Ivan Michael Schaeffer, president and CEO, Woodside 
  Travel Trust...................................................   198
Statement of Lauraday Kelley, vice president, CruiseLink.........   200
    Prepared statement...........................................   202
Statement of Larry Darby, president, Darby Associates............   204
Analysis of AT&T market power in the resale marketplace..........   205
Deregulation and telecommunications..............................   219
Prepared statement of Larry F. Darby.............................   221
Yield management benefit.........................................   224
Business travel pricing practices................................   224
Airline competition versus Telecom competition...................   226
Large volume discounts...........................................   227
Yield revenue management.........................................   228
The stock market versus the airline industry.....................   229
Statement of Patrick V. Murphy, Deputy Assistant Secretary, 
  Aviation and International Affairs, Department of 
  Transportation.................................................   231
A competition problem............................................   231
Proposed enforcement policy......................................   232
Statutory authority..............................................   232
Alliances........................................................   233
Prepared statement of Patrick V. Murphy..........................   234
Enforcement policy...............................................   238
Determining predatory activity...................................   239
Level of competition.............................................   239
Midwest Express Airlines.........................................   240



                THE IMPLICATIONS OF AIRPORT DEREGULATION

                              ----------                              


                       TUESDAY, OCTOBER 21, 1997

                           U.S. Senate,    
             Subcommittee on Transportation
                              and Related Agencies,
                               Committee on Appropriations,
                                                    Washington, DC.
    The subcommittee met at 1:44 p.m., in room SD-124, Dirksen 
Senate Office Building, Hon. Richard C. Shelby (chairman) 
presiding.
    Present: Senators Shelby, Gorton, Bennett, and Byrd.

                       NONDEPARTMENTAL WITNESSES

STATEMENT OF DR. STEVEN A. MORRISON, DEPARTMENT OF 
            ECONOMICS, NORTHEASTERN UNIVERSITY, BOSTON, 
            MA

                   Opening Remarks of Senator Shelby

    Senator Shelby. The committee will come to order. We will 
go ahead and start. My colleagues are still in a caucus, but we 
do this every Tuesday.
    I want to thank each of our witnesses for coming here today 
to share their expertise on an issue which affects thousands of 
Americans every day, that is, competition in the aviation 
industry.
    The purpose of our hearing today is to examine a number of 
obstacles to free market competition among airlines in America 
and to determine what additional tools, if any, would be 
necessary for the Federal Aviation Administration to carry out 
its job in an environment in America of increased airline 
competition which all Americans I believe profit from.
    The Fiscal Year 1998 Transportation Appropriations 
Conference Report provided a first step I believe in increasing 
competition at one airport in America by strengthening the 
competition allowed under the Wright Amendment at Love Field in 
Dallas, TX. The Wright Amendment inhibited competition in the 
Dallas-Fort Worth Metroplex by prohibiting direct service out 
of Love Field to any State which did not border Texas. Our bill 
changed the Wright Amendment to expand the number of States to 
which commercial jets may fly out of Love Field.
    My preference would have been to repeal the Wright 
Amendment in its entirety so that all States could have greater 
competitive access to Dallas, TX, and final destination points 
served from there. But in order to get the bill passed, I 
agreed to accept this first step--and it is a first step, but a 
big one--for the time being.
    The purpose of this hearing today is to look beyond the 
initial step Congress made on access to Love Field and to look 
more broadly at barriers to competition across the entire 
national airport system. We want to explore and we want to 
consider what steps could and should be taken to inject greater 
competition into the Nation's system of air transportation.
    We want to discuss other anticompetitive restrictions in 
place at other airports across the country. For example, four 
airports, Chicago's O'Hare, New York's LaGuardia and Kennedy, 
and Washington National, are governed by what we call the high 
density rule, and Washington National is also subject to a 
perimeter rule.
    We hope to gain a better understanding today of how these 
restrictions affect competition, ticket prices for consumers, 
and the safety of our Nation's airspace. We also want to have a 
better understanding of how increased competition will have an 
impact on resource requirements for the FAA and the complexity 
of FAA's air traffic management mission.
    The hearing will consist of two panels. The first panel 
will be composed of experts in the field of aviation economics 
and aviation marketing. Dr. Steven Morrison--Dr. Morrison, 
thank you for coming--professor of economics at Northeastern 
University is our first witness. And he has authored numerous 
articles and books on the airline industry and airline 
deregulation.
    Our next witness is Dr. Fred Allvine. Is that correct?
    Dr. Allvine. Yes.
    Senator Shelby. From Georgia Institute of Technology. Dr. 
Allvine is professor of marketing at Georgia Tech and has 
testified before the Congress on a broad range of issues, 
including competition in the industry.
    Our last guest on the first panel is Dr. Jay Sterling, 
professor of marketing and logistics at the University of 
Alabama in my hometown of Tuscaloosa. Dr. Sterling has a 25-
year career in the field of logistics and transportation and 
has written numerous articles on the subject during that time.
    For the second panel, we have two representatives from the 
Department of Transportation. We have Mr. Jeff Griffith, 
Planning Director for the Air Traffic Operations at the Federal 
Aviation Administration. Mr. Griffith has extensive personal 
experience with airspace management and can speak definitively 
on the safety aspects of increased airport deregulation.
    Finally, we have Mr. Pat Murphy, Deputy Assistant Secretary 
of Transportation for Aviation and International Affairs. Mr. 
Murphy has more years of experience at the FAA than his 
youthful appearance would indicate and is one of the most 
knowledgeable and thoughtful individuals in Washington on these 
matters.
    I want to thank all of you for being here today. I think it 
is very important that we build the record, and this will be 
the first of some of the hearings we will address this issue 
before our Subcommittee on Transportation Appropriations, as 
well as the authorizing committee will do the same thing.
    Your written testimony will be made part of the record in 
its entirety and, Dr. Morrison, we will start with you, if we 
can, anything you want to say.
    Dr. Morrison. Thank you, Mr. Chairman.
    If I may give a brief summary of the effects of airline 
deregulation to provide a context for what we are going to be 
talking about in this panel and the next panel.
    Senator Shelby. You proceed. Yes, sir.

                       statement of dr. morrison

    Dr. Morrison. From 1977, a year before deregulation, to 
1996, we have seen about 31 percent more carriers per route. 
Long-haul routes have seen more entrants however. But as 
important or perhaps more important of how many carriers are 
entering, the question and the issue of who is entering. 
Deregulation has spawned the growth of the former intrastate 
carriers, particularly Southwest Airlines and new entrant 
carriers that typically have low cost and charge low fares.
    In 1996, low-cost, or that is new entrant, carriers 
provided 18 percent of domestic passenger miles up from zero 
before deregulation, but that 18-percent number minimizes or 
understates the true effect of low-cost carriers because their 
presence in a market spreads beyond the number of miles that 
they provide. Low-cost carriers now are influencing fares in 
about 40 percent of U.S. city-pair markets.
    The costs of providing service, costs per available ton-
mile, are down 28 percent. The percentage of seats filled are 
up 25 percent.
    The reason we care about these things is their impact on 
consumers and particularly their impact on fares.
    Senator Shelby. Dr. Morrison, would you repeat what you 
just said for the record about the cost?
    Dr. Morrison. Costs per available ton-mile are down 28 
percent since 1977.
    Senator Shelby. OK.
    Dr. Morrison. This, of course, has implications for fares. 
If we compare yield, average fare per passenger mile in 1977 
with 1996, down 40 percent. Now, anyone who looks at yield 
statistics will observe that there has been a downward trend in 
those figures since 1926 when the first data was gathered. So, 
the question of how much can we contribute to deregulation 
comes up.
    Work I have done with Cliff Winston of the Brookings 
Institution suggests that about 60 percent of the decline in 
fares is due to deregulation. The other 40 percent would have 
happened anyway. So, fares are about, we think, 25 percent 
lower today than they would have been had regulation continued.
    If we look at the effect in a more disaggregate level to 
see the role of new entrants, if you look at routes that have 
no new entrants or not serve any entrant carriers, fares are 
just 15 percent lower at those airports.
    If we look at the other end of the spectrum at routes that 
have Southwest Airlines and other new entrants serving them, 
fares are 54 percent lower in 1996 than they were in 1978.
    Fares are down on average, but not everyone has gained. Our 
work indicates that routes carrying about 80 percent of 
passengers to have lower average fares and that accounts for 90 
percent of the passenger miles since these tend to be longer 
routes.
    Overall, about $20 billion in savings attributed to 
deregulation fare savings, time savings, convenience, when we 
take all of the factors into account.
    But as this hearing indicates, there are some trouble spots 
remaining and I want to spend the remainder of my time, such as 
it is, talking about some work I recently did on the effect of 
the Wright Amendment, perimeter rules, and slots on airfares.
    The Wright Amendment creates an artificial scarcity at Love 
Field by limiting service to the four contiguous States. I took 
a look at the effect that that regulation and the relaxation 
that was recently passed that the three new States would have 
and found that fares to those three States are 44 percent 
higher than they would be once your amendment to the Wright 
Amendment takes place. So, 44 percent higher, about $72 a round 
trip, conservatively about $11 million a year.
    If we considered the Wright Amendment being eliminated 
entirely and thus Love Field could provide competitive pressure 
in principle for all flights from Dallas-Fort Worth, the figure 
that I came up with was 76 percent. Fares are 76 percent higher 
to the noncontiguous States than they would be were there not a 
Wright Amendment. That's $133 a round trip or a whopping $800 
million a year in higher fares.
    Senator Shelby. Explain that again, if you would. Seventy-
six percent higher?
    Dr. Morrison. Yes.
    Senator Shelby. And that is because of the impediment 
there?
    Dr. Morrison. Yes; Love Field provides competitive pressure 
now against Dallas-Fort Worth for those four States that 
Southwest can fly to. Were that eliminated, my research 
indicates that the competitive pressure that Love Field would 
permit would--it currently causes fares to be 76 percent 
higher.
    I have to caution, though, that although that's a big 
number, that that assumes that Dallas-Fort Worth could, in 
fact, be competitive for all flights to all destinations with 
Dallas-Fort Worth and it's not big enough to do that, but it 
does give an order of magnitude of how much these restrictions 
are influential, and on a route-to-route basis, I think the 
number is probably in the ball park. It is when one multiplies 
it by all routes that you get a number that may be a little too 
big to be fully believed.
    So, the Wright Amendment by my reckoning creates 
multimillion, $800 million if you like, higher fares than would 
occur without it.
    The perimeter rules that you mentioned at LaGuardia, a 
1,500 mile perimeter, and Washington National a 1,250 
perimeter, like the Wright Amendment these are restrictions 
that create an artificial scarcity designed to promote Kennedy 
Airport and Dulles Airport.
    A similar analysis that I did of those airports finds that 
long-haul fares at Dulles are 25 percent higher than they would 
be without the perimeter rule, and long-haul fares at Kennedy 
are 14 percent higher than without the perimeter rule, 
amounting to about $100 million at each airport annually in 
excess fares.
    Bottom line, if you add up the perimeter rules and the 
Wright Amendment, you get something on the order of $1 billion 
which is certainly significant----
    Senator Shelby. Dr. Morrison, would you explain just for 
the hearing here and the audience the origin of the perimeter 
rule and what it does?
    Dr. Morrison. Well, I do not know its origin, but what it 
does in order to protect the two airports, Kennedy and Dulles, 
it limits flights from LaGuardia to airports within a 1,500-
mile radius and it limits flights to and from National to 
airports within a 1,250-mile radius. Its origins I do not know, 
but designed to protect Kennedy and Dulles and push long-haul 
traffic to those airports in a similar vein to what the Wright 
Amendment does for Dallas-Fort Worth.
    Senator Shelby. And how much is the estimated cost to the 
consumer on that?
    Dr. Morrison. About $100 million each for the perimeter 
rules for each of the two airports.
    Senator Shelby. $100 million each.
    Dr. Morrison. Yes.
    Senator Shelby. OK.
    Dr. Morrison. Now, I treat slots separately because slots 
are a somewhat different issue because the Wright Amendment and 
the perimeter rules create artificial scarcities. That was 
their intention.
    The high density rule which implemented slots was designed 
in 1969 to combat congestion, and so it does not create an 
artificial scarcity but was an attempt to deal with the real 
scarcity of landing and takeoff opportunities at those 
airports, airports of National, LaGuardia, and O'Hare and 
Kennedy, although my work shows that fares at Kennedy are not 
any higher than they would be elsewhere. But fares at National, 
LaGuardia, and O'Hare are some 11 to 15 percent higher than 
flights by the same carriers for comparable distances. That 
amounts to about $33 to $44 a round trip.
    It is not clear, though, that eliminating slots would make 
people better off. The fact that slots have value--and one 
reads about values in the low millions of dollars for the right 
to take off and land at one of these airports in a peak 
period--indicates that if the slots were removed, the number of 
carriers using the airport would increase and presumably 
congestion would increase. So, it is not clear that passengers 
would, in fact, be better off with slots removed and nothing 
put in their place.
    I have written in the past about the benefits of congestion 
pricing. I mention it in passing here, that whatever problems 
there are with slots, they may well be better than no slots at 
all, but there are other policies that could help like 
congestion pricing.

                           prepared statement

    The restrictions of perimeter rules and the Wright 
Amendment date from either literally the regulated era or 
shortly thereafter, and removing them would yield significant 
benefits perhaps in the hundreds of millions or even a billion 
dollars.
    Thank you.
    [The statement follows:]

                Prepared Statement of Steven A. Morrison

                              introduction
    Domestic aviation was deregulated in 1978 with the passage of the 
Airline Deregulation Act, ending 40 years of tight regulation by the 
federal government. Although airlines may now serve the routes they 
choose and charge the fares that the market will bear, some regulations 
remain regarding use of airports. Following a brief history of airline 
regulation and an assessment of airline deregulation, this testimony 
analyzes the effect of the Wright Amendment, airport perimeter rules, 
and slots on air fares.
  a brief history of airline regulation and an assessment of airline 
                              deregulation
    The aviation age began in 1903 at Kitty Hawk, North Carolina, when 
Wilbur and Orville Wright performed the first power-driven, heavier-
than-air, controlled flight. It was just 11 years later, in 1914, that 
scheduled commercial passenger service began. For $5.00 the St. 
Petersburg-Tampa Airboat Line carried passengers 18 miles between Tampa 
and St. Petersburg, Florida. Significant growth in the industry would 
wait until after World War I, and then it was mail rather than 
passenger transportation that developed.
    The first regular airmail service began in 1918, operated by the 
Post Office. By 1927, the Post Office had contracted out all airmail 
service to private carriers. Private carriage was feasible because the 
federal government undertook the expense of constructing the air 
infrastructure (e.g., lighted civil airways and beacons for 
navigation).
    Aviation continued to develop during the early 1930's, despite the 
Depression, because of significant technical advances in aircraft 
design and manufacturing. Reacting to new problems, in 1934 Congress 
passed an act that divided control of air transportation among three 
agencies. This also proved unworkable because carriers submitted 
ridiculously low bids to one agency (zero in at least one case) to win 
a mail contract, knowing that another agency had the power to raise 
rates that were too low. Finally, in 1938 Congress passed the Civil 
Aeronautics Act, which remained basically unchanged until deregulation 
in 1978. To implement the regulations, the Act created what was to 
become the Civil Aeronautics Board (CAB). This legislation, enacted 
during the Great Depression, reflected the widespread distrust of 
market forces that prevailed then and the belief that government 
regulation could improve the market outcome.
    The Civil Aeronautics Act required carriers to have a certificate 
of public convenience and necessity issued by the Board. The 16 
carriers operating when the Act was passed received ``grandfather'' 
rights and were granted certificates for the routes they served. Other 
applicants had to show that they were ``fit, willing, and able'' to 
perform the proposed service and that the service was ``required by the 
public convenience and necessity.''
    Economists began criticizing CAB regulation as early as the 1950's. 
Gradually, more and more analysts accepted the position that the 
airline industry did not have characteristics that made economic 
regulation necessary. The critics argued that airline regulation had 
led to higher fares than would prevail in an unregulated market, yet 
the industry was not earning excess profits.
    Since the Civil Aeronautics Act regulated ``interstate air 
transportation,'' airlines operating only within one state were not 
subject to federal regulation. This aspect of the law set up an 
interesting ``controlled'' experiment of sorts: by comparing 
unregulated intrastate fares with fares on similar interstate routes, a 
measure of the effects of regulation could be obtained. One 
particularly influential study pointed out that in 1965 the fare 
charged by the intrastate carrier Pacific Southwest Airlines (PSA) 
between San Francisco and Los Angeles (338 miles) was $11.43, while the 
fare charged by CAB certificated carriers between Boston and 
Washington, D.C. (400 miles) was $24.65.\1\
---------------------------------------------------------------------------
    \1\ Michael E. Levine, ``Is Regulation Necessary? California Air 
Transportation and National Regulatory Policy,'' Yale Law Journal, 74 
(July 1965), pp. 1416-47.
---------------------------------------------------------------------------
    In 1978, Congress passed and President Carter signed the Airline 
Deregulation Act. The overriding objective of the Act was reliance on 
competition. Entry regulations were phased out; since 1982 carriers 
have been free to enter any route they desire, as long as they are fit, 
willing, and able. Exit regulations were eliminated; carriers can now 
exit at will. Fare regulation was also phased out. In 1983, the CAB's 
authority over fares was eliminated. Carriers can charge whatever fares 
they desire. Finally, in 1985 the CAB ceased to exist; its remaining 
functions (e.g., review of mergers, international aviation, consumer 
protection) were transferred to the Department of Transportation.
    Without government restriction on route entry, airlines were free 
to enter (or exit) at will. Figure 1 shows the trend in the number of 
``effective competitor'' \2\ at the route level from 1977, the year 
before formal deregulation, through 1996. The number of carriers per 
route averaged about 1.7 in 1977 and rose to about 2.5 by 1986. 
Following the merger wave of the mid-1980's and bankruptcies in the 
early 1990's, there have been about 2.2 carriers per route since 1993, 
an increase of more than 30 percent since 1977.
---------------------------------------------------------------------------
    \2\ Because a simple count of carriers on a route would treat a 
carrier with a large market share as of equal importance as one with a 
small market share, a measure of competition that takes market share 
into account is appropriate. In particular, we use the inverse of the 
widely used Herfindahl index, which equals the sum of the square of 
each firm's market share. Thus, if two carriers each had a 50 percent 
market share, the Herfindahl index would be 0.50 \2\ + .0502 \2\ = 
0.50. Inverting gives two equal-sized competitors. The same result 
would occur with three carriers with market shares of two-thirds, one-
sixth, and one-sixth.
---------------------------------------------------------------------------
    In addition to the number of competitors on a route, the identity 
of those competitors is also important. Deregulation allowed entry by 
existing airlines into new routes but it also allowed the entry of new, 
usually low-cost, low-fare airlines into the industry. The extent of 
competition provided by these new entrants is shown in Figure 2, which 
distinguishes between Southwest Airlines and other new entrants. 
Competition by new entrants began rising immediately after deregulation 
until it reached a peak in 1985 at about 17 percent of domestic 
passenger miles. The importance of new entrants declined from 1985 
until 1988 due to the acquisition of People Express by Texas Air 
Corporation in 1986 and the significant expansion of the 
prederegulation airlines. However, since 1989, the share of domestic 
passenger miles flown by new entrants has continued to increase and in 
1996 reached nearly 18 percent, its all time high.
    The extent of airline competition is of interest because of its 
effects on air fares. A simple way to look at the effect of 
deregulation on air fares is to see how air fares have changed relative 
to the overall price level. In particular, we can calculate real air 
fares by adjusting actual air fares by the changes in the Consumer 
Price Index (CPI). This is shown in Figure 3, which plots real airline 
yield from 1970 through 1996. (Yield is revenue per revenue passenger 
mile.) Real air fares have fallen under deregulation, regardless of 
when you consider deregulation to have started. As of 1996, air fares 
were 40 percent lower than their level in 1977. But can this decrease 
be attributed to deregulation? As the figure shows, yields had a 
downward trend even before the beginning of the deregulation movement. 
Here a counterfactual comparison is appropriate, in which actual 
deregulated fares are compared with what fares would have been if 
regulation had continued. Results of such a counterfactual for 1993 
show that fares were 22 percent lower than they would have been had 
regulation continued.\3\ From 1978 through 1993, the fare savings to 
travelers attributed to deregulation amount to $12.4 billion annually 
(1993 dollars).\4\
---------------------------------------------------------------------------
    \3\ Of course, one has no way of knowing for sure what regulated 
fares would be. However a good guess can be made with an updated 
version of the fare formula that the CAB used during the last few years 
of regulation. See Steven A. Morrison and Clifford Winston, ``The 
Evolution of the Airline Industry'' (Washington, DC: The Brookings 
Institution, 1995).
    \4\ It should be noted that this figure does not take into account 
that the lower fares that most travelers enjoy today come at the 
expense of restrictions (e.g., minimum stay of a Saturday night) that 
are much more prevalent than during regulation.
---------------------------------------------------------------------------
    Table 1 takes a closer look and shows the average fare change on 
routes based on what types of carriers served them in 1996:4. Real 
fares on the average route declined by 32.2 percent between 1978:4 and 
1996:4. However, the decline ranged from 14.7 percent on routes that 
were not served by new entrants in 1996:4 to 54.3 percent on routes 
that were served by both Southwest Airlines and other new entrants in 
1996:4.\5\
---------------------------------------------------------------------------
    \5\ These figures suggest the importance of Southwest Airlines and 
other new entrants in generating fare savings under deregulation. 
However, these figures likely overstate this importance because, for 
example, Southwest and other new carriers may simply have entered those 
routes where fares were most out of line with costs. Had they not 
entered, other carriers may have.
---------------------------------------------------------------------------
                          airport restrictions
    Even though airlines have been ``deregulated'' as outlined above, 
legacies of regulation remain in the form of restriction on airport 
use.
The Wright Amendment
    The Wright Amendment, enacted in 1979, placed restrictions on the 
use of Love Field in Dallas in order to protect Dallas-Fort Worth 
Airport (DFW). In particular, airlines using Love Field may only offer 
flights to other cities in Texas or to the four contiguous states 
(Arkansas, Louisiana, New Mexico, and Oklahoma). A recent change to the 
Wright Amendment enlarges the list of approved states by three to 
include Alabama, Kansas and Mississippi. Love Field is the home base of 
Southwest Airlines, a low-cost, former Texas intrastate carrier. By 
prohibiting Southwest (or other carriers) from flying to non-contiguous 
states, airlines offering flights to non-contiguous states from DFW are 
subject to less competition than they would be in the absence of the 
Wright Amendment. Figure 4 shows, for 1978 through 1996, the extent by 
which fares from (or to) DFW to (or from) the three states covered by 
the recent change (before it took effect) exceed fares to the four 
contiguous states.\6\ In 1996, the last full year of data available, 
fares to the three new states were about 44 percent higher than fares 
to the four contiguous states to which Southwest Airlines provides 
competitive pressure. This amounts to about $72 per round trip. A 
conservative estimate of its overall impact is $11 million annually.\7\
---------------------------------------------------------------------------
    \6\ The results in the figure were obtained by first comparing 
average fares (including frequent flier tickets) that carriers charged 
to/from DFW to the four contiguous states with fares that the same 
carriers charged for flights of the same distance (using 100 mile 
bands) on routes not involving DFW. Next, the same procedure was used 
to compare fares from DFW to/from the three additional states. The 
results in the figure combine the two results in the following way. For 
example, in 1996 fares from DFW to/from the three new states were 8.9 
percent higher than comparable flights elsewhere. Fares to/from DFW to 
the four contiguous states were 24.3 percent lower than comparable 
routes. Thus, fares from DFW to/from the three new states were (1 + 
0.089)/(1 - 0.243)-1 = 43.9 percent higher than flights to/from the 
four contiguous states.
    \7\ The estimate is conservative in that the per-passenger figure 
is (only) multiplied by the number of passengers who took one-way or 
single-destination round-trip flights (that returned to the initial 
point of origin). Thus, the number of passengers affected is 
understated.
---------------------------------------------------------------------------
    Figure 5 reports results of a similar analysis that compares fares 
to/from DFW to/from (all) non-contiguous states with fares involving 
the four contiguous states. Results for 1996 indicate that fares to 
non-contiguous states were about 76 percent higher than fares to the 
contiguous states, amounting to about $133 per round trip. However, 
this figure likely overstates the impact of removing the Wright 
Amendment completely because it assumes that ``Southwest-style'' 
competition could be offered to all domestic destinations that are 
served from DFW, which seems unlikely, given the market niches that 
Southwest and other low-cost carriers have chosen and the limited 
capacity of Love Field. However, if this limitation is not considered, 
the aggregate fare savings from eliminating the Wright Amendment exceed 
$800 million annually.
    Finally, notwithstanding Southwest Airlines' significant 
contributions to the fare savings from deregulation outlined above, 
nonetheless, due to their dominant position at Love Field, they do 
charge higher fares there than they do on routes involving other 
airports they serve. Figure 6 shows that in 1996 Southwest charged 15 
percent higher fares (about $18 per round trip) from Love than from 
other airports.
Perimeter Rules
    Perimeter rules exist at New York's LaGuardia Airport and at 
Washington's National Airport. In particular, flights to or from 
LaGuardia that exceed 1,500 miles are prohibited as are flights to or 
from National that exceed 1,250 miles. Like the Wright Amendment, these 
rules are designed to limit competition among airports and promote 
Dulles Airport in Washington and Kennedy Airport in New York as long 
haul airports.
    Figures 7 and 8 show results of analyses similar to that done for 
the Wright Amendment. In the Washington case, for example, average 
fares by carrier for flights to/from Dulles longer than 1,250 miles 
were compared with comparable flights (100 mile bands) by the same 
carrier that did not involve Dulles. The same procedure was used for 
flights longer than 1,250 miles. As shown in the figures, in 1996, 
long-haul fares at Dulles were nearly 25 percent higher ($83 per round 
trip) and at Kennedy they were nearly 14 percent higher ($48 per round 
trip). However, these figures likely overstate the impact of removing 
the perimeter rules because (see below) the ability of airlines at 
LaGuardia and National to exert competitive pressure on airlines at 
Kennedy and Dulles is limited because operations at the former two 
airports are constrained by ``slots.'' Notwithstanding this 
qualification, removing the perimeter rules could save passengers in 
New York $100 million per year and save passengers in Washington $90 
million per year.
Slots
    Since 1969 there have been regulatory limits (``slots'') on the 
number of takeoffs and landings that air carriers (and others) may 
conduct each hour at four major airports, Chicago O'Hare, New York 
LaGuardia, New York Kennedy, and Washington National. These limits mean 
a loss in departure frequencies and in the extent of competition, both 
of which hurt travelers on routes involving these airports. Figure 9 
shows estimates of the extent to which fares by carriers operating at 
these airports exceed the fares those carriers charge for similar 
flights (100 mile bands) involving other airports. In 1996, these 
premia ranged from 11 to 15 percent ($33-$44 per round trip) on routes 
involving Chicago O'Hare, New York LaGuardia, and Washington National 
compared with what the same carriers charged for flights of similar 
distance (100 mile bands) that did not involve slot-controlled 
airports. Fares at Kennedy Airport were not higher than on comparable 
routes.
    Unlike the Wright Amendment and perimeter rules, which were 
designed to reduce competition (among airports), slots were designed to 
reduce congestion. Nonetheless, slots do reduce competition. However, 
although eliminating slots may well reduce air fares, the increased 
trip times due to increased congestion could make travelers worse off 
overall. A better solution would be to eliminate slots and replace them 
with congestion pricing. Congestion pricing amounts to charging 
aircraft for their takeoffs and landings according to the cost of the 
delay that each aircraft imposes on other aircraft. During peak travel 
times, when one plane can delay many others, the cost would be high; 
during off-peak periods the cost would be low, perhaps nothing. Current 
airport fees are based on aircraft weight and have nothing to do with 
delay costs. Congestion charges should reduce delays from congestion by 
encouraging planes, especially general aviation and commuter planes, to 
use congested airports during off-peak periods or to switch to less 
congested airports.
                         summary and conclusion
    Airlines were deregulated nearly twenty years ago, but vestiges of 
regulation remain in the form of constraints on airlines' use of 
airports. Table 2 summaries for 1996 the possible effect of eliminating 
these restrictions. Although the figures in the table overstate the 
likely effect of eliminating the restrictions because they assume that 
other constraints (e.g., airport capacity) are not binding, they do 
provide a perspective on the magnitude of the problem--on the order of 
$1 billion annually.
[GRAPHIC] [TIFF OMITTED] T12SOC21.001

[GRAPHIC] [TIFF OMITTED] T12SOC21.002

[GRAPHIC] [TIFF OMITTED] T12SOC21.003

 Table 1.--Average Change in Real Fares between 1978:4 and 1996:4. For 
               All Domestic Routes Served in Both Periods

               [Percent (Using 1996:4 passenger weights)]

        Type of Route                                        Fare Change

Routes not served by new entrants in 1996:4 (5,983 routes)........ -14.7
Routes served by new entrants in 1996:4 but not by Southwest 
    Airlines (1,579 routes)....................................... -30.5
Routes served by Southwest Airlines in 1996:4 but not by other new 
    entrants (372 Routes)......................................... -47.2
Routes served by both Southwest Airlines and other new entrants in 
    1996:4 (360 Routes)........................................... -54.3
                        -----------------------------------------------------------------
                        ________________________________________________
      All Routes (8,294 routes)................................... -32.2

Source: Steven A. Morrison and Clifford Winston, ``Regulatory Reform of 
U.S. Intercity Transportation,'' in J. Gomez-Ibanez, W. Tye, and C. 
Winston, eds., ``Essays in Transportation Economics and Policy: A 
Handbook in Honor of John R. Meyer'' (Washington, DC: The Brookings 
Institution, 1998).

[GRAPHIC] [TIFF OMITTED] T12SOC21.004

[GRAPHIC] [TIFF OMITTED] T12SOC21.005

[GRAPHIC] [TIFF OMITTED] T12SOC21.006

[GRAPHIC] [TIFF OMITTED] T12SOC21.007

[GRAPHIC] [TIFF OMITTED] T12SOC21.008

[GRAPHIC] [TIFF OMITTED] T12SOC21.009


        TABLE 2.--THE EFFECT OF AIRPORT RESTRICTIONS ON AIR FARES
                          [Based on 1996 data]
------------------------------------------------------------------------
                                                    Cost
                                   -------------------------------------
                                                  Per
            Restriction                        passenger     Aggregate
                                     Percent    (round     annual effect
                                                 trip)    (millions) \1\
------------------------------------------------------------------------
Wright Amendment..................        76        $133           $813
Perimeter Rules:
    At National...................        25          83             91
    At LaGuardia..................        14          48            100
Slots:
    At National...................        15          44  ..............
    At Kennedy....................  ........  ..........  ..............
    At LaGuardia..................        11          33  ..............
    At O'Hare.....................        11          33  ..............
                                   -------------------------------------
      Total.......................  ........  ..........          1,004
------------------------------------------------------------------------
\1\ Aggregate figures overstate the impact of eliminating these
  restrictions because other constraints would come into effect (e.g.,
  Love Field does not have the capacity to exert competitive pressure
  for all flights from DFW to non-contiguous states. Aggregate figures
  are not given for slots because increased congestion could make
  passengers worse off on balance.

Source: Author's calculations. See text for details.

STATEMENT OF JAY U. STERLING, PH.D., C.P.A., ASSOCIATE 
            PROFESSOR OF MARKETING AND LOGISTICS, 
            UNIVERSITY OF ALABAMA, TUSCALOOSA, AL
    Senator Shelby. Dr. Sterling.
    Dr. Sterling. I would like to start with some comments on 
the effects of deregulation as it applies to the hub and spoke 
system. As we all know, the hub and spoke system originated 
shortly after deregulation. The underlying goals were good, 
which was to take advantage of size and scope, economic, lock 
customers into using a carrier for the entire trip, and 
efficiently provide service to a broader expanded number of 
markets, and thereby squeeze smaller carriers out of major 
traffic lanes.
    Although they are sound, in practice this hub and spoke 
system has created several major problems. Service to customers 
has deteriorated in the form of increased cancellations, late 
departures and arrivals, missed connections, and congestion. 
Does anybody really enjoy flying through a hub such as Atlanta, 
Dallas, or Chicago? Not me.
    There is evidence that airfares originating and terminating 
at hubs are significantly higher than to and from outlying 
spokes. For example, if I want to fly to Dallas from 
Birmingham, the nondiscounted round-trip fare is $968. If I 
want to fly to Houston, which means I have to go through 
Atlanta, the fare is $307.
    The number of flights into and out of these hubs has 
increased to such an extent that overcrowding capacity 
constraints are a severe problem, particularly during peak 
periods.
    Because of the huge investments incurred to construct and 
build these hubs, carriers generally focus a disproportionate 
amount of time and effort on protecting these facilities 
against actual and would-be competitors.
    Slots, or gates, become a premium commodity and are 
frequently controlled by the hub carrier in order to preclude 
increased competition such as Southwest.
    Now, whenever customers are locked into using a single hub 
airport as their origin or destination, as I have said, 
airfares escalate to exorbitant levels. For example, if I want 
to fly to Atlanta, which is a 29-minute flight, it is $586; to 
Memphis, $529, another half-hour flight; to Dallas, $968, as I 
have said.
    Conversely, whenever I can fly to a city with multiple 
airports, such as Chicago, Washington, DC, Detroit, I can get 
significantly lower fares, for example, to Chicago, $307. These 
are all nondiscounted Y fares that the business travelers 
typically use. To Washington, D.C. area for $250 and Detroit 
for $374. Why is this? Because each of these cities is served 
by multiple carrier airports.
    And why? Because typically at a hub, an airline controls 60 
to 80 percent of the traffic volume into and out of the hub.
    I think the airlines have figured out that it is fruitless 
to fight for market share at these hubs when the principal 
carrier controls 60 to 80 percent of the business, and frequent 
flyer programs incent business travelers, which range between 
60 and 75 percent of carriers' customers, to use the hub 
carrier for all of the trip's legs in order to gain necessary 
mileage. That is why fight for a few percentage points for a 
small piece of the pie when they can do the same thing at their 
own hub?
    In a free market, competitive industry prices should put 
pressure on large carriers to transform themselves into 
airlines that look and operate like Southwest. That was the 
purpose of the Motor Carrier Act and one of the major purposes 
in the Rail Act, the Staggers Act in 1980. Those two acts have 
worked as they were intended to, but it has not worked in the 
airline industry.
    One other area I need to cover before we leave deregulation 
is the area of customer service which is another major 
objective of deregulation. Service, in the form of on-time 
arrivals, length of flight times, baggage handling and stowage, 
comfortable, spacious seating has deteriorated, particularly in 
the past few years. Part of the problem is that the way the 
airlines report performance, on-time arrivals and on-time 
departures, is fictitious. It is smoke and mirrors. They have 
lengthened their flight times in order to make themselves look 
good. What we need to do is have measurements that measure 
themselves in the eyes of consumers, such as the number of 
cancellations, the number of missed connections.
    Now, with respect to the Wright Amendment, I say rather 
than amend this amendment, I think that the whole thing, as you 
said, should be repealed. Allowing hub carriers such as 
American and Delta to set prices for the industry at DFW and 
determine and control the routes they wish to fly while 
simultaneously restricting low-cost carriers from both 
accessing the DFW airport and then trying to prevent them from 
flying similar routes from Love is both monopolistic and a 
restraint of trade.
    How do we improve the airline environment? I have some 
specific recommendations I will briefly summarize.
    We should encourage and nurture low-cost carriers by 
insuring that gates are made available at all airports and that 
they are included in the industry's proprietary reservation 
systems and not locked out.
    Repeal all restrictive measures such as Wright.
    Require that any price change to the airline fare clearing 
house must be offered for a minimum of 30 to 60 days. Today 
basically we have collusion and price fixing in the airline 
industry because they have access to the common reservation 
system that does not exist in any other industry I know of. 
They send signals to one another. Fares can last for 1 or 2 
days as they send signals about what they like to do and they 
see, when they run it up the flagpole, if they do not get any 
reaction, they leave it stand. Otherwise, they pull it back 
based on what their competitors indicate with similar type of 
actions. By doing this, putting a fare in for 30 to 60 days, it 
might preclude some of this signaling.
    Require that every gate owned by a carrier at a hub must be 
utilized a minimum number of times each weekday. This would 
prevent these carriers from gobbling up all the excess gates 
and trying to prevent other carriers from entering.
    Stop penalizing industry's core market business travelers. 
One possibility would be to prohibit prices into a hub that are 
greater than the closest high volume destination through the 
hub. I do not know if this is practical, but something needs to 
be done. We talk about lower fares overall, but if you look at 
the Y class, the fares have accelerated, and those are the 
fares that most business travelers use because they make most 
of their plans at the last minute or have to change them.
    Encourage and nurture travel agents rather than trying to 
put them out of business by continually cutting their 
commissions. Are these cuts primarily intended to reduce costs, 
or are they an attempt to stifle competition? Because as the 
role of travel agents declines, that means you have to call an 
800 number or get it on the Web. Now, if I call Delta or I call 
American, they are not going to say, well, you can get a better 
deal on Northwest.
    Encourage the major airlines to seek innovative ways to cut 
operating costs and overhead which is again, one of the major 
hoped for outcomes of deregulation, forcing carriers--and the 
same thing happened in the motor carrier industry and the rail 
industry--to cut costs.
    Reexamine the hub and spoke concept. Is it as profitable as 
originally perceived given the huge capital investments, large 
fleets and manpower required to operate these facilities?
    Is there a maximum size or capacity for a major hub beyond 
which frequent delays and turnaround times expand acceptable 
levels? This needs to be researched.
    Have the airlines become so obsessed with catering to 
vacation, price-sensitive customers that long-term 
profitability is endangered unless they sock it to business 
travelers?

                           prepared statement

    Finally, and I know this is controversial, but consider 
allowing foreign carriers to fly to destinations within the 
United States after their initial landing on the U.S. soil. 
This would certainly open it up for more competition.
    That concludes my statement.
    Senator Shelby. Thank your, Dr. Sterling.
    [The statement follows:]

                 Prepared Statement of Jay U. Sterling

                         background information
    I am presently an Associate Professor of Marketing and Logistics in 
the Culverhouse College of Commerce and Business Administration at the 
University of Alabama in Tuscaloosa, Alabama. I have been employed by 
the University since 1984. My area of expertise and research interests 
focus on transportation and logistics management, the measurement and 
evaluation of marketing and distribution costs, and the determination 
of the profitability of business segments. I teach both an 
undergraduate and graduate course in logistics and a graduate course in 
marketing profitability analysis.
    During my academic career, I have conducted over thirty research 
and consulting projects that were funded by either Alabama based or 
large national and multi-national firms. All of these projects involved 
transportation and/or logistics issues and concerns. I have also either 
conducted, or been a speaker at, over 100 transportation/logistics 
executive development seminars sponsored by various universities (e.g., 
Michigan State University, Northwestern University, the Universities of 
South and North Florida and the University of Alabama) and professional 
organizations (e.g., the Council of Logistics Management).
    Prior to working on my Ph.D. at Michigan State University from 
1981-1984, I spent twenty-five years in industry. I began my working 
career in 1956 with the international public accounting firm of Arthur 
Andersen & Company. In 1959 I joined Whirlpool Corporation, first as an 
internal auditor and then as a tax accountant. In 1967 I became the 
Controller for the newly created Physical Distribution/Logistics 
Division. As such, I was responsible for: Designing and managing the 
company's transportation and warehousing accounting systems; 
supervising all budgeting related activities; and, providing the data 
required to negotiate transportation and warehousing rates. In 1971 I 
was promoted to Director of Logistics Planning for the same division. 
In this capacity I supervised the development and implementation of the 
division's annual and long-range business plans, coordinated the 
division's data processing/management information systems resources and 
developed and measured the financial and customer service performance 
metrics for all logistics related activities.
    In 1976 I left Whirlpool Corporation to become Director of 
Distribution for Heil Quaker Corporation (now International Comfort 
Products) in Nashville, TN. This company was a wholly owned subsidiary 
of Whirlpool at the time, but was subsequently sold to Inter City 
Products. Heil Quaker manufactured and sold central heating and cooling 
products. I was responsible for administering all logistics related 
activities: Transportation, warehousing, customer service/order 
management, forecasting/production planning and the private fleet 
operation.
    From 1979 to 1981 I served as director of Distribution for The 
Limited Stores, Inc. in Columbus, Ohio. In this position, I managed all 
transportation activities from both our domestic and international 
suppliers into our Distribution Center in Columbus, as well as outbound 
to our retail stores, including a large private fleet operation. I also 
supervised a work force of approximately 220 people who processed, 
ticketed and distributed merchandise to our stores.
    I have been an active member of the world's largest logistics based 
professional organization, the Council of Logistics Management since 
1971. I have also published articles in all of the major 
transportation/logistics focused journals; including the Transportation 
Journal, the Journal of Business Logistics, the International Journal 
of Physical Distribution and Materials Management and Production and 
Inventory Management Review. I also serve on the Board of Directors of 
Mark VII, Inc., which is a large multi-modal transportation service 
company. Mark VII is the largest broker for intermodal and truckload 
transportation shipments and is also a leading ``third party'' provider 
of outsourced transportation and logistics activities. As such, it 
manages integrated logistics processes for fortune 1000 firms, such as 
Whirlpool Corp., Strohs, Coors, Frito-Lay, Oxy Chemical, Mobil Oil, 
Cott Beverage and Georgia Pacific. It also manages dedicated truck 
fleets for companies and is heavily involved with both air freight and 
marineland carriers in managing the import and export of containers for 
customers.
                  deregulation in the airline industry
    Deregulation has literally revolutionized the transportation 
industry. Beginning with airlines (1978) and motor carriers and rail 
(1980), these Congressional acts have changed the way both shippers and 
carriers do business. The primary intent of deregulating any industry 
(e.g., financial institutions and telecommunications, as well as 
transportation) is to increase competition through a free market 
environment. Competitive market forces, in turn, should force managers 
of the firms involved to better control costs by increasing 
productivity and operating efficiency, provide customers with better 
service, and reduce the prices charged to customers. This theory has 
worked well in both the trucking and rail industries (notwithstanding 
the current Union Pacific/Southern Pacific merger related problems). 
Such is not the case in the airline industry. Airline industry analysts 
(both practitioners and educators) generally agree that the 
underpinning of the deregulation concept, a free market environment, 
has not flourished in a deregulated airline industry.
    Initially, deregulation increased the number of competitors in the 
airline industry. However, with the exception of ``feeder'' (commuter) 
lines, many of these carriers have either merged or gone out of 
business in the ensuing 19 years. Operating profits of the scheduled 
airline industry have deteriorated. Only in the past two or three years 
have the largest carriers recorded profits. Many of these profits may 
be illusory, due to cutbacks and deferment of maintenance that 
eventually will have to be accelerated, and a looming horizon of 
significant new debt that will be required to replace a generally aging 
fleet. With the exception of Southwest Airlines, the major carriers 
have not solved their labor/management problems. A few, such as United 
(now effectively owned by its employees) have established low-cost 
operations to compete directly with Southwest's short-haul business. 
However, long-term they still face a problem similar to those faced by 
highly organized work environments (e.g., the U.S. auto, motor carrier 
and rail industries): How to restructure work rules and reduce 
uncompetitive wages that have resulted from years of suspect labor 
negotiations.
    The industry has grown exponentially in terms of its 
infrastructure. Virtually every major carrier has restructured its 
service areas into a ``hub and spoke'' system. The goals underlying 
this concept were to take advantage of size and scope (economic), lock 
customers into using the carrier for the entire trip, efficiently 
provide service to a broader, expanded number of markets, and thereby 
squeeze smaller carriers out of major traffic lanes.
    Although, in theory, these goals appear to be sound, in practice, 
the hub and spoke system has created several major problems, both for 
carriers and shippers:
    1. Service to customers (passengers) has deteriorated in the form 
of increased cancellations, late departures and arrivals, missed 
connections and congestion (Does anyone really enjoy flying through a 
hub, such as Atlanta, Dallas or Chicago?)
    2. There is evidence that airfares originating, and terminating at 
hubs are significantly higher than to/from outlying ``spokes'' (Please 
see Exhibit 1, which compares the non-discounted fares from Birmingham 
and Mobile Alabama.)
    3. The number of flights into and out of these hubs have increased 
to such an extent that over crowding and capacity constraints are a 
severe problem, particularly during periods of peak business travel.
    4. Because of the huge investments incurred to construct and build 
these hubs, carriers generally focus a disproportionate amount of time 
and effort on protecting these facilities against actual and would be 
competitors.
    5. Slots (gates) become a premium commodity and are frequently 
``controlled'' by the hub carrier in order to preclude increased 
competition, particularly from low-cost carriers, such as Southwest.
    The final issue that must be addressed when discussing deregulation 
of the airline industry is ``price''. This industry is unique among all 
U.S. industries: It is possible, legally, to collude and jointly 
determine both pricing policies and specific, point-to-point airfares. 
To Airline Tariff Publishing Company (the airline fare clearing house) 
administers industry wide fares for all carriers. As a result 
``signals'' are routinely sent by carriers to competitors in the form 
of fares possessing very short expiration dates. For example, it is 
possible for Carrier ``A'' to create monopolies in its strongest 
markets by threatening to cut prices in targeted competitor ``B's'' 
markets, if ``B'' tries to take share away from ``A''. Thus, this fare 
network is used to discipline dissidents, negotiate ``common'' fares, 
stifle competition, and thwart smaller and/or start-up carriers from 
offering discounts.
    When this common sharing of fare information (signaling) is 
combined with the ``hub and spoke'' network several things happen:
    1. Whenever consumers are locked into using a single hub airport as 
their origin or destination, airfares escalate to exorbitant levels. 
Exhibit 1 shows that if I want to fly from Birmingham Alabama to a hub 
with only one alternative airport, the fares will be significantly 
greater than if I were to fly to a hub city with competing airports.
    For example the fare for the 29-minute flight to Atlanta is $586, 
to Memphis--$529 and to Dallas--$968.
    Conversely, I can fly to Chicago for $307, to the Washington, D.C. 
area for $250 and to Detroit for $374. Why? Because each of these 
cities are served by multiple airports.
    2. Fares to destinations beyond the monopolistic (single carrier) 
hub are typically less than to the hub itself. For example, I can fly 
to San Antonio for $445, to Lubbock for $448, to Albuquerque for $498, 
to Houston for $307 and to San Francisco for $601, versus the $998 it 
will cost me to fly to Dallas.
    Why? Because one airline controls 60 percent to 80 percent of the 
traffic volume into and out of the hub.
    Why does this dichotomy exist? I believe that airlines have figured 
out that it is fruitless to fight for market share when the principle 
hub carrier controls 60-80 percent of the market and frequent flyer 
programs incent frequent ``business'' flyers (60-75 percent of a 
carriers' customers) to use the hub carrier for all of a trip's legs in 
order to gain the necessary mileage required for free trips. That is, 
why fight for a few percentage points of a small piece of the pie, when 
they can do the same thing at their hub locations?
    In a free market, competitive industry, prices should put pressure 
on large carriers to transform themselves into airlines that look and 
operate like Southwest (lower cost, no frills competitors)--in order to 
achieve sustained profitability. Unfortunately, Southwest is locked out 
of a majority of the U.S. airline reservations systems, as well as 
denied access to most of the major hubs because of the control of gates 
by the major hub carrier.
    Research has shown that business travelers who account for upwards 
of 60 percent of passengers, normally pay the highest fares (non-
discounted ``Y'' class) because of the need to make and change plans at 
the last minute. Therefore, the most important criteria when traveling 
is frequent and convenient on-time departures and arrivals. That is, 
they want the plane to arrive on-time, with no lost or damaged luggage. 
Time is money!
    Before leaving this subject, we need to look at the area of 
customer service. This represents (or should represent) the output of a 
carrier's operations, and was one of the major, hoped-for benefits when 
the industry was deregulated in 1978. Unfortunately ``service'' in the 
form of on-time arrivals, length of flight times, baggage handling and 
stowage, and comfortable, spacious seating has deteriorated, 
particularly in the past few years. Based on my personal experiences as 
a frequent flyer and those of business acquaintances, the major 
airlines have not figured out this equation. They still focus on 
``frill'' services, such as fancier meals, attractive gate areas, food 
courts at hubs and credit card or long-distance ``deals''. They 
invariably fail in providing sufficient time to make connections and 
minimizing flight cancellations. They are able to report consistently 
high on-time departures and arrivals to the federal government by 
resorting to ``smoke and mirrors''. For example a flight is officially 
counted as ``leaving'' when the ramp is pulled away from the plane, 
which can and does sit at its gate while luggage is still being loaded 
or the aircraft sits in the takeoff queue for lengthy periods. In order 
to make the numbers, airlines extend (pad) scheduled flight times to 
guarantee on-time arrivals, rather than address the real causes of 
these problems--over-worked ground crews and capacity constraints at 
hubs. Passengers now ``carry-on'' their luggage because they believe it 
won't get to their destination, will be damaged in-transit or will take 
too long to claim at congested airports. This has created a nightmare 
for flight attendants.
    To summarize, deregulation of the airline industry has not achieved 
its primary goals of increased competition, higher service levels and 
lower costs. We should not infer, however, that deregulation in general 
is bad or won't work. One merely has to look at the successes achieved 
in both the motor carrier and rail industries to determine the 
significant benefits that can accrue to both carriers and shippers when 
carriers embrace and adopt the concepts of a free market environment.
                            wright amendment
    The Wright Amendment was initially adopted in 1980 to insure that 
the Dallas Ft. Worth Airport (DFW) would protect the revenue stream 
required to pay off the bonded indebtedness incurred to build the 
airport in 1974. DFW is presently operating at or near capacity and 
recently completed a 3.5 billion dollar expansion to handle its 
continuing growth. Therefore, the need for this financial ``security 
blanket'' can no longer be economically justified. Rather than amend 
this amendment to redefine ``56 seat'' aircraft and add more states to 
its permissible geographic market area, the amendment should be 
repealed in its entirety.
    If airlines are going to operate in an unregulated environment that 
fosters competition in a free market, fictitious barriers to market 
entry must be torn down. (Carriers can't have their cake and eat it 
too!). Allowing hub carriers, such as American and Delta, to set prices 
for the industry at DFW and determine and control the routes they wish 
to fly, while simultaneously restricting low cost carriers from both 
accessing the DFW airport (by denying them gates) and preventing them 
from flying similar routes and lanes from a competing site (Love 
Field), is both monopolistic and in restraint of trade!
    This is not a Texas or Southeast issue. The Wright Amendment 
affects the heart of deregulation. Will carriers be permitted to fly 
from origins of their choosing to destinations they desire, will they 
be allowed to establish competitive prices without collusion with other 
carriers and will start-up, low cost carriers, be permitted to survive 
and grow into viable competitors? These are the real questions that 
need to be addressed.
    Opponents to the repeal of the Wright Amendment contend that 
traffic congestion would increase since Love Field and DFW are only 
6\1/2\ miles apart. This hasn't prevented Southwest from initiating 
over 130 flights a day. Nor is it a problem in other cities with 
multiple airports (e.g., Chicago, Detroit, Washington D.C. and Miami/
Ft. Lauderdale).
    Another argument against repeal is the noise that expanded service 
would impose on nearby residents. Since Love originated in 1917, the 
vast majority of the residential areas surrounding Love Field were 
consciously developed with the knowledge that an airport was adjacent 
to these residences. The following question needs to be asked: How will 
expansion of Love Field create additional problems, given the steady 
volume that already exists? Finally, American has threatened to 
transfer a portion of its daily flights from DFW to Love if Love's 
current restrictions are lifted. Is this a real threat or an attempt to 
usurp gates and control prices as it does at DFW?
             how to improve the current airline environment
    In order to develop a free market environment with value based 
pricing, the airline industry must be converted to one that is founded 
on real competition. Some economists contend that an oligopolistic 
industry (a market that contains few suppliers) leads to higher prices 
and reduced competition. In practice, market concentration is often no 
advantage at all. A few heavy-weights fighting for a single market tend 
to do the work of many competitors, by increasing the degree of 
competition rather than diminishing it. Thus firms frequently piddle 
away their advantages.
    For example, instead of coaxing consumers to buy higher quality, 
higher priced products, manufacturers in the packaged goods industry 
spend millions of dollars cheapening their products' images by offering 
allowances to retailers, coupons and price cuts. Two suppliers in the 
major home appliance industry account for two-thirds to three-quarter 
of the market (Whirlpool and General Electric) and the top five 
manufacturers account for 95 percent of the industry's annual volume. 
Competition is so fierce that price levels are virtually the same that 
they were in the 1970's. How have these firm's survived?--by constantly 
seeking improvements in manufacturing processes, information 
technologies and supply chain/logistics activities. Economists and 
CEO's have long associated high market share with high profits. Share 
has nothing to do with profits! If you want profitable market share, 
hire and develop better managers and produce better products/services!
    In order to increase competition and thereby foster competitive, 
market based pricing in the airline industry, I recommend that Congress 
and/or the Federal Aviation Administration consider the following 
changes to existing laws and/or regulations:
    1. Encourage and nurture ``low cost'' carriers by insuring that 
gates are made available at all U.S. airports and that they are 
included in the industry's proprietary reservation systems. That is, 
any airline that wants to fly out of an airport should not be barred 
from doing so.
    2. Repeal all restrictive measures, such as the Wright amendment to 
encourage free access to all markets by any financially stable carrier. 
Legislation such as Wright restricts competition, hinders economic 
development and imposes undue costs on the flying public.
    3. Require that any price change to the airline fare clearing house 
must be offered for a minimum of 30 to 60 days. This will drastically 
curtail the day to day signaling that permeates the industry and breeds 
collusion. Strictly enforce a ban on collusion.
    4. Require that every gate ``owned'' by a carrier at a ``hub'' must 
be utilized a minimum number of times each weekday. This will prevent 
the dominant carrier from leasing gates to bar low-cost carriers such 
as Southwest.
    5. Consider re-implementing the ban on predatory pricing that 
existed for all transportation modes prior to deregulation. That is, 
carriers should not publish regular (business related) fares that are 
less than their operating costs. This will reduce the present practice 
of socking it to segments that have no alternative choices in order to 
subsidize other customer groups or routes.
    6. Stop penalizing the industry's core market, business travelers. 
One possibility would be to prohibit prices into a hub that are greater 
than the closest high volume destination through the hub (Thus the 
Birmingham to Houston fare would be the ceiling for the Birmingham to 
Dallas fare.).
    7. Encourage and nurture travel agents rather than trying to put 
them out of business by continually cutting their commissions. Are 
these cuts primarily intended to reduce costs--or are they an attempt 
to stifle competition? Its very difficult to get the absolute best fare 
(regardless of the carrier) when one calls an airline's 800 number or 
accesses its Web site!
    8. Encourage the major airlines to seek innovative ways to cut 
operating costs and overhead. For example why not outsource baggage 
handling activities, particularly at non-hub locations? A shared work 
force provided by a third-party firm would be more economical and 
efficient.
    9. Reexamine the HUB and spoke concept. Is it as profitable as 
originally perceived, given the huge capital investments, large fleets 
and manpower required to operate these facilities? It certainly has not 
benefited the consumer. Missed connections, lost/damaged luggage, 
longer transit times, and cancelled flights are an everyday occurrence 
for most business travelers.
    10. Frequent Flyer programs build brand preference/loyalty. The key 
questions are: Does this loyalty to one airline reduce competition? 
And, do these programs encourage airlines to not spend funds trying to 
please their customers? These issues need to be studied.
    11. Is there a maximum size or capacity for a major hub, beyond 
which frequent delays and turn-around times expand to unacceptable 
levels? Should traffic at certain hubs be shifted to less busy 
airports? These concerns need to be analyzed and studied further.
    12. Have the airlines become so obsessed with catering to vacation, 
price sensitive customers that long-term profitability is endangered 
unless they ``sock it to'' business travelers? The long-term 
profitability of carriers needs to be assessed, given the huge capital 
expenditures that are planned over the next ten years and recent 
decreases in maintenance spending.
    13. Consider allowing foreign carriers to fly to destinations 
within the U.S., after their initial landing on U.S. soil. Several U.S. 
carriers are doing this in Europe and elsewhere. Such a move would 
significantly increase competition, worldwide.
    Taken individually, the problems identified in this summary 
statement do not appear to be overly serious. However, when one 
combines them into a single profile, it is obvious that if the airline 
industry is to survive long-term and customers are to receive real 
value for their money, something more than a recommended patchwork 
approach is required. These recommended changes will also force major 
carriers to reengineer their business processes to reduce costs, and 
eliminate duplicate or non-value adding activities. Business Process 
Reengineering (BPR) is a concept that numerous companies in other 
industries have endorsed and adopted in order to increase their 
competitive position. The old approach of reducing workforces without 
changing by key processes and cutting wages are short-term approaches 
that frequently create more problems than they solve.

Exhibit 1.--Comparative Non-Discounted (Y) Airfares From ALA Origins to 
              Selected Destinations as of October 17, 1997

Birmingham to Dallas:
    Delta.....................................................   $968.00
    American..................................................    968.00
    Continental...............................................    968.00
    Northwest.................................................    970.00
Birmingham to San Antonio:
    Northwest.................................................    445.00
    Continental...............................................    445.00
    American..................................................    445.00
    Delta.....................................................    445.00
Birmingham to Lubbock:
    Northwest.................................................    448.00
    Continental...............................................    448.00
    American..................................................    448.00
    Delta.....................................................    448.00
Birmingham to Albuquerque:
    Northwest.................................................    498.00
    American..................................................    498.00
    Delta.....................................................    498.00
    American..................................................    498.00
    Continental...............................................    652.00
Birmingham to Houston (Hobby Airport):
    Northwest.................................................    307.00
    American..................................................    307.00
    US Air....................................................    307.00
    Delta.....................................................    307.00
Birmingham to Houston (Intercontinental):
    Northwest.................................................    307.00
    American..................................................    307.00
    Continental...............................................    307.00
    Delta.....................................................    307.00
Birmingham to Boston:
    Northwest.................................................  1,302.50
    Delta.....................................................  1,300.49
    United....................................................  1,300.49
    US Air....................................................  1,300.49
Birmingham to Buffalo:
    Northwest.................................................  1,054.00
    United....................................................  1,052.00
    US Air....................................................  1,052.00
    Delta.....................................................  1,052.00
Birmingham to LaGuardia (New York):
    Northwest.................................................  1,054.00
    United....................................................  1,052.00
    US Air....................................................  1,052.00
    Delta.....................................................  1,052.00
Birmingham to Newark (Newark, NJ):
    Northwest.................................................  1,054.00
    US Air....................................................  1,052.00
    Delta.....................................................  1,052,00
    United....................................................  1,052.00
Mobile to Washington (National Airport):
    Delta.....................................................    925.00
    Northwest.................................................    295.00
    Continental...............................................    386.00
Mobile to Baltimore (Washington):
    Northwest.................................................  1,021.00
    Continental...............................................  1,019.00
    Delta.....................................................  1,073.00
Mobile to Washington (Dulles Airport):
    Northwest.................................................    295.00
    Continental...............................................    386.00
    Delta.....................................................    925.00
Birmingham to Chicago (O'Hare):
    Northwest.................................................    307.00
    United....................................................    307.00
    Delta.....................................................    307.00
    US Air....................................................    307.00
Birmingham to Chicago (Midway): Delta.........................    307.00
Birmingham to Washington (National):
    Northwest.................................................    854.00
    United....................................................    852.00
    US Air....................................................    852.00
    Delta.....................................................    852.00
Birmingham to Baltimore:
    Delta.....................................................    250.00
    US Air....................................................    250.00
    United....................................................    250.00
    Northwest.................................................    904.00
Birmingham to Washington (Dulles Airport):
    Northwest.................................................    854.00
    Delta.....................................................    852.00
    US Air....................................................    852.00
    United....................................................    852.00
Birmingham to Detroit:
    Northwest.................................................    374.00
    Delta.....................................................    374.00
    US Air....................................................    374.00
    United....................................................    374.00
    TWA.......................................................    374.00
Birmingham to San Francisco:
    Northwest.................................................    601.00
    Delta.....................................................    601.00
    United....................................................    601.00
    American..................................................    601.00
    US Air....................................................    601.00
Birmingham to Seattle:
    Northwest.................................................    624.00
    Delta.....................................................    624.00
    American..................................................    624.00
    US Air....................................................    624.00
    United....................................................    624.00
Birmingham to Memphis:
    Delta.....................................................    529.00
    Northwest.................................................    529.00
Birmingham to Atlanta: Delta..................................    586.00
Birmingham to Charlotte:
    US Air....................................................    779.00
    Delta.....................................................    779.00
Birmingham to Mobile:
    Delta.....................................................    553.00
    Northwest.................................................    553.00
STATEMENT OF DR. FRED C. ALLVINE, PROFESSOR OF 
            MARKETING, GEORGIA INSTITUTE OF TECHNOLOGY, 
            ATLANTA, GA
    Senator Shelby. Dr. Allvine.
    Dr. Allvine. Senator, I very much appreciate, applaud your 
undertaking these hearings. I think they are very important, as 
I will try to explain in a moment. It is courageous on your 
part that you do it. The airline industry would rather not have 
a careful examination of how the structure of competition has 
changed dramatically. There are considerable costs to 
questioning what has happened in the airline industry that I 
think we all fairly well understand.
    Let me state that we just finished the 10-year anniversary 
of the stock market crash and the Government looked into the 
problems of the original crash and put in action to see that it 
did not happen again. And we went smoothly over this 
anniversary. Gray Friday and Black Monday we just passed.
    We are now coming up on the 20th year anniversary of 
deregulation of the airline industry. If my math is any good, 
1978, 1988, and 1998 will be the 20th year anniversary. I hope 
that other committees will look at deregulation and determine 
where it is working and where it is not working and try to fix 
what is not as good as it might be.
    Let us look at the first decade following deregulation. The 
founders of deregulation in Congress hoped to stimulate 
competition, and there was a huge number of new entries. Fares 
remained very low. Competitive services were high.
    The second decade I think is entirely a different 
situation, Senator. We have seen 95 percent of the airplanes 
that came into existence in the first decade following 
deregulation, they are gone. We see more than one-half of the 
airlines that were in business at the time of deregulation, 
they are gone: Eastern, Piedmont, New York, Republic, PSA. You 
go on and on and on and on.
    Over the past decade, we have seen a dramatic change in the 
structure of competition. I think the committee needs to 
carefully look at what has happened in the United States. Our 
studies show that about one-third of the United States remains 
very competitive and has benefitted from deregulation. That is 
the western and the southwestern parts of the country. The 
eastern third of the country and the north-central part of the 
country are finding rapidly diminishing benefits of 
deregulation.
    We had one of the longest price wars in the history of any 
industry in the early 1990's. It cost the industry $13 billion 
and it wiped out scores of competitors in the industry. What 
was created in its place were large hub airports in the major 
cities where airline concentration soared from 1978, 1988 to 
1997.
    The major airlines I believe are on a course to destroy the 
benefits of deregulation in the eastern half of the country and 
the upper midwest. You hear--and I think it is correctly 
stated--that they have developed a hub and spoke system and a 
fortress hub is increasingly----
    Senator Shelby. Doctor, how did they destroy the 
competition?
    Dr. Allvine. With this price war that went on from 1990 to 
early--the mid-1990's, 1993, 1994, it just drove out of 
business. It was so bad that even Northwest and Continental 
sued American for its predatory behavior, and it just wiped out 
scores of competitors and left the airline industry very 
concentrated and increasingly concentrated in the eastern half 
and the north-central part of the country and came out of this 
thing the major airline hubs.
    Studies from the GAO, even from the DOT, which we will hear 
from in a while, showed fares in hub markets are oftentimes 30 
to 70 percent higher than in competitive markets. Atlanta, my 
home city. We will talk about that if we have a chance.
    So, fundamentally what we have is a split personality of 
the airline industry. Deregulation has worked in the Southwest 
and the West. The rest of the country is being stifled. It has 
become increasingly concentrated with monopoly power to raise 
prices considerably above the competitor, and that is 
Minneapolis. And that is Chicago O'Hare. And that is 
Pittsburgh. And that is Cincinnati. And that is Atlanta, GA. 
And that is Dallas, TX, and the like.
    So, I think that we have to look at and recognize what is 
going on. What the major airlines have done is they developed 
their high market share hubs and they protect them by predatory 
pricing. They lower prices 40, 50, and 60 percent only during 
the time when a low-cost competitor comes in, and once that 
competitor is gone, up goes the price. It is like a $40,000 
automobile company lowering its prices temporarily to meet the 
prices of an $18,000 automobile company, driving out of 
business, then increasing their prices back. That is how 
ludicrous it is, Senator, of what is going on in this country.
    What can be done? I think there are several things.
    One, continue the hearings. The airline industry does not 
want careful examination of the efforts to wreck deregulation 
in the eastern part of the country. It is excellent what you 
are doing and I encourage you and applaud you. And I know there 
are costs to you and costs to me and costs to Georgia Tech that 
we speak out.
    No. 2, have the GAO do some further studies and report back 
to you. Have them look at market concentration in the hubs and 
show how they have increased over the last 10 years.
    No. 3, I recommend that Congress look at both the DOT and 
the DOJ and see if they are capable of using the authorities 
they have to protect competition in America. The study that we 
have done of the DOT behavior, it is pro large business time 
and time and time again. Even today, where the second wave of 
discount is virtually destroyed, the DOT is basically sitting 
on the sidelines like a major business publication and doing 
nothing to try to reinvigorate the competitive process.
    The DOT did a study in April 1996, and they mislabeled the 
report. They talked about the low-cost airline revolution 
saving American citizens $6 billion. They saw it wrong, 
Senator. They should have looked at the other two-thirds of the 
country and shown that the monopoly powers were costing this 
country $10 billion or more.
    So, I am suggesting to you, Senator, that it is very 
courageous to undertake these hearings and that more needs to 
be looked at, what we can do to make the airlines more 
competitive.
    I think with one or two final comments, if I could, I would 
like to talk about Atlanta, GA.
    Senator Shelby. You go ahead.
    Dr. Allvine. Atlanta, GA, is one of those hub cities. 
Eastern Airlines went out of business in the early 1990's like 
so many other airlines did as we had the price wars. The 
Federal Government did not do anything about those price wars. 
Delta's market share in Atlanta went up 50 percent. Delta 
became the monopolistic carrier on 65 percent of the flights or 
thereabout. They have no competition on 75 percent of the 
flights. They have 75 percent or more of the flights.
    There was a major corporation based in Atlanta, GA, that a 
couple years ago instructed publicly their employees to fly any 
line but Delta Airlines if at all possible. The problem was 
there were no alternatives in that highly concentrated market.
    Looking on at what is happening, just this past week I 
learned that the Chamber of Commerce--and it has not been in 
the newspaper--has asked for bids from consulting firms to look 
at what they can do in Atlanta, GA, to increase competition and 
to drive prices down in this market area. That is very serious 
when you take the home city of Delta Airlines, that the Chamber 
feels so threatened with these high fares, that something has 
to be done.
    My final comment is I checked the fares to fly to 
Washington today. The fare to Dulles, where I came into, was 
considerably lower. The fare premium was 130 percent more for 
Delta Airlines to fly to Washington National than to Dulles. I 
said, gee, what about if we look at New York City. Let us 
compare Newark to LaGuardia. It was a 135 percent increase in 
terms of a slot-controlled airport.
    You are looking at the right issues, Senator, and we need 
to look at predatory pricing. The Justice Department and the 
DOT talk about doing something on predatory pricing. They have 
done nothing. They have done absolutely nothing. They sit there 
while the second wave of discount airlines has almost been 
obliterated in this country.

                           prepared statement

    So, unlike Steve, I am not very comfortable about what is 
happening in two-thirds of the United States. Deregulation is 
being destroyed by monopolistic practices in a growing portion 
of this country, Senator.
    I thank you.
    Senator Shelby. Thank you, and I thank all of you.
    [The statement follows:]

                 Prepared Statement of Fred C. Allvine

                                overview
    I applaud this committee for starting hearings Examining Ways To 
Make The Airline Industry More Competitive. In a historical sense it is 
very appropriate to do this. Over the past few days there has been 
considerable discussion regarding the 10 Year Anniversary of the 1987 
Stock Market Crash. Introspection into what went wrong led the Federal 
government to take steps to try and assure that such a melt-down would 
not happen again.
    Next year will be the 20th Anniversary of De-regulation of the 
Airline Industry and I encourage this committee to take a long hard 
look at the extent to which de-regulation of the airline industry has 
and has not worked. There is no questions about the general benefits of 
de-regulation in the airline industry. However, I believe you will find 
on closer examination that several of the major large airlines are 
attempting to destroy de-regulation and replace it with their monopoly 
control over a large portion of the country.
    I will first describe what generally has happened in the airline 
industry over the last twenty years. The discussion is divided into two 
time periods--the first and second decades following de-regulation. The 
designers of airline de-regulation wanted to increase competition and 
keep prices as low as possible. De-regulation was an unquestionable 
success over the first decade from 1978 to 1988. Large numbers of new 
airlines came into existence, the airline industry grew rapidly, and 
competition kept fares very low.
    The second decade of de-regulation (from 1988-1998) has ushered in 
a new experience and the nature and structure of competition in the 
airline industry has changed dramatically. What fundamentally has 
happened is that the airline industry has developed a split personality 
over the last decade. Part of the U.S. remains highly competitive which 
is a consequence of de-regulation, but a large and growing section of 
the airline market is being monopolized. The big change in the 
structure of competition in the airline industry was associated with 
the four year price war in the early 1990's that cost an amazing $13 
billion. Due in a large part to the massive price war 95 percent of the 
new entrants and many of the existing airlines were destroyed. I 
predict that historians will look back on this period and call it the 
rape of the airline industry.
    The major airlines who benefited most from the huge price war 
developed high market share hubs in large sections of the country. 
Given the market power that they have developed, the major airlines 
have raised prices to far above the competitive level in their market 
hubs (as study after study has shown). Furthermore, the major airlines 
defend their high-price hub markets with predatory pricing. These 
markets are descriptively called ``fortress hubs.'' One consequence of 
the destructive price wars and predatory pricing is that the major 
airlines are now earning record profits.
    While a large part of the U.S. has been virtually monopolized over 
the last decade, there is still another part of the country that is 
benefiting from de-regulation. The Competitive Portion of the Country 
is the Southwest and West (approximately a third of the market) and the 
increasingly Monopolized Portion of the Country is the Eastern half of 
the country and the North-central Region (the remaining two thirds of 
the market). The dual personality of the airline industry (part 
competitive and a growing part monopolized) is confusing, but is 
critical to understanding this industry.
    One does not have to be a genius to see the possible benefits of 
what could be accomplished if the competitive nature of the airline 
industry in the Southwest and West were introduced in the remainder of 
the country. In fact this is largely the position-philosophy of the 
Department of Transportation as explained in their May 1996 report 
called ``The Low Cost Service Revolution.'' De-regulation could be 
rescued if the competitive nature of the airline industry in the 
Southwest and Western parts of the country could be introduced in the 
remainder of the country. However, Knowing What Needs To Be Done and 
Doing It Are Two Different Things. I sincerely hope that airline de-
regulation can be salvaged before it becomes necessary to re-regulate 
the airline industry. None of us like government regulation with its 
inefficiency, but that is preferable to permitting airlines to 
monopolize large sections of the country where they charge high 
monopoly fares to the flying public.
    I fear, however, that the Forces Of Monopoly Will Win Over The 
Forces Of Competition and I will try to explain why I am not optimistic 
regarding the outcome. We can all study the competitive portion of the 
country and see what has happened, and then hopefully transfer these 
conditions to the remainder of the country (that is where the D.O.T. is 
coming from). To put it simply, what we find in the Southwest and the 
West is that competitive entry into these markets is relatively easy. 
As a consequence Southwest has brought quality, low discount fares to 
much of this region of the United States.
    Just as we are able to determine what it requires to have 
competitive markets, the large airlines do the same and they know the 
industry much better than we do. But the goal of the major airlines is 
to see that competition does not succeed in their markets, and they 
have huge resources and influence with the Federal government (Congress 
and Federal government agencies) to try and stop competition from 
spreading into the Eastern half of the country. There is no doubt in my 
mind that they are very displeased about this hearing and would like to 
stop further such hearings.
    There are two things that the major airlines are doing to 
monopolize large segments of the country. First, they work hard to see 
that entry to their huge markets remains closed or difficult. Second, 
if a discounter enters a few of their markets they use predatory 
pricing to drive the discounters out of business. Senator Shelby, if 
you really want to strike a blow for the consumer and against monopoly 
forces, then do not just amend the Wright Amendment, work to have it 
abolished. Then you can stand back and watch what competition will do 
for your state of Alabama and other nearby states. Fares will fall by 
as much as 50 percent, and it will be a victory for the consumer and 
for the economy. Congress will have made a difference, and that is what 
it is supposed to be all about.
    I would like to suggest some things that could be done immediately 
to help restore competition in a large section of the country.
    1. It is recommended that Congress hold a series of hearings 
regarding how the airline industry can be made more competitive (and 
this hearing is a great start). The last thing that the airline 
industry wants to happen is for there to be a series of hearings 
regarding how competition is being weakened and destroyed in large 
parts of the airline industry and what steps are going to be taken to 
reverse the situation. Please, Senators, press on!
    2. The Government Accounting Office should be instructed to do a 
number of studies and report to Congress in 6 months about several 
issues of great importance to the public interest. This agency has a 
reputation of largely being above political influence and doing high 
quality studies. One such study should look at the ``trend over the 
last decade in market concentration in large airline hubs.'' I have 
started such a study and it is eye-opening. A second study would 
estimate the cost of slot and other controls stopping entry into 
markets like Washington National, LaGuardia, Newark, O'Hare. The study 
would also estimate the cost of gate controls at airports like 
Cincinnati and Minneapolis.
    3. An investigation should be conducted of whether the Department 
of Transportation and the Department of Justice can and will do their 
jobs to stop the growing monopolization of the airline industry. I 
believe such an investigation would show that many on the staff of 
these committees understand what needs to be done, but that 
administrators are stopping action that needs to be taken to strengthen 
competition. What we continue to get from the D.O.T. and D.O.J. are 
promises they will act to ensure that markets are competitive, but 
nothing happens (more about this later on). Congress should not 
tolerate the failure of these agencies to keep the airline industry as 
competitive as possible.
    In conclusion, I sincerely believe that this committee and Congress 
can make a big difference and stop and reverse the growing 
monopolization of the airline industry. It is important for all 
Americans that you take the necessary steps to reverse the growing 
monopolization of the airline industry and see that competition is 
injected in large regions of the airline industry that are highly 
monopolized at this time. There is a great burden on your shoulders to 
take action to preserve and restore competition in the airline 
industry. I wish you well on the challenging task.
  a short explanation of the monopolization of the atlanta airport by 
                             delta airlines
    I will commence right at home in Atlanta, Georgia and try to 
address the question of how serious the problem is of the growing 
monopolization of airports in large sections of the country. Atlanta is 
indicative of what has been happening in two-thirds of the United 
States. Delta's market share over the last decade has increased from 
around 50 percent to 75 percent of the passengers flying through 
Atlanta (Delta's market share has increased 50 percent over the last 
decade). Given Delta's dominance of this market, it is able to raise 
fares to monopoly levels in Atlanta.
    Is the Atlanta airport large enough to support more airlines? It is 
now ranked the 2nd largest airport in the United States (1st is Chicago 
and 3rd is Dallas), and given the size of the market it could 
economically support much more competition. An Intra-market study I 
completed a month ago shows that Delta either monopolizes or dominates 
(i.e. has from three-fourths to 100 percent of the flights) almost 75 
percent of the cities served from Atlanta. With little or no 
competition on such a high portion of the direct flights, Delta is able 
to charge monopoly fares on a large portion of its flights.
    There are some other major, high-cost and full-service airlines 
that fly a few flights from their hub airports to Delta's Atlanta hub. 
But the major airlines have learned to ``live and let live'' with 
Delta. What ``live and let live'' means is I will keep prices high in 
your hub market if you do the same in my hub market. It is not just a 
question of whether there is competition, but that competition comes 
from low-cost discount airlines that have the cost structure to sell 
day in and day out for less (and not just when they are predating and 
temporarily lowering price to destroy competition). The composition of 
competition is a very important concept that this committee needs to 
understand. What is being discussed is the important difference between 
``intra-type competition'' (i.e. competition between the major high-
cost airlines) and ``inter-type competition'' (i.e. competition between 
the high-cost carriers and the low-cost, discount airlines).
    On a practical basis, is there really a problem with high and 
monopoly fares from Atlanta? I think so and I believe it is huge. 
Studies of Federal government agencies show that fares from Atlanta are 
30-50 percent higher than they are in competitive markets where market 
concentration is low. Are others complaining? The answer is yes. A few 
years ago a large company with headquarters in Atlanta was so upset 
with Delta's high monopoly fares that the company went public with 
instructions to their employees to fly any airline other than Delta 
Airline when at all possible. The problem is that Delta so monopolizes 
the Atlanta market that there are few or no significant alternatives.
    I hear business people repeatedly complaining that it costs $500-
$700 to fly a few hundred miles round-trip from Atlanta and a thousand 
dollars to book a 500-600 mile round-trip flight from Atlanta. Many in 
the business community wish that Delta had more competition, and in 
particular from low-fare competition. There is still further data 
suggesting that Delta charges very high prices to fly to and from 
Atlanta. Last week I learned that the Atlanta Chamber of Commerce has 
recently asked for bids from consulting firms to conduct a study of how 
to increase airline competition in Atlanta in order to reduce airline 
fares. Why would the Atlanta Chamber of Commerce sponsor such a study 
when Delta is such an important factor in the community? The reason is 
that the Chamber realizes that while high fares are good for Delta, 
they hurt air travel to Atlanta and hurt the local economy. Atlanta 
represents just one large city that is concerned about monopoly fares 
being charged in hub cities of the major airlines.
    Consider what I found when I was making reservations to fly to 
Washington for these hearings. I called Delta and asked what the round-
trip fare was to Washington National Airport. Delta's round-trip fare 
from Atlanta to Washington National Airport was $856. Washington 
National is one of the slot control airports so I asked what was the 
fare to fly to Washington Dulles Airport (which is not slot controlled) 
from Atlanta and the round-trip fare quoted was $352. The premium to 
fly to National in comparison to Dulles was 143 percent.
    Given the huge difference in flying to Dulles instead of National, 
I decided to check fares to fly from Atlanta to New York LaGuardia 
(another slot controlled airport) and then to fly from Atlanta to 
Newark, New Jersey. The round-trip fare I was quoted to fly on Delta's 
monopoly route to LaGuardia was $1,106 versus $466 to fly Delta to 
Newark. In this case the fare premium to fly to a slot controlled 
airport was 137 percent. (I verified the fares quoted over the phone 
through Delta's electronic ticketing service. The electronic quotes 
were the same or close. I could provide the committee copies of the 
electronic fare quotes that were printed.) An interesting fact is that 
ValuJet flies from Atlanta to Washington Dulles and Kiwi flies from 
Atlanta to Newark. Before ValuJet flew to Dulles, Delta charged the 
same high fare to fly to Washington National and to Dulles.
 request that three relevant reports i have prepared be made a part of 
                               the record
    Over the last two years I have prepared three reports/studies that 
are relevant to the concerns of this committee regarding issues of 
competition in the airline industry. I request that they be made a part 
of the record. The reports are briefly described below.
    1. The first report was my analysis of D.O.T. Report on ``The Low 
Cost Service Revolution'', April, 1996.
    One of my areas of research has long been discount competition and 
efforts to destroy discount competition. In the introduction to ``The 
Low Cost Service Revolution'' Secretary of Transportation Federico Pena 
stated that the D.O.T. would remain vigilant, watching for and stopping 
predatory pricing. However, that very report documented that the major 
airlines had decreased prices by 40-60 percent in several markets that 
low-cost, discount airlines had entered. Subsequently many of these 
discounters have been driven out of business by predatory pricing. The 
D.O.T. did nothing but stand quietly on the sidelines and watch the 
discounters be destroyed as the major airlines used predatory pricing 
to defend their high-price ``fortress hubs.''
    Indicative of what has happened is a recent article in Business 
Week entitled ``Called Startups Start To Stall'' (Dec. 9, 97, p. 64) 
that stated:
    ``Large carriers are now on the attack as regulators sit passively 
on the sidelines (emphasis added) and stormy times for the smaller 
airlines are not seen as abating soon. Investors and consumers alike 
have been hurt. In early 1995, when Midway Airlines Corp exited the 
Chicago-New York LaGuardia route, the most economical round-trip 7-day 
advance purchase fare climbed from $124 to $1,144 now offered by 
American Airlines and United Airlines.''
    The D.O.T. (with more authority than the D.O.J. to act) has stood 
frozen on the sidelines, while the 100 Pound Gorillas have driven many 
of the start-up, low-cost, discount airlines out of business using 
predatory pricing. The D.O.T. has made other decisions over the years 
that have contributed to the growing monopolization of the airline 
industry by a few large airlines. The D.O.T. agreed to sell airline 
slots to the major airlines in several large and limited capacity 
airports. This decision locked discounters out of these markets where 
the major airlines charge prices 100 percent higher than nearby 
competitive markets. The D.O.T. also permitted Northwest to take over 
Republic, a merger that the D.O.J. opposed. The merger increased 
Northwest's market share of its Minneapolis hub from approximate 50 to 
75 percent of the market. This gave Northwest the monopoly power to 
raise prices above the competitive level. This merger that the D.O.T. 
permitted contributed to Northwest's monopolizing 83 percent of the 
direct served cities from Minneapolis. What the D.O.T. did was to 
create one of the strongest ``fortress hubs'' in the country. Based on 
experience it is hard for me to believe that the D.O.T. will be pro-
consumer today instead of pro-large airlines.
    2. The second statistical study I did early this year was concerned 
with the ``Growing Monopolization Of The United States Commercial 
Airline Business Through The Development And Defense Of Fortress Hubs--
The Atlanta Story.'' Major conclusions of this study include the 
following:
    1. Competition thrived over the years immediately following de-
regulation and several new airlines were formed. A major goal of de-
regulation was achieved.
    2. Over the last 10 years anti-competitive conduct has destroyed 
many airlines and the industry has become increasingly concentrated.
    3. Several large airlines have developed ``fortress hubs'' in large 
cities and have used their monopoly power to raise and maintain prices 
above competitive level.
    4. According to American Express Travel, business fares have soared 
86 percent over the last 5 years. This is due in large part to the 
growing monopoly power of airlines to raise prices above the 
competitive level.
    5. Major airlines use predatory pricing to destroy discount 
airlines which attempt to enter their ``fortress hubs'' so they can 
continue to charge monopoly prices.
    6. Slot and gate control have contributed to monopolization of 
other large airports and markets. High prices in such markets are used 
to subsidize predatory pricing.
    7. The growing monopolization of the airline industry is costing 
the public billions of dollars a year in monopoly fare premiums and 
other monopoly costs. The fare premium in monopoly markets could run 
over ten billion a year.
    8. Government intervention was necessary in the American Airline 
strike since American dominated some large markets and the cost of a 
strike was too high to society. This is just the tip of the iceberg 
since other airlines also dominate critically important markets.
    9. Competition has been ravaged by anti-competitive conduct and the 
closure of markets to competition. Action is needed before monopoly 
powers grow beyond the point of no return.
    10. Actions of the Department of Transportation have contributed to 
growing monopolization of airline industry. Furthermore, the D.O.T. has 
failed to use its authority to stop unfair and anti-competitive 
behavior destroying the industry.
    11. The Department Of Justice also has the authority to take action 
to stop practices contributing to the monopolization of the airline 
industry.
    3. The most recent study I completed a month ago was An Intra-
Market Analysis Of Direct Non-stop Flight For The Major Hubs Of Delta, 
US Airways, and Northwest. This study was part of a report to Mr. Roger 
W. Fones, Chief Transportation, Energy, and Agricultural Section, 
Antitrust Division, U.S. Department Of Justice.
    The letter to Mr. Fones encouraged the D.O.J. to enforce the 
antitrust laws against monopolization and predatory pricing. From 
studying a speech by Mr. Fones regarding predatory pricing in the 
airline industry, I believe that the D.O.J. knows how to proceed. 
However, for some reason the D.O.J., like the D.O.T., talk a good 
story, but does not use its authority to enforce the antitrust laws. I 
do not know for certain, but I get the impression that on his own Mr. 
Fones could lead and win a monopolization and predatory pricing suit 
against some of the major airline industry. The question remains 
whether the Administration will stand up to the large airlines and 
their unions. They represent large political contributions to the 
Administration. A further possibility is that the economists on the 
staff of the D.O.J. are so biased towards the naive Chicago School 
``Theory of Perfect Markets'' that it is hard for this agency to get 
the support of its own industrial organization staff to bring a suit.
    Data from the Intra-market study I did of direct flights from major 
airline hubs is presented below. This data shows the monopoly power 
that the major airlines have in their hub markets that permit them to 
increase prices far above the competitive level. Monopoly market share 
and prices go hand-in-glove together.

       NUMBER DIRECT, NONSTOP, DOMESTIC FLIGHTS, IN 8 HUB MARKETS
------------------------------------------------------------------------
                                   Northwest flights     Other airline
                                 --------------------       flights
            Hub city                                 -------------------
                                   Number    Percent   Number    Percent
------------------------------------------------------------------------
NORTHWEST HUBS:
    Minneapolis.................       480      85.3        83      14.7
    Detroit.....................       488      82.6       103      17.4
    Memphis.....................       221      82.2        48      17.8
US AIRWAYS:
    Charlotte...................       414      92.6        33       7.4
    Pittsburgh..................       456      87.5        65      12.5
    Philadelphia................       303      67.9       143      32.1
DELTA HUBS:
    Cincinnati..................       481      87.5        69      12.5
    Atlanta.....................       787      76.7       239      23.3
------------------------------------------------------------------------

    The above data shows that Delta, US Airways, and Northwest control 
from 77-93 percent of the direct flights in their respective hubs. When 
airlines have such dominance in their hub markets, they are able to 
increase prices to far above the competitive level as several studies 
have shown (GAO, DOT, and my analysis). A 1996 GAO study of several of 
these markets indicates that fares have been increased from 27-88 
percent above the competitive level. However, statistics about the 
market share of passengers (GAO and DOT) only partially explain the 
monopoly pricing occurring in major airline hubs. Monopoly power and 
the ability to charge monopoly prices depends in a large part on 
dominance of routes flown from hub markets as the Intra-market studies 
show.
american's share of direct flight from the dallas international airport
    I did an Intra-market Analysis of direct flights that American has 
from the Dallas International Airport. The analysis showed that 
American dominates this hub airport having 72 percent of the direct 
flights and Delta has 19 percent of the flights. American and Delta 
combined fly 91 percent of the direct flights from the Dallas 
International Airport. Together they dominate the third largest airport 
in the United States. G.A.O. studies show that when one airline has 60 
percent of the flights, or two have 80 percent from a market, they have 
monopoly power to raise prices above the competitive level. What makes 
the situation still worse is that both American and Delta are high-
cost, full-service airlines. They practice ``live and let live'' when 
operating in each other's hub markets and keep prices high.

    Senator Shelby. I want to ask you a basic question because 
this came up in our deliberations on the Wright Amendment and 
so forth. It was argued on one side of the fence that this was 
a local issue and I said this is not a local issue. The Wright 
Amendment affects interstate commerce. Dr. Sterling, do you 
have a comment on that?
    Dr. Sterling. That is exactly what I said in my comments as 
a matter of fact. This is not a Dallas or not a southeast 
issue. It goes to the heart of deregulation. It goes to the 
heart of free competition, free market entry because it is just 
like--this will strike a raw note I know--the tax code. Every 
time we simplify it, what happens? It gets more complex. 
Everybody is looking for a loophole. Once you get something 
like this, then something else comes in like the LaGuardia, et 
cetera.
    I am just dead set against it. If we are going to have true 
competition, it is going to drive prices down and this protects 
prices basically.
    Senator Shelby. We have got to have real competition for 
the American consumer--all of us are consumers----
    Dr. Sterling. That is correct.
    Senator Shelby. [continuing]. To benefit in an era of 
airline deregulation. Is that correct? All of you agree to 
that?
    Dr. Allvine. No question about it.
    Dr. Sterling. The same situation. You go to the trucking 
industry after deregulation. What happened there? The number of 
carriers increased from 18,000 to 36,000 in a short period of 
time and every one of those carriers, except one, was a low-
cost truckload carrier. And what has happened to truckload 
rates? They have gone down significantly. Competition is fierce 
and intense, and there is a good example of how things can go 
right.
    Senator Shelby. Dr. Allvine, was your figure that all these 
impediments that we still have and concentration and everything 
that goes with it is costing the American people about $10 
billion a year?
    Dr. Allvine. I would say that that is a very conservative 
figure.
    Senator Shelby. Conservative figure.
    Dr. Allvine. That the failure of competition throughout 
two-thirds of the country--the DOT talks about the benefits 
through 1995 being $6 billion. They did not look at the other 
two-thirds of the country where, if you had competition 
occurring, we could save the general public in the order of $10 
billion plus a year, Senator.
    Senator Shelby. Thank you.
    Dr. Morrison, in your testimony, you have advocated 
congestion pricing as an alternative to slots. Are there other 
alternatives we should consider if congestion pricing is not 
feasible in the current political environment?
    Dr. Morrison. Yes; the slot system, as I indicated, 
probably does good in the sense of reducing congestion, but 
even within the context of not going to congestion pricing, I 
think the slot system probably could be modified.
    First of all, the question would be is the number of slots 
the right number. Could it be more?
    Second, there is an issue of the partitioning of slots into 
general aviation air carrier, commuter carriers that basically 
ensures that slots go to those who do not value them the most. 
If it was an open market for slots, then they could go to those 
who value them the most.
    Others have advocated--I think GAO and I do not disagree 
with it--moving away from the buy-sell rule where slots are 
more or less property in perpetuity to some kind of a leasing 
system where slots become available all the time for any 
carrier, particularly new entrant carriers.
    Senator Shelby. Dr. Sterling, you probably know off the tip 
of your tongue the exact figure, but I was thinking of a 
competitive price, say from two or three airlines, from 
Birmingham to Houston nonstop was in the range of $300?
    Dr. Sterling. Yes; all four carriers have the same price.
    Senator Shelby. Nonstop from Birmingham to Houston.
    Dr. Sterling. Well, it stops at Dallas and goes through. 
So, you are going to pay more to stop in Dallas than you will--
three times more to stop in Dallas than you will to go on to 
Houston.
    Senator Shelby. Compare the figure. I believe you had a 
figure of $900 more or less.
    Dr. Sterling. $968.
    Senator Shelby. To Dallas? Birmingham to Dallas?
    Dr. Sterling. Yes; Delta, American, Continental, and 
Northwest is $970. This was as of last Friday. Birmingham to 
Houston, all four carriers, Northwest, American, US Air and 
Delta, were $307.
    Senator Shelby. And was one of them a shorter distance? Is 
Dallas closer to Birmingham than Houston?
    Dr. Sterling. Yes; last time I checked the map it was.
    Senator Shelby. OK, but not the price. Right?
    Dr. Sterling. No; both Habe and Intercontinental again--
see, you got two airports.
    Senator Shelby. You got some competition.
    Dr. Sterling. Yes; and even if I want to go to San 
Francisco, it is only $601 through Dallas.
    Senator Shelby. Dr. Sterling, in your view how do 
restrictions on air travel impact the flow of goods and 
services in our country, and what is the end result to our 
customers?
    Dr. Sterling. Well, if we are talking about air freight--
are we talking primarily about air freight now versus passenger 
transportation?
    Senator Shelby. Right, both.
    Dr. Sterling. Air freight is fairly good.
    Senator Shelby. By good, you mean competitive?
    Dr. Sterling. Yes; very competitive because there are a lot 
of freight forwarders. They basically own no assets acting like 
a broker.
    I am on Mark VII's board of directors, one of the largest--
the largest broker of transportation services in the country. 
We do a lot of import support, we do a lot of air freight. And 
the rates there are very, very competitive, both domestically 
and overseas, and that is because of competition again. You 
have got a lot of other carriers who are not also airline 
carriers and you have also got a lot of freight forwarders who 
are trying to get the best deal using different carriers. It is 
a great example of comparing two parts of the same industry and 
seeing a dichotomy.
    Senator Shelby. Dr. Morrison, I have always been taught 
that predatory pricing was illegal.
    Dr. Morrison. Correct.
    Senator Shelby. But we have seen a lot of predatory 
pricing. You have spoken of it.
    Dr. Morrison. I have not spoken of it.
    Senator Shelby. Dr. Allvine.
    Dr. Morrison. I really do not have a view on that. 
Predatory pricing is illegal but it is very, very difficult to 
prove because it is hard to separate the intent to predate from 
the intent to meet competitive price. A new airline enters and 
an incumbent airline lower its price. What should they do? Not 
lower their price? A new carrier exits, a carrier raises its 
price. To one set of eyes that looks like predation. To another 
set of eyes, it looks like meeting the competition.
    Senator Shelby. Dr. Allvine.
    Dr. Allvine. Senator, I think that the head of the 
Transportation Division of the Department of Justice, Mr. F-o-
n-e-s, Fones, just had a speech that he gave on predatory 
pricing in the airline industry, and he explains that there are 
symptoms you can look at that go on here. If the major airlines 
cut their prices and add capacity, the whole question of 
incremental costing is out of the window, and you look at what 
is going on.
    Pressed, I think the Department of Justice in Mr. Fones' 
division could bring major predatory pricing suits. I keep my 
fingers crossed. I hope that they are talking to the Department 
of Transportation and that after long last the DOT in 
combination in consulting with the DOJ is going to do something 
about predatory pricing. Simply lowering prices 50 or 60 
percent, driving the low-cost competitor out, and raising 
prices back is very contrary to the public interest. If you 
look below the surface, you can find the symptom.
    And that is how the fortress hubs like Atlanta, GA, and 
others maintain their monopoly position. They only reduce the 
prices to Mobile, like we are hearing about, which was $700 
before ValuJet started flying it, and then they reduced it to 
$150, and then ValuJet announced they were going to go, and the 
price went up to $600. And then ValuJet came back in and they 
lowered the prices back again. There is a big difference 
between competitive based pricing and predatory pricing.
    Senator Shelby. Market forces will work but they will not 
work unless there is competition, will they?
    Dr. Allvine. When the 700-pound gorillas pounce on small 
airlines that are 1 or 2 or 3 percent--and they focus their 
resources--it is just not a question of if they are going out, 
it is a question of when they are going out of business.
    The DOJ and the DOT have done nothing about predatory 
pricing. As I look at the new wave of discounters that they 
were so proud of in the 1996 report, they are all virtually 
destroyed at this particular point in time because of failure 
of the DOT and the DOJ to stop predatory pricing against true 
low-cost carriers. One-third of the country where it is 
competitive has low-cost competition. The major airlines in the 
large hubs are going to use predatory pricing to try to squash 
any new discounter that dares to enter those cities, Senator.
    Senator Shelby. Senator Bennett.
    Senator Bennett. I have no questions.
    Senator Shelby. Gentlemen, we appreciate you coming. We 
have got another panel. We appreciate your views.
    What some of us are interested in is real competition in 
America. If we are going to talk about market forces working, 
they will not ever work unless there is real competition I 
believe.
    Thank you.
                      DEPARTMENT OF TRANSPORTATION

                        Office of the Secretary

STATEMENT OF PATRICK V. MURPHY, DEPUTY ASSISTANT 
            SECRETARY, AVIATION AND INTERNATIONAL 
            AFFAIRS

                    Federal Aviation Administration

STATEMENT OF JEFF GRIFFITH, PLANNING DIRECTOR, AIR 
            TRAFFIC OPERATIONS

                       Introduction of Witnesses

    Senator Shelby. Our second panel will be Mr. Patrick 
Murphy, the Deputy Assistant Secretary for Aviation and 
International Affairs, U.S. Department of Transportation, and 
Mr. Jeff Griffith, Planning Director, Air Traffic Operations, 
Federal Aviation Administration.
    Secretary Murphy, any statement that you might have written 
will be made part of the record and you can proceed as you 
wish.

                     statement of patrick v. murphy

    Mr. Murphy. Thank you, Mr. Chairman, Senator. Thank you for 
holding this important hearing today.
    In recent months there has been an increasing dialog on the 
economic implications for airline competition caused by 
restrictions at some of our Nation's commercial airports.
    At the outset let me state that airline deregulation, which 
is now 19 years old, has been a success. Airfares are lower. 
Travel has increased substantially. U.S. airlines are 
profitable. Safety has increased. Aircraft noise is decreasing, 
and U.S. airlines are highly competitive in the global 
marketplace. U.S. travelers and communities are well served by 
the deregulated airlines.

                          restricted airports

    Nevertheless, because certain airports that serve major 
cities are restricted, there is a view that airport 
restrictions are preventing the full benefits of deregulation 
from being enjoyed by our citizens and our air carriers.
    Discussions on this topic generally involve five airports. 
They are Chicago O'Hare, New York's Kennedy and LaGuardia, 
Washington National, and Dallas Love Field. These five airports 
are subject to various restrictions which generally fit into 
one or more of three categories. First, slot restrictions on 
how many operations may take place; second, perimeter 
restrictions on how far aircraft my fly; and third, aircraft 
size limitations.
    The Department of Transportation has conducted studies on 
the high density rule and on the Wright Amendment at these 
airports. In 1995, at the direction of Congress, the President, 
and the Airline Commission, the Department completed a study on 
the high density rule which affects Washington, Chicago, and 
New York. We concluded that a change in the high density rule 
would not affect safety. Eliminating the rule is likely to 
result in increased operations at the airports in these cities, 
which in turn would benefit consumers in the form of expanded 
air services and reduction in airfares as a consequence of 
increased competition. These increased operations would lead to 
more revenues for the airports.
    As a result of these increased operations, we also forecast 
increased travel delay and costs due to increased peaking of 
demand. Furthermore, in the short term, there would be 
increased noise impact. However, in the longer term, the 
transition to quieter all stage 3 aircraft would reduce noise 
levels to a point even lower than experienced today.
    We also concluded that since 1968, when the slot rule was 
issued, air traffic control has changed dramatically. 
Implementation over the last 30 years of sophisticated 
technology in traffic management initiatives has enhanced the 
efficiency of the air space system. It is the traffic 
management system today, not the high density slot rule, that 
ensures the safe operation of the air traffic system.

                            wright amendment

    As for our study of the Wright Amendment, this was 
completed by an interdepartmental task force in July 1992. The 
report showed that a change in the Wright Amendment would 
result in more airline service and competition at Love Field. 
This would result in lower fares for Dallas and the south-
central region of the United States. Because of the phasing in 
of stage 3 aircraft, noise impacts would continue to decline 
around Love Field regardless of any action on the Wright 
Amendment. We projected that the Dallas/Fort Worth airport 
would continue to grow under all scenarios that we could 
envision and would remain the dominant airport in the region. 
We also concluded that the amount of additional service that 
can be provided at Love Field would be limited by airspace 
interactions. Aircraft delays at Love Field would become a 
significant problem only if aircraft operations reached the 
level that we consider to be highly unlikely. In any event, we 
concluded that safety would be maintained by FAA-imposed air 
traffic procedures.

                  dot position on airport restrictions

    Following the release of both of these studies, the 
Department made no recommendations to modify or repeal the 
high-density rule or the Wright Amendment. This partially 
reflects the Department's assessment that these decades' old 
airport restrictions have to some extent evolved beyond their 
original intent to control aircraft operations. Environmental 
and regional development concerns emerge each time changes in 
these restrictions are contemplated. We are of the view that it 
is up to Congress and local authorities to decide whether to 
modify these longstanding arrangements.
    We take this position while at the same time recognizing 
that airline deregulation is premised on the concept of open 
competition and the elimination of economic restrictions on the 
airline industry. Several studies done outside DOT have 
demonstrated that slot restrictions lead to higher fares and 
less competition.
    While Congress, through hearings such as today's, evaluates 
these longstanding restrictions, the Department intends to 
exercise its exemption authority to a limited degree to allow 
some additional competition at the high-density airports in 
Chicago and New York.
    We also intend to undertake a study as to how the existing 
slots are utilized at the airports in order to determine 
whether the existing slot rules might be modified. We will, of 
course, report to Congress on our findings.
    With regard to Love Field, we will monitor carefully the 
impact of loosening the Wright Amendment to determine what 
benefits and difficulties might be created.

                           prepared statement

    In conclusion, I would like to thank the committee for 
allowing us to testify today and for examining the important 
topic of restrictions at some of our Nation's most important 
airports.
    [The statement follows:]

                Prepared Statement of Patrick V. Murphy

    Thank you Mr. Chairman, and members of the subcommittee. I 
appreciate the opportunity to discuss the important subject of 
restrictions on commercial air service at airports within the United 
States. In recent months, there has been an increasing dialogue on the 
economic implications for airline competition caused by restrictions at 
some of our Nation's commercial airports.
    At the outset, let me state that there is a nearly unanimous view 
that airline deregulation, which is now 19 years old, has been a 
success. Air fares are lower, travel has increased substantially, U.S. 
Airlines are profitable, safety has increased, aircraft noise is 
decreasing, and U.S. Airlines are highly competitive in the global 
marketplace. U.S. Travelers and communities are well served by a 
deregulated airline industry. Nevertheless, because certain airports 
that serve major cities are restricted, there is a view that airport 
restrictions are preventing the full benefits of deregulation from 
being enjoyed by our citizens and our air carriers.
                          restricted airports
    Discussions on this topic generally involve five airports. They 
are: Chicago O'Hare, New York's Kennedy and LaGuardia, Washington 
National, and Dallas Love Field. These five airports are subject to 
various restrictions which generally fit into one or more of three 
categories. First, slot restrictions on how many operations may take 
place. Second, perimeter restrictions on how far aircraft may fly. And 
third, aircraft size limitations. There are a few other airports which 
have been allowed to impose certain environmental restrictions, but 
they generally are smaller airports and are not viewed by observers of 
the industry as major impediments to airline competition.
    Slot restrictions apply to Chicago O'Hare, New York's LaGuardia and 
Kennedy and Washington National. They were adopted nearly thirty years 
ago in November of 1968 in order to limit daily and hourly operations 
and thereby reduce delays at what were then the Nation's most congested 
airports. The rule which implements these slot restrictions is known as 
the high density rule, and an aircraft or a flight at these airports 
may be operated only if it has a slot for that time period. Beginning 
in 1985, the Department of Transportation has allowed airlines to buy 
and sell their slots in order to permit the most efficient use of these 
limited resources.
    The most recent change affecting the high density rule occurred in 
1994 when the Secretary of Transportation was given authority to grant 
exemptions from the slot rule at Chicago and New York. This authority 
allows operations above the limitations now in effect. The Secretary 
has used this authority very sparingly and until now has only granted 3 
domestic exemption applications at O'Hare and one exemption at Kennedy. 
We now have pending before us 13 exemption applications. We are 
contemplating granting some slot exemptions in the near future in order 
to promote competition.
                            perimeter rules
    In addition to slot limitations, both LaGuardia and National 
Airport are subject to perimeter rules. The perimeter rule at 
Washington National Airport dates back to 1966 when airline operations 
were limited to 650 miles. Over time that limitation became a Federal 
restriction and evolved to 1,000 miles and then to 1,250 miles.\1\ This 
rule was developed to manage air traffic at National Airport, 
especially since Dulles airport had been opened in 1962 and was not 
being fully utilized. At LaGuardia, the current perimeter rule is 
imposed by local authorities and dates back to 1984. It currently 
limits aircraft operations to 1,500 miles.\2\
---------------------------------------------------------------------------
    \1\ At National both the limit on slots and the perimeter rule were 
set by Congress in 1984.
    \2\ Both National and LaGuardia also have aircraft size limits due 
to their small size.
---------------------------------------------------------------------------
                            wright amendment
    Dallas Love Field operates under a separate set of Federal 
restrictions commonly referred to as the Wright Amendment. This 
legislation limited operations at Dallas Love Field beginning in 1980. 
The legislation prohibited both non-stop and through air service with 
large aircraft between Dallas Love Field and cities other than those 
located in Texas, Arkansas, Louisiana, New Mexico and Oklahoma.\3\ As 
you know, very recently Congress has taken action to loosen this 
restriction to allow air service to three more states--Alabama, 
Mississippi, and Kansas. Like the perimeter rule at Washington 
National, this restriction was imposed at Dallas in order to assist the 
development of a newer airport. Dallas/Ft. Worth International Airport 
opened in 1974, and the Wright Amendment came five years later. The 
restriction was consistent with an agreement between the cities of 
Dallas and Fort Worth.
---------------------------------------------------------------------------
    \3\ Small aircraft of 56 seats or less were allowed to operate 
beyond these five states.
---------------------------------------------------------------------------
                   dot study of airport restrictions
    The Department of Transportation has conducted studies on the high 
density rule and on the Wright Amendment. In 1995, at the direction of 
Congress, the President, and the Airline Commission, the Department 
completed a study on the high density rule. We concluded that a change 
in the high density rule would not affect safety. Eliminating the rule 
is likely to result in increased operations at these airports, which in 
turn would benefit consumers in the form of expanded air services and 
reductions in air fares as a consequence of increased competition. 
These increased operations would lead to more revenues for the 
airports. As a result of these increased operations, we also forecast 
increased travel delay time and costs due to increased peaking of 
demand. Furthermore, in the short term there would be an increased 
noise impact; however, in the longer term, the transition to quieter 
all stage 3 aircraft would reduce noise levels to a point lower than 
experienced today.
    We also concluded that since 1968 when the slot rule was issued, 
air traffic control has changed dramatically. The implementation over 
the last 30 years of sophisticated technology in traffic management 
initiatives has enhanced the efficiency of the air space system. It is 
the traffic management system, not the high density rule, that ensures 
the safe operation of the air traffic control system.
    As for our study of the Wright Amendment, this was completed by an 
interdepartmental task force in July 1992. The report showed that a 
change in the Wright Amendment would result in more airline service and 
competition at Love Field. This would result in lower fares for Dallas 
and the south central region of the United States. Because of the 
phasing in of stage 3 aircraft, noise impacts would continue to decline 
around Love Field regardless of any action on the Wright Amendment. We 
projected that Dallas/Ft. Worth airport would continue to grow under 
all scenarios that we could envision, and would remain the dominant 
airport in the region. We also concluded that the amount of additional 
service that can be provided at Love Field would be limited by air 
space interactions. Aircraft delays at Love Field would become a 
significant problem only if aircraft operations reached a level that 
can be considered unlikely. In any event, we concluded that safety 
would be maintained by FAA-imposed air traffic procedures.
                  dot position on airport restrictions
    Following the release of both of these studies the Department made 
no recommendations to modify or repeal the high density rule or the 
Wright Amendment. This partially reflects the Department's assessment 
that these decades old airport restrictions have to some extent evolved 
beyond their original intent to control aircraft operations. 
Environmental and regional development concerns emerge each time 
changes to these restrictions are contemplated. We are of the view that 
it is up to Congress and local authorities to decide whether to modify 
these long-standing arrangements.
    We take this position while at the same time recognizing that 
airline deregulation is premised on the concept of open competition and 
the elimination of economic restrictions on the airline industry. 
Several studies done outside DOT have demonstrated that the slot 
restrictions lead to higher fares and less competition.
    While Congress, through hearings such as today's, evaluates these 
long standing restrictions, the Department intends to exercise its 
exemption authority to a limited degree to allow some additional 
competition at the high density airports. We also intend to undertake a 
study as to how the existing slots are being utilized at the airports 
in order to determine whether the existing slot rules might be 
modified. We will, of course, report to Congress on our findings. With 
regard to Love Field, we would monitor carefully the impact of 
loosening of the Wright Amendment to determine what benefits and 
difficulties might be created.
    In conclusion, I would like to thank the committee for allowing us 
to testify today and for examining the important topic of restrictions 
at some of our Nation's most important airports.

    Senator Shelby. Thank you, Mr. Secretary.
    Next panelist, Mr. Jeff Griffith, Planning Director, Air 
Traffic Operations, Federal Aviation Administration.
    Mr. Griffith. Yes, sir; good afternoon, Mr. Chairman.
    Senator Shelby. We thank you for coming.
    Mr. Griffith. You are welcome.
    Senator Shelby. Any statement you want to make, you 
proceed.
    Mr. Griffith. Mr. Chairman, I have not prepared a 
statement, but I am here to answer any questions that the 
committee may have regarding air traffic.
    Senator Shelby. At this point I would like to recognize the 
senior Senator from Washington, Senator Gorton, who is the 
chairman of the authorizing subcommittee on aviation, but he is 
also a member of this committee. He comes with a lot of 
experience and knowledge. Senator Gorton, we appreciate you 
being here.
    Senator Gorton. Thank you, Mr. Chairman. I appreciate your 
delving even more deeply into this issue because it is an issue 
that involves a wide range of issues of free competition, of 
justified or unjustified expectations. It has transportation-
related issues in connection with it. It has passenger 
convenience and choice issues related to it that is a most 
important issue.
    I am sorry that I am in on the middle of the hearing, so I 
prefer to hear what questions you have to offer and to read the 
testimony of the witnesses.

                          airspace management

    Senator Shelby. Thank you, Senator.
    Mr. Griffith, it is my understanding that the Federal 
Aviation Administration's primary mission is to provide a safe 
air transportation system in the United States. Do you share 
that view?
    Mr. Griffith. Yes, sir, Mr. Chairman, I do.
    Senator Shelby. Does the Federal Aviation Administration 
allow an unsafe airspace management situation to develop or to 
exist once it has been identified?
    Mr. Griffith. No, sir, Mr. Chairman. The Federal Aviation 
Administration does not.
    Senator Shelby. Is there anywhere in the United States 
today that unsafe airspace management exists that you know of?
    Mr. Griffith. No, sir.
    Senator Shelby. Which of the following airports or airspace 
management areas present the most complex air traffic 
management challenges such as Atlanta, Boston, Chicago, Dallas, 
Denver, San Francisco, Los Angeles, Miami, Minneapolis, New 
York, New Jersey, Salt Lake City, Seattle, and the Washington 
capital area? Do any of those areas present a more complex air 
traffic management challenge than others?
    Mr. Griffith. Mr. Chairman, all the locations that you have 
named are busy locations.
    Senator Shelby. Are they well managed?
    Mr. Griffith. Yes, sir; they are.
    Senator Shelby. Do you feel comfortable with them as far as 
safety is concerned?
    Mr. Griffith. Yes, sir; I do.
    Senator Shelby. I know you are giving this off the top of 
your head, but would you provide that assessment for the record 
and for the benefit of this committee as well as Senator 
Gorton's committee?
    Mr. Griffith. Mr. Chairman, in each one of those locations, 
they all have unique complexities. I have worked at three of 
those locations. I worked as the manager at Minneapolis and 
Chicago O'Hare.
    For the record, it would be best for me to take that back 
and look at each one of those locations based on procedures and 
airspace alignment and then provide that information for you.

                economic impact of airport restrictions

    Senator Shelby. Thank you. That would be very helpful to 
us.
    Secretary Murphy, many people believe that restrictions on 
the capacity or operations at individual airports translate 
into higher fares for consumers that are utilizing these 
airports or competitor airports. Do you share that view?
    Mr. Murphy. Absolutely, yes, sir; we do. Our studies --
    Senator Shelby. In other words, these impediments we have 
been talking about and the economists talked about earlier are 
impediments to competition in America, are they not?
    Mr. Murphy. Yes; they are. Some of the numbers that we have 
found--the slot rule creates, we believe, fare premiums in the 
neighborhood of 20 percent at O'Hare, 35 percent at LaGuardia, 
and as high as 45 percent at Washington National. We also found 
that the Wright Amendment was costing in the neighborhood of 
$200 million in higher airfares in the Dallas metroplex region. 
So, we think that these restrictions have large impacts.
    Senator Shelby. Why are these restrictions so difficult to 
act on or to change if they appear, as I believe and you do, 
that they would be in the public interest to change?
    Mr. Murphy. Mr. Chairman, some of these restrictions go 
back almost 30 years. I believe that the metropolitan areas 
where you find these restrictions have come to rely on them for 
reasons of local development and noise control, and so we can 
talk about it today as an economic issue. But those other 
issues quickly come to the fore and we get involved with the 
local officials in those issues.
    Senator Shelby. Secretary Murphy, do you have any concerns 
about the impact of piecemeal restrictions on individual 
airports on the capacity or the integrity of the national 
airport system? In other words, we have deregulation per se in 
America. Yet, we have these impediments that we have been 
discussing here today.
    Mr. Murphy. Well, these impediments have economic 
consequences that ripple throughout the entire system. So, yes, 
we have a concern from a national standpoint about that.
    Senator Shelby. You have heard the testimony of the first 
panel. Do you agree or disagree with the thrust of the 
testimony of the experts that we have just heard from?
    Mr. Murphy. I do not disagree with the thrust with regard 
to these restrictions. I must say I think that Dr. Allvine and 
Dr. Sterling went further than we would at the Department with 
criticisms of airline deregulation. There are some problems, 
but we do not think there is a fundamental failure with airline 
deregulation as was almost suggested. We think there are 
problems that we need to continue to work on, however.

       fares at airports with capacity or operating restrictions

    Senator Shelby. The Department that you are involved with 
has done a great deal of work on comparing fares between city 
pairs. What conclusions would you draw about the pricing 
behavior at airports with capacity or operating restrictions, 
and what conclusions would you draw about airports where the 
traffic is dominated by one carrier, which we have at times?
    Mr. Murphy. We have found, when both of those are present, 
when you have airport restrictions or when you have domination 
by a single carrier, you are going to have significantly higher 
fares. As I mentioned earlier, GAO has some numbers for the 
airports that are slot controlled. We also found that at Dallas 
there is a premium being paid at that airport because of the 
domination by one or two carriers in the neighborhood of 20 
percent higher fares in Dallas than we would expect to find if 
it were a more competitive situation.

                  safety in the dfw airport metroplex

    Senator Shelby. Secretary Murphy, you noted in your 
testimony and I believe you referenced a DOT study which 
concluded that if the Wright Amendment was repealed, safety 
would be maintained by the FAA-imposed air traffic procedure in 
the Dallas/Fort Worth airport metroplex. Mr. Griffith is also 
an expert in that area.
    Do you believe that there will be any problem with safety 
with FAA riding herd on it?
    Mr. Murphy. Absolutely none, Mr. Chairman. We ran computer 
models. We worked closely with the FAA when we did our study on 
the Wright Amendment.
    Senator Shelby. Was that study completed before the 
airspace in the Dallas/Forth Worth metroplex was reconfigured 
substantially----
    Mr. Murphy. That was completed even before the reconfigured 
airspace. With the reconfigured airspace, I expect the results 
or the benefits could be even greater from a repeal of the 
Wright Amendment.

                 dot study of slot-controlled airports

    Senator Shelby. OK.
    Secretary Murphy, you also indicated in your testimony that 
the Department of Transportation will undertake a study to 
determine how the existing slots at the four slot-controlled 
airports are being utilized and how they should be modified, if 
at all. When do you expect this study will be completed? Can 
you give us any indication of that?
    Mr. Murphy. I really cannot, Mr. Chairman. We have just 
begun that.
    Senator Shelby. Just begun it.
    Mr. Murphy. I might mention, however, there are several 
bills that I have begun to see in the Congress that are being 
drafted that go to this issue as well and would have the 
Department redistribute some of these slots in the near term.
    Senator Shelby. OK.
    Secretary Gorton. Secretary. I promoted, did I not? 
[Laughter.]
    Senator Shelby. Senator Gorton. Excuse me.
    Senator Gorton. Thank you, Mr. Chairman. I am just here to 
listen.

                  dot's efforts to enhance competition

    Senator Shelby. OK.
    Where we have the concentration, other than dealing with 
slots and so forth, how do we bring competition?
    Mr. Murphy. We in the Department in the last year, Mr. 
Chairman, have been looking to take four actions.
    One, we have begun to make available to civic officials and 
to the public more information on airfares. When civic 
officials see that the fares are substantially different in 
their city than in some neighboring city because there is less 
competition, we have found they will go right to the airlines 
and make an issue of this, and we think that is helpful.
    Second, we have begun some rulemaking with regard to 
computer reservation systems. We know the large carriers can 
use their computers to their advantage. We want to make sure 
those systems remain competitive.
    Third, we are looking at exemptions from the slot rule.
    And fourth, we are looking to develop guidelines for what 
would be appropriate forms of competition so that the smaller 
carriers and the larger carriers will have some idea of what 
the ground rules are for competition, especially at these large 
dominated hubs.
    Senator Shelby. I want to thank all the witnesses, the 
first panel and the second panel, for your time and your 
thoughts today. This is very important. The committee 
appreciates your candor and the effort that went into your 
preparation for this hearing. You certainly have given us a 
great deal of food for thought, and you have helped make a very 
complex area of the aviation industry a little bit more clear.

                     Additional committee questions

    We realize this is just the beginning of this. As I said 
earlier, the other committee that Senator Gorton chairs has 
legislative jurisdiction of this, but we on the Transportation 
Appropriations Committee are very interested in competition, 
how it affects American people. As one of the first panelists 
testified--I believe Dr. Allvine--that $10 billion is 
conservative what it is costing the American consumers, it is 
time Congress stepped into this I believe to make competition a 
reality in America.
    [The following questions were not asked at the hearing, but 
were submitted to the Department for response subsequent to the 
hearing:]

                 Questions Submitted by Senator Shelby

                             airport slots
    Question. Carriers were grandfathered slots at LaGuardia, National, 
O'Hare, and Kennedy at no cost. As a result, those carriers may use the 
slots forever, and can sell them or lease them and keep the funds they 
receive for those transactions. Is that accurate? The GAO has stated 
that slots are not readily available for purchase in small numbers. Do 
you agree? Haven't most slot transactions been part of larger deals?
    Answer. Carriers were initially awarded at no cost the slots they 
held on December 16, 1985, subject to the proviso that slots could be 
withdrawn based on a lottery number assigned to each slot for use in 
essential air service and international service and for other purposes. 
Also, there was a one-time withdrawal of slots for new entrants. The 
original slot holders were free to buy, sell, trade, or lease the 
remaining numbered slots to others. It is our understanding that today 
there are very few carriers willing to sell slots, although leases are 
offered, particularly at LaGuardia, and many are for terms of several 
years. It is also true as you note that the majority of slot 
transactions in the past have been part of larger transactions.
    Question. In 1980, Secretary Goldschmidt withdrew slots from 
incumbent carriers and provided them to New York Air to start a shuttle 
operation. Since that date, has any Secretary taken similar steps to 
provide slots to new entrants? Would you agree that the Secretary has 
the authority to withdraw slots from incumbents and to reallocate them 
to new entrants?
    Answer. Secretary Goldschmidt's action took place in the era of 
scheduling committees, before the buy/sell rules were established in 
1985. During that time there were no use-or-lose rules and carriers 
typically held some slots that they were not using. Secretary 
Goldschmidt directed the committees to provide slots to New York Air. 
When the buy/sell rule was established in 1985, there was an initial, 
one-time withdrawal of slots for distribution to new entrants through a 
lottery. Other than that one-time withdrawal, provided for in the rule, 
there have been no other redistributions strictly for domestic new 
entrants. Slots have been taken for essential air service and 
international service as provided for in the buy/sell rule, although 
Congress has statutorily restricted this authority at Chicago O'Hare 
Airport. We agree that the Secretary has authority to redistribute 
slots, but under the existing rules he cannot do so, and a revision of 
the existing rules through the public rulemaking process would be 
necessary.
    Question. What percentage of slots do new entrants hold at high 
density airports? Since 1988, how many new entrants have obtained high 
density slots? Is it true that foreign carriers hold approximately 2-3 
times more slots than new entrants?
    Answer. Since the start of the buy/sell rule in 1986, the following 
U.S. new entrant carriers obtained slots or limited incumbent carriers 
increased slots at the following airports:


                  Airline                              Airport

Air Wisconsin.............................  National.
AirCal....................................  O'Hare.
America West..............................  National, Kennedy,
                                             LaGuardia.
Braniff Airways...........................  National, LaGuardia, O'Hare.
Carnival..................................  Kennedy, LaGuardia.
Frontier Airlines (old)...................  LaGuardia, O'Hare.
Jet America...............................  National.
McClain Airlines..........................  O'Hare.
MGM Grand Air.............................  Kennedy.
Midway/Jet Express........................  National, LaGuardia.
Midwest Express...........................  National, LaGuardia, O'Hare.
Pan American (new)........................  Kennedy.
Presidential Airways......................  National, Kennedy,
                                             LaGuardia.
Private Jet/National Air..................  LaGuardia.
Sun Country...............................  O'Hare.
Sunbird Airways...........................  LaGuardia.
Tower.....................................  Kennedy.
Trump Shuttle.............................  National, LaGuardia.
UltraAir..................................  LaGuardia.
USAir Shuttle.............................  National, LaGuardia.
ValuJet...................................  LaGuardia.
Western Airlines..........................  National, LaGuardia.
World Airways.............................  LaGuardia.
Atlantic Coast............................  National, Kennedy,
                                             LaGuardia.
Colgan....................................  LaGuardia.
Comair....................................  LaGuardia.
Trans World Express.......................  National, Kennedy,
                                             LaGuardia.
Trans States Airlines.....................  National, Kennedy, O'Hare.


    Data on the markets that were served by these carriers using these 
slots are not readily available. Certain transactions involving 
commuter carriers, complex slot arrangements, or situations where there 
was a doubt about a carrier's inclusion in the new entrant or limited 
incumbent category have been omitted.
    Based on the above list of carriers, new entrants and limited 
incumbents are estimated to have operated six to eight percent of the 
total domestic slots at high density airports in early 1997. (If only 
recent low-fare new entrants were counted, this percentage would be 
less than one percent.)
    A comparison of new entrant slots with foreign carrier slots is 
somewhat misleading since foreign carriers generally hold slots in a 
different manner than U.S. airlines. Some foreign carriers may have an 
arrival and a departure slot on Monday, Wednesday and Friday only while 
a U.S. carrier would have one arrival and one departure slot which 
would be effective for all seven days of the week. Moreover, there are 
virtually no foreign operations at LaGuardia or National.
    Question. In 1997, how many requests for slots were submitted to 
DOT? How many have you acted upon?
    Answer. During 1997 we received requests from 4 airlines for 
exemptions from the high density rule for O'Hare service, from 7 
airlines for slot exemptions for LaGuardia, and exemption requests from 
one airline each at JFK and Washington National. We are within one week 
of acting on nearly all of the outstanding requests, including two that 
we received prior to 1997.
    Question. For a carrier proposing to serve a high density airport 
from a small/medium market, what options does that carrier have to 
obtain slots?
    Answer. There are many small and medium sized communities getting 
service to high density airports, but the service is invariably 
provided by a code sharing affiliate of a large incumbent airline at 
the high density airport. Currently, unaffiliated carriers have 
virtually no realistic opportunity to purchase slots, but leases are 
sometimes available.
    Question. In an August 1990 report, the General Accounting Office 
suggested that several options could open up the slot market and 
promote new entry. In its October 1996 report, GAO again stated that 
little new entry has taken place at the high density airports. What 
actions has DOT taken since 1990 to implement the recommendations made 
by GAO that would increase competition?
    Answer. Using legislative authority granted by Congress, the 
Department has adopted a policy to create access for new entrant 
carriers to slot controlled airports by granting exemptions to the slot 
rule. As already noted, we will act on most of the outstanding requests 
for slot exemptions. It is always possible to change the rules of the 
slot allocation system. Various concepts have been studied such as 
eliminating the slot rule altogether. This is an option that needs to 
be reviewed periodically. GAO's 1990 suggestion to convert slots to a 
lease system is another possibility. Every approach has drawbacks 
affecting carriers and communities.
    Question. In the 1996 report, GAO stated that allowing carriers to 
buy and sell slots would reduce competition. They then stated that the 
large carriers have increased their control over slots. Do you agree 
that large carriers now control a larger percentage of slots than 
before the buy-sell rule was implemented?
    Answer. Yes. FAA data show that the large carriers have increased 
their control of slots since the buy-sell rule was established.
    Question. Doesn't a deregulated environment envision open markets? 
Can you have true deregulation when some of the nation's most important 
business markets are closed?
    Answer. It would be far better for open competition if we did not 
have slot controlled airports. They exist because in the past the 
demand for service to important cities exceeded the capacity of 
specific airports to accommodate that demand without significant 
delays. Congress has recognized that these restrictions have evolved 
beyond their original intent to limit delays and any attempts to change 
these restrictions today invariably raise environmental and regional 
development issues.
             uneven distribution of deregulation's benefits
    Question. In its 1996 report, GAO stated that although deregulation 
has spurred new entry and intense competition in many domestic markets, 
the full benefits of deregulation have yet to be realized because of 
problems with access to certain airports and the cumulative effect of 
certain marketing strategies employed by established airlines. Do you 
agree with that statement?
    Answer. The GAO report recognized that some marketing strategies, 
such as frequent flyer programs and code sharing, have had negative 
effects for competing carriers that cannot use these strategies 
effectively. On the other hand, these practices have consumer benefits. 
Given this qualification, we generally agree with the GAO statement. In 
addition, the Department believes that more direct unfair competitive 
activities may be impeding the spread of deregulation's benefits, 
particularly in the local markets involving hub airports dominated by a 
major network carrier.
    Question. What parts of the country have yet to realize the full 
benefits of deregulation?
    Answer. We believe most regions of the country have received some 
benefits from deregulation, if not from lower average fares, then from 
more frequent, better-timed service. Some have benefited much more than 
others. The benefits from deregulation are greatest where competition 
has flourished. In general, markets in the west and across the south 
have done the best, particularly from the point of view of lower 
average fares. That leaves Appalachia, the northeast and upper midwest 
as having the least fare benefits.
                        ticket pricing practices
    Question. When Mr. Hunnicutt testified before the Commence 
Committee, he stated that he has seen evidence of predatory behavior on 
the part of the large carriers. He went on to state that the Department 
would continue its review. What is the status of the review?
    Answer. We continue to view certain actions we have seen by some 
major airlines as crossing the line from vigorous to unfair 
competition, but until recently have not felt we had an analytical 
framework to adequately define illegal behavior. After a thorough 
review of this behavior, we now believe we have developed such a 
framework and we are preparing a policy statement that will describe 
the behavior that we believe clearly crosses the line. We have analyzed 
instances where we now believe unfair competitive behavior has taken 
place including one instance where detailed company records were 
analyzed to gain a fuller understanding of how and why such behavior 
occurs. We have been receiving informal complaints for several years, 
but have used informal methods to try to deal with the problem. With 
our policy statement we hope to move to a more formal approach. We plan 
to apply any new policy on a prospective basis.
    Question. Are you familiar with the situation that occurred in 
Mobile, Alabama when Valujet announced it was pulling out, and the 
subsequent action taken by Delta Airlines to increase prices? What 
actions can DOT take to ensure that other communities are not faced 
with pricing actions that drive competitors out, and then prices are 
raised?
    Answer. We are familiar with the Mobile case and have received 
numerous other complaints from new entrant carriers of similar 
anticompetitive activity at other cities around the country. We believe 
the Department has the legal authority to deal with anticompetitive 
behavior and plan to issue a policy statement defining what behavior is 
illegal, which will give us the predicate for taking enforcement action 
against unfair exclusionary behavior.
    Question. Do you agree that airfares have increased significantly 
this year? Do you agree that those hit hardest by those increases are 
those living in small and medium communities?
    Answer. The data do not show that air fares have on average 
increased this year. For example, the average domestic fare per mile 
for the major U.S. airlines was down 0.6 percent for the 12 months 
ended September 1997 compared to the same period a year earlier. If 
adjusted for inflation, the decline would be even greater. While fares 
on average are going down, there are other trends behind those averages 
that are moving in different directions. We have read a great deal in 
the press about business fares going up, which we assume is accurate. 
Going in the opposite direction, we know in markets where low-fare new 
entry occurs, fares go down dramatically. However, the data needed to 
assess fares by city size beyond the first quarter of 1997 will not be 
available for some time, so we cannot confirm that small and medium 
communities have experienced a different trend in average fares this 
year than larger cities.
                      new entries and market share
    Question. A recent Solomon Brothers report stated that market share 
analysis shows that at the 50 largest U.S. airports there is ``an 
unprecedented degree of concentration in the airline industry''. Do you 
agree? What steps is the Department taking to address this factor?
    Answer. It has been our experience that measures of national 
concentration do not provide a very useful tool in explaining industry 
pricing or service performance. For example, the Solomon Brothers study 
showed that industry concentration in the top 50 airports actually 
reached its peak in 1992 and has gone down since. Yet, thanks to fare 
wars, 1992 was a banner year for low fares and high traffic. Although 
concentration at hubs is part of the story, it can be very misleading. 
The most concentrated airport in the Solomon Brothers study is Dallas 
Love Field, which has had a single major carrier operating there since 
1988. But because the carrier is Southwest Airlines, fares are very low 
there. In contrast, the Solomon Brothers study lists Buffalo as a 
relatively unconcentrated airport, yet it has some of the highest fares 
in the country as shown in our quarterly fare report. Why? Because, 
although it is served by seven different airlines, it is served almost 
exclusively to hub airports dominated by a single network carrier, and 
has service by only one low-fare carrier to one Florida market.
    It is the Department's view that the growth of low fare competition 
holds the key to the regional high fare problem. The Department has 
taken a series of actions to help competition from new low fare 
carriers, including Computer Reservation System rule changes, the award 
of slot exemptions, public information activities like our Consumer 
Fare Report to highlight where competition is needed, and the 
development of a competition policy statement that will help to prevent 
anticompetitive actions by the large carriers against new entrants.
    Question. How important is competition and new entry to holding 
down fares?
    Answer. The Department's studies show that competition from low-
fare airlines and new entry is the most important discipline on fares 
in today's U.S. domestic airline industry, especially in short- to 
medium-haul markets. For example, in a 1996 study of low fare airline 
service, we estimated that consumers save $6.3 billion per year due to 
competition from these low-fare airlines and that virtually all the 
domestic traffic growth in recent years is attributable to the spread 
of low-fare service competition. The study also found that, at network 
hub cities where low-cost carriers do not compete, fare premiums are 
quite high and are increasing.
    Question. How many carriers are in the pipeline? Is the number of 
new carriers sufficient to foster new competition?
    Answer. As of October 21, 1997, there were no applications for new 
scheduled jet service. Only one low fare new entrant has started 
operations over the past 16 months. It goes without saying that more 
new entry as well as the expansion of service from existing low-fare 
carriers is needed.
              wright amendment/dallas-fort worth metroplex
    Question. In a number of studies, DOT has stated that consumers in 
the Dallas area would benefit from relaxation of the Wright Amendment. 
Am I correct in stating that consumers in markets added to Love Field 
would also benefit from the Wright Amendment's relaxation?
    Answer. In our July 1992 report entitled ``Analysis of the Impact 
of Changes to the Wright Amendment,'' we stated that a change to the 
Wright Amendment would result in more service, more competition, lower 
fares, and more traffic for the Dallas-Fort Worth Metroplex and the 
region. We also went on to say that travelers (consumers) to or from 
the Metroplex region would save an estimated $183 million per year in 
airfares. Thus, you are correct that consumers in markets added to Love 
Field would benefit from the Wright Amendment's relaxation in our view.
    Question. Has concentration at DFW increased over the past several 
years? According to the Solomon Brothers report, DFW is one of the most 
concentrated large hubs in the U.S. Is that correct? Have fares also 
continued to increase at DFW?
    Answer. As is shown in the Solomon Brothers report, which uses DOT 
data, concentration at DFW has gone up in the past several years. The 
Solomon Brothers report lists DFW as the 15th most concentrated airport 
in the top 50 U.S. airports. Our data do not show that average fares 
have increased significantly at DFW. However, in city-pair markets 
involving DFW where new low-fare competition has appeared, fares are 
generally down significantly.
    Question. Has the Department received complaints about anti-
competitive behavior on the part of American Airlines from carriers 
operating at DFW?
    Answer. Yes. It has been our policy to investigate such complaints 
informally, and we have not publicly discussed the details of such 
allegations. Separately, we are developing a formal airline competition 
policy, which, when adopted, will create a formal basis for 
investigating such complaints and taking enforcement action.
    Question. Do you consider O'Hare to be a major international 
gateway? Isn't there a significant number of domestic flights at Midway 
Airport? How close is Midway to O'Hare? As close as Love Field is to 
DFW? Has Southwest or any of the other carriers hurt the international 
growth at O'Hare? Is DFW increasing its international activity?
    Answer. O'Hare is a major international gateway. Midway has over 60 
thousand flights per year, a significant number. Based on the 
geographic centers of the airports, Dallas-Fort Worth is 10.1 nautical 
miles from Dallas Love Field and Chicago O'Hare is 13.5 nautical miles 
from Midway Airport. There is no reason to believe that Southwest or 
other carriers are impeding international growth at O'Hare. 
International flights out of DFW are growing.
    Question. Won't DFW likely control over 80 percent of the traffic 
and passengers in the Dallas area, no matter what happens with the 
Wright Amendment?
    Answer. Yes, DFW will likely continue to control over 80 percent of 
the traffic and passengers, because it is a major hub and because Love 
Field has many constraints on expansion. In 1992, the Department 
released a report titled ``Analysis of the Impact of Changes to the 
Wright Amendment'' that was prepared by an interdepartmental task 
force. That report showed that, assuming the Wright Amendment were 
repealed and then only if a carrier established a major origin and 
destination base or a major hub at Love Field, would DFW account for 
less than 80 percent of total operations at the two airports. The 
report also showed that landside constraints (adjacent industrial and 
residential development, limited road access, deed-restricted 
concourses, inadequate gates requiring major reconstruction) would need 
to be overcome before Love Field could significantly increase its share 
of operations and passengers.
    Question. In 1996, the FAA implemented a new DFW Metroplex Air 
Traffic System Plan. Didn't this plan dramatically increase capacity at 
all DFW area airports? Will it reduce delays and improve on-time 
service at all DFW area airports?
    Answer. Yes, the DFW Metroplex Plan has increased capacity at all 
DFW area airports, particularly on the airside. The Plan provides 
additional, more efficient arrival routes and redundant and better 
radar coverage. Airspace delays, which occurred about 13 times per day 
at DFW, have been reduced. Airspace delays that do occur are typically 
caused by inclement weather. Groundside delays, however, have increased 
slightly.
    The Metroplex Plan has provided only limited increased capacity at 
Love Field. Love Field has parallel dependent runways--simultaneous 
instrument approaches are not permitted--when demand exceeds 36 VFR or 
24 IFR arrivals per hour, traffic management restrictions may be 
implemented. During the peak times of 7-8 a.m., 11 a.m.-1 
p.m., and 4-7 p.m., increased capacity at Love Field is 
limited because it shares the airspace with DFW.
    Question. Is DFW Airport continuing to grow? Are additional runways 
planned? How will this growth impact airspace in the area? What type of 
delays are currently reported at DFW?
    Answer. Yes, DFW is continuing to grow. The FAA forecasts 
operations to grow at an annual rate of 3.1 percent between 1997 and 
2010 and enplanements to grow at an annual rate of 4.1 percent over the 
same period.
    The current airport layout plan for DFW includes an additional 
runway, a north-south parallel runway located on the west side of the 
airport. It would be the eighth runway and allow DFW to accommodate 
quadruple simultaneous IFR arrivals.
    The DFW Metroplex Air Traffic System Plan was brought on-line in 
October 1996. That plan took into consideration forecast aircraft 
operations at all airports in the Dallas/Fort Worth metropolitan area. 
The plan also assumed the construction of two new runways at DFW. One 
runway (17L/35R) was opened on October 1, 1996. The second runway is 
expected to be constructed in the future. The new Metroplex Air Traffic 
System was developed to accommodate the forecast increase in aircraft 
operations and expansion of DFW.
    Estimated delays at DFW were approximately 1.06 minutes per 
operation for 1997. This is up slightly from 1996, when delays were 
1.02 minutes per operation. This increase can be attributed to severe 
weather and ground delays (e.g., lack of available gates, delays in 
taxiing across active runways).
    Question. What happens at an airport where there are too many 
flights scheduled? Do you just let them take off, or do you use flow 
control to limit the number of operations in any specific period of 
time? Therefore, is it fair to say that the FAA can safely handle 
aircraft traffic regardless of the number of operations scheduled?
    Answer. No matter how many flights are scheduled at an airport, the 
FAA, through Air Traffic Control (ATC), limits the number of operations 
to those it can safely control. Techniques such as flow control, 
metering, adjusting arrival and departure routes (heading and 
altitude), and utilizing different runways are used by ATC to manage 
operations. Aircraft delays could occur, but under all conditions, the 
FAA ensures the safety of all operations.
    Question. From an ATC perspective, is there a difference in 
handling a turboprop or small jet?
    Answer. At DFW, the answer is yes, although both large commercial 
airplanes and smaller general aviation aircraft are provided equal 
access. Air traffic controllers in the DFW Metroplex System Plan 
separate jets, turboprops, and propeller-driven airplanes into three 
structures. Because of their varied operating performances, each 
category may be given a different runway and different routes or 
headings and different altitudes both for arrivals and departures. This 
system increases the number of aircraft that the controllers can 
manage.
    Question. Does flight peaking at hub airports place a strain on the 
air traffic system?
    Answer. Yes. Under the hub and spoke system, many airplanes arrive 
and depart at the same time, placing a strain on the air traffic 
system. As a result, aircraft delays could occur, but the safety of all 
operations is never compromised. The various elements of the DFW 
Metroplex Plan have reduced some of this strain.

                          subcommittee recess

    Senator Shelby. The subcommittee will recess until March 5, 
1998 at 10 a.m.
    [Whereupon, at 3:08 p.m., Tuesday, October 21, the 
subcommittee was recessed, to reconvene subject to the call of 
the Chair.]



                    BARRIERS TO AIRLINE COMPETITION

                              ----------                              


                        THURSDAY, MARCH 5, 1998

                           U.S. Senate,    
            Subcommittee on Transportation,
                              and Related Agencies,
                               Committee on Appropriations,
                                                    Washington, DC.
    The subcommittee met at 10 a.m., in room SD-124, Dirksen 
Senate Office Building, Hon. Richard C. Shelby (chairman) 
presiding.
    Present: Senators Shelby, Gorton, Faircloth, Lautenberg, 
and Reid.

                                Panel 1

                       NONDEPARTMENTAL WITNESSES

STATEMENT OF PAUL DEMPSEY, VICE CHAIRMAN, BOARD OF 
            DIRECTORS, UNIVERSITY OF DENVER/COLLEGE OF 
            LAW

                            Opening Remarks

    Senator Shelby. The committee will come to order.
    Good morning. I want to welcome you to the Subcommittee on 
Transportation Appropriations first hearing of the second 
session of the 105th Congress. Today, we are picking up where 
we left off last fall on the topic of competition in the 
aviation industry. At our last hearing, I indicated that we 
would have a series of hearings on competition and today's 
hearing is designed to focus on how airlines compete with one 
another. A day does not seem to go by without someone we know 
complaining about some aspect of the aviation industry. The 
complaints we hear most frequently are: Fares are too high; The 
airline schedules are all the same and are not convenient for 
non-business travelers; There are not enough options for the 
infrequent traveler; There is not enough service to mid-size 
communities; You cannot get anywhere without flying through a 
major hub; and Airline ticket prices do not make sense.
    The more I look into the state of the competition in the 
aviation industry, the more I realize that it is not a subject 
area that lends itself to a fast or even to a simple analysis. 
The aviation industry characteristics of intensely competitive 
markets--intensely noncompetitive markets, all kinds of 
pressures, overtures of international competitiveness and a 
seemingly endless array of competitive and anticompetitive 
proposals put forth by anyone who has ever piloted, owned, 
flown on or seen a plane. I guess it is all of us.
    To state the obvious, the aviation industry is a very 
complicated industry, which is why I initiated this series of 
hearings on competition. I hope we can make a very complicated 
industry a little more understandable to the people and to 
Congress.
    Initially, I believe that deregulation of airlines has been 
very successful. More people can afford to fly today than could 
have been imagined when deregulation was enacted 20 years ago. 
The vast majority of Americans have a greater selection of 
flights, carriers, and in some cases airports than ever before. 
However, this does not mean that the state of competition in 
the aviation industry is perfect or that it does not require 
the continued attention of Congress, the administration, the 
press and consumer groups.
    I believe we must continue our efforts to remove barriers 
to achieve an even more competitive environment in aviation 
transportation. Competition means lower fares, more choices and 
better service for all Americans. I am determined to make sure 
that the aviation industry is as competitive as possible. I am 
a firm believer that the American consumer will be the ultimate 
beneficiary of increased competition.
    Part of my role as chairman of this subcommittee is to 
ensure that as the Department of Transportation carries out 
their programs they do so in a way that will promote 
competition and efficiency in the aviation industry, not to 
stifle competition. To meet that goal, I believe we must have a 
better understanding of the competitive dynamics of this 
industry.
    At our October 1997 hearing, we touched on perimeter rules, 
slots and the Wright Amendment. In the future, we hope to 
explore the airlines' ticket pricing practices, yield 
management strategies, impact of regional jets on traffic 
patterns, current hubs and their impacts on the system, the 
future role of reliever airports, and the impact of the 
domestic aviation industry on international route negotiations 
and agreements. Today, I hope we can learn a little bit about 
one aspect of the industry--how airlines compete with one 
another.
    To help us in this task, we have with us today the 
following experts: Paul Dempsey, an attorney and the vice 
chairman of Frontier Airlines; Mark Kahan, the executive vice 
president and general counsel of Spirit Airlines; Michael Boyd, 
an economist and aviation consultant; John Anderson, Jr., the 
GAO director for the Transportation Issues, Resources, 
Community and Economic Development; and Patrick Murphy, the 
deputy assistant secretary of transportation for Aviation and 
International Affairs.

                           prepared statement

    I thank you, gentlemen, for agreeing to help us to explore 
these issues for the American people.
    [The statement follows:]

                  Prepared Statement of Senator Shelby

    Good morning. I want to welcome you to the Subcommittee on 
Transportation Appropriations' first hearing of the second session of 
the 105th Congress. Today, we're picking up where we left off last fall 
on the topic of competition in the aviation industry. At our last 
hearing, I indicated that we would have a series of hearings on 
competition, and today's hearing is designed to focus on how airlines 
compete with one another.
    A day does not seem to go by without someone we know complaining 
about some aspect of the aviation industry. The complaints we hear most 
frequently are:
  --Fares are too high;
  --The airlines' schedules are all the same and are not convenient for 
        non-business travelers;
  --There are not enough options for the infrequent traveler;
  --There is not enough service to mid-sized communities;
  --You can't get anywhere without flying through a major hub; and
  --Airline ticket prices don't make sense.
    The more that I look into the state of competition in the aviation 
industry, the more I realize that it is not a subject area that lends 
itself to a fast or simple analysis. The aviation industry has 
characteristics of intensely competitive markets, intensely non-
competitive markets, oligopolistic pressures, overtures of 
international competitiveness, and a seemingly endless array of 
competitive and anti-competitive proposals put forth by anyone who has 
ever piloted, owned, flown on, or seen a plane. To state the obvious, 
the aviation industry is a very complicated industry, which is why I 
initiated this series of hearings on competition. I hope we can make a 
very complicated industry a little more understandable.
    Initially, I believe that deregulation of airlines has been very 
successful. More people can afford to fly today than could have been 
imagined when deregulation was enacted 20 years ago. The vast majority 
of Americans have a greater selection of flights, carriers, and in some 
cases, airports than ever before. However, this does not mean that the 
state of competition in the aviation industry is perfect, or that it 
does not require the continued attention of Congress, the 
Administration, the press, and consumer groups. We must continue our 
efforts to remove barriers to achieve an even more competitive 
environment for aviation transportation.
    Competition means lower fares, more choices and better service for 
all Americans, and I'm determined to make sure that the aviation 
industry is as competitive as possible. I'm a firm believer that the 
American consumer will be the ultimate beneficiary of increased 
competition. Part of my role as chairman of this subcommittee is to 
ensure that, as the Department of Transportation carries out their 
programs, they do so in a way that will promote competition and 
efficiency in the aviation industry--not stifle it. To meet that goal, 
I believe we must have a better understanding of the competitive 
dynamics of this industry.
    At our October 1997 hearing, we touched on perimeter rules, slots, 
and the Wright Amendment. In the future, we hope to explore the 
airlines' ticket pricing practices, yield management strategies, the 
impact of regional jets on traffic patterns and current hubs, the 
future role of reliever airports, and the impact of the domestic 
aviation industry on international route negotiations and agreements. 
Today, I hope we can learn a little bit about one aspect of the 
industry--how airlines compete with one another.
    To help us in this task, we have with us today the following 
experts: Paul Dempsey, an attorney and the vice chairman of Frontier 
Airlines; Mark Kahan, the Executive Vice President and General Counsel 
of Spirit Air Lines; Michael Boyd, an economist and aviation 
consultant; John H. Anderson, Jr., the GAO Director for the 
Transportation Issues, Resources, Community and Economic Development 
Division; and Patrick Murphy, the deputy assistant secretary of 
transportation for Aviation and International Affairs.
    Thank you, gentlemen, for agreeing to help us explore these issues 
this morning. Senator Lautenberg, do you have an opening statement?

                    STATEMENT OF SENATOR LAUTENBERG

    Senator Selbey. Senator Lautenberg.
    Senator Lautenberg. Thanks very much, Mr. Chairman. My 
flight was late in taking off.
    Senator Shelby. We just complained about flights on time.
    Senator Lautenberg. Yes.
    Senator Shelby. Yours was not on time.
    Senator Lautenberg. We went from New York this morning.
    Senator Shelby. OK.
    Senator Lautenberg. It is not easy. I thank you, Mr. 
Chairman, because this day we begin our first in a series of 
hearings for the fiscal year that is coming up. I want to 
commend you for dedicating two of these hearings exclusively to 
critical issues in the areas of aviation commerce.
    Today's hearing, as I am sure you have indicated, is going 
to focus on the issue of barriers to competition. This is not a 
new issue to this Senator because prior to my arrival in the 
Senate I served as a commissioner of the Port Authority of New 
York and New Jersey, which owns and manages three major 
commercial airports in the New York/New Jersey region. Indeed, 
two of those airports are among the few slot-control airports 
in the Nation.
    When I first came to the Senate, which was 5 years after 
deregulation, I served on the Commerce Committee. At that time, 
the committee was just beginning to assess the new landscape 
that deregulation brought to our national aviation system. 
Also, as a traveler who flies frequently back and forth from 
Washington to the north Jersey and New York area, it seems to 
me that I pay rates that are quite different depending on the 
airport that I travel from. I am familiar with the concerns 
that are voiced over price competition or the lack thereof in 
some aviation markets.
    No one denies the extraordinary benefits that have accrued 
to our Nation as a result of deregulation. The traveling public 
is enjoying dramatically lower fares in many places, greater 
choices. Together, these forces have prompted the extraordinary 
growth we currently witness in air travel in our country, 
growth that is expected to continue well into the next century.
    The numbers in the growth have stunned people, where there 
is constant shortfalls in the estimates that they had for the 
system necessary to carry the traffic. However, the consensus 
that exists over the benefits of deregulation legislation 
disappears when we turn to the issue of barriers to airline 
competition.
    There is vast disagreement over whether the barriers to 
competition are real or perceived, whether the true 
entrepreneur is the new entrant to airline or the older 
established airline that cuts its fares to lead the 
competition. Some new entrant airlines have asserted that the 
older, established airlines have been deliberately cutting 
fairs in order to shut the door on new entrants into the 
business.
    On the other hand, we have heard from Mr. Crandall, the 
chairman of AMR, when he stated that he sees the emergence of a 
double standard. He argues that ``When a low-cost carrier 
enters a market and lowers fares, it is applauded for providing 
healthy competition; but when an established airline chooses to 
defend the market by matching the lower fares, or increasing 
capacity or both, it is denounced as predatory.''
    As in any major industry, we have seen some new entrants in 
the aviation business fail while others have flourished. 
Similarly, like other major industries, we have seen some new 
entrants fail largely on their own while others have failed 
with the aggressive help of their competitors.
    Importantly, as an Appropriations Subcommittee it is our 
job to determine whether the Department of Transportation is 
fulfilling its responsibility to enforce the existing statute 
designed to maintain, if not to maximize competition.
    I am grateful, Mr. Chairman, that you have included our 
Deputy Assistant Transportation Secretary Pat Murphy on our 
witness list today, the DOT, along with the Department of 
Justice. He is charged with enforcing several different 
statutes regarding competition in the airline industry.
    We have several colleagues in the House and the Senate who 
have proposed additional legislation to address this 
competition question. As you might expect, these legislative 
proposals address the competition question from all sides of 
the debate. I am one Senator who believes that the Congress 
must act with caution in addressing the question regarding 
competition. If we are not careful, we could easily bring some 
harm to the situation. Our solution for one carrier or one 
market could mean the deterioration of another carrier and 
severe dislocation of the service in another market.
    I do not advocate that the Congress sit idly by if we do, 
indeed, find that there are gross anticompetitive practices 
ongoing that are poisoning the marketplace, but I want to be 
convinced that the DOT and the Department of Justice do not 
currently have statutory tools necessary to address this 
problem and whether or not they have neglected to address it. I 
like to see competition.
    Mr. Chairman, that is when the rates really reflect the 
marketplace. Once again, I say thank you for holding these 
hearings.
    Senator Shelby. Thank you.
    Senator Gorton, before I call on you I just want to 
recognize that Senator Gorton, as a lot of you know, is not 
only a member of the Subcommittee on Appropriations, the 
Transportation Committee, he chairs the Authorizing Committee's 
Subcommittee on Aviation.
    Senator, thank you.

                      STATEMENT OF SENATOR GORTON

    Senator Gorton. Well, you just took the first 30 seconds of 
my opening statement, Mr. Chairman.
    Senator Shelby. You could probably articulate it better.
    Senator Gorton. There is a certain degree of tension always 
between the Appropriations Committee members and the 
Authorizing Committee members. The subject matter of this 
hearing certainly fits more traditionally under the guise and 
jurisdiction of the Authorizing Committee.
    On the other hand, increased knowledge on the part of 
Senators, increased sophistication on these issues is always 
extremely valuable and as a consequence of this hearing is a 
good idea. I can second something that Senator Lautenberg said 
about caution. I look at your opening statement, Mr. Chairman, 
and you list six most frequent complaints, none of which it 
seems to me is the appropriate subject of legislation because 
they have to do with fares and the moment that the Congress of 
the----
    Senator Shelby. If the Senator would yield?
    They might not be the subject of legislation, they are the 
subject of oversight and something where we can certainly talk 
about.
    Senator Gorton. The moment that we start passing laws on 
price fixing, we will have come up with a cure that is 
considerably worse than the disease.
    Senator Shelby. I do not think there was anything in there 
about that.
    Senator Gorton. Yes; some of the barriers that we have 
already discussed and will discuss have an impact on those 
prices and are appropriate subjects for legislation in addition 
to oversight. You know, when competing airlines are frozen out 
of a market by the domination of a major airport by a single 
carrier and where a carrier can, in effect, engage in 
monopolistic practices, we are faced with a situation that is 
the appropriate subject of not only oversight, but perhaps of 
legislation itself.
    Yet, it is interesting this morning's Washington Post, Mr. 
Chairman, in the business section includes a story about a 
number of additional gates, I think 10 additional gates, and 
the potential of 100 additional flights out of BWI by Southwest 
Airlines, an airline that has created a competitive market and 
has benefited the consumers by lower fares literally in ever 
market in which it has entered. The impact of Southwest at BWI 
is felt at National, or Reagan, and at Dulles as well.
    The encouragement of that kind of entry without guarantees 
into a market is really important. You know, one of the major 
items that we need to understand is the degree to which 
airports in the same rough metropolitan area really compete 
with one another. You know, how well a Southwest can do even 
though it is not operating right out of the District of 
Columbia here in creating a competitive market is very, very 
important. Perhaps, the hardest things for members of Congress 
to do is to understand the large number of areas in which the 
best thing for them to do is to stay the hell out and let 
competitive forces work.
    We do need to see to it that there is a structure in which 
competition can take place and the condition of airports, which 
almost without exception are owned by governmental bodies and 
may have in their own governing bodies interests other than 
competition, the way in which we regulate those Government-
owned enterprises that are airports.
    The way in which we try to see to it that competition is 
possible there or in the immediate vicinity is a vital and 
important consideration, but trying to tell given airlines when 
they should schedule planes, how they should schedule planes, 
and what their fares ought to be I am convinced is a cure far 
worst than the disease.

                     STATEMENT OF SENATOR FAIRCLOTH

    Senator Shelby. Senator Faircloth.
    Senator Faircloth. Thank you, Mr. Chairman.
    I heard only the later portion of what Senator Gorton had 
to say, but I agree with much of it and tend to echo it. I 
believe that airline deregulation has been one of the real 
success stories. Fares are lower and service is better than it 
overall has been in 20 years. There are going to be some areas 
that need attention, but I think deregulation has been a 
tremendous benefit to most, though not all, of the flying 
public.
    Senator Gorton, I do not know whether you remember or not, 
but it used to be that you never saw anybody on an airplane 
that did not have on a blue suit, a white shirt and a red tie. 
Now it has become public transportation, but back then it was 
expensive and only a very few people were flying.
    North Carolina is a high-growth State, and we have had a 
real increase in air travel. We are served by the major and the 
low-fare airlines in North Carolina. I believe that the smaller 
airlines are necessary since they offer a critical part of the 
service, and there should be room for them for competition.
    I sense that there is a movement in the DOT to beat up on 
the larger carriers. The carriers are making some money now. 
Now here comes the DOT with a lot of advice on how to do it, 
but I did not see them coming forth with any subsidies when the 
airlines were losing trainloads of money in the past decade. I 
do not think that now that the airline business has been able 
to get on its feet and start working that we need to come in 
with new constraints and restrictions.
    Thank you, Mr. Chairman.
    Senator Shelby. I just want to say again that this Senator 
is not ever going to be interested in price fixing ever, this 
Senator is not ever going to be trying to mandate what ticket 
fares are, but this Senator is going to be involved in making 
sure as much as we can by oversight hearings or other means 
that there is competition, real competition in the airline 
industry. That is what we are talking about. We are not going 
to stay the hell out of that, but we are going to stay the hell 
out of the other, that is: setting prices and routes.
    If we leave what is going on now in America, I believe you 
are going to create monopolies more and more and you are going 
to have less and less competition and the consumer is going to 
get burned more and more. There are areas in the airline 
industry right now where people are getting burned because 
there is no real competition, and we know it.
    Mr. Dempsey, Mr. Kahan, and Mr. Boyd, if you all would come 
forward.
    Your written statements will be made part of the record in 
their entirety. We will give you 5 minutes, if you would, to 
sum up your testimony and then we will have time for questions.
    Mr. Dempsey, do you want to start?

                       statement of paul dempsey

    Mr. Dempsey. Chairman Shelby, distinguished Senators, my 
name is Paul Stephen Dempsey. I am a professor of law at the 
University of Denver and vice chairman and director of Frontier 
Airlines. It is an honor and a pleasure to be here with you 
this morning.
    In the two decades of deregulation, we have never seen such 
a large and growing chorus of constituencies dissatisfied with 
the status quo in the airline industry. First, business 
travelers, which have experienced a 17-percent increase in 
business fares last year, are beginning to curtail travel. 
Prices are likely to rise again in 1989--1998, excuse me.
    Second, mayors, airport directors, and chambers of commerce 
in America's medium-sized cities are also complaining about 
poor service and higher airfares resulting from inadequate 
competition. One need only visit with the community leaders of 
cities as diverse as Mobile, Huntsville, Chattanooga, 
Charleston, Allentown, Rochester, Des Moines, and Fargo to 
understand that the pricing practices of the megacarrier 
monopolists are less than benign.
    Third, travel agents whose revenue has been unilaterally 
reduced 20 percent by the major airlines are increasingly 
dissatisfied by the market power that the megacarriers wield.
    Fourth, the new entrant airlines are appalled by 
megacarrier efforts to drive them out of business. Despite 
record industry profitability in the last year, the number of 
new entrant airlines collapsing exceeded the number of new 
airlines entering the market. Competition is, therefore, 
declining.
    Now, more than 150 airlines have gone belly up in the two 
decades of deregulation. Not all have been wounded or destroyed 
by predatory conduct. Many embraced a defective business plan, 
failed to find a market niche to satiate consumer demand, or 
were the victims of the downward slope of the market cycle or a 
spike in fuel costs.
    Our Government should never protect a company from its 
managerial ineptitude or incompetence. While our Government 
should not be concerned about the survival of individual 
competitors, it should and must be concerned about the survival 
of competition.
    Frontier Airlines has made its mistakes, too, but after 
Frontier achieved profitability, Frontier found itself in the 
crosshairs of the world's largest airline, United, which has 
been on a relentless 15-year homicidal mission to destroy 
competition and create a fortress hub monopoly at Denver.
    The megacarriers insist that the affordable air carriers 
are out to reregulate the airline industry. They have it 
backward. Deregulation was not an end in itself; it was a means 
to an end. The purpose of deregulation was to enhance 
competition. Removing barriers to entry at slot-constrained 
airports and eliminating archaic perimeter rules are consistent 
with the goals of enhancing competition, the primary goal of 
deregulation.
    We do not seek reregulation of the airline industry. We do 
ask that the competition and the antitrust laws applicable to 
every other industry in our economy also be applied to the 
airline industry. Ironically, that which might eventually lead 
to calls for reregulation lies within the exclusive control of 
the megacarriers.
    The arrogance of monopolistic exploitation of business 
travelers in medium-sized cities, the predatory practices 
designed to drive small airlines out of business, the hypocrisy 
of demanding greater access to slot-constrained international 
airports while resisting competitive entry domestically, the 
growing concentration of the domestic market accelerated with 
the recent acquisition of control of Continental Airlines by 
Northwest, and the creation of global cartels shrouded with 
antitrust immunity--these are the abusive practices most likely 
to lead to a call for reregulation.

                           prepared statement

    Paradoxically, if the affordable airlines are successful in 
restoring competition to the marketplace, any movement for 
reregulation will die stillborn. In an industry like 
transportation, like air transportation, so vital to the 
economic health of so many industries in our economy and 
geographic regions of our country, monopolistic exploitation 
cannot long be tolerated. After all, the airports and the 
airways belong to the public. Wherever possible competition is 
preferable to Government as regulator of the market. We are 
proponents of competition, Mr. Chairman, not regulation.
    Thank you.
    [The statement follows:]

               Prepared Statement of Paul Stephen Dempsey

    Chairman Shelby, distinguished Senators, my name is Paul Stephen 
Dempsey. I am Vice Chairman and Director of Frontier Airlines, Inc. I 
am also Professor of Law and Director of the Transportation Law Program 
at the University of Denver. Thank you for inviting me to testify here 
today on a matter of profound public importance--barriers to airline 
competition.
    The new Frontier Airlines is a carrier born in the Summer of 1994. 
Today, it serves 14 cities with 14 Boeing 737 jet aircraft from a base 
in Denver, Colorado. Denver is a concentrated hub airport dominated by 
the world's largest airline, United Airlines. Several studies by the 
U.S. General Accounting Office and the U.S. Department of 
Transportation reveal that a fortress hub monopolist charges origin-
and-destination consumers between 19 percent and 27 percent more than 
consumers are charged in competitive markets.
    Frontier is a founding member of the Air Carriers Association of 
America. The Air Carriers Association was initially formed to deal with 
the effort of the major airlines to shift the tax burden away from the 
largest airlines and onto the smaller, affordable airlines. But as we 
came together, we learned we had something else in common. The major 
airlines appeared to be on a homicidal mission to destroy the low-fare 
airlines, and thereby, suppress competition.
    The window of opportunity appeared after the ValuJet catastrophe in 
the Everglades, on May 11, 1996. The Department of Transportation had 
been a champion of the competition brought to bear by the new entrant 
airlines, praising their annual $6 billion contribution to consumer 
savings as a clear success of deregulation. But the Everglades crash 
occurred in an election year, and for political reasons, DOT soon found 
itself neutralized. ValuJet's 53 aircraft were grounded. The question 
in the industry became, ``Why did Delta allow ValuJet to grow so large? 
Why didn't Delta kill off ValuJet when it had the chance?''
    That mind-set put a number of relatively smaller airlines in the 
cross-hairs of the majors. It was open season on the upstart airlines. 
For example, the world's largest airline, United, targeted Frontier and 
Western Pacific Airlines. American allegedly targeted Vanguard and Sun 
Jet International. Delta allegedly targeted ValuJet (now AirTran). 
Northwest allegedly targeted Reno and Spirit Airlines.
    Capacity dumping and below-cost pricing were the essential 
ingredients of this campaign to eradicate competition. In each 
situation, the tactics differed somewhat, but the purpose was the 
same--destroy the affordable airlines so as to raise consumer prices.
    The major airlines have falsely claimed that the economic problems 
which confronted the affordable fare airlines is that consumers shied 
away from them after the Everglades crash. In Frontier's case, bookings 
took a modest dip in May 1996, coinciding with that unfortunate 
disaster in Florida, but then were restored relatively quickly. A far 
more significant hit in bookings occurred for Frontier in the Summer of 
1996, coincident with Frontier's announcement of its first and second 
consecutive quarterly profits. It was at that point that United began a 
surreptitious campaign to destroy Frontier Airlines, engaging in the 
following practices:
  --Adding seat capacity and flight frequency to deny competitors of 
        realistic or achievable break-even load factors (in the Denver-
        Los Angeles market, for example, United added 8,600 seats per 
        week);
  --Dropping prices to below-cost levels (United dropped its prices in 
        Frontier's markets by about 30 percent below United's costs, 
        while raising prices sharply in its monopoly markets) while 
        opening up low-fare ``buckets'' to flood the market with low-
        fare seats;
  --Refusing competitors non-discriminatory access to its network 
        (through discriminatory ticketing-and-baggage, joint-fare, 
        frequent-flyer program, and code-sharing agreements);
  --Biasing its computer reservations system against more convenient 
        competitive offerings (by adding the equivalent of 1,440 
        minutes to interline flights in order to dominate the 
        connecting market through its dominant hub);
  --Paying travel agents commission overrides to steer business toward 
        United and away from competitors; and
  --Entering into ``exclusive dealing'' arrangements with corporate 
        purchasers and regional turboprop carriers.
    I have published a study entitled ``Unfriendly Skies Over Colorado: 
United Airlines' Fortress Hub Monopoly At Denver,'' which chronicles 
United Airlines' activities over a 15-year period designed to establish 
and maintain a monopoly hub at Denver.
    Frontier initially sought to restore nonstop jet service to a 
number of city-pairs which formerly enjoyed jet service prior to the 
elimination of the Continental Airlines' hub at Denver. Because United 
Airlines monopolizes the feed traffic necessary to provide adequate 
load factors in those ``thin'' markets, Frontier has been forced to 
amend its route strategy to focus on large city-pair markets radiating 
from Denver.
    Since inaugurating service in July 1994, Frontier has withdrawn 
from the following city-pairs:
    Denver-Bismarck, N.D.; Denver-Fargo, N.D.; Denver-Minot, N.D.; 
Denver-Grand Forks, N.D.; Denver-Billings, Mont.; Denver-Great Falls, 
Mont.; Denver-Bozeman, Mont.; Denver-Missoula, Mont.; Denver-Tuscon, 
Ariz.; Denver-Las Vegas, Nev.; Denver-St. Louis, Mo.; and Denver-San 
Diego, Cal.
    Again, Frontier Airlines' original route strategy was to restore 
jet service to markets which previously enjoyed it, prior to 
Continental Airlines elimination of its Denver hub. Frontier began 
service between Denver and four cities in North Dakota, and Denver and 
four cities in Montana. These were markets which had sufficient local 
and connecting traffic to support jet service, particularly at a cost 
structure of a new low-cost airline like Frontier. Because the 
competing service in most of these nonstop markets was in high-cost, 
slow turboprop aircraft (flying as United Express), Frontier would 
dominate the local origin-and-destination market, for Frontier offered 
superior jet service at a competitive price. But United would 
monopolize the connecting market at the Denver hub, denying Frontier 
reasonable access to connecting passengers who might prefer to connect 
to a Frontier jet to a United Express turboprop aircraft. The means by 
which United would deny Frontier connecting traffic were as follows:
    1. United refused to enter into a ticketing-and-baggage agreement 
with Frontier, though most other major airlines did enter into such an 
agreement with Frontier. This meant that passengers seeking to connect 
at Denver between United and Frontier flights would have to collect 
their bags from the incoming flight in the main terminal at Denver 
International Airport, then check them again onto their outgoing 
flight. Such an inconvenience would dissuade passengers from making the 
connection. It was not until the Department of Transportation ``jaw 
boned'' United into giving Frontier a ticketing-and-baggage agreement 
that United reluctantly did so.
    2. United refused to enter into a joint-fare agreement with 
Frontier. Typically, carriers interlining passengers agree on a 
discounted combination of the A-B fare and the B-C fare, so that the 
passenger pays an overall A-C fare lower than the sum of the two 
undiscounted fares. United has joint-fare arrangements with its United 
Express affiliates. United (connecting at Denver with United Express) 
could therefore offer consumers a lower price between, for example, Los 
Angeles and Fargo, N.D., than could Frontier.
    3. United refused to enter into a code-sharing agreement with 
Frontier. Code-sharing is a means whereby an airline falsely sells an 
interline connection as if it were an on-line connection. Thus, a 
United Airlines Los Angeles-Denver connection with a Great Lakes 
Aviation flight on a Beech 1900 turboprop flight between Denver-Fargo, 
N.D., is falsely portrayed as a United flight connected to a United 
flight both on the computer reservations systems [CRS's] and the ticket 
issued to the passenger. Most tickets are sold via CRS's, the retail 
distribution center for the overwhelming majority of flights. United 
owns a controlling interest in the Apollo CRS, which is strongly biased 
against non code-sharing interline flights. By using a CRS algorithm 
prejudiced against the United-Frontier (and all other interline 
connections which do not enjoy a code-share), United assures that such 
connections will not be displayed on the first page of the CRS screen, 
where travel agents sell 85 percent of all flights. This allows United 
to monopolize the connecting traffic at Denver.
    4. United biases its computer reservations system against 
competitive connecting service. The overwhelming number of airline 
tickets are sold by travel agents. Travel agents sell 85 percent of 
tickets from the first page of their computer reservations screen. The 
computer reservations systems are owned by the major airlines, and are 
strongly biased against independent carrier connections. Although many 
(perhaps most) consumers would prefer to connect to a jet rather than a 
turboprop airplane, many at Denver have been funneled onto small 
turboprop aircraft operated by companies like Great Lakes Aviation, 
Mesa Airlines and Air Wisconsin, all operating at Denver as ``United 
Express.'' Ironically, jet aircraft have lower available seat mile 
costs than do turboprop aircraft. The Apollo computer reservations 
system, which United controls, adds the equivalent of 1,440 minutes (24 
hours) to United's connections with Frontier at Denver, while adding 
zero additional time to its connections with Great Lakes, Mesa and Air 
Wisconsin. Adding such a severe penalty to independent carrier 
connections assures that they are not displayed on the first page of 
the CRS screens, and therefore, are rarely sold, even if consumers 
would prefer them.
    5. United prohibits its code-sharing affiliates from code-sharing 
with Frontier. United has several code-sharing partners which feed its 
Denver hub--Air Wisconsin, Mesa Airlines and Great Lakes Aviation--all 
operating as ``United Express.'' United prohibits these companies from 
entering into commercial relations with Frontier, so as to deny 
Frontier connecting traffic at Denver. Recently, Air Wisconsin (a 
company over which United Airlines exercises considerable influence) 
purchased Mountain Air Express [Max], a Denver-based code-sharing 
partner of Frontier, which provided new traffic to Frontier from such 
cities as Kansas City, Tulsa, Oklahoma City, Colorado Springs and 
Hayden/Steamboat Springs, and Montrose, Colorado. Because of Air 
Wisconsin's exclusive contractual relationship with United, Max has 
announced its intention to cancel its code-sharing agreement with 
Frontier. Connecting service from these cities will be lost to 
Frontier, and gained by United.
    These reasons made it necessary for Frontier to withdraw from the 
four cities in North Dakota and the four cities in Montana, and 
contributed to its decision to withdraw from the Tucson market as well. 
These city-pair markets are simply too ``thin'' to be served by a 
competitive low-cost jet carrier where the dominant hub carrier 
monopolizes the connecting traffic. Frontier believes that United's hub 
network is an ``essential facility,'' in the same way that AT&T's 
telecommunications network was deemed an ``essential facility'' for 
antitrust purposes, leading to its divestiture of local operating 
telephone companies in the 1980's.
    Frontier's withdrawals from Denver-Las Vegas, Denver-St. Louis and 
Denver-San Diego were also influenced by United's monopolization of 
connecting traffic, but since they are significantly larger markets, it 
was less of a factor. However, Denver-Las Vegas is a market where 
United flooded the route with a significant increase in flight 
frequencies with its competitive ``weapon'', Shuttle by United, and 
significantly dropped fares (then, of course, raised them sharply after 
Frontier left the market). Shuttle has also appeared in the Denver-
Phoenix and Denver-Salt Lake City markets, which may have caused the 
departure therefrom of another low-fare carrier, Vanguard Airlines. 
Though United portrays Shuttle as a consumer-friendly low-cost/low-fare 
alternative. The facts suggest otherwise. Though United still offers 
low fares in the Denver-Phoenix market (where it competes with Frontier 
and America West), United Shuttle raised fares sharply after Frontier 
withdrew from the Denver-Las Vegas market:

     A TALE OF TWO CITIES: UNITED'S LOWEST REGULAR FARES (EACH WAY)
------------------------------------------------------------------------
                                                 Feb. 11,
                                     Before        1997        Feb. 11,
                                    shuttle    introductory      1998
                                                   fare
------------------------------------------------------------------------
Denver-Phoenix (608 miles)......          $49           $49          $84
Denver-Las Vegas (649 miles)....           69            49          112
------------------------------------------------------------------------

    Additional predatory practices of United which have driven Frontier 
from markets, or caused it financial injury so that it could not expand 
its operations, include the following:
    1. United engaged in below-cost pricing until Frontier was driven 
out of the markets.--Average fare data produced by the U.S. Department 
of Transportation reveals that United typically lowered its average 
fares to Frontier's levels until Frontier exited the market, then 
increased fares to levels above those which preceded Frontier's entry. 
Since, in some markets, United offers a first-class product, an average 
fare which appears to match Frontier's actually undercuts Frontier's 
single-class coach product, for the DOT's average fare data includes 
all tickets sold, first and coach class. United also refused to raise 
fares in Frontier's markets after Congress re-imposed the 10 percent 
ticket tax in August 1996, though United raised its prices in all non-
Frontier markets radiating from Denver to account for those increased 
costs. Frontier's research revealed that United was pricing its product 
about 30 percent below its costs in the Fall of 1996. We believe 
Northwest Airlines may also be engaging in below-cost pricing in the 
Minneapolis-Denver market, but we do not have specific evidence to 
substantiate our belief at this time.
    2. United has dumped excessive capacity into markets Frontier has 
entered.--For example, after Frontier entered the Denver-Los Angeles 
market, United added 8,600 seats per week in the Summer 1996 vis-a-vis 
average levels a year earlier. In this period, United increased its 
average capacity, year-over-year, as follows:

                                                                 Percent
Denver--Salt Lake City............................................   +28
Denver--Phoenix...................................................   +30
Denver--Las Vegas.................................................   +32
Denver--Omaha.....................................................   +35
Denver--Los Angeles...............................................   +24

    3. United entered into ``exclusive dealing'' contracts with 
corporate purchasers.--Frontier has attempted to sell its product to 
corporations in Denver and other major cities it serves, only to learn 
that United has contractually prohibited companies to which it gives a 
corporate discount from enjoying a discount from a competitor. United 
is not alone in such behavior, as Frontier also has encountered 
corporate purchasers in Minneapolis who are tied to Northwest Airlines' 
exclusive dealing contracts. In essence, these megacarriers are saying 
to corporations, ``We'll give you a discount only if you don't fly 
Frontier.''
    4. United bribes travel agents to book flights on United.--A 
``bribe'' is defined by Webster's as ``money or favor bestowed on or 
promised to a person in a position of trust to pervert his judgment or 
corrupt his conduct,'' or ``something that serves to induce or 
influence.'' The overwhelming majority of airline tickets are sold by 
travel agents. Travel agent commission overrides have become 
increasingly important to agents now that major airlines have rolled 
back and capped commissions, reducing agent revenue by 20 percent or 
more. Overrides are earned where travel agents exceed prescribed quotas 
on United's flights well in excess of United's capacity in those 
markets. In order to meet those quotas, agents must sell more of 
United's product and less of a competitor like Frontier. To do so, they 
must somehow steer purchasers to United's product, even if it is higher 
priced or offered at a less convenient departure time. An airline like 
Frontier which offers only a few frequencies per market can never 
provide sufficient capacity to compete with those override quotas. 
Northwest Airlines uses the same tactics in Minneapolis. In essence, 
these megacarriers are saying, ``We'll give you a commission override 
check only if you don't book too many flights on Frontier.''
    5. United refuses to sell Frontier access to its Mileage Plus 
frequent flyer program.--Although United Airlines sells Mileage Plus 
frequent flyer miles to its code-sharing partner airlines, car rental 
agencies, hotels, florists, mortgage companies, clothiers, credit card 
companies, and a plethora of other businesses, United steadfastly 
refuses to sell Mileage Plus miles to Frontier. An overwhelming number 
of Denver's regular air passengers belong to United's Mileage Plus 
program. Because they cannot earn Mileage Plus miles on Frontier, they 
are thereby dissuaded from purchasing Frontier's product. Frontier does 
offer its passengers Continental Airlines' One Pass miles (for 
Continental does not have such an exclusionary policy), but far fewer 
of Denver's frequent flyers belong to the One Pass mileage program.
    More recently, United Airlines has taken yet another blatantly 
anticompetitive move to further monopolize the Denver hub. On February 
2, 1998, Frontier Airlines proposed to the Western Pacific Airlines 
[WestPac] Chapter 11 bankruptcy estate that, if Western Pacific shut 
down, Frontier be allowed to fly off WestPac's air traffic liability 
(tickets sold but not yet flown) on a non-exclusive basis. Frontier 
would wet lease between 2 and 4 of WestPac's Boeing 737-300 aircraft to 
restore low-fare service between Denver--Dallas and Denver--San Diego, 
markets in which Western Pacific provided the only low-fare nonstop 
alternative to United Airlines.
    To digress for a moment, all three carriers--United, Western 
Pacific and Frontier--hubbed at Denver International Airport [DIA]. In 
the latest month for which we have data (December), United and its 
code-sharing affiliates operating as United Express controlled 70.9 
percent of the passenger traffic at DIA (of which United had 64.7 
percent and United Express had 6.2 percent), Western Pacific had 5.5 
percent, and Frontier had 3.5 percent.\1\
---------------------------------------------------------------------------
    \1\ Data: Denver International Airport.
---------------------------------------------------------------------------
    On Wednesday morning, February 4, United made a preemptive strike 
against Frontier, cutting an exclusive deal with the bankruptcy estate 
to fly all the air traffic liability. Without this source of tickets to 
accelerate the ramp-up of demand, Frontier cannot take on WestPac's 
aircraft to open new service to Dallas and San Diego. With Western 
Pacific's grounding on February 4, this results in a situation where no 
low-fare competitor operates in either market. With the demise of 
Western Pacific, and the preemptive strike against Frontier's entry, 
United now has a full monopoly in the Denver-San Diego nonstop market, 
faces only two high-cost competitors (American and Delta) in the 
Denver-Dallas nonstop market, and effectively takes WestPac's 5.5 
percent market share.
    Given United's relatively high load factors in Denver, it will be 
difficult for United to accommodate many Western Pacific customers. By 
the agreement, they are precluded from using their Western Pacific 
tickets on Frontier. Also, given the low average fares at which the 
Western Pacific tickets were sold (because WestPac was having 
difficulty filling seats while it was in Chapter 11 bankruptcy), and 
the fact that United agreed to fly the tickets for 50 percent of their 
face value, the revenue potential of these tickets cannot be a 
realistic motivation for United.
    The only reason this makes sense for United is that it causes 
competitive harm to Frontier, effectively prohibits Frontier from 
immediately entering the Denver-Dallas and Denver-San Diego markets, 
prohibits these Western Pacific customers from being introduced to the 
Frontier product, allows United to control another 5.5 percent of the 
Denver market, limits Frontier's ability to acquire new aircraft, and 
exacerbates Frontier's Stage 3 aircraft compliance obligations by 
December 31, 1998.
    Frontier flys only 14 aircraft to 14 cities from Denver and, again, 
accounts for only 3.5 percent of the Denver market. United is the 
largest airline in the world. United has been on a 15-year quest to 
suppress competition and monopolize the Denver market via a plethora of 
means--capacity dumping, below-cost pricing, exclusive dealing 
contracts with regional feeder airlines and corporate purchasers, 
travel agent commission overrides, computer reservation systems bias, 
and discriminatory ticketing-and-baggage, joint-fare, and code-sharing 
agreements. If it is free from the competition laws, as it perceives 
itself to be, it can destroy low-fare competition in Denver.
                monopolization under the antitrust laws
    On February 11, 1997, Frontier Airlines filed a complaint with the 
U.S. Department of Justice alleging unlawful monopolization by United 
Airlines of Denver International Airport [DIA] and city-pair markets 
radiating therefrom. Frontier identified eight antitrust doctrines that 
United appears to have violated: Dumping excess capacity into 
competitors' markets; Pricing discrimination; Predatory pricing; 
Monopoly leveraging; Refusal to deal; Refusal to share an essential 
facility; Raising rivals' costs; and Exclusive dealing arrangements.
    Section 2 of the Sherman Act provides that ``every person who shall 
monopolize, or attempt to monopolize * * * any part of the trade or 
commerce * * * is guilty of a felony.'' \2\ A Section 2 claim can be 
brought against the use of monopoly power ``to foreclose competition, 
to gain a competitive advantage, or to destroy a competitor.'' \3\ 
Frontier believes United Airlines' activities over the past 15 years 
have been aimed at destroying competitors, controlling prices, and 
foreclosing competition at Denver, Colorado. One who effectively 
controls a market may not lawfully use any exclusionary practice 
against a competitor, even though it is not technically a restraint of 
trade in violation of section 1 of the Sherman Act.\4\ A monopolist may 
not legitimately deter potential competitors from entering its market 
or existing rivals from increasing their output.\5\
---------------------------------------------------------------------------
    \2\ Section 2 has two elements: (1) the possession of monopoly 
power in the relevant market, and (2) the willful acquisition or 
maintenance of that power, as distinguished from growth or development 
as a consequence of a superior product, business acumen, or historic 
accident.
    \3\ United States v. Griffith, 334 U.S. 100 (1948).
    \4\ Herbert Hovencamp, Economics and Federal Antitrust Law 136-37 
(1984).
    \5\ Id at 138.
---------------------------------------------------------------------------
                policies of the airline deregulation act
    The Airline Deregulation Act of 1978 specifically provides that 
deregulation was not designed to condone unfair methods of competition, 
or deceptive, anticompetitive and monopolistic practices. Specifically, 
the Airline Deregulation Act provides:
    ``[T]he Secretary of Transportation shall consider the following 
matters, among others, as being in the public interest:
    ``(4) the availability of a variety of adequate, economic, 
efficient, and low-priced services without unreasonable discrimination 
or unfair or deceptive practices * * *.
    ``(9) preventing unfair, deceptive, predatory, or anticompetitive 
practices in air transportation.
    ``(10) avoiding unreasonable industry concentration, excessive 
market domination, monopoly powers, and other conditions that would 
tend to allow at least one air carrier * * * unreasonably to increase 
prices, reduce service, or exclude competition in air transportation.
    ``(11) maintaining a complete and convenient system of continuous 
scheduled interstate air transportation for small communities * * *
    ``(13) encouraging entry into air transportation markets by new and 
existing air carriers and the continued strengthening of small air 
carriers to ensure a more effective and competitive airline industry.'' 
\6\
---------------------------------------------------------------------------
    \6\ 49 U.S.C. Sec. 40101.
---------------------------------------------------------------------------
    Each of these policies has been thwarted by United Airlines' 
predatory and anticompetitive activities at Denver, and in city-pair 
markets radiating therefrom. Over the past decade, several studies 
performed by the U.S. General Accounting Office have chronicled the 
plethora of predatory weapons used by major airlines to thwart these 
Congressional goals. In its most recent report, the GAO concluded:
    ``[W]e identified a number of policy options 6 years ago that DOT 
could consider to lower these barriers [to entry] and increase 
competition. Since then, there has been little progress toward reducing 
these barriers, and some * * * have grown worse. Therefore, we believe 
that DOT must now take positive steps to address several of the most 
serious barriers.'' \7\
---------------------------------------------------------------------------
    \7\ U.S. General Accounting Office, Airline Deregulation: Barriers 
to Entry Continue to Limit Competition in Several Key Domestic Markets 
22 (Oct. 1996).
---------------------------------------------------------------------------
    In its 1996 report on new entrant airlines, DOT expressed concern 
that hub dominant airlines have an incentive to discourage competitive 
entry by engaging in predatory behavior and unfair competitive 
practices:
    ``[W]e will not be indifferent to attempts to exclude or preclude 
new entry through predatory activity * * *. [T]he beneficial impact of 
low cost new entry--especially in disciplining fares and filling 
service voids--is simply too important to permit predation to undermine 
it. Anticompetitive activity can take myriad forms, from sudden and 
targeted service increases and sharp and highly selective fare cuts to 
* * * other doing business problems. The Department will continue to 
evaluate which actions cross the line from tough competition to 
anticompetitive predation and react accordingly.'' \8\
---------------------------------------------------------------------------
    \8\ U.S. Dept. of Transportation, The Low Cost Airline Service 
Revolution 32-33 (l996).
---------------------------------------------------------------------------
    It is for these reasons that Frontier has asked the U.S. Department 
of Transportation to investigate United Airlines' predatory and 
anticompetitive practices at Denver and routes radiating therefrom.
           unfair competition under the federal aviation act
    Section 41712 (formerly section 411) of the Federal Aviation Act 
provides:
    ``On the initiative of the Secretary of Transportation or the 
complaint of an air carrier * * * and if the Secretary considers it is 
in the public interest, the Secretary may investigate and decide 
whether an air carrier * * * has been or is engaged in an unfair or 
deceptive practice or an unfair method of competition in air 
transportation * * *. If the Secretary, after notice and an opportunity 
for a hearing, finds that an air carrier * * * is engaged in an unfair 
or deceptive practice or unfair method of competition, the Secretary 
shall order the air carrier * * * to stop the practice or method.'' \9\
---------------------------------------------------------------------------
    \9\ 49 U.S.C. Sec. 41712.
---------------------------------------------------------------------------
    This statutory provision is modeled after section 5 of the Federal 
Trade Commission Act. \10\ Both the Federal Trade Commission and the 
DOT may forbid anticompetitive practices before they become 
sufficiently serious to violate the Sherman Act.\11\ The DOT has 
acknowledged that its authority under this provision ``allows us to 
define practices that do not violate the antitrust laws as unfair 
methods of competition, if they violate the spirit of the antitrust 
laws.'' \12\ United Airlines' predatory and anticompetitive activities 
at Denver violate not only the spirit of the antitrust laws, but 
arguably the letter of those laws as well.
---------------------------------------------------------------------------
    \10\ 15 U.S.C. Sec. 45. United Air Lines v. Civil Aeronautics 
Board, 766 F.2d 1107 (7th Cir. 1985).
    \11\ Pan American World Airways, Inc., v. United States, 371 U.S. 
296 (1963); Atlantic Refining Co. v. FTC, 381 U.S. 367 (1965).
    \12\ 61 Fed. Reg. 42,208, 42,215.
---------------------------------------------------------------------------
    We hope DOT will take forceful action to preserve competition, 
which was among deregulation's principal objectives.
   antitrust enforcement is not the equivalent of re-regulating the 
                            airline industry
    United Airlines falsely claims that Frontier advocates re-
regulation of the airline industry.\13\ That allegation is patently 
absurd. Frontier is an airline born of deregulation, and has never 
requested re-regulation in any form. Frontier merely asks that the 
existing competition laws, applicable to every other industry in the 
United States, also be made applicable to the world's largest airline, 
United Airlines. One must recall the admonitions of Alfred Kahn, the 
father of deregulation, who repeatedly insisted, ``When we deregulated 
the airlines, we certainly did not intend to exempt them from the 
antitrust laws.'' \14\ Yet the antitrust laws have not been applied 
with full force to the airline industry. Until 1985, the Civil 
Aeronautics Board provided antitrust oversight. With the sunset of that 
agency, it is now time for the Justice Department to fill the void.
---------------------------------------------------------------------------
    \13\ See Roger Gibson, Controls Could Turn Clock Back 20 Years, 
Denver Post, May 4, 1997, at El.
    \14\ Melanie Pickett, The Air Fare Puzzle, Los Angeles Times, Nov. 
19, 1989, at D3.
---------------------------------------------------------------------------
    Re-regulation ot the airline industry would require a substantial 
legislative overhaul of the Federal Aviation Act. We do not believe 
that will be necessary if the Airline Deregulation Act and Sherman 
Antitrust Act are applied as citizen (though perhaps, as explained 
below, it may be useful for Congress to clarify what constitutes unfair 
and deceptive practices and unlawfull monopolization under these 
statutes).
    To the extent we do perceive a need for legislative change, we see 
it in the arena of farther deregulation in order to enhance 
competition--deregulating the buy-sell slot rule, deregulating the 
airport perimeter rules, deregulating exclusive airport gate agreements 
and majority-in-interest clauses, and stripping major airlines of the 
ability to regulate computer reservations systems in a manner which 
distorts competition, or to bias travel agents with consumer overrides. 
That's not re-regulation. That's eliminating anticompetitive barriers 
to entry which suppress competition. Eliminating barriers to entry was 
among the fundamental purposes of the Airline Deregulation Act of 1978. 
Allowing the largest airlines to monopolize gates, slots, and the 
computerized distribution system is nowhere listed among deregulation's 
objectives.
    Ironically, the major airlines have been vigorous proponents of 
competitive access in foreign markets. Testifying before a Senate 
Judiciary Subcommittee on April 22, United Airlines' Vice President 
Cyril Murphy said, ``It would be irresponsible for governments not to 
protect their citizens against the possibility of [cartelization and 
monopoly pricing].'' \15\ In opposing the proposed American Airlines/
British Airways alliance (which, incidentally, would compete with the 
United/Lufthansa alliance, which had been conferred immunity from the 
application of the antitrust laws) United's Murphy said, ``Governmental 
bodies have as their dual goals freeing the industry in terms of the 
elements of competition and protecting their citizens from the 
potential for anti-competitive abuse of that new, open environment. 
This means * * * developing anti-monopoly policies that provide strict 
scrutiny of the `superhubs' so as to maintain the opportunity for 
meaningful intrahub competition.'' \16\ Among the remedies proposed by 
United was the surrender, by American Airlines and British Airways, 
without compensation, of slots at Heathrow, JFK and Chicago O'Hare 
Airports, a restriction on the acquisition of new slots, and the 
termination of code-sharing agreements with British Midland. Though 
United had received free slots at O'Hare and LaGuardia Airports in the 
1980's, United objected when new entrant airlines like Frontier 
recently asked for access to these slot-constrained airports.\17\ 
Because of slot regulation, United has been able to capture a monopoly 
premium associated with monopolization of a finite public resource. 
Frontier believes that deregulation of slots would open a clogged 
monopoly bottleneck.
---------------------------------------------------------------------------
    \15\ Statement of Cyril Murphy Before the U.S. Senate Judiciary 
Antitrust, Monopolies and Business Rights Airline Subcommittee (April 
22, 1997).
    \16\ Id.
    \17\ United Airlines Press Release. May 8, 1997.
---------------------------------------------------------------------------
    Though United advocates ``open skies'' in international markets, 
United takes a different view when addressing competition issues in the 
superhubs it dominates.
    Though United Airlines advocates vigorous governmental intervention 
to prevent monopoly abuse at London's Heathrow Airport, on April 10, 
United Airlines CEO Gerald Greenwald said, ``Try to get the government 
to come in and solve [Denver's] competitive issues, and we will all 
regret it.'' \18\ Apparently, developing anti-monopoly policies for 
strict scrutiny is appropriate only at superhubs United Airlines does 
not monopolize.
---------------------------------------------------------------------------
    \18\ Richard Williamson, United Slaps Back At Frontier, Rocky 
Mountain News, April 10, 1997, at 1B.
---------------------------------------------------------------------------
                          legislative proposal
    It would remiss of me to come before you and not offer a model 
remedy to the problems I have discussed here, and their pernicious 
impact on consumers and disadvantaged regions of our nation. I have 
suggested that the Justice and Transportation Departments have 
significant statutory means of addressing these problems. Certainly, 
the Appropriations Committee can assure that these agencies have 
sufficient resources to address anticompetitive issues in the airline 
industry. But to clear up some of the case law which, for example, has 
unduly narrowed the concept of predatory pricing under the Sherman Act, 
and to apply the competition laws more precisely to the specific 
problems which emerge in the airline industry, I would respectfully 
suggest consideration of proposed legislation along these lines:
                    airline competition act of 1998
Preamble
    The Congress hereby recognizes that the competition unleashed by 
airline deregulation has been beneficial to large segments of the 
consuming public, but that competition should be further advanced so 
that a larger universe of Americans can enjoy the benefits of airline 
deregulation. In the Airline Deregulation Act of 1978, Congress 
explicitly affirmed its commitment to preventing unfair, deceptive, 
predatory or anticompetitive practices in air transportation, avoiding 
unreasonable industry concentration, excessive market domination, 
monopoly power and other conditions that would allow a carrier 
unreasonably to increase prices, reduce service or exclude competition 
in air transportation. Congress is concerned that prices are not fully 
competitive for travel to or from airports dominated by a single 
airline, and for travel to and from small communities. Congress is also 
concerned that market dominant airlines are using their domination of 
public resources in a manner to suppress competition. Because airports 
and the airways are public resources, they should be used for public 
benefit, and airline competition is a major public benefit.
    1. Definitions: (a) A ``market dominant airline'' is an airline 
which transports more than 60 percent of the passengers, leases more 
than 60 percent of the gates, or flys more than 60 percent of the 
flights, to or from any major U.S. airport. It shall be considered a 
market dominant airline only at the airport it so dominates.
    (b) A ``market dominant airport'' is an airport at which a single 
airline transports more than 60 percent of the passengers, leases more 
than 60 percent of the gates, or flys more than 60 percent of the 
flights.
    (c) An ``exclusive dealing contract'' is a contract which prohibits 
a contracting party from entering into a like or similar contract with 
another airline.
    (d) A ``travel agent commission override'' is any supplementary 
economic or other compensation paid to a travel agency based on its 
sales of the market dominant airline's product, above that paid to all 
other travel agencies.
    (e) A ``code-sharing arrangement'' is a marketing relationship by 
which two airlines agree to use each other's two-letter codes for 
display in computer reservations systems and other sales outlets.
    (f) A ``joint-fare arrangement'' is an agreement between two 
carriers to provide interline air travel at an agreed-upon division of 
joint fares.
    (g) A ``ticketing-and-baggage arrangement'' is an agreement between 
carriers to honor each other's tickets issued by the Airline Reporting 
Corporation and transfer baggage between them.
    2. A market dominant airline may not enter into exclusive code-
sharing, joint-fare or ticketing-and-baggage arrangements at any 
airport it dominates. Any such code-sharing and joint-fare relationship 
must be offered to all carriers seeking such relationships on a non-
discriminatory basis for travel to and from the market dominant 
airport.
    3. A market dominant airline may not lawfully enter into an 
exclusive dealing contract with a connecting airline for service to or 
from an airport it dominates. Any such exclusive dealing contract is 
null and void.
    4. A market dominant airline may not lawfully enter into an 
exclusive dealing contract with a corporate purchaser of air travel at 
any city located within 50 miles of an airport which the airline 
dominates. Any such exclusive dealing contract is null and void.
    5. A market dominant airline may not lawfully offer or pay any 
commission overrides to any travel agency or travel agent at any city 
located within 50 miles of an airport which the airline dominates.
    6. A market dominant airline may not lawfully refuse to sell 
frequent flyer mileage to its airline competitors for travel to or from 
a market dominant airport at a price higher than the lowest available 
price offered to any purchaser.
    7. Any violation of these provision shall constitute an unfair and 
deceptive practice under 49 U.S.C Sec. 41712 and unlawful 
monopolization under 15 U.S.C. Sec. 2.
    This is only a suggested model of what might be appropriate 
legislation. I leave it to the Honorable Senators and their capable 
staff to draft a bill which better accomplishes the competition 
enhancement goals we share.
                               conclusion
    The arsenal of anticompetitive activities used by major airlines 
against new entrants is not new, though these tactical weapons have 
been used with increasingly better precision and effectiveness by the 
major airlines. Several low-cost/low-fare airlines now find themselves 
in the cross-hairs of the major airlines. It is also apparent that a 
failure of government agencies to impose sanctions against such 
practices has led to a widespread belief among the major airlines that 
our nation's competition laws do not apply to them. It would therefore 
be helpful if the U.S. Department of Justice and the U.S. Department of 
Transportation take such enforcement action as is necessary to preserve 
competition, while there is still competition to preserve.
    Despite record profits earned by the major airlines, the number of 
low-cost low-fare airlines is declining. Within the last year, new 
entrant airlines like Air South, Sun Jet International, Western Pacific 
and Pan American World Airways have disappeared from the competitive 
landscape. That environment would change profoundly if the 
Transportation Department and Justice Department took formal action 
against a major hub-dominant airline for blatantly anticompetitive 
activities such as those described herein.
    Neither the Department of Transportation nor the Department of 
Justice need protect an individual competitor from the rigors of the 
marketplace. They should, however, protect competition. Without 
application of the competition laws, predation runs riot, and 
competition is jeopardizes. Because of the profound economic 
externalities airlines impose upon communities and businesses across 
America, monopolization in the airline industry cannot be tolerated. 
After all, the American people own the airways and the airports. These 
are public resources to be used in the public interest. Therefore, it 
is reasonable to insist that air carriers serve the public interest. 
Monopolistic exploitation is antithetical to that duty.
    Thank you.
                                 ______
                                 

                          Biographical Sketch

                          paul stephen dempsey
    Paul Stephen Dempsey is Vice Chairman & Director of Frontier 
Airlines. He is also Professor of Law and Director of the 
Transportation Law Program at the University of Denver. He formerly 
served as an attorney with the Civil Aeronautics Board and the 
Interstate Commerce Commission in Washington, D.C. Professor Dempsey 
has written more than fifty law review and professional journal 
articles, scores of newspaper and news magazine editorials, and several 
books:
    Airline Management: Strategies for the 21 st Century (Coast Aire 
1997).
    Air Transportation: Foundations for the 21st Century (Coast Aire 
1997).
    Denver International Airport: Lessons Learned (McGraw-Hill 1997).
    Aviation Law & Regulation (two volumes, Butterworth 1993).
    Airline Deregulation & Laissez-Faire Mythology (Quorum Books 1992).
    Flying Blind: The Failure of Airline Deregulation (Economic Policy 
Institute, 1990).
    The Social & Economic Consequences of Deregulation (Quorum Books 
1989).
    Law & Foreign Policy in International Aviation (Transnational 
1987).
    Law & Economic Regulation in Transportation (Quorum Books 1986).
    Professor Dempsey was a Fulbright Scholar, was awarded the 
Transportation Lawyers Association Distinguished Service Award, and was 
designated the University of Denver's Outstanding Scholar. He was the 
first individual designated the University of Denver's Hughes Research 
Professor and DePaul University's Distinguished Visiting Professor of 
Law. He was inducted into the Colorado Aviation Hall of Fame. Since 
1979, he has been faculty editor of the ``Transportation Law Journal.'' 
He also serves on the Editorial Boards of the ``Denver Business 
Journal,'' and ``The Aviation Quarterly.''
    Since 1986, he has been the host of KWGN-TV's weekly talk show, 
``Your Right To Say It.'' Professor Dempsey has appeared on the ABC 
Evening News with Peter Jennings, the NBC evening news with Tom Brokaw, 
the MacNeil-Lehrer News Hour, ABC World Business Report, NBC Today, ABC 
Good Morning America, CNN Crossfire, National Public Radio, CBS Radio, 
NBC Mutual Radio, and other news broadcasting networks in the United 
States and abroad. His editorials have been published numerous 
newspapers and news magazines, including Newsweek, the New York Times, 
and the Wall Street Journal.
    Professor Dempsey has served as President of Americans for Sound 
Aviation Policy. He has also been a consultant to U.S. and foreign 
airlines, railroads, motor carriers, transportation labor 
organizations, travel agents, telecommunications companies and 
governmental agencies. Dr. Dempsey holds the following degrees: A.B.J., 
J.D., University of Georgia; LL.M., George Washington University; 
D.C.L., McGill University. He is admitted to practice law in Colorado, 
Georgia and the District of Columbia.
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[GRAPHIC] [TIFF OMITTED] T12SMA05.002

[GRAPHIC] [TIFF OMITTED] T12SMA05.003


        U.S. AIRLINE INDUSTRY--MARKET SHARE BASED ON ENPLANEMENTS--DENVER STAPLETON INTERNATIONAL AIRPORT
                                              [Units in thousands)
----------------------------------------------------------------------------------------------------------------
                                                                         Percentage
                                           ---------------------------------------------------------------------
                                              1987      1990      1991      1992      1993      1994      1995
----------------------------------------------------------------------------------------------------------------
United....................................     43.02     48.44     46.76     48.54     52.57     62.94     69.94
Delta.....................................      2.67      4.21      4.46      4.54      4.32      4.48      5.08
American..................................      2.02      3.23      3.59      4.07      3.61      4.20      4.83
Continental...............................     43.51     34.26     36.83     35.45     31.34     16.97      3.39
----------------------------------------------------------------------------------------------------------------

                                                                                                        [GRAPHIC] [TIFF OMITTED] T12SMA05.004
                                                                                                        
                       Denver, CO--10 City Pairs

         [Year-over-year percent change (Q3 1997 vs. Q3 1996)]

Full Coach........................................................    30
Typical Business..................................................    35

Source: The American Express' Airfare Index, American Express 
Consulting

                     TYPICAL BUSINESS FARE SAMPLING
------------------------------------------------------------------------
                                                          Fare   Percent
------------------------------------------------------------------------
1998 \1\...............................................    $448       +5
1997...................................................     426      +16
1996...................................................     366       +9
1995...................................................     335       +3
1994...................................................     326       -6
1993...................................................     282     +22
------------------------------------------------------------------------
\1\ Projected

Note: Average Yearly Increase + 8 percent.

Denver International Airport--The Big Prize
  --A $5 billion air market
  --6th Largest market in the United States
  --73 percent of Total Traffic Controlled by UAL
  --97 percent of Connecting Traffic Controlled by UAL
UAL Combines Tactics to Create Monopoly Power
  --Prices below its cost \19\
  --Dumps seat capacity \19\
  --Refuses Economic Connections to their System
  --Precludes feed traffic from UAL affiliates
  --Pays Override Commissions to Travel Agents \19\
  --Denies competitive shelf space in CRS displays
  --Enters exclusive contracts with large corporations \19\
---------------------------------------------------------------------------
    \19\ This reverses direction once competition is eliminated.
    [GRAPHIC] [TIFF OMITTED] T12SMA05.005
    

                        DOLLAR SAVINGS COMPARISON
------------------------------------------------------------------------
                                  Frontier   United
           Denver to:            Corporate   Walk-up   Dollar    Percent
                                  fare BNR  fare BUA   savings   savings
------------------------------------------------------------------------
Albuquerque....................       $174      $423      $249        59
Baltimore/Washington...........        282       732       450        61
Bloominton-Normal..............        237       N/A       N/A       N/A
Boston.........................        324       878       554        63
Chicago (Midway)...............        216       584       368        63
El Paso........................        209       N/A       N/A       N/A
Los Angeles....................        189       622       433        70
Minneapolis-St.Paul............        248       498       250        50
New York LGA...................        399       843       444        53
Omaha..........................        219       523       304        58
Phoenix........................        195       273        78        29
Salt Lake City.................        198       260        62        24
San Francisco..................        219       682       463        68
Seattle/Tacoma.................        230       673       443        66
------------------------------------------------------------------------

                                                                [GRAPHIC] [TIFF OMITTED] T12SMA05.006
                                                                
   DOMESTIC MARKET SHARE--DENVER INTERNATIONAL AIRPORT--DECEMBER 1997

        Airlines                                                 Percent
United............................................................  64.7
United Express....................................................   6.2
Frontier Airlines.................................................   3.5
Delta.............................................................   4.7
Continental.......................................................   2.6
American..........................................................   4.5
Western Pacific...................................................   5.5
Other.............................................................   6.1
Northwest.........................................................   2.2
[GRAPHIC] [TIFF OMITTED] T12SMA05.007

                                 ______
                                 

Unfriendly Skies Over Colorado: United Airlines' Fortress Hub Monopoly 
                               at Denver

                       (By Paul Stephen Dempsey)

                                foreword
    This study documents the predatory practices used by United 
Airlines to monopolize the air transportation market at Denver. Having 
used such tactics to drive two major hub competitors out of Denver--the 
original Frontier Airlines and Continental Airlines--United is now 
focusing its gun sights on new, low-cost entrants to the Denver 
marketplace, principally the ``new'' Frontier Airlines. Frontier is 
attempting to counter United's actions through a number of major new 
marketing programs. At the same time, Frontier is seeking public and 
governmental understanding of the need to reestablish a level playing 
field at Denver. Frontier does not believe that United's tenacious 
determination to maintain a monopoly at Denver can withstand the light 
of day.
[GRAPHIC] [TIFF OMITTED] T12SMA05.008

                           executive summary
           united airlines' monopolization of the denver hub
Introduction: United Airlines' Determination to Establish and Maintain 
        a Monopoly Hub at Denver
    United Airlines is the largest airline in the world. In 1996, 
United and its code-sharing affiliates controlled nearly 80 percent of 
the Denver passenger market, and more than 95 percent of the connecting 
passenger market flowing through its Denver Fortress Hub. United's 
dominance of the Denver hub was accomplished by several predatory 
practices designed to eliminate or subdue competitors: (1) add seat 
capacity and flight frequency to deny competitors realistic or 
achievable break-even load factors; (2) drop prices to below-cost 
levels; (3) refuse competitors nondiscriminatory access to its network; 
(4) bias its computer reservations system against more convenient 
competitive offerings; (5) paying travel agents commission overrides to 
steer business toward United and away from competitors; and (6) enter 
into ``exclusive dealing'' arrangements with corporate purchasers. Once 
a competitor has been driven from the Denver market, United has behaved 
like a rational wealth-maximizing monopolist--raising fares to monopoly 
levels. Chronologically, these unfair and deceptive practices have 
manifested themselves in the following order:
 eliminate the original frontier airlines as a competitor to create a 
                 united & continental duopoly at denver
    In 1982, United Airlines launched a plan to drive the original 
Frontier Airlines (then, along with United and Continental Airlines, 
one of Denver's three dominant airlines) from the Denver market. By 
increasing its capacity at Denver by a third, cross-subsidizing losses 
on deeply discounted fares in the Denver market with profits earned 
elsewhere in its vast route network, and biasing its computer 
reservations system to mislead travel agents, United was able to force 
Frontier to suffer its first losses in a decade. As its losses mounted, 
Frontier was forced to sell most of its assets to United Airlines, in 
1985. After its sale to People Express, Frontier collapsed into 
bankruptcy, in 1986.
   drive continental out of denver to create a fortress hub monopoly
    After Frontier's departure, United continued to engage in below-
cost pricing. At first, United opposed the construction of a new 
airport at Denver, fearing that new competitors might enter the market. 
Once Continental Airlines signed up for Concourse A at the new Denver 
International Airport [DIA], United signed up for Concourse B, though 
insisting on a contractual provision that the new airport would not 
open until it was satisfied with the performance of the automated 
baggage system it had insisted be installed. In 1992, United designated 
Denver its ``major domestic initiative.'' Using a variety of predatory 
practices, United turned up the heat on Continental, which began to 
lose $10 million a month at Denver, and half a billion dollars over 
three years. Although DIA could have opened in 1993, United delayed its 
opening until Continental downsized its hub at Denver. By 1995, when 
United finally allowed DIA to open, Continental flew only 13 flights a 
day to Denver from three cities. To ensure that no other airline would 
emerge as a significant competitor at Denver, United insisted that it 
be allowed to take over the Concourse C automated baggage system, that 
rents on Concourse A would disproportionately be assessed for its 
baggage system (which has never worked), and that United's maintenance 
hangar would be built on the site of a future concourse.
                extract monopoly fares at the denver hub
    After Continental's departure, United raised fares sharply. Though 
it blamed DIA's high costs, United had begun to raise fares to monopoly 
levels well before DIA opened, as Continental downsized its operations. 
Moreover, United's belated and massive construction scope changes were 
the single most important factor in driving up DIA's costs.
monopolize the connecting passenger market flowing over the denver hub 
and, as a by-product, deny jet service to small communities throughout 
               the rocky mountain and great plains region
    United enters into discriminatory and monopolistic interline 
arrangements with select carriers at Denver. By refusing to enter into 
joint-fare and code-sharing agreements with unaffiliated domestic jet 
carriers, and adding the equivalent of 1,440 minutes (24 hours) to the 
elapsed flight time in their displays in its Apollo computer 
reservations system [CRS], United ensures that competing jet carriers' 
flights often will be shoved off the first page of the CRS display, 
where 85 percent of all flights are sold. United's competitors are 
thereby denied sufficient connecting traffic to attain break-even load 
factors in thin markets. By monopolizing the connecting passenger 
market at the Denver hub, United dictates that small communities 
throughout the Rocky Mountain and Great Plains region will be served 
only by high-cost, high-price monopoly ``United Express'' affiliates 
from Denver, most of which fly only small turboprop aircraft.
  drive new low-cost competitors from the denver fortress hub and the 
                    nearby colorado springs airport
    As a few small low-cost competitors emerged at DIA and Colorado 
Springs to offer prices lower than United's monopoly fares, United 
responded aggressively, by dumping additional aircraft capacity in 
their markets, lowering fares to levels below costs, paying travel 
agents commission overrides to steer business toward United and away 
from competitors, entering into ``exclusive dealing'' contracts with 
business purchasers, and in February 1997, launching its competitive 
weapon--Shuttle by United--to markets in which low-cost entrants have 
emerged. The mission of the Shuttle is not to lower prices (though low 
prices it will initially bring); it is to drive low-price competition 
out of Denver.
          extract monopoly fares at the denver hub: round two
    If United is successful in driving the new Frontier Airlines from 
Denver, and Western Pacific Airlines from Colorado Springs, it will 
extract monopoly fares from passengers who begin or end their trips 
there. This will result in a wealth transfer of several hundred million 
dollars from consumers to the monopolist, United Airlines. Monopoly 
fares will have an adverse impact on Colorado's $6 billion a year 
tourism industry, and dissuade new business investment in Colorado.
    In December 1996, when asked how much of the Denver market United 
wanted, United Airlines Vice President Roger Gibson said, ``I'd like it 
all.'' That, of course, includes the 3 percent market share of Frontier 
Airlines. United's mission is to drive competitors from Denver so that 
it can charge Colorado's Consumers whatever the market will bear. 
Monopoly is the Name of the Game.
introduction: united airlines' determination to establish and maintain 
                   a monopoly fortress hub at denver
    United Airlines is the largest airline in the world. Beginning in 
1982, United launched a plan to monopolize the Denver non-stop and 
connecting passenger market. Virtually every step United has taken with 
respect to competitors at Denver has been consistent with that goal.
    The monopolization of the Denver hub has been achieved with several 
careful and deliberative steps. Step one was to eliminate the original 
Frontier Airlines as a competitor, which it did in 1986. Step two was 
to drive Continental Airlines out of Denver as a hub competitor, which 
it did in 1994. Steps three and four are to eliminate the new Frontier 
Airlines as a low-cost Denver competitor, and to drive Western Pacific 
[WestPac] out of Colorado Springs.
    The means by which United accomplishes these goals have been 
consistent: (1) add seat capacity and flight frequency in competitors' 
city-pairs in order to drive its competitors' load factors to below 
break-even levels; (2) drop prices to levels at or below those of any 
competitor which dares to enter its market, even if the price is below 
United's costs; (3) refuse any competitor access to its dominant 
passenger network; (4) bias its computer reservations system to 
dissuade travel agents from selling its competitors' services; (5) 
bribe travel agents with commission overrides to steer passenger 
business toward United; and (6) enter into exclusive dealing 
arrangements with corporate purchasers. After a competitor is 
eliminated, United's conduct as a monopolist has also been strikingly 
consistent--raise prices in its monopoly city-pairs to whatever the 
market will bear. This gives it the economic resources to repeat the 
cycle whenever a new entrant attempts to invade its fortress hub.
    This study documents the anticompetitive behavior of United 
Airlines toward its competitors chronologically, beginning shortly 
after airline deregulation.
 eliminate the original frontier airlines as a competitor to create a 
                united and continental duopoly at denver
    The original Frontier airlines began service as a ``local service 
carrier'' in 1946. By the beginning of 1982, Frontier Airlines had more 
flights at Denver than any other carrier, serving a total of 85 cities 
from its Denver hub. Frontier had been consistently profitable during 
the previous ten years.\1\ Although the industry as a whole lost money 
in 1981, Frontier earned $32 million of profit on revenue of $577 
million.\2\ It was to be Frontier Airlines' last good year.
---------------------------------------------------------------------------
    \1\ H. Laws & R. Lossee, Frontier (monograph Dec. 2,1986). at 2.
    \2\ History of the Former Frontier Airlines: 1946-1986.
---------------------------------------------------------------------------
    According to Aviation Daily, in 1982, ``United, a major competitor 
at Denver Stapleton, launched a massive campaign to capture a bigger 
share of the Denver market and to become the dominant carrier at the 
airport.'' \3\ The 1981 air traffic controllers' strike had led the FAA 
to impose a cap on landing slots. In 1982, as it began its buildup at 
Denver, United was buying slots from anyone who would sell them, moving 
acres of seats to Denver.\4\ (See Appendix B). United increased its 
flights out of Denver by a third, predominantly adding capacity in 
Frontier's markets.\5\ In its ``United's High On Denver'' plan, United 
Airlines executives explicitly identified Frontier Airlines as its 
principal target.\6\ From May to July of 1982, United increased its 
flights from 96 to 133 daily departures, becoming Denver's largest 
carrier, versus 120 daily departures by Frontier and 110 by 
Continental.\7\ This author's study of the airline industry (published 
in 1992) discussed this period as follows:
---------------------------------------------------------------------------
    \3\ Aviation Daily (Sept. 2, 1986), at 348.
    \4\ Dee Mosteller & Danna Henderson, Denver's Stapleton Airport: A 
Good Place To Watch Deregulation, Air Transport World (Nov. 1986), at 
64.
    \5\ Id.
    \6\ United is Biggest, Best at Denver, Friendly Times (Oct. 1982).
    \7\ Id.
---------------------------------------------------------------------------
    ``United, the nation's largest airline, was determined to dominate 
Denver. With a deep pocket that could cross-subsidize losses in 
competitive markets, a powerful computer reservations system that could 
discriminate against competitors, and an attractive frequent-flyer 
program that could lure business travelers (the most lucrative segment 
of the passenger market), United, the nation's largest airline, began 
to turn up the heat on Frontier.'' \8\
---------------------------------------------------------------------------
    \8\ Paul Dempsey & Andrew Goetz, Airline Deregulation & Laissez-
Faire Mythology 70 (1992).
---------------------------------------------------------------------------
    1982 marked the first time United Airlines was described by the 
press as ``the 800-pound gorilla.'' \9\ It is a metaphor that has since 
been almost universally embraced by observers of the airline 
industry.\10\
---------------------------------------------------------------------------
    \9\ Frank Lorenzo Lures a Co-Pilot, Bus. Week (Dec. 6. 1982). at 
42.
    \10\ See e.g., Steven Lolford. Carriers Moves On Labor Costs Are 
Viewed As Bold Decisions, Travel Weekly (Sept. 12. 1983), at 1; Douglas 
Feaver, Airline Charts New Course After Best Year, Washington Post, 
Feb. 24. 1985, at G1; Joan Feldman, Is There Any Justice in Reagan's 
Airline Merger Policy? Air Transport World (May 1986), at 18; Mark 
Hornway, Ferris Loads Up On Debt To Thwart Allegis Buyout, Crains 
Chicago Bus., June 1, 1987, at 2; MacNeil/Lehrer NewsHour, Nov. 4, 
1987; Robert Rose, Taking Off: United Airlines Begins To Pick up 
Altitude, Wall St. J., July 28. 1988, at 1; Stanley Ziemba, Sleeping 
Giant United Wakes Up, Chicago Tribune, Feb. 9, 1992, at C1; Paul 
Betts. Grounded After a Bumpy Flight, Financial Times, Jan. 10, 1994, 
at 14; Gene Amole, Blame Romer, Pena for DIA Fare Hike, Rocky Mountain 
News, Jan. 31, 1995, at 5A; Colorado Business Strategy, Rocky Mountain 
News, Feb. 12, 1995, at 98A; James Ott, Domicile Issue Divides UAL, 
Cabin Crews, Av. Week & Space Tech. (Nov. 20, 1995), at 52; Chuck 
Green, Supporting DIA Tests a Person's Endurance, Denver Post, Jan. 14, 
1996, at B1; and Robert Moorman, The ``New'' New Frontier, Air 
Transport World (Aug. 1996), at 86.
---------------------------------------------------------------------------
    By 1983, United had added over 100,000 seats per week at Denver 
since deregulation, and increased its frequencies to 174 departures per 
day at Denver's Stapleton International Airport. Frontier had 138 daily 
departures and 24.3 percent of the market, while Continental had 18.5 
percent.\11\ Frontier was being squeezed by a determined United 
Airlines. That year, despite a significant cost-saving labor agreement, 
an 11.2 percent increase in passenger boardings, and an improvement in 
revenue, Frontier posted a net loss of $13.8 million, the first in more 
than a decade.\12\ (See appendices C and D). By the end of 1983, 
Continental Airlines collapsed into Chapter 11 bankruptcy.
---------------------------------------------------------------------------
    \11\ Texas Air Makes Bid for Frontier, Aviation Daily, Apr. 5, 
1985. at 201.
    \12\ Frontier Airlines, Annual Report (1983).
---------------------------------------------------------------------------
    By 1984, average fares in Denver were the lowest in the United 
States. In 1985, they dropped another 8.3 percent.\13\ Frontier was 
forced to begin liquidating assets, and United seized the opportunity. 
In early 1985, Frontier sold five McDonnell-Douglas aircraft to United 
Airlines for $95 million, and in May of 1985, was forced to sell half 
its remaining fleet (25 of 51 of its Boeing 737's) to United for $265 
million. By purchasing more than half of Frontier, United was able to 
gradually downsize its competitor.\14\ The rest of Frontier was sold to 
Newark-based new entrant airline People Express in November 1985.\15\
---------------------------------------------------------------------------
    \13\ Stapleton International Airport, Average Airline Fares for 
Selected U.S. Airpons (1988).
    \14\ Certain aircraft were leased back to Frontier for short 
periods of time.
    \15\ Frontier Begins Downsizing Operations, Aviation Daily (May 15, 
1985), at 83.
---------------------------------------------------------------------------
    By 1986, United controlled nearly 40 percent of the Denver market, 
followed by Continental at 28 percent and People-owned Frontier at 18 
percent.\16\ (See Appendix A). Fares at Denver fell another 4.6 percent 
in that year.\17\ Denver was being described as the ``fare wars capital 
of the world,'' with the lowest unrestricted fares of any major hub in 
the United States. Yields (the amount of revenue charged per seat) were 
as low as 5 cents a mile, while Frontier's seat-mile costs were north 
of 8 cents.\18\
---------------------------------------------------------------------------
    \16\ Stapleton Int'l Airport, Domestic Market Shares (July 1986).
    \17\ Stapleton Int'l Airport, Average Airline Fares for Selected 
U.S. Airports (1988).
    \18\ Dee Mosteller & Danna Henderson, Denver's Stapleton Airport: A 
Good Place To Watch Deregulation, Air Transport World (Nov. 1986), at 
64.
---------------------------------------------------------------------------
    Below-cost pricing began to take its toll on smaller carriers the 
Denver market. In May 1986, Pioneer Airlines, a long-time Denver 
commuter carrier, ceased operations.\19\ In addition to below-cost 
pricing, United launched a program offering a $100 reward to Denver 
travel agents every time they told a customer ``it's just as easy and 
just as cheap to fly United.'' \20\
---------------------------------------------------------------------------
    \19\ Id.
    \20\ Henry Dubroff, Touters of United Rewarded, Denver Post, Mar. 
8, 1986.
---------------------------------------------------------------------------
    In July 1986, with Frontier still losing money, People Express 
agreed to sell Frontier to United, and transferred many of Frontier's 
most important assets to United while the deal was pending. United was 
able to acquire $43.2 million worth of assets from Frontier, including 
some of its most valuable properties--five takeoff and landing slots at 
Chicago O'Hare, three gates at Dallas/Ft. Worth, contracts to acquire 
two MD-80 aircraft, and two hangars and six gates at Denver.\21\ By 
now, United had spent more than $400 million directly on Frontier's 
assets, and hundreds of millions of dollars more in below-cost pricing, 
in an effort to eliminate Frontier as a competitor at Denver. 
Continental filed a lawsuit objecting to the monopoly Frontier's 
acquisition by United would create.\22\
---------------------------------------------------------------------------
    \21\ In re Frontier Airlines, Inc. (memorandum opinion and order on 
motion to approve settlement, Case No. 85 B 8021 E, Mar. 23, 1987) at 
4.
    \22\ Dee Mosteller & Danna Henderson, Denver's Stapleton Airport: A 
Good Place To Watch Deregulation, Air Transport World (Nov. 1986), at 
64.
---------------------------------------------------------------------------
    Once it had acquired several of Frontier's prized assets, United 
began to take a hard line stance in its negotiations over the 
acquisition of the rest of Frontier. Although United had agreed to 
purchase Frontier, and agreed to ``use its best efforts'' to resolve 
potential labor problems, United balked at consummating the acquisition 
as its pilots refused to accede to United's insistence that Frontier's 
pilots be integrated into United's labor force at their existing wage 
levels (in effect, a ``C'' scale, with wages 40 percent below those of 
United's pilots). Some speculated that United failed to exercise good 
faith in the negotiations (for example, United never negotiated with 
the other union groups), because it knew that Frontier's deteriorating 
cash position would soon cause it to collapse in bankruptcy. By walking 
away, United could eliminate Frontier without having to conclude the 
purchase agreement with People Express.
    Meanwhile, People Express continued to lose money, and was forced 
to shut down Frontier on August 24, 1986.\23\ Frontier entered 
bankruptcy two days later. A United Airlines' publication revealed, 
``United will benefit from eliminating the instability of Denver's 
three-carrier hub. This will translate into higherfares and better 
returns and will ensure that another carrier does not attempt to build 
a presence in Denver.'' \24\
---------------------------------------------------------------------------
    \23\ Agis Salpukas, Frontier Files for Bankruptcy, N.Y. Times, Aug. 
29, 1986, at D1.
    \24\ Reporters, Analysts Applaud United's Frontier Purchase, 
Friendly Times (Aug. 1986), at 2 [emphasis supplied].
---------------------------------------------------------------------------
    But United did not anticipate that Continental would pick up the 
pieces of a grounded Frontier. Only a month after People put Frontier 
into bankruptcy, Frank Lorenzo's Texas Air offered to purchase both 
People Express and Frontier, and by February 1987, they were both 
folded into Continental (along with New York Air).\25\ After a 
settlement with United over the transfer of assets from Frontier,\26\ 
Continental came away with most of Frontier's aircraft, in addition to 
three hangars and two concourses (C and D) at Denver's Stapleton 
Airport.\27\ With the acquisition of Frontier, Continental surpassed 
United with 236 daily departures compared to United's 218, and briefly 
held the dominant position at Denver from June 1987 to May 1988.\28\ 
The era of three hubbing airlines in Denver was over.
---------------------------------------------------------------------------
    \25\ Paul Dempsey & Andrew Goetz, Airline Daregulation & Laissez-
Faire Mythology (Quorum 1992), at 87.
    \26\ See In re Frontier Airlines, Inc., 74 Bankr. 973 (1987).
    \27\ Paul Dempsey & Andrew Goetz, Airline Deregulation & Laissez-
Faire Mythology (Quorum 1992), at 88.
    \28\ Continental Expects To Operate 250 Daily Denver Departures By 
Yearend, Aviation Daily (Nov. 3, 1986), at 182.
---------------------------------------------------------------------------
    Subsequently, an antitrust action was filed against United by a 
large number of former Frontier pilots, flight attendants, and ticket, 
reservations and station agents against United Airlines. In that case, 
plaintiffs alleged that United engaged in various anticompetitive 
activities designed to destroy Frontier. Among the more prominent 
allegations was that United: (1) exerted monopoly power in the computer 
reservations system [CRS] market in Denver and also with respect to its 
Apollo CRS; (2) overcharged Frontier for its participation in the 
Apollo system; (3) caused Apollo to operate unfairly in ticket sales; 
and (4) purposefully did not go forward with the stock purchase 
agreement it had concluded with Frontier, leaving Frontier so weakened 
financially that it failed.\29\ Unfortunately, the court held that 
employees lack standing to bring an antitrust claim, and never reached 
the merits of the complaint.\30\
---------------------------------------------------------------------------
    \29\ Sharp v. United Airlines, 967 F.2d 404 (10th Cir. 1992).
    \30\ Id.
---------------------------------------------------------------------------
    Another lawsuit brought in 1985 by Continental Airlines objected to 
the manipulation and display bias, and suppression of competitors' 
fares and schedules imposed by United and American Airlines in their 
computer reservations systems.\31\ In the mid-1980's, United's Apollo 
CRS was used by between 70 percent and 80 percent of Denver-area travel 
agencies.\32\ A federal district court ``found sufficient evidence that 
United and American committed mail fraud and wire fraud in connection 
with their CRS's to allow Continental to proceed with a jury trial on 
its $1 billion RICO (Racketeering Influenced and Corrupt Organizations 
Act) claim against the carriers,'' to allow the case to proceed to a 
jury.\33\ Continental claimed United had programmed its CRS to favor 
United's flights over those of its competitors, even when a 
competitors' flight was more convenient for a customer. Continental 
also alleged that United overcharged it and other carriers for 
participation in its CRS. The court found that United and American 
``had specific intent to defraud'' when they ``deceitfully concealed 
material facts concerning the manipulation of the Continental 
plaintiffs flight information in Sabre and Apollo.'' \34\ After 10 
weeks of trial, on the eve of jury deliberations, United settled the 
suit for about $70 million.\35\
---------------------------------------------------------------------------
    \31\ American, Continental Spar As CRS Suit Heads To Court, 
Aviation Daily, Feb. 27, 1989, at 295.
    \32\ Dee Mosteller & Danna Henderson, Denver's Stapleton Airport: A 
Good Place To Watch Deregulation, Air Transport World (Nov. 1986), at 
64.
    \33\ American, Continental Spar As CRS Suit Heads To Court, 
Aviation Daily, Feb. 27, 1989, at 295.
    \34\ Continental Lawsuit Going To Trial, Denver Post, Feb. 24, 
1989.
    \35\ Continental Settles Lawsuit, N.Y. Times, Mar. 30, 1990, at 
D13.
---------------------------------------------------------------------------
    With Frontier and People Express gone, the Denver market became a 
duopoly for Continental and United. For a short while (until United 
decided to force Continental out of Denver), it resembled more of a 
``shared monopoly,'' as each carrier attempted to recoup some of the 
losses incurred in the battle with Frontier.\36\ Accordingly, airline 
ticket prices at Denver rose by 17.6 percent in 1987 and a record 39.2 
percent in 1988.\37\ Without Frontier, passenger enplanements at Denver 
declined sharply, exacerbated by the fare increases.
---------------------------------------------------------------------------
    \36\ Paul Dempsey & Andrew Goetz, Airline Deregulation & Laissez--
Faire Mythology (Quorum 1992), at 89.
    \37\ Stapleton Int'l Airport, Average Airline Fares for Selected 
U.S. Airports (1988).
---------------------------------------------------------------------------
   drive continental out of denver to create a fortress hub monopoly
    With Frontier out of business, United's market share at Denver 
climed to 50 percent. But half the market wasn't enough for United. 
United wanted all of it.
    Founded as Varney Speed Lines in 1934, Continental Airlines' first 
route was from El Paso to Denver. From 1937 to 1963, Continental was 
headquartered in Denver.\38\ After Frontier and People Express went out 
of business, and Frontier's gates and aircraft folded into Continental, 
for a short while Continental became Denver's leading carrier. In 1987, 
Continental accounted for 42 percent of total enplaned passengers at 
Denver.\39\ The status was short-lived, however, as United quickly 
regained the lead in May 1988, a position it never again relinquished. 
(See Appendix A). By 1990, Continental was in bankruptcy for the second 
time in a decade.
---------------------------------------------------------------------------
    \38\ Jeffrey Leib, Continental's Denver Departure, Oct. 23, 1994, 
at H1.
    \39\ Leigh Fisher Associates Analysis Prepared for the City and 
County of Denver (1994).
---------------------------------------------------------------------------
    Former United Airlines' CEO Stephen Wolf said, ``I never fought 
anything so hard in my life'' as the new Denver International Airport 
[DLA].\40\ Opposition was predicated on cost, and (though never said by 
United publicly), the possibility that a large new airport might have 
sufficient capacity to attract new competition. But once Continental 
jumped on the DIA bandwagon, United had little choice but to jump 
aboard too.
---------------------------------------------------------------------------
    \40\ Don Phillips, $3.1 Billion Airport At Denver Preparing for 
Rough Takeoff, Washington Post, Feb. 13, 1994, at A10.
---------------------------------------------------------------------------
    Among the last things Frank Lorenzo did as CEO of Continental was 
to sign a lease with the city of Denver in the summer of 1990 for 20 
gates at the new Denver International Airport. Because Continental 
became DIA's first hub carrier, it was able to reserve the closest (and 
therefore most desirable) concourse (A) to the main terminal building, 
and the city agreed to build a pedestrian bridge linking the terminal 
directly to that concourse. When United subsequently signed up for 
Concourse B (which had no pedestrian bridge to the main terminal), it 
insisted the city make the glass on Continental's Concourse A bridge 
opaque, so that no passenger could see the splendid view of the 
Colorado Rocky Mountains from it, for United believed the bridge 
offered Continental a competitive advantage. Mercifully, DIA engineer 
Ginger Evans refused, and the city breached its contractual 
agreement.\41\ United chose not to press its case, undoubtedly fearing 
the public relations fallout once the new airport opened.
---------------------------------------------------------------------------
    \41\ Woman of the Year Ginger S. Evans, Engineering News-Record 
(Feb. 11, 1994), at 34.
---------------------------------------------------------------------------
    United took several actions to pressure Continental to depart. For 
example, United refused to allow DIA to open until its automated 
baggage system could deliver 225 bags a minute. DIA's chief engineer, 
Ginger Evans, contends DIA could have opened early in 1994 with the 
baggage system operating at 40 bags per minute, adequate to allow 
United to meet its connect times.\42\ ``Virtually every design and 
construction professional [who] was involved directly or as a 
consultant * * * believed at that time the project, including the BAE 
automated baggage system, could have been completed by October 21, 1993 
[the originally scheduled opening date].'' \43\ If an allegedly 
malfunctioning baggage system was not the fundamental cause of the 
delay, what was? One plausible and widely accepted explanation has been 
proffered by former Denver airport director George Doughty in testimony 
before the U.S. Congress:
---------------------------------------------------------------------------
    \42\ See Paul Dempsey, Andrew Goetz & Joseph Szyliowicz, Denver 
International Airport: Lessons Learned (McGraw Hill 1997).
    \43\ Greiner Says SEC Staff Case Against Denver Consultants Not 
Legitimate, Airports, Dec. 19, 1993.
---------------------------------------------------------------------------
    United Airlines did not want to go to DIA. United could have 
cooperated with the City to work out options for manual bag handling, 
but they did not * * *. As to exactly what United's rationale [was] one 
can only speculate, but a few things are clear. United had no incentive 
to move in 1994. They had just increased their operations at Denver in 
order to capture an even greater market share that would eventually 
force Continental to dismantle its hub. It was to their advantage not 
to move until that was assured * * *.\44\
---------------------------------------------------------------------------
    \44\ George Doughty, Testimony Before the U.S. House Transportation 
Subcommittee on Aviation (May 11, 1995).
---------------------------------------------------------------------------
    In 1992, Continental reached its last high water mark of 285 
flights per day (including Continental Express) at Denver. With 38 
percent of the market, Continental was still second to United's 40 
percent. United designated Denver its ``major domestic initiative,'' 
and increased its capacity by 30 percent over the next several years in 
what appeared to be a deliberate move to oust Continental once and for 
all.\45\ UAL's 1992 Annual Report spoke of ``an aggressive plan for 
expansion'' at Denver: ``At Denver, United phased in a dramatic 
increase in departures during the year, moving from 180 flights last 
spring to 217 during the summer and, by March of this year, to 247 
departures [plus 105 by United Express carriers].'' \46\ Its 1993 
Annual Report stated, ``An aggressive buildup has made a significant 
contribution to revenue improvement at [the Denver] hub. United ended 
1993 with 257 daily departures in Denver, up from 212 a year earlier * 
* *. Already the number one carrier in the Mile High City, United had 
increased its capacity over the last two years by nearly 30 percent.'' 
\47\ United's aggressive behavior at Denver was clearly targeted at 
Continental. United pulled away and never looked back as it steadily 
increased market share, leading to Continental's decision to pull out.
---------------------------------------------------------------------------
    \45\ ``United Airlines, the dominant carrier in the Denver market, 
has been increasing its service to pressure Continental,'' Bill Mintz, 
Denver A Victim of Continental's Fare Strategy, Houston Chronicle, July 
8, 1994, at 2. See also Paul Dempsey, ``Rip United Airline's Hold from 
DIA,'' Denver Business Journal, August 25-31, 1995.
    \46\ UAL Corp., 1992 Annual Report 7 (1993) [emphasis supplied].
    \47\ Id. at 6 [emphasis supplied].
---------------------------------------------------------------------------
    Toward the end, Continental was losing $10 million a month at its 
Denver hub, and could not face the prospect of continuing hub 
operations at the more expensive new airport. Denver airport director 
Jim DeLong described it as a ``fierce battle for dominance of the 
Denver market.'' \48\ Continental's Annual Report revealed that the 
company had lost $130 million at Denver in 1993, and lost $500 million 
at Denver from 1990-1993.\49\ According to Continental's CEO Robert 
Ferguson, ``Continental's losses are at unacceptably high levels in 
Denver, even with our reduced flying.'' \50\ Continental's Annual 
Report said, ``Although the new facilities [at DIA] will be greatly 
superior to those presently serving Continental's Denver passengers, 
they also will be much more expensive.'' \51\ It was estimated that 
increased landing fees required to pay off bonds issued to finance DIA 
would have added another $50 million to Continental's costs.\52\
---------------------------------------------------------------------------
    \48\ Jeffrey Leib, GAO Study Encouraging for DIA's Financing, 
Denver Post, Feb. 14, 1995, at C3.
    \49\ Continental Airlines, 1994 Annual Report 19 (1995).
    \50\ Michelle Mahoney, Denver Exit Costly One for Continental 
Airlines, Denver Post, July 10, 1994, at 2D; Continental To Close 
Denver Crew Bases This Fall, Aviation Daily, July 8, 1994, at 38.
    \51\ Michelle Mahoney, Denver Costly for Continental, Denver Post, 
June 18, 1994, at A23.
    \52\ Bill Mintz, Denver A Victim of Continental Fare Strategy, 
Houston Chronicle, July 8, 1994, at 2; Michelle Mahoney, Airline's Memo 
Jolts Morale, Denver Post, Mar. 31, 1994, at C1.
---------------------------------------------------------------------------
    The advantages Continental gained from signing the first lease at 
DIA were never fully realized because Continental ultimately was forced 
to cry ``uncle,'' in March 1994, and announced its decision to abandon 
its Denver hub operations and relinquish the market to United. 
Continental had already downsized its presence in Denver from a high of 
285 flights a day in February 1992, to 165 flights in August 1993, to 
148 flights in January 1994, to 107 flights in March 1994. 
Continental's Denver operations dropped to 86 flights in July 1994, 59 
in September 1994, and 19 in March 1995.\53\ Meanwhile, United 
increased its flights to 280.\54\
---------------------------------------------------------------------------
    \53\ City and County of Denver, Airport System Revenue Bonds, 
Series 1994 (Sept. 1, 1994); Michelle Mahoney, Airline Changes Buffet 
Denver, Denver Post (Feb. 13, 1994).
    \54\ Leigh Fisher Associates Analysis Prepared for the City and 
County of Denver (1994).
---------------------------------------------------------------------------
    Following Continental's announcement that it was scaling back its 
Denver hub beginning in the fall of 1993, the withdrawal proceeded 
throughout the following year. Continental dropped 26 routes through 
August 1994, and an additional 23 on October 31, 1994. By the time DIA 
opened, Continental was down to 13 flights a day to three cities.
    Passenger traffic, which was increasing since 1990, began to 
decline after Continental's pullout. In 1995, only 31 million total 
passengers were flown to, from or through Denver, down from 33 million 
in 1994. A contributing factor in this decline is the fare increase 
strategy that United enacted as it realized more monopoly 
opportunities.
    United's goal of becoming the dominant carrier in Denver has been 
fully realized, as United and its code-sharing affiliates now control 
nearly 80 percent of the total passenger market at Denver. By September 
1996, United flew to 55 cities from Denver and Colorado Springs.\55\ In 
1994, United's CEO, Gerald Greenwald, confessed that United's strategy 
to dominate the Denver market had paid off in increased market share 
and profitability.
---------------------------------------------------------------------------
    \55\ Jeffrey Leib, United Joins Fare War, Denver Post, Sept. 19, 
1996, at A1.
---------------------------------------------------------------------------
    Outgoing United CEO Stephen Wolf called Denver the ``major domestic 
initiative'' for the airline over the preceding two years. According to 
Greenwald, ``United has done a fantastic job of building strength in 
Denver and we'd like to take advantage of that, if anything, and build 
it stronger.'' \56\
---------------------------------------------------------------------------
    \56\ Michelle Mahoney & Jeffrey Leib, UAL's Success Key To Denver, 
Denver Post, July 13, 1994, at C1.
---------------------------------------------------------------------------
    As noted above, United may have purposely delayed opening of DIA in 
order to encourage Continental to abandon its Denver hub. Along the 
way, United also cut several additional deals with the city to 
disadvantage its competitors. United insisted it be allowed to take 
over the Concourse C automated baggage system loop, so that only United 
would have a high-speed baggage system. Ironically, the Concourse C 
automated system was the only one operating well before United occupied 
it. Other airlines were relegated to traditional tug-and-cart 
technology.
    Further, United insisted that carriers using Concourse A pay a 
disproportionate share of the costs of that concourse's automated 
baggage system, though the system has never been functional. (On a per-
passenger basis, Continental Airlines pays the highest costs of any 
carrier at DIA; it absorbs a portion of the additional costs of its two 
sub-lessees on Concourse A; but because of this agreement, half of 
Concourse A's domestic gates remain empty.) United's insistence assures 
that the high cost of Concourse A's gates will dissuade new carrier 
entry on that concourse for years to come, despite its superior 
location. Unfortunately, DIA's costs have dissuaded many low-fare 
airlines (including Southwest Airlines) from entering the market, and 
driven low-cost airlines (e.g., Midway and Morris Air) from it. 
Finally, United insisted the city build it a hangar directly north of 
Concourse C, on land a future concourse is supposed to occupy. No such 
future concourse can be built without tearing down United's hangar.
    In summary, though unable to stop construction of a new airport at 
Denver, United Airlines was able to ensure its Fortress Hub dominance 
of DIA by driving up its costs, withholding permission to open DIA 
until Continental Airlines had succumbed to United's below-cost pricing 
and fully committed itself to eliminating its Denver hub, by ensuring 
Concourse C carriers would be deprived use of an automated baggage 
system and that Concourse A carriers would pay an exorbitant price for 
its automated baggage system (though a back-up baggage system was 
welded on top of it, thereby denying Concourse A carriers the automated 
system whose costs they must pay).
           extract monopoly fares at the denver fortress hub
    As Continental departed, an airline executive observed, ``Denver 
residents will know the true definition of high fares.'' \57\ By mid-
1995, United enjoyed about 70 percent of Denver's passenger traffic, 
and even a higher percentage of DIA's $5 billion travel market.\58\ 
Continental Airlines, once an airline as large in Denver as United, 
accounted for less than 3 percent of DIA's traffic. Without a major 
airline to discipline the monopolist, United could extract whatever the 
market would bear.
---------------------------------------------------------------------------
    \57\ Alex Berenson, Continental Fading Away, Denver Post, July 29, 
1994, at A1.
    \58\ Jeffrey Leib, DIA Floats Bid for Southwest, Denver Post, June 
26, 1995, at E1.
---------------------------------------------------------------------------
    United raised fares to monopoly levels in virtually every market 
Continental abandoned. For example, United Airlines quadrupled its 
unrestricted coach fare from Denver to San Francisco (from $238 to 
$954), and tripled its fare from Denver to Los Angeles (from $298 to 
$892).\59\ United would boast that nearly 60 percent of its seats at 
DIA are discounted, with approximately 55 percent discounted up to 35 
percent or more of the full fare.\60\ That makes United sound like a 
benign monopolist until you compare these statistics with industry-wide 
data compiled by the Air Transport Association of America [ATA]. 
According to ATA, more than 90 percent of passengers fly at a discount, 
and the average discount is more than 60 percent of the full fare, and 
has been for nearly a decade.\61\ In 1996, 93 percent of U.S. travelers 
were flying on a discounted ticket (compared with 60 percent on United 
at Denver), and the average discount was 67.5 percent off the full fare 
(compared with only 55 percent of Denver's United travelers enjoying a 
35 percent discount off the full fare).\62\ It is remarkable that 
United would insist that Denver passengers should be grateful for its 
pricing when its Denver discounting was so miserly.
---------------------------------------------------------------------------
    \59\ Jeffrey Leib, United Forging `Fortress Hub,' Denver Post, Aug. 
24, 1994, at C1.
    \60\ United Airlines, 3 The Plane Fax (Apr. 1996) (newsletter by 
UAL Vice President Roger Gibson).
    \61\ Air Transport Ass'n, 1996 Annual Report 8 (1996).
    \62\ Julius Maldutis, Airline Update--November 1996 (Dec. 10, 
1996), at 11.
---------------------------------------------------------------------------
    In a study of Denver International Airport, the U.S. General 
Accounting Office reported to Congress that United Airlines raised 
prices at Denver 38 percent from June 1994-95, while the average ticket 
price nationally increased only 7 percent over the same period.\63\ In 
August 1995, American Express Travel said its Denver customers were 
paying 46 percent more.\64\ However, in September 1995, United insisted 
average fares were only up 16 percent, but included free frequent-flyer 
tickets in this calculation.\65\ Moreover, it is unclear whether United 
was calculating fares for all Denver passengers, or only origin and 
destination [O&D] passengers (passengers who begin or end their trips 
in Denver). One would expect that connecting ticket prices would be 
priced competitively, for a consumer traveling east-to-west (or vice 
versa) has a multitude of airlines from which to choose and hubs 
through which to connect, while local O&D passengers are subject to the 
monopolist's whim on pricing.
---------------------------------------------------------------------------
    \63\ U.S. General Accounting Office, Denver Airport: Operating 
Results and Financial Risks 6 (1996); Jeffrey Leib, GAO Study 
Encouraging for DIA's Financing, Denver Post, Feb. 14, 1996, at C3.
    \64\ Ann Imse, United Disputes Air Fare Reports, Rocky Mountain 
News, Aug. 18, 1995, at 53A.
    \65\ Ann Imse, United Targets Fare Gripes, Rocky Mountain News, 
Sept. 2, 1995, at 74A. United would later claim its fares were up only 
15 percent. See Roger Gibson, United Airlines Decries Guest Editorial, 
Denver Bus. J., Oct. 6, 1996.
---------------------------------------------------------------------------
    United contended it also had to raise prices to cover the $210 
million in increased costs attributable to Denver International Airport 
over the airport it replaced, Stapleton.\66\ Earlier, United had 
estimated that its costs of operations at the new airport would 
increase by only $100 million.\67\ But most of United's fare increases 
were imposed as Continental downsized its Denver hub, months before DIA 
opened. With DIA opening, and blaming DIA's high costs, United 
announced it was adding another $40 round trip to the prices of tickets 
beginning or ending at Denver.
---------------------------------------------------------------------------
    \66\ United To Raise Fares To Pay for New Denver Airport, Orlando 
Sentinel, Jan. 29, 1995, at A26.
    \67\ News In Brief, Airline Financial News, Apr. 18, 1994.
---------------------------------------------------------------------------
    But because of DIA's efficient runway configuration, terminal 
spacing, and triple Cat. III simultaneous landing capability, United's 
operating costs at DIA (excluding airport fees) would be significantly 
lower than those at Stapleton Airport. Stapleton had been plagued by 
congestion and delays (particularly during periods of inclement 
weather), which mutilate efficient aircraft and labor utilization. 
Thus, DIA's efficiencies offset a portion of United's facility fees and 
landing costs at DIA.
    Because of United's poor credit rating, the city had financed many 
major facilities for United at DIA--including a hangar with six 
aircraft maintenance bays, an 18-bay ground equipment maintenance 
building, an air freight facility, kitchens, and a baggage system--many 
of which are traditionally tenant-financed facilities, and at other 
airports would not be included in fees paid to the airport authority.
    Moreover, in Congressional testimony, Denver aviation director Jim 
DeLong identified United Airlines' belated and massive scope changes as 
the most significant cause of increased construction costs at DIA.\68\ 
``It is clear that your airline is a significant contributor to what 
you describe as the high cost of DIA,'' \69\ Denver mayor Wellington 
Webb told United. ``It is no secret that when one air carrier becomes 
dominant in a market, that they develop as a fortress hub, and as a 
result, fares have always increased.'' \70\ Webb was right. United's 
massive scope changes negotiated after construction on the main 
terminal was well under way, coupled with its insistence on delaying 
the airport opening, contributed to hundreds of millions of dollars in 
additional construction and interest expenses at DIA. In order to avoid 
DIA's high costs, other airlines were flying over DIA to reach Colorado 
ski resorts like Vail and Aspen directly.\71\ Low-cost/low-fare 
carriers like Midway Airlines and Morris Air departed Denver, MarkAir 
collapsed into bankruptcy, and Southwest Airlines announced DIA's costs 
made that airport prohibitively expensive to enter.
---------------------------------------------------------------------------
    \68\ James DeLong, Testimony Before the U.S. House of 
Representatives Aviation Subcommittee (May 11, 1995).
    \69\ Patrick O'Driscoll, Webb Blasts United, Denver Post, Jan. 29, 
1995, at A1.
    \70\ Kevin Flynn & Burt Hubbard, Webb Berated United for $40 Fare 
Increase, Rocky Mountain News, Jan. 29, 1995, at 4A.
    \71\ See Ann Imse, Vail Gains Link to World With 3 Big Air Routes, 
Rocky Mountain News, June 16, 1995, at 68A.
---------------------------------------------------------------------------
    United's market dominance has also been a significant factor 
dissuading other new airline entrants at DIA. The city of Denver 
launched a campaign to try to recruit new entrants to fill the 
competitive void left by the departure of Continental Airlines. Denver 
mayor Wellington Webb observed, ``every carrier we have spoken with is 
concerned with United's dominance of the market.'' \72\ A letter to the 
editor of the Denver Post put it well: ``Since Continental's withdrawal 
from this market, United's behavior has been that of a monopolist * * 
*. The only serious question with regard to United Airlines is why the 
antitrust regulators have been so quiescent.'' \73\
---------------------------------------------------------------------------
    \72\ Jeffrey Leib, Additional Carriers Among Webb's DIA Goals for 
'96, Denver Post, Dec. 31, 1995, at H1.
    \73\ Letter to the Editor from Virginia Anne Housum, Denver Post, 
Oct. 6, 1995, at B6.
---------------------------------------------------------------------------
    Then there's the hypocrisy. While United relishes the role of 
monopolist at Denver, it objected to a proposed agreement between 
British Airways and American Airlines on grounds that the alliance 
would create a monopoly, with the two airlines controlling the majority 
of routes between the United States and London.\74\ United officials 
also complained about ``predatory pricing'' by smaller rivals in Denver 
and Chicago.\75\ United was the only major carrier to support 
promulgation of the Airline Deregulation Act of 1978, whose principal 
purposes included the following:
---------------------------------------------------------------------------
    \74\ United Requests Inquiry Into American-British Air Alliance, 
Dallas Morning News, Oct. 10, 1996, at 4D.
    \75\ Jeffrey Keyes, Minneapolis Star Tribune, June 22, 1992, at 3D.
---------------------------------------------------------------------------
  --The availability of a variety of adequate, economic, efficient, and 
        low-priced services without unreasonable discrimination or 
        unfair or deceptive practices.
  --Preventing unfair, deceptive, predatory, or anticompetitive 
        practices in air transportation.
  --Avoiding unreasonable industry concentration, excessive market 
        domination, monopoly powers, and other conditions that would 
        tend to allow at least one air carrier * * * unreasonably to 
        increase prices, reduce services, or exclude competition in air 
        transportation.
  --Maintaining a complete and convenient system of continuous 
        scheduled interstate air transportation for small communities 
        and isolated areas.
  --Encouraging entry into air transportation markets by new and 
        existing air carriers and the continued strengthening of small 
        air carriers to ensure a more effective and competitive airline 
        industry.\76\
---------------------------------------------------------------------------
    \76\ 49 U.S.C. Sec. 40101.
---------------------------------------------------------------------------
    Though the only major airline to support airline deregulation in 
the 1970's, United Airlines has thwarted each and every one of these 
policies embraced by the legislation.
monopolize the connecting passenger market flowing over the denver hub, 
and as a by-product, deny low-cost jet service to small communities in 
               the rocky mountain and great plains region
    The new Frontier Airlines, Inc., inaugurated service in the Summer 
of 1994. Its strategic plan was to restore jet service from Denver 
markets which had recently been abandoned by Continental Airlines, 
which was in the process of sharply down-sizing its Denver hub. 
Although a high-cost carrier like United Airlines (which dominates the 
Denver market) might not be able to break-even with jet service in thin 
markets, Frontier, with its significantly lower cost structure, 
believed it could. In July 1994, Frontier inaugurated jet service 
between Denver and four cities in North Dakota (Bismarck, Fargo, Grand 
Forks, and Minot). In August and September 1994, Frontier launched jet 
service to four cities in Montana (Billings, Bozeman, Great Falls and 
Missoula). As late as 1993 (before Continental's departure) most of 
these cities enjoyed two round-trip jet flights a day from Denver; half 
still had turboprop service.\77\ In October 1994, Frontier began 
service to Albuquerque, El Paso and Tucson.\78\ (See Appendix E).
---------------------------------------------------------------------------
    \77\ Frontier Airlines, Inc., Prospectus (Apr. 21, 1994).
    \78\ Frontier Airlines, Inc., Annual Report 2 (1996).
---------------------------------------------------------------------------
    Most of these markets previously were served by another airline by 
the same name (Frontier), which, as noted above, was acquired by 
Continental Airlines in 1986. Many of the new Frontier Airlines' 
executives and employees served the old Frontier Airlines, and 
understood that sufficient traffic flows existed to support jet service 
(provided by a low-cost carrier) from Denver to many medium and small-
size cities across the Great Plains and Rocky Mountain regions. Both 
the original Frontier, and Continental, had proven that many of these 
thin markets had sufficient traffic to provide adequate load factors to 
support jet service from Denver. The new Frontier's marketing studies 
confirmed the existence of ample traffic to support two round-trip 
Boeing 737's a day. Again, while a large, established major carrier, 
with its high cost structure, may be unable to provide jet service to 
such markets, a new entrant carrier, with its relatively lower cost 
structure, should be able to. Frontier believed that passengers in 
these communities prefer the speed and comfort of jet service over 
flying relatively slower turboprop planes without in-flight amenities 
(such as lavatories or galleys).
    Because Frontier flew the only jets in several of these markets, 
Frontier enjoyed a disproportionately large share of local origin-and-
destination traffic (e.g., Denver-Bozeman, Denver-Bismarck). But United 
refused to allow Frontier to connect passengers with it. As a 
consequence, Frontier was deprived of sufficient connecting traffic to 
make these flights viable.
    From the outset, Frontier began to try to tap the feed traffic off 
the huge networks of the dominant hub carriers at Denver--United 
Airlines and Continental Airlines. Since cooperative code-sharing and 
related arrangements were the only means by which Frontier could tap 
sufficient connecting traffic to make thin routes viable, Frontier 
asked each company for cooperative joint-fare and code-sharing 
agreements. United repeatedly refused.
    Continental promptly entered into joint-fare and code-sharing 
relationships with Frontier. Unfortunately, Continental no longer 
maintains a hub at Denver, and has reduced service there to 13 flights 
a day from but three cities (Houston, Cleveland, and Newark). The 
passenger and cargo feed from Continental's network is welcomed 
traffic. But unfortunately, it is insufficient to provide adequate 
incremental traffic to sustain break-even load factors on Frontier's 
flights to Montana and North Dakota.
    It may not be immediately apparent why discriminatory joint-fares 
and code-sharing, and the related impact of discriminatory display bias 
in computer reservations systems, adversely affect competition and 
small community service, so let us digress a moment to explain how 
these relationships affect connecting traffic. Under deregulation, most 
of the traffic which moves today connects between aircraft, usually at 
a hub, like Denver, Salt Lake City, St. Louis, Chicago, Dallas/Ft. 
Worth, or Minneapolis. A passenger flying from Grand Forks or Bismarck, 
North Dakota, to Tucson or San Jose might connect over Denver or 
Minneapolis. Without a joint-fare and code-sharing relationship with 
United, it is very difficult for any carrier providing service from 
Denver to attract that passenger, even though the routing and 
connection over Minneapolis might involve a more circuitous and time-
consuming journey. Alternatively, a passenger can take a direct code-
sharing routing on a slow, noisy turboprop aircraft to Denver to 
connect to a jet headed for Tucson or San Jose.
    Joint fares.--Typically, the longer the distance flown, the lower 
the price per mile. Part of this is a reflection of cost 
considerations, and part is a reflection of competitive considerations. 
A passenger flying from A to C via B will usually be given a lower 
through fare from A to C than the sum of adding the A to B fare with 
the B to C fare. A joint-fare agreement between two carriers allows a 
passenger to take advantage of a lower through rate (prorated on a 
discount basis between the connecting carriers), as opposed to the 
higher sum of two point-to-point fares. But in the absence of a joint-
fare agreement between the connecting carders, a passenger is charged 
the individual A to B fare, plus the individual B to C fare. Without a 
joint fare agreement between United and Frontier, many passengers 
attempting to fly from, say, Bozeman, Montana, to Kansas City, Kansas, 
found the more circuitous Delta Air Lines connection over Salt Lake 
City or Northwest Airlines connections over Minneapolis to be the lower 
ticket price. While several major airlines (including Continental, TWA 
and USAir) have entered into joint fare agreements with Frontier, 
United refuses.\79\ It was not until the U.S. Department of 
Transportation intervened that United consented to entering into a 
bilateral ticketing-and-baggage agreement with Frontier.
---------------------------------------------------------------------------
    \79\ Id. at 3.
---------------------------------------------------------------------------
    Code-sharing.--Code-sharing is a means whereby two carriers agree 
to be displayed in the airline computer reservations systems as an 
``on-line'' (Carrier X to Carrier X) connection, rather than an 
interline (Carrier X to Carrier Y) connection. At Denver, United has 
marketing and code-sharing agreements with Mesa Airlines, Great Lakes 
Aviation and Air Wisconsin, flying mostly turboprop aircraft throughout 
the Rocky Mountain and Great Plains region.\80\ United's connections 
with Mesa, Great Lakes and Air Wisconsin are falsely displayed in the 
CRS as on-line connections between United and ``United Express.'' 
Without a code-sharing agreement with United, the United-Frontier 
connection is shown as what it truly is--an interline connection 
between United and Frontier. Unfortunately, the CRS system of which 
United is principal owner saddles the displays of all interline 
connecting flights with the equivalent of an artificial and astounding 
1,440 minutes (24 hours), which is added to the true elapsed time of 
the flight. Zero minutes are added to the United-Great Lakes, United-
Air Wisconsin or United-Mesa Airline interline connections, for they 
are falsely treated as ``on-line'' connections, as if it were a United 
jet connecting to a United jet.
---------------------------------------------------------------------------
    \80\ Leigh Fisher Associates Analysis Prepared for the City and 
County of Denver (1994).
---------------------------------------------------------------------------
    Eighty-five percent of flights are sold by travel agents off the 
first page of the computer reservations system screen. By adding the 
equivalent of an artificial 1,440 minutes to Frontier's connecting 
flights, they are often shoved off the first page of the screen, and 
hence, rarely sold. In other words, a United jet connecting to a Great 
Lakes Beech 1900, 19-seat aircraft, gets superior retail shelf space to 
a United jet connecting to a Frontier jet, even though consumer 
preferences for speed, convenience and safety may favor jet-to-jet 
connections rather than jet-to-turboprop connections. This is 
fundamentally unfair to small airlines like Frontier, to small 
communities seeking competitive jet service, and to consumers.
    For example, Frontier flew from Denver to Bismarck and Fargo, North 
Dakota, in 108-seat Boeing 737 jets. Great Lakes Aviation (United 
Express) flew Beech-1900 19-seat turboprop aircraft, without a lavatory 
or in-flight amenities, requiring flight times that took nearly an hour 
longer than the Frontier flight. The Wall Street Journal described the 
United Express flight from Denver to Bismarck as among the longest 
commercial commuter-flights in the United States.\81\ Now most 
passengers, if given a choice, would prefer to fly a jet rather than a 
turboprop aircraft. But with code-sharing (combined with the CRS bias 
described above), most of United's connecting passengers were funneled 
aboard the Beech-1900's.
---------------------------------------------------------------------------
    \81\ Lisa Miller, Odds & Ends, Wall St. J., July 28, 1995, at 9.
---------------------------------------------------------------------------
    Let's pose an analogy. Suppose Frontier was in the bean business, 
and made the best beans money could buy. Suppose also, that the major 
supermarket chains in Denver (i.e., Safeway, Albertson's, and King 
Soopers) were owned by the major bean companies (i.e., Green Giant, 
Campbell's, and Libby's). Frontier asks for shelf space to sell its 
product, and each of its competitors refuses. Frontier would have the 
option of either opening its own supermarket chain (impossible), or 
hawking their wares from carts on the street. United Airlines owns the 
majority interest in the Apollo CRS. In fact, the major airlines 
variously control the four major CRS's, and each of them discriminate 
against non-code-sharing connecting flights.
    United Airlines and its code-sharing affiliates control nearly 80 
percent of the traffic at Denver. Without a joint-fare or code-sharing 
agreement with United, Frontier cannot attract sufficient traffic to 
make thin routes viable. Frontier cannot profitably restore jet service 
to communities which have lost it, though, in fact, that was precisely 
its original intent.
    Frontier urged United to enter into joint-fare and code-sharing 
relationships with it for sound business reasons. Convenient interline 
connections are a two-way street; they allow passengers to flow 
conveniently over the networks of both carriers. Frontier pointed out 
to United that it can provide United's passengers superior and more 
convenient jet service vis-a-vis the turboprop connections which now 
exist. Frontier emphasized to United that a large volume of the traffic 
that now flows over the Salt Lake City and Minneapolis hubs could be 
funneled by Frontier over Denver to feed the United Airlines network. 
Frontier believes it makes sound business sense for United to do 
business with Frontier. But at a meeting with Frontier's executives at 
United's Elk Grove Township, Illinois, headquarters, United's then-
Senior Vice President Rakesh Gangwal responded, ``Frontier is a low-
cost provider. United can never be a low-cost provider. Therefore we 
think of you as the enemy.'' \82\ No enemy will be given either a 
joint-fare or a code-sharing agreement.
---------------------------------------------------------------------------
    \82\ The meeting was held between United Airlines Senior Vice 
President Rakesh Gangwal and Frontier Airlines CEO Sam Addoms and 
Frontier Vice President Dan Love.
---------------------------------------------------------------------------
    United Airlines is a $15 billion corporation, more than 200 times 
the size of Frontier.\83\ United perceives Frontier to be the enemy.
---------------------------------------------------------------------------
    \83\ Comparison of gross revenues of the two companies. UAL 
Corporation 1995 Annual Report (1996); Frontier Airlines, 1996 Annual 
Report (1996).
---------------------------------------------------------------------------
    Frontier informed United Airlines that it believed that its refusal 
to allow Frontier nondiscriminatory access to United's network 
potentially poses a serious potential antitrust problem for them. An 
analogous problem arose in the 1970's and 1980's in the 
telecommunications industry with AT&T's refusal to permit MCI 
nondiscriminatory access to its network. It took years, but ultimately 
MCI won a multi-million dollar verdict against AT&T, and the U.S. 
Justice Department forced divestiture of AT&T into seven regional 
holding companies, and one long-distance carrier. Today, federal 
regulatory authorities require that all telecommunications companies be 
given nondiscriminatory access to the networks of their competitors. 
USWest would never be allowed to enter into preferential connections 
and rates with, say, Sprint, depriving or dissuading consumers who 
preferred AT&T of access. Just as AT&T was the largest telephone 
company in the world, United is the largest airline in the world. 
Frontier can no more be expected to replicate the vast United Airlines 
route network than could MCI have been expected to replicate the vast 
AT&T network.
    If such a rule (requiring nondiscriminatory connections between 
telecommunications networks) existed with respect to the transportation 
networks, Frontier's Montana and North Dakota service likely would have 
been profitable, and as a consequence, Frontier would not have been 
forced to terminate service to Montana in September 1995, and to two 
North Dakota markets in January 1995, and the final two in September 
1996. Frontier has re-deployed those Boeing 737's to markets which 
already had frequent jet service, such as Denver-Los Angeles, Denver-
Chicago, Denver-San Francisco, and Denver-Phoenix, where sufficient 
nonstop origin-and-destination passenger traffic exists to provide 
break-even load factors. (See Appendix E). As a result of the shift in 
its route structure, Frontier enjoyed two profitable quarters in 1996, 
despite its considerable losses in serving these remaining small 
communities, and the cost of shifting its route structure toward dense 
markets.
    Of course, passengers in those dense markets to which Frontier has 
re-deployed its aircraft benefit from new competition. Fares have 
fallen dramatically (but as we shall see below, this has put Frontier 
in United's cross hairs). Nevertheless, large sections of the nation 
are wholly excluded from jet service because of discriminatory joint-
fare and code-sharing arrangements, as well as computer reservations 
systems bias which shoves non-code-sharing interline arrangements off 
the first page of the CRS screen. That is not to suggest that all small 
communities have sufficient traffic to support jet service. But many 
small communities which could support jet service from a low-cost 
carrier are denied it because of these pernicious code-sharing 
practices.
    United's refusal to enter into joint fare and code-sharing 
relationships with domestic jet airlines results in relegating small 
communities to inferior and high-cost monopoly turboprop aircraft. 
Code-sharing is a way of defrauding consumers into believing they will 
be flying a megacarrier's jets, when on most occasions they are 
funneled onto a smaller carrier's turboprop aircraft at the hub, all in 
a deliberate attempt to steer feed traffic away from jet 
competitors.\84\
---------------------------------------------------------------------------
    \84\ United does maintain code-sharing with Air Wisconsin on a 
carefully limited number of smaller jets.
---------------------------------------------------------------------------
    Even competing turboprop carriers are injured by these 
discriminatory arrangements. GP Express (formerly Continental 
Connection) also suffered from an inability to tap the United Airlines 
network. United entered into preferential joint-fare and code-sharing 
agreements with select carriers (one per city-pair market) which gave 
their interline connections preferred space on the computer 
reservations systems. For example, United code-shared with Mesa 
Airlines out of Denver to Rocky Mountain cities like Telluride and 
Grand Junction. United's interline with Mesa is falsely shown on the 
CRS as an ``on-line'' connection from United to United Express. As a 
pseudo-on-line connection, it enjoys a higher display on the CRS 
screens. The United-GP Express interline would be shown as an interline 
(in this instance, no deceit), and often shoved off the first page of 
the CRS screen. With Continental's departure from Denver, and unable to 
tap United's feed at the Denver hub, GP Express collapsed into 
bankruptcy in 1995. The net result of these discriminatory and 
anticompetitive practices is poorer and more expensive air service to 
many small communities across America.
    The U.S. Department of Transportation [DOT] has found that 34 small 
communities have lost all service since promulgation of the Airline 
Deregulation Act of 1978; many communities which had jet service lost 
it to turboprop aircraft; out of 320 small communities, the number 
served by major carriers declined from 213 in 1978 to 33 in 1995; the 
number of small communities served by multiple carriers has decreased 
from 135 in 1978, to 122 in 1995.
    The DOT studies severely understate the problem. Of the 514 non-hub 
communities receiving air service in 1978, by 1987 (a decade after 
deregulation began) 313 (60.8 percent) had suffered declines in flight 
frequency, and 144 (28 percent) had lost all service; only 32 (6.2 
percent) enjoyed the inauguration of new service.\85\ By 1995, things 
were even worse. Of the 514 non-hub communities receiving air service 
in 1978, by 1995 167 (32.5 percent) had been terminated, while only 26 
(5.1 percent) gained new service.\86\
---------------------------------------------------------------------------
    \85\ Andrew Goetz & Paul Dempsey, Airline Deregulation Ten Years 
After: Something Foul in the Air, 54 J. Air L. & Com. 927, 947 (1989). 
See also, Paul Dempsey & Andrew Goetz, Airline Deregulation & Laissez-
Faire Mythology (1991).
    \86\ Unpublished study by Dr. Andrew Goetz, University of Denver.
---------------------------------------------------------------------------
    The DOT's studies were unable to comment meaningfully about pricing 
of air service to small communities, for commuter carriers generally do 
not report pricing data. But the U.S. General Accounting Office has 
found that passengers flying from small-city airports to major airports 
paid 34 percent more if the major airport was concentrated and 42 
percent more if both the small-city and major airport were 
concentrated.
    For those small community city-pair markets with sufficient volume 
to support jet service by a low-cost carrier, the code-sharing 
phenomenon insures that they will instead be relegated to relatively 
higher-cost/higher-priced turboprop service. For example, one of the 
nation's largest connecting turboprop carriers, Mesa Airlines (which in 
some parts of the country operates as a United Airlines code-sharing 
affiliate--``United Express''), charges yields of nearly 35 cents per 
mile, compared with about 12 cents a mile by United Airlines. Even 
USAir, which operates short-haul high-cost jet service, charges only 
about 18 cents a mile--about half that charged by a turboprop 
carrier.\87\ A low-cost jet entrant typically charges consumers 
significantly less than do the major airlines.
---------------------------------------------------------------------------
    \87\ 1996 data from Julius Maldutis, Airline Update-August 1996 
(Sept. 8, 1996).
---------------------------------------------------------------------------
    For most Colorado communities (and many small communities 
throughout the Rocky Mountain and Great Plains region), the result of 
United's discriminatory and anti-competitive practices is that they are 
served from Denver only by a United Express affiliate flying turboprop 
aircraft and charging sky high air fares, even in those markets which 
have sufficient traffic to sustain jet service.
    In 1995, United Airlines controlled 95 percent of the connecting 
passenger tropic at Denver International Airports.\88\ Projections are 
that United will control 97 percent of that market in 1996.\89\ But 
United wants all of it. United's overwhelming dominance of DIA (and the 
city-pair markets radiating from it) is attributable to its ability to 
fill seats by flowing connecting passengers over the Denver hub, and to 
deprive any other competitor of the ability to do that.
---------------------------------------------------------------------------
    \88\ Leigh Fisher Associates, Year End Settlement of 1995 Rental 
Fees and Charges at DIA, Tab 4, table 1 (June 28, 1996) [data are for 
the 10 months of 1995 during which DIA was open].
    \89\ Leigh Fisher Associates, Midyear Adjustments to 1996 Rentals, 
Fees and Charges at DIA, Table 1, (Aug. 8, 1996).
---------------------------------------------------------------------------
  drive new low-cost competitors from the denver fortress hub and the 
                    nearby colorado springs airport
    With Continental's departure from Denver in 1994, United's market 
share at Denver climbed to 60 percent. But 60 percent of the market 
wasn't enough for United. United wanted all of it.
    As Continental downsized its hub at Denver, United raised prices 
sharply in the city-pair markets Continental exited. In many cases, 
fares became so high that some Denver travelers chose to fly out of the 
Colorado Springs airport located 65 miles south of downtown Denver. A 
new low-cost airline, Western Pacific, started hub operations in 
Colorado Springs in 1995, and attracted a sizable number of Denver 
travelers who prefer driving the extra distance to avoid the high fares 
at Denver. In summer 1995, regular shuttle van service to Colorado 
Springs from Denver was inaugurated to tap into the growing exodus. As 
we shall see below, diversion of some of Denver's traffic to Colorado 
Springs put Western Pacific in United's cross-hairs.
    After Continental folded its hub at Denver, a few (very few) low-
cost, low-fare airlines emerged to serve Denver--MarkAir (which moved 
its operations in Chapter 11 to Denver from Alaska, then collapsed 
entirely in late-1995), Vanguard (headquartered in Kansas City), Reno 
Air (serving Denver through Reno, Nevada), and Frontier (a new airline 
with many of the same officers as the original airline by the same 
name). Most found United engaging in various types of predatory 
behavior--pricing at fares at or below those of competitors, dumping 
excess capacity in competitors' markets, and paying travel agents 
commission overrides to steer business toward United.
    MarkAir moved the base of its operations from Anchorage to Denver 
in 1993. In 1994, MarkAir provided 17 daily nonstops to 10 cities from 
Denver.\90\ The question was whether MarkAir could stay off United's 
radar screen. MarkAir CEO Neil Bergt described his strategy as ``bottom 
fishing,'' trying to expand the market with low fares without upsetting 
competitors.\91\ One airline analyst predicted that ``as soon as the 
industry hits a bump, Denver's resident giant, United Airlines, will 
force MarkAir out of Denver.'' \92\ Another accurately predicted, ``As 
soon as United decides that they've had enough, then it's all over for 
MarkAir.'' \93\ In markets where it had a monopoly, United charged 
monopolistic prices ($1,064 round-trip for a walk-up ticket from Denver 
to San Francisco, for example). But where MarkAir competed with United, 
United met its fares on a capacity-controlled basis (both United and 
MarkAir charged $160 round-trip for a walk-up ticket from Denver to Los 
Angeles) on flights in close proximity to MarkAir's.\94\ United's 
employee-owner pilots took credit for derailing a deal which would have 
allowed the city of Denver to guarantee $30 million of MarkAir's debt 
to retain MarkAir's competitive presence at Denver.\95\ After MarkAir 
moved its headquarters from Alaska to Denver, United also launched a 
promotion to wound MarkAir in Alaska, matching its promotion ``ticket-
for-ticket'' to trade books of travel coupons for Alaska residents' 
``permanent fund'' $980 dividend.\96\
---------------------------------------------------------------------------
    \90\ Leigh Fisher Associates Analysis Prepared for the City and 
County of Denver (1994).
    \91\ Aldo Svaldi, Can MarkAir Stay Aloft?, Denver Bus. J., Oct. 22, 
1993, at 1A.
    \92\ Helen Jung, MarkAir Red Ink Runs Deep, Anchorage Daily News, 
May 20, 1995, al C1.
    \93\ Helen Jung, MarkAir Cuts Anchorage Lower 48 Link, Anchorage 
Daily News, Apr. 20, 1995, at A1.
    \94\ Ann Imse, Frontier Will Fly To West Coast, Rocky Mountain 
News, Sept. 22, 1995, at 58A.
    \95\ Alex Berenson, UAL Pilots Fought MarkAir, Denver Post, Nov. 
24, 1994, at D1.
    \96\ United, MarkAir War Heats Up, Denver Post, Oct. 11, 1994, at 
C1. The ``permanent fund'' dividend is paid by the state of Alaska 
annually to each state resident based on oil royalties earned by the 
state from oil production at Prudhoe Bay.
---------------------------------------------------------------------------
    MarkAir collapsed into bankruptcy and liquidation in 1995. 
MarkAir's demise resulted in ``dramatically higher prices for 
unrestricted, or walk up, tickets to certain cities'' including Atlanta 
(United's $1,066 compared to MarkAir's $376), Seattle (United's $1,296 
compared to MarkAir's $342), and San Diego (United's $1,002 compared to 
MarkAir's $304).\97\
---------------------------------------------------------------------------
    \97\ Ann Imse, MarkAir Demise costly for DIA, Rocky Mountain News, 
Nov. 1, 1995, at 42A.
---------------------------------------------------------------------------
    After MarkAir's demise, Frontier announced it would fill some of 
the void of the MarkAir departure (and the earlier Continental 
departure) by inaugurating service to several of the most popular 
travel destinations from Denver, beginning with Chicago and 
Phoenix.\98\ As noted above, without joint fares and code-sharing with 
the dominant hub carrier at Denver, Frontier could not hope to fill 
sufficient seats in thin markets to break even. In 1995, Frontier 
terminated service to four cities in Montana, two in North Dakota, and 
one in Arizona, and began service from Denver to Omaha, Las Vegas, 
Phoenix, Chicago (Midway), Los Angeles, Minneapolis, Salt Lake City, 
and San Francisco. In 1996, Frontier terminated service at Bismarck and 
Fargo, North Dakota, and began service to Seattle, St. Louis, and San 
Diego. By the end of 1996, Frontier flew 10 Boeing 737 aircraft to 13 
cities from Denver, accounting for slightly more than three percent of 
the Denver passenger market. Each of these markets had undergone 
significant capacity constriction with Continental and MarkAir's 
departures, many of which had become a United nonstop monopoly.
---------------------------------------------------------------------------
    \98\ Steve Caul, Frontier Steps Up Expansion, Rocky Mountain News, 
Aug. 3, 1995, at 50A.
---------------------------------------------------------------------------
    Going head-to-head with United was a risky strategy, for as the 
world's largest airline, United had the power to crush an airline as 
small as Frontier. But Frontier had little choice but to make a 
``midcourse correction'' in its route strategy. (See Appendix E). 
Without an ability to connect with the United network, Frontier could 
do nothing but lose money serving small communities. It needed to serve 
markets with sufficient origin-and-destination traffic to provide 
adequate load factors. Frontier hoped that by offering no more than two 
or perhaps three round trips per market, the ``800-pound gorilla'' \99\ 
would sleep. The gorilla slept soundly until Frontier posted its first 
two quarterly profits in Jan.-Mar. and Apr.-June 1996. Then the gorilla 
awoke in a foul mood.
---------------------------------------------------------------------------
    \99\ See e.g., Gene Amole, Frontier Airlines Needs Your Business, 
Rocky Mountain News, Nov. 14, 1996.
---------------------------------------------------------------------------
    Meanwhile, there had been a profound change in Washington. As DOT 
Secretary, Federico Pena had championed the cause of new entrant 
airlines. Early in the Clinton Administration, the DOT and Justice 
Department ``jaw-boned'' Northwest Airlines into backing off its 
predatory capacity dumping and pricing practices targeted at Reno Air, 
which had just opened a route from Reno, Nevada, to Minneapolis 
(Northwest's hub).
    The facts were these. In February 1993, Reno Air announced plans to 
serve Minneapolis with three daily flights beginning April 1. Northwest 
countered by announcing it would serve the Reno-Minneapolis market, for 
the first time, also with three daily flights beginning April 1, as 
well as new flights from Reno to Los Angeles, San Diego and Seattle, 
three of Reno Air's most important markets. Northwest also matched Reno 
Air's fares in these markets. Nevada Senators Richard Bryan and Harry 
Reid urged the U.S. Department of Justice to investigate Northwest's 
alleged antitrust violations. Northwest succumbed to the pressure, and 
withdrew from the Reno markets.
    A 1996 report of the U.S. Department of Transportation reached the 
following conclusions:

    The high fares hub dominant carriers have enjoyed at their hub 
cities clearly provides the incentive for those carriers to discourage 
competitive entry. And allegations of predatory behavior have increased 
as a result of the recent emergence and growth of a number of low cost, 
low fare new entrant airlines. Given the incentives and the reality of 
very high prices for local passengers at certain network hubs, we have 
to be concerned about possible predatory behavior or unfair competitive 
practices * * *.
    [W]e will not be indifferent to attempts to exclude or preclude new 
entry through predatory activity * * *. [T]he beneficial consumer 
impact of low cost new entry--especially in disciplining fares and 
filling service voids--is simply too important to permit predation to 
undermine it. Anticompetitive activity can take myriad forms, from 
sudden and targeted service increases and sharp and highly selective 
fare cuts, to hoarding unneeded gate space or slots, as well as other 
``doing business'' problems. The Department will continue to evaluate 
which actions cross the line from tough competition to anticompetitive 
predation and react accordingly. \100\
---------------------------------------------------------------------------
    \100\ U.S. Dept. of Transportation, The Low Cost Airline Service 
Revolution 32-33 (1996).
---------------------------------------------------------------------------
    In 1996, Pena announced, ``In the past year, American consumers 
have saved an estimated $6.3 billion in airline fares because of the 
competition brought about by the new low cost, low fare airlines.'' 
\101\ But by the end of President Clinton's first term, it was clear 
that Pena would not be DOT Secretary in his second term. This political 
vacuum gave United the freedom to move brazenly against competitors in 
the city he once served as mayor. At this writing, it is unclear 
whether DOT will be as vigorous in protecting new entrants against 
unfair and deceptive practices in President Clinton's second term.
---------------------------------------------------------------------------
    \101\ Id.
---------------------------------------------------------------------------
    The Denver market is estimated to be about a $5 billion revenue 
prize. With approximately 300 daily departures and service to 62 
cities, United has the market power to influence passenger choices 
through its schedule frequency and frequent flyer program. United also 
controls the regional distribution channels through the use of a large 
corporate discount program and the payment of commission overrides to 
key travel agencies.
    However, United is a relatively high-cost airline when measured in 
industry terms of Cost per Available Seat Mile [CASM].\102\ Airlines 
enjoy a significant cost taper over distance. Using second quarter 1995 
data (the most recent data we could find) produced independently by 
Roberts Roach & Associates, when adjusted for stage length (the length 
of the flight), United's system-wide operating costs are as follows:
---------------------------------------------------------------------------
    \102\ See Roberts Roach & Associates, Scorecard: Airline Industry 
Cost Management (3rd ed. 1996).
---------------------------------------------------------------------------

    Table 1.--United Airlines Domestic Boeing 737-300 Available Seat

                           [Mile Costs\103\]

                                                              United ASM
        Stage Length (miles)                               Costs (cents)
200............................................................... 19.35
250............................................................... 16.95
300............................................................... 15.35
350............................................................... 14.21
400............................................................... 13.35
450............................................................... 12.68
500............................................................... 12.15
550............................................................... 11.71
600............................................................... 11.35
650............................................................... 11.04
700............................................................... 10.78
750............................................................... 10.55
800............................................................... 10.35
850............................................................... 10.17
900............................................................... 10.02
950...............................................................  9.88
1000..............................................................  9.75
1050..............................................................  9.64
1100..............................................................  9.53
1150..............................................................  9.44
1200..............................................................  9.35

\103\ Roberts Roach & Associates, Scorecard: Airline Industry Cost 
Management 51 (3rd ed. 1996). The costs in this study have not been 
adjusted for specific Denver operating costs. They are based on system-
wide costs. Some upward adjustment should be made to reflect the higher 
operating costs of Denver International Airport to more accurately 
reflect United's true cost of operation at the Denver hub.

    The data above reflect break-even seat mile costs and 
assume that all seats on a flight are filled (that is, the 
flight has a 100 percent load factor). But because of hourly, 
daily, seasonal and directional cycles in demand, no carrier 
fills all of the seats on its flights all of the time (most 
major airlines achieve annual average load factors of between 
65 percent and 70 percent). Thus, these data understate, by 
about a third, United's actual break-even seat mile costs. In 
other words, United's average prices must be about a third 
higher than these ASM costs in order for it to break-even. For 
this reason, the following analysis errs on the side of 
conservatism.
    Comparing Frontier's ASM costs to United's requires an 
apples-to-apples comparison of stage-lengths. In the second 
quarter of 1995, Frontier's average stage length was 407 miles; 
Frontier's ASM costs were 9.29 cents per mile. As Table I 
reveals, United's ASM costs at a 400 mile stage length were 
13.35 cents per mile. Thus, Frontier's costs are about 30 
percent lower than United's. Operating costs at Denver are 
likely higher than United's system-wide averages revealed in 
Table 1, somewhere in the neighborhood of an additional one 
cent per ASM. This suggests the difference in Frontier's vis-a-
vis United's costs is even greater than 30 percent.
    Despite the fact that United's costs are significantly 
higher than Frontier's, United is pricing not only below its 
costs, but below Frontier's as well. In several instances, 
United has lowered prices below Frontier's lowest price. United 
is pricing significantly below its true operating costs in 
order to disrupt, disable or destroy its low-fare competitors.
    As Table 2 below reveals, the sale fares announced by 
United Airlines in December 1996 averaged 99.47 percent of 
United's unit costs. But in city-pair markets radiating from 
Denver in which Frontier competed, United's prices were only 
68.85 percent of cost, and in markets where Frontier does not 
compete, United's prices were 109.04 percent of costs. Stated 
differently, in markets in which Frontier competes, United 
prices its product an average of 31 percent below its costs. 
United cross-subsidizes these losses with revenue derived from 
non-competitive and international markets.
[GRAPHIC] [TIFF OMITTED] T12SMA05.009

    \104\ This analysis was prepared by Frontier Airlines CEO Sam 
Addoms. Cost data are based on Roberts Roach & Associates, Scorecard: 
Airline Industry Cost Management (3rd ed. 1996).

    (The above findings are displayed graphically in Appendices 
F and G).
    For three reasons, these data understate the differential 
between United's costs and prices by a significant margin. 
First, given that most major airlines fill only about 65 
percent to 70 percent of their seats annually, these data 
understate United's break-even revenue requirements by about 
one-third. Second, the significant increase in the cost of 
aviation fuel has not been included. Fuel cost between 52-54 
cents a gallon in the second quarter of 1995; by the fourth 
quarter of 1996, it had increased 23 percent, to more than 70 
cents per gallon.\105\ Third, the above calculations are based 
on United's system-wide costs which are lower than operations 
from DIA, for Denver International Airport's fees account for 
about one cent per ASM higher than other airports. In other 
words, the difference between United's costs and its prices is 
significantly greater than these calculations. Finally, these 
prices are United's lowest. Frontier does not have the 
proprietary data to determine the size of the inventory over 
which these seats have been spread. However, Frontier's booking 
and sales data suggest that United's low-fare seat buckets were 
opened wide after Frontier announced quarterly profits.
---------------------------------------------------------------------------
    \105\ Julius Maldutis, Airline Update--November 1996 (Dec. 10, 
1996), at 11.
---------------------------------------------------------------------------
    Even before entering Denver's largest air passenger 
markets, Frontier had already brought down United's fares here 
and there. For example, before Frontier's entry into the 
Denver-Omaha market, United's lowest walk-up fare was $460 
round-trip. Frontier entered with a $140 fare, which United 
promptly matched. According to U.S. Department of 
Transportation data, in the first quarter of 1994, United's 
average one-way fare in the Denver-Albuquerque market was $187; 
in the fourth quarter of 1994, as Frontier entered the market, 
United's average one-way fare dropped to $87. In the Denver-
Bismarck market, United dropped its average $310 fare to $104 
after Frontier entered. (See Appendices H through J).
    Beginning in 1995, Frontier began entering Denver's largest 
nonstop markets. In the Denver-Los Angeles market, United's 
average one-way fare dropped from $163 in the third quarter of 
1995, to $122 as Frontier entered in the fourth quarter of 
1995. In the Denver-Phoenix market, United dropped its average 
one-way fare from $147 in the second quarter of 1995, to $89 in 
the fourth quarter of that year. (See Appendices J through L).
    American Express reported that Denver's cheapest fares fell 
44 percent in November 1996 (compared to a year earlier) for 10 
routes out of Denver in which Frontier competed. In contrast, 
United's business fares increased 21 percent.\106\ The 
unrestricted business fare also becomes a revenue source with 
which to cross-subsidize below-cost pricing against 
competitors. In a letter to the editor of the Denver Post, one 
consumer summarized what more and more Colorado residents are 
experiencing:
---------------------------------------------------------------------------
    \106\ Rocky Mountain News, Dec. 23, 1996.

    ``I travel extensively on business, and it is my experience 
that United is deliberately manipulating prices to put its 
competitors out of business.
    ``A recent round trip to Boston on United cost $1,667. The 
following week, I flew to Minneapolis, again on United, at a 
cost of $146. The difference is because Frontier flies to 
Minneapolis. United is charging excessive fares on some routes 
and using the profits to undercut competition where it exists.
    ``This unethical behavior would be bad enough on its own. 
But United is using the taxpayer-supported airports, and the 
taxpayer-funded air traffic control system in its anti-
competitive efforts.'' \107\
---------------------------------------------------------------------------
    \107\ Letter to the Editor by Michael Reilly, Denver Post, Dec. 26, 
1996, at 10B.

    United's pricing in markets Frontier has been forced to 
abandon is even more remarkable. In the Denver-Billings market, 
United's average one-way fare was $168 before Frontier entered 
(in the third quarter of 1994); United dropped it to $92 after 
Frontier entered (in the first quarter of 1995), then increased 
it to $208 after Frontier departed. United's average one-way 
fare in the Denver-Tucson market was $178 in the second quarter 
of 1994, dropped to $104 after Frontier entered, then rose to 
as high as $186 after Frontier departed (see Appendices M and 
N). United offers high prices before and after low-fare 
competitors enter its markets, but not while it is trying to 
drive them out of its markets. Indeed, United uses the high 
prices it extracts from its monopoly markets to cross-subsidize 
below-cost predatory pricing in markets in which low-cost 
carriers dare to enter. (See Appendix O).
    All airlines suffered higher costs in the second half of 
1996. Fuel costs increased between 18 percent and 25 percent. 
Congress re-imposed a 10 percent excise tax in late August. 
Frontier attempted to raise its prices modestly to recover 
these costs on six different occasions. United matched only one 
of those price increases in markets in which Frontier offers 
service, but raised prices significantly in many markets in 
which Frontier does not. Of course, Frontier has no choice but 
to reduce its prices to United's level even though United has 
set them at levels below Frontier's costs, and well below 
United's.
    Taking advantage of this unique intersection of two 
potentially unfavorable events (the double whammy of sharply 
higher taxes and fuel costs), United appears to have initiated 
a deliberate effort to suppress prices at the lowest end of 
their pricing scale. Simultaneously, year over year, coinciding 
with the end of Frontier's first two profitable quarters, 
United dramatically expanded seat and flight capacity available 
at these lower prices so that Frontier's profitability would 
turn south.\108\ (See Appendix P).
---------------------------------------------------------------------------
    \108\ Unfortunately, while the actual fare data is public, only 
United Airlines knows the actual number of seats it offers at the 
lowest price. Moreover, actual cost data and actual fare data for the 
last quarter of 1996 will not be known until about mid-April of 1997.
---------------------------------------------------------------------------
    This had the effects of eroding Frontier's market share, 
causing a decline in Frontier's load factors, eroding 
Frontier's yield, and creating a higher break-even load factor 
requirement for Frontier precipitated both by lower average 
fares and higher unit costs. (See Appendix Q and R). Frontier's 
seven consecutive months of profitable operations have turned 
into significant monthly losses.
    This appears to be a deliberate effort to cause Frontier to 
hemorrhage revenue. United knows that only a fool enters a 
bleeding contest against a blood bank. While consumers enjoy a 
short-term benefit in below-cost pricing, they will again enjoy 
the monopoly pricing of United if it is successful in driving 
Frontier from the market.
    Until May 1996, United matched Frontier's lowest fares only 
on flights in close departure proximity to Frontier's 
flights.\109\ That month, United matched Frontier's fares on 
all flights, spreading its lowest fares across square miles of 
seats. To add insult to injury, by the fall of 1996, United was 
under-pricing Frontier on many routes in which they competed, 
despite United's significantly higher cost structure.\110\ 
United then began to add flight frequencies in several of the 
markets in which Frontier competed.
---------------------------------------------------------------------------
    \109\ Jeffrey Leib, Frontier Joins Discount Fray, Denver Post, Aug. 
15, 1995, at C1.
    \110\ Ann Imse, Fronter Exec Calls United Predatory, Rocky Mountain 
News, Nov. 9, 1996, at 1B.
---------------------------------------------------------------------------
    For example, United increased its frequencies in the 
nonstop Denver-Los Angeles market from 14 daily round-trips in 
August 1994, and 15 in August 1995, to 20 in August 1996. That 
increased United's share to more than 90 percent of the flights 
in that city-pair market. The Denver-Los Angeles market is the 
sixth biggest market in United's system,\111\ and United was 
determined to increase its monopoly position in the market. 
Comparing August 1995 to August 1996, United also added a new 
daily round-trip flight in the Denver-San Francisco market and 
the Denver-Salt Lake City market, and two in the Denver-Las 
Vegas market. Again, flights were added in these markets after 
Frontier entered.
---------------------------------------------------------------------------
    \111\ Aviation Daily, Dec. 9, 1996, at 392.
---------------------------------------------------------------------------
    For example, comparing 1996 with 1995, in the Denver-Las 
Vegas Market, United increased its seat capacity up to 71 
percent and flights 37 percent; in the Denver-Los Angeles 
market, United increased seats up to 34 percent and flights 33 
percent; in the Denver-Phoenix market, United increased seats 
up to 38 percent and flights 27 percent; and in the Denver-San 
Francisco market, United increased seats up to 19 percent and 
flights 16 percent. (See Appendices S through V). At cities 
Frontier departed, United tended to reduce seat capacity and 
flights, year over year. For example, in the Denver-Billings 
market, United reduced seats and flights by as much as a third. 
(See Appendix W).
    In late 1996, United announced it was adding capacity from 
Denver to 12 cities, 11 of which were cities in which either 
Frontier or Western Pacific competed. Even though United had 
confessed that it was losing money in the Denver-Las Vegas and 
Denver-Phoenix markets (in both of which Frontier competes), 
United announced sharp increases in frequencies in these 
markets with Shuttle by United to operate low-fare high-
frequency service.\112\ According to one source, ``The Shuttle 
is United's weapon against a growing swarm of low-cost airlines 
that are winning fliers with low fares.'' \113\ A United 
spokesman describes United's Shuttle in these terms, ``Shuttle 
by United was created by the employees to be a competitive tool 
against low-fare, short-haul carriers.'' \114\ Whether a 
``tool'' or a ``weapon,'' Shuttle by United is designed to 
subdue, punish and destroy low-fare competitors.
---------------------------------------------------------------------------
    \112\ Ann Imse, Frontier Exec Calls United Predatory, Rocky 
Mountain News, Nov. 9, 1996, at 1B.
    \113\ Julie Schmit, West Coast Showdown, USA Today, Sept. 30, 1994, 
at 1B.
    \114\ Penny Parker, United Taps Low Fares To Launch Its Shuttle, 
Denver Post, Nov. 20, 1996, at C3.
---------------------------------------------------------------------------
    Originally launched in West Coast markets to discipline 
Southwest (an airline which, United learned, was too large to 
destroy), United was now turning the Shuttle toward Frontier 
and Western Pacific. Beginning February 11, 1997, United would 
fly 13 round trips in the Denver-Phoenix market (up from 9), 
and 12 round-trips in the Denver-Las Vegas market (up from 7). 
Vanguard Airlines announced it was exiting the Denver-Phoenix 
market.\115\ United insisted that one of the reasons it was 
losing money in these markets was the equipment--its DC-10's 
would be replaced by the Shuttle's 737's.\116\ Anyone who 
understands anything about airline economics knows the 
Available Seat Mile [ASM] costs of a wide-bodied aircraft like 
a DC-10 are typically lower than the ASM costs of a narrow-body 
aircraft like a 737, even though the pilots in the cockpit of a 
wide-bodied aircraft are paid significantly more than those of 
a narrow-body aircraft. United refuses to reveal the Shuttle's 
costs (perhaps to obfuscate them in an attempt to repel 
allegations that it is engaging in predatory pricing, an 
antitrust violation). But operating from Denver, any legitimate 
accounting methodology would likely place United's Shuttle 
costs significantly higher than Frontier's.\117\ Even with the 
Shuttle, United's system-wide 737 costs rose 4 percent, year-
over-year. Shuttle by United accounts for 45 percent of 
United's total Boeing 737-300 operations.\118\ Thus, the above 
chart revealing United's 737-300 system-wide domestic cost 
structure probably reflects costs which approximate those of 
the Shuttle, particularly given that DIA's fees and charges add 
about one cent per mile to carrier costs.
---------------------------------------------------------------------------
    \115\ Jeffrey Leib, Vanguard Cancels Flight Before Shuttle Debuts, 
Denver Post, Nov. 9, 1996, at 3D.
    \116\ Jeffrey Leib, Low-Fare United Shuttle DIA-Bound, Denver Post, 
Nov. 7, 1996, at 1C.
    \117\ Roberts Roach & Associates, Scorecard: Airline Industry Cost 
Management (3rd ed. 1996).
    \118\ Id. at 18.
---------------------------------------------------------------------------
    Why, then, is United bringing the Shuttle to Denver? Former 
Denver airport director George Doughty offered this 
explanation:

    ``[I]t is clear that United is not doing this because it 
wants to provide a low-fare product at its fortress hub. You 
can bet if there were no low-fare competitors, there would be 
no shuttle. It goes counter to its pricing philosophy, which is 
to maximize fares. You need only compare fares available in 
markets where United has a monopoly or competes only with 
another Big Seven carrier to markets where there is a competing 
low-fare carrier.'' \119\
---------------------------------------------------------------------------
    \119\ George Doughty, Smart Business Travelers Can Invest In Fare 
Competition, Denver Business Journal, Nov. 29, 1996, at 27A.

    The reason United is bringing its Shuttle to Denver is not 
to lower fares at its Denver fortress hub. It is to drive the 
low-fare competitors at Denver out.
    United also offers major travel agencies commission 
overrides in various city-pairs radiating from Denver, several 
in which Frontier competes. With agent commissions capped at 
$50 by the major airlines in 1994, overrides have become a far 
more important, if not essential stream of revenue for agents. 
Agencies only earn overrides if they book an extremely high 
percentage (e.g., 90 percent) of flights on the carrier which 
offers them. Thus, agents are incentivized to book their 
customers on United even when Frontier (or any other 
competitor) has a more desirable schedule or better service.
    Agents also rely on computer reservations systems which, as 
we have seen, are biased against non code-share connections.
    United Airlines also includes a contractual provision in 
its corporate discount contracts with Denver businesses 
prohibiting them from entering into similar agreements with 
other carriers. Typically, it provides: ``During the Term of 
this Agreement, Customer will not enter into any similar 
agreement with any other airline under which air transportation 
is provided to Customer in return for any incentive on the air 
routes serviced by United.''
    The combination of United's strategy of (1) dumping excess 
capacity in Frontier's markets, (2) lowering prices to or below 
Frontier's, (3) paying agents commission overrides to steer 
business toward United, and away from Frontier, (4) refusing to 
enter into joint-fare or code-sharing agreements with low-cost 
jet competitors, (5) biasing its CRS against interline flights, 
and (6) imposing ``exclusive dealing'' requirements with 
corporate accounts, began to take its toll. Although Frontier 
was profitable in the first two calendar quarters of 1996, it 
lost money in the third (at this writing, fourth quarter 
returns are not out). By October and November 1996, Frontier 
was filling only 50.7 percent and 52.7 percent of its seats, 
respectively (compared with 58.4 percent and 61.1 percent, 
respectively, a year earlier).\120\
---------------------------------------------------------------------------
    \120\ Jeffrey Leib, Frontier's Passenger Traffic Dips, Denver Post, 
November, 1996, at C1; Frontier Fills Fewer Seats, Denver Post, Dec. 
12, 1996, at 2C.
---------------------------------------------------------------------------
    Western Pacific began serving Colorado Springs Airport 
(about 75 miles south of Denver) in 1993. In September 1995, 
United ``counterattacked an upstart Colorado Springs airline * 
* * and sharply cut ticket prices on tickets from Denver to 16 
cities [in 13 of which Western Pacific competed].'' \121\ 
Despite its significantly higher cost structure, United began 
matching or beating WestPac's fares.
---------------------------------------------------------------------------
    \121\ Jeffrey Leib, United Cuts Fares To Meet, Beat Springs Deals, 
Denver Post, Sept. 22, 1995, at A1.
---------------------------------------------------------------------------
    By late 1996, WestPac was serving 20 cities with fifteen 
138-seat Boeing 737-300 aircraft.\122\ WestPac's lowest walk-up 
fare to San Francisco was $417, while United's was $1,080.\123\ 
United's management described WestPac as a ``nuisance,'' taking 
several actions to clip its wings.\124\ First, United began 
matching WestPac's fares on a capacity controlled basis. For 
example, United dropped its Colorado Springs-Washington 
(Dulles) round-trip fare to $228, though flying the same 
aircraft out of Denver cost consumers $1,138.\125\ Then United 
began matching WestPac's fares from Colorado Springs on a 
``seat-for-seat'' basis.\126\ By replacing 737 service from 
Colorado Springs to Chicago with DC-10's, United increased its 
capacity by 20 percent.\127\ Pricing below cost and dumping 
capacity are two of the consistent tactics United has used to 
drive competitors from markets it seeks to dominate.
---------------------------------------------------------------------------
    \122\ Carriers Suffer With Rising Fuel Prices, Reduced Traffic and 
Taxes, Airline Financial News (Oct. 14, 1996).
    \123\ Ann Gottlieb & Jeffrey Leib, Competition Would Cut Fares, 
Denver Post, July 16, 1996, at A10.
    \124\ United Airlines Chief: WestPac's a Nuisance, Colorado Springs 
Gazette Telegraph, Jan. 10, 1006, at D1.
    \125\ Ann Imse, Computer Helps You Find Lowest of the Low Fares, 
Rocky Mountain News, Mar. 24, 1996.
    \126\ United Airlines Chief: WestPac's a Nuisance, Colorado Springs 
Gazette Telegraph, Jan. 10, 1006, at D1.
    \127\ Bill Vogrin, United Makes Denver Flights a Big Deal, Colorado 
Springs Gazette Telegraph, Mar. 5, 1996, at A1.
---------------------------------------------------------------------------
    A December 1996 cover story of the Wall Street Journal 
summarized the predatory behavior targeted at small airlines 
like Western Pacific and Frontier by megacarriers like United:

    ``[After the ValuJet crash in the Everglades caused a 
temporary drop in new entrant airlines' bookings] [b]ig 
carriers, sensing vulnerability, aggressively matched fares and 
added flights on routes flown by small airlines * * *.\128\
---------------------------------------------------------------------------
    \128\ Scott McCartney, Start-Ups Still Suffer From ValuJet Crash 
and FAA's Missteps, Wall St. J., Dec. 9, 1996, at 1.
---------------------------------------------------------------------------
    ``[B]ig carriers such as United * * * were increasing 
pressure on Western Pacific and other start-ups. Trying to win 
back customers, UAL Corp.'s United, for example, increased its 
flights between Denver and Colorado Springs and even added a 
DC-10 on the short hop. The carrier more aggressively matched 
the fares of Western Pacific and Frontier, and announced plans 
to bring its low-fare Shuttle by United from the West Coast 
into Denver.'' \129\
---------------------------------------------------------------------------
    \129\ Id. at A10.

    Both Frontier and Western Pacific are in United's cross 
hairs, and United appears to be firing at its targets with 
impunity.
    As we have seen, United engages in a multitude of unfair, 
deceptive, anticompetitive and predatory practices designed to 
establish and preserve a Fortress Hub monopoly at Denver:
  --United Airlines is willing and able to dump low-priced capacity in 
        any market in which a competitor appears.
  --United Airlines is willing and able to engage in predatory pricing 
        to maintain and increase its monopoly at Denver. Where United 
        faces competition at Denver, it has priced as much as 42 
        percent below cost.
  --International and monopoly markets provide United with ample 
        revenue to cross-subsidize losses incurred because of its 
        below-cost pricing in its competitive markets.
     extract monopoly fares from the denver fortress hub: round two
    As it has driven competitors out of markets, United has raised 
prices sharply. For example, before Frontier entered the Denver-
Billings market, United's lowest round-trip fare was $384. After 
Frontier entered, United lowered its fare to $198. After Frontier 
departed, United raised its fares to $345.\130\
---------------------------------------------------------------------------
    \130\ Ann Imse, Frontier Exec Calls United Predatory, Rocky 
Mountain News, Nov. 9, 1996, at 1B.
---------------------------------------------------------------------------
    The Denver-Boulder metropolitan area is the largest center of 
business activity in the Rocky Mountain Region. Unfortunately, Denver 
is an oasis of population isolated from other business centers in North 
America. For example, the distance from Denver to Phoenix is nearly 600 
miles, to Dallas nearly 650 miles, to Minneapolis 700 miles, to Los 
Angeles 850 miles, to Chicago 900 miles, and to Seattle 1,000 
miles.\131\ Amtrak rail service exists to some of these cities, but it 
is extremely slow. Interstate highways make these cities accessible by 
automobile, but the distances and driving times are vast. These 
features make Denver and Colorado more reliant on air transportation 
than most other American cities. As a consequence, an unusually high 
proportion (58 percent) of passengers at Denver International Airport 
are origin-and-destination [O&D] passengers.\132\ It is these 
passengers upon whom a monopoly fare can be placed by a dominant 
airline.
---------------------------------------------------------------------------
    \131\ Leigh Fisher Associates Analysis Prepared for the City and 
County of Denver (1994).
    \132\ U.S. General Accounting Office, Denver Airport: Operating 
Results and Financial Risks 18 (1996).
---------------------------------------------------------------------------
    A 1990 study by the U.S. General Accounting Office comparing 
pricing between concentrated and unconcentrated hub airports found that 
O&D fares were 27 percent higher at the concentrated hubs.\133\ A 
separate study performed that year by the U.S. Department of 
Transportation found that average yields were 18.7 percent higher at 
single-carrier hubs.\134\ A 1996 study by DOT concluded that the 
presence of low-cost competitors produce a 40 percent fare savings to 
consumers at dominated network hubs.\135\
---------------------------------------------------------------------------
    \133\ U.S. General Accounting Office, Airline Competition: Industry 
Operating and Marketing Practices Limit Market Entry (1990).
    \134\ U.S. Dept. of Transportation, Secretary's Task Force on 
Competition in the U.S. Domestic Airline Industry: Airports, Air 
Traffic Control, and Related Concerns (1990).
    \135\ U.S. Dept. of Transportation, The Low Cost Airline Service 
Revolution 9 (1996).
---------------------------------------------------------------------------
    A 1994 study of airline pricing at Denver prepared for the city 
estimated 16.5 million enplaned passengers, of whom 8.25 million were 
O&D. Average airfares of $362 multiplied times 8.25 million O&D 
passengers produced $3 billion in gross revenue. Assuming a 15 percent 
increase in air fares attributable to the hub monopoly of United 
Airlines, the annual cost to Denver consumers from monopolization of 
the Denver hub was $450 million. Assuming a 27 percent increase, the 
annual consumer cost of monopolization was $810 million in 1994 terms. 
(See Appendix X). The airport itself loses $10 million in revenue 
because higher prices translates into fewer passengers. (See Appendix 
Y). Thus, in a relatively short time frame, United could recover the 
losses it incurred in its below-cost fare wars with its competitors at 
Denver.
    These are highly conservative estimates. By 1996, the consensus was 
that DIA produced $5 billion in gross revenue for the airlines which 
serve it, that 58 percent of the traffic was O&D, and that a monopoly 
airline could charge fares 42 percent higher than in competitive 
markets. This suggests a potential direct negative impact on Colorado 
consumers in excess of a billion dollars a year. Much of that increase 
is attributable to United Airlines' dominance of virtually all spokes 
radiating from Denver.
    These are the minimum costs imposed on the Colorado economy by 
monopolization of DLA. They do not account for the ripple effect on 
business, particularly travel-related business, such as hotel, 
convention and tourism. In Colorado, the ski industry does nearly $2 
billion in retail activity, while tourism is a $6 billion industry. The 
success and well being of both industries is directly tied to the 
reasonableness of air fares to Colorado. A perception that Colorado is 
an expensive tourism destination will send tourists elsewhere. United's 
monopoly will siphon tens of billions of dollars of revenue out of the 
Colorado economy over the long term, significantly dampening 
discretionary traffic in an economy strongly dependent on tourism.
    It has been proven statistically that a 15 percent increase in air 
fares results in a 4.5 percent decrease in passenger traffic; a 27 
percent increase in fares results in about an 8 percent decrease in 
passenger traffic.\136\ In 1994, it was estimated that the tourism 
economic impact of Stapleton International Airport was $892 million 
(comprised of $622 million in winter tourism, $222 in summer tourism, 
and $48.4 million in business travel and conventions). A decline in 
passenger traffic of between 4 percent and 8 percent attributable to 
monopoly air fares translates directly into a loss of tens of millions 
of dollars in lost income for these industries. The aggregate impact of 
higher ticket prices imposed by United Airlines upon O&D passengers, 
plus the loss of revenue sustained by the Colorado tourism industry and 
Colorado business more generally, plus declining DIA revenue 
attributable to dampened passenger demand, may be well over $1 billion 
annually.
---------------------------------------------------------------------------
    \136\ Julius Maldutis, Airline Update-August 1996 (Sept. 9, 1996), 
at 2.
---------------------------------------------------------------------------
    The only thing that stands between a consumer's wallet and a 
wealth-maximizing monopolist is a competitor. United Airlines is 
determined to see to it that there will be no low-fare competitor at 
Denver or Colorado Springs.
    Like a colonial government, the Elk Grove Township, Illinois-based 
megacarrier is determined to control its Colorado territorial economy 
to maximize United's wealth, irrespective of the impact of the 
indigenous inhabitants who rely on the Fortress hub it dominates. 
United forgets that taxation without representation is what led to the 
American Revolution.
    Many industry observers have described United Airlines as Denver's 
``800-pound gorilla.'' \137\ United Airlines recently announced it was 
inaugurating a new public relations campaign to improve its image. One 
travel expert believed United was trying to combat its 800-pound 
gorilla image at DIA.\138\ Whether splashing money on public relations 
in Denver can put the beast in lamb's clothes or not, it will still 
walk, and talk, and growl like a gorilla, and crush any small animal 
that dares enter its cage. A gorilla clad in lamb's wool is nonetheless 
a gorilla.
---------------------------------------------------------------------------
    \137\ Rocky Mountain News, Nov. 14, 1996.
    \138\ Ian Oldeirson, United Launches Image-Improving Bid, Denver 
Business J., Dec. 6, 1996, at 5A.
---------------------------------------------------------------------------
    As 1996 drew to a close, United Airlines and its code-sharing 
affiliates controlled nearly more than 95 percent of the connecting 
traffic, and nearly 80 percent of the total passenger traffic at the 
Denver hub. (See Appendix Z). In December 1996, speaking before about 
300 Denver business leaders, when asked how large a market share the 
carrier seeks at DIA, United Airlines Vice President Roger Gibson 
responded, ``I'd like all of it.'' \139\
---------------------------------------------------------------------------
    \139\ Statement before the Denver Rotary Club breakfast meeting at 
the Denver Athletic Club, Dec. 12, 1996.
---------------------------------------------------------------------------
    United Airlines wants all of it.

                               Appendix A
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                               Appendix B
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                               Appendex C
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                               Appendix D
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                               Appendix E
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                               Appendix F
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                               Appendix G
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                               Appendix H
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                               Appendix I
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                               Appendix J
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                               Appendix K
[GRAPHIC] [TIFF OMITTED] T12SMA05.020

                               Appendix L
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                               Appendix M
[GRAPHIC] [TIFF OMITTED] T12SMA05.022

                               Appendix N
[GRAPHIC] [TIFF OMITTED] T12SMA05.023

                               Appendix O
[GRAPHIC] [TIFF OMITTED] T12SMA05.024

                               Appendix P
[GRAPHIC] [TIFF OMITTED] T12SMA05.025

                               Appendix Q
[GRAPHIC] [TIFF OMITTED] T12SMA05.026

                               Appendix R
[GRAPHIC] [TIFF OMITTED] T12SMA05.027

                               Appendix S
[GRAPHIC] [TIFF OMITTED] T12SMA05.028

                               Appendix T
[GRAPHIC] [TIFF OMITTED] T12SMA05.029

                               Appendix U
[GRAPHIC] [TIFF OMITTED] T12SMA05.030

                               Appendix V
[GRAPHIC] [TIFF OMITTED] T12SMA05.031

                               Appendix W
[GRAPHIC] [TIFF OMITTED] T12SMA05.032

                               Appendix X

                     public cost of a fortress hub
Colorado Air Passenger Market
    16.5 million enplaned passengers (per year-SIA)
    8.25 million O&D passengers
    Average airfares $362  8.25 million = $3 billion
Airfare Increases With Fortress Hub\140\
---------------------------------------------------------------------------
    \140\ 1990 General Accounting Office and Dept. of Transportation 
Studies.
---------------------------------------------------------------------------
    Scenario 1--27 percent increase in fares  $3 billion = 
$810 million
    Scenario 2--15 percent increase in fares  $3 billion = 
$450 million

                               Appendix Y

                      Total Cost of a Fortress Hub

                        [In millions of dollars]

Airfares.......................................................... 450.0
Airport Funds Lost................................................  10.2
Tourism Dollars Lost....................................................
Multiplier..............................................................
                        -----------------------------------------------------------------
                        ________________________________________________
      Total Cost..................................................  +500

                               Appendix Z

                   Domestic Market Share--October 1996

                              [Percentage]

United............................................................  71.8
Delta.............................................................   4.6
Other.............................................................   4.5
Continental.......................................................   2.2
American..........................................................   3.8
Northwest.........................................................   2.0
Frontier..........................................................   3.2
America West......................................................   1.5
United Express....................................................   6.4
                                 ______
                                 

                   [From the Denver Business Journal]

                   Rip United Airline's Hold From DIA

                           (By Paul Dempsey)

    Welcome to Denver International Airport, the impenetrable fortress 
hub of United Airlines. Air fares have risen here an astounding 46 
percent since last year, sucking $400 million out of the Colorado 
economy. Watch as the convention and tourism industries wither. Observe 
Denverites drive their families down 1-25 to Colorado Springs to get a 
fair price for a flight.
    This is not the vision Mayor Federico Pena had in mind when he told 
us to ``Imagine a great city.'' In the years DIA was planned, Denver 
was uniquely blessed with three hub competitors. In 1986, Frontier was 
absorbed by Continental, and then there were but two.
    But in the last few years, United turned up the heat, increasing 
Denver capacity by 30 percent in a deliberate effort to shove 
Continental out. Continental lost $10 million a month at Denver, and no 
politician would lift a finger to save its maintenance base at 
Stapleton (cost--three flights a day, max. on one north-south runway; 
benefit--1,500 good-paying jobs and at least 60 flights a day to 
discipline United). Continental, which inaugurated service half a 
century ago in Pueblo, all but abandoned the state that give it birth, 
moving its planes east of the Mississippi. And United has raised fares 
to monopoly levels in virtually every market Continental abandoned.
    Along the way, United cut a remarkable deal with the city to strip 
essential parts from the infamous BAE automated baggage system out of 
Concourse C and move them to Concourse B so that only United would have 
a high-speed system. Other airlines were relegated to 19th century tug-
and-cart technology. Unfortunately, DIA's massive cost overruns have 
dissuaded many low-fare airlines from entering the market.
    In fact, one by one, the low-cost, low-fare airlines have exited 
Denver--Morris Air, Midway Airlines and GP Express. Now MarkAir 
languishes in Chapter 11 bankruptcy, while United tries to push it into 
Chapter 7 liquidation, selectively lowering fares on flights in close 
proximity to MarkAir's and bribing travel agents to steer traffic to 
United via commission overrides.
    United also refuses to enter into joint fare and code-sharing 
relationships with domestic jet airlines, which results in relegating 
small communities to inferior and high-cost turboprop aircraft, flying 
below the weather without in-flight amenities or lavatories.
    Code-sharing is a way of defrauding consumers into believing they 
will be flying a megacarrier's jets, when in fact they are funneled 
onto a tiny carrier's turboprop or piston aircraft at the hub, all in a 
deliberate attempt to steer feed traffic away from jet competitors. The 
new Frontier Airlines sought joint fares and code-shares with United so 
that Frontier can continue 737 jet service to Montana and North Dakota. 
United refuses. Although consumers clearly prefer jets to turboprops, 
United's computer reservations system adds an astounding 1,440 minutes 
to the United-Frontier interline, often shoving it off the first page 
of the computer screen, where 90 percent of all flights are sold by 
travel agents.
    Could anyone imagine that the Federal Communications Commission 
would tolerate U S West entering into preferential connections and 
rates with Sprint, making it difficult for consumers who preferred MCI 
or AT&T to get access? As yet, no one has litigated the antitrust 
implications of discriminatory connections related predatory conduct in 
aviation. But if the telecommunications industry is at all analogous, 
United Airlines has an antitrust problem--a serious antitrust problem.
    Unfortunately, antitrust takes years to litigate, and the people of 
Denver need relief now. The man who conceived DIA, Pena, is now our 
nation's secretary of transportation. The Federal Aviation Act commands 
the secretary protect the ``public interest'' by forbidding ``unfair 
and deceptive practices'' and ``unfair methods of competition.'' The 
public interest is defined in that statute to include ``preventing 
unfair, deceptive, predatory or anticompetitive practices'' and 
``avoiding unreasonable industry concentration, monopoly powers, and 
other conditions that would tend to allow at least one carrier * * * 
unreasonably to increase prices, reduce services, or exclude 
competition in air transportation.'' That hits the nail on the head. If 
only we can convince Secretary Pena to pick up the hammer and swing.
    Join me in urging Pena to loosen the monopoly stranglehold United 
Airlines has on the great airport he imagined. His address is: The 
Honorable Federico Pena, Secretary of Transportation, 400 Seventh St. 
S.W., Washington, D.C. 20590.
    Do it, or pay the price.
                                 ______
                                 

                 [From the Denver Post, Sept. 4, 1986]

                     Deregulation's Toll Is Rising

                       (By Paul Stephen Dempsey)

    The bankruptcy of Denver-based Frontier Airlines is but the latest 
chapter in an industry struggling in the turbulent headwinds of 
deregulation. Even deregulation guru Alfred Kahn admits the airline 
industry is becoming an ``uncomfortably tight oligopoly'' in the 
Darwinian marketplace of bankruptcies and acquisitions.
    In the short run, deregulation has meant a more competitive 
marketplace, where consumers have been given a wider choice of price 
and service (mostly price) options. Braniff became the first major 
casualty of improvident management after deregulation, and its 
bankruptcy served as a warning to others. Carrier management and labor, 
which had grown fat and lethargic under regulation, were forced to 
tighten their belts--to become mean flying machines.
    Lower lean, ticket prices and increased industry productivity are 
considerable benefits of airline deregulation. But deregulation has not 
been without its costs.
    Low fares have been distributed unevenly in favor of America's 
major cities, where the competition has been most intense for market 
share. But the empirical evidence suggests a positive correlation 
between higher ticket prices and fewer competitors. ``Transcontinental 
fares are sometimes lower than the price of flying to a small American 
city at less than half the distance away.
    Passenger convenience has waned; today's traveler is flown on 
intensely packed aircraft funneled into congested hubs on flights that 
are chronically delayed, while he is served cardboard food. With all 
that, he feels lucky that he wasn't stranded by overbooking, as are 
many others less fortunate.
    Stockholders and employees also have been stranded in the icy 
headwinds of deregulation. In the early years of deregulation, its 
advocates were slow to accept any blame, pointing fingers at the 
economic recession and wildly escalating fuel prices. But the recession 
hasn't reared its ugly head in a while and aviation fuel prices have 
been sent wildly crashing through the floor, as have wages for many 
employees.
    Frontier's economic Armageddon may be People Express's as well, for 
its founder, Donald Burr, suffers from the fatal flaw of the first of 
deregulation's airline mavericks, Sir Freddie Laker--excessively 
aggressive expansion. By purchasing Denver-based Frontier last year, 
Burr hoped to join the club of the four or five megacarriers that 
analysts predict will eventually dominate the industry. But Burr bit 
off more than he could chew in the hotly competitive Denver market, 
dominated by three major hub carriers--United, Continental and 
Frontier.
    Burr was forced to reverse course, signing an agreement earlier 
this year to sell Frontier to the industry behemoth, United. The United 
purchase fell through and People put Frontier into bankruptcy as a 
tourniquet to stop the hemorrhaging of losses totaling $10 million a 
month.
    Although United failed to acquire Frontier, it had already 
purchased many of its aircraft, hangers and gates at Denver. As the 
nation's largest airline and the premiere industry proponent of 
deregulation, it is vertically and horizontally integrated into a 
megacarrier that owns Weston Hotels and the Apollo computer 
reservations system, and has recently purchased Hertz Rent-a-Car as 
well as Pan American's transpacific routes.
    How quickly will the industry come to be dominated by only a 
handful of airlines? Northwest Orient and Republic have just 
consummated the largest merger in aviation history. Texas Air (which 
owns Continental and New York Air) will likely refile its application 
with the Department of Transportation to acquire ailing Eastern 
Airlines (which purchased Braniff's South American operations upon the 
bankruptcy of that airline). TWA's application for acquisition of Ozark 
is also pending at DOT. TWA's owner, Carl Icahn, admits it will still 
need another merger partner if TWA is to be successful.
    Together, Frontier's bankruptcy and these massive mergers will 
likely result in less competition and higher ticket prices at the hubs 
of Denver, Detroit, Minneapolis/St. Paul, New York, St. Louis and 
Washington, D.C.
    These mergers and bankruptcies are not the last we will see. The 
weaker birds cannot fly in such fierce headwinds. Some will be consumed 
by larger predators. The skies of deregulation will get darker and 
stormier still before the dust settles on an indus try dominated by 
giants.
    The social Darwinists can celebrate the net result of deregulatlon. 
But we consumers have been taken for a ride.
STATEMENT OF MARK KAHAN, EXECUTIVE VICE PRESIDENT AND 
            GENERAL COUNSEL, SPIRIT AIRLINES
    Senator Shelby. Mr. Kahan.
    Mr. Kahan. Thank you, Mr. Chairman.
    I am Mark Kahan, vice chairman of Spirit Airlines 
headquartered in Detroit. As a personal note, I came to 
Washington 20 years ago with Dr. Alfred Kahn to deregulate the 
airlines. In fact, my job was airline pricing. I was supposed 
to be an expert in the law and economics of pricing, and my job 
was to get the Government out of airline pricing and also to 
raise high barriers to any complaints about predation. 
Interestingly, the first one that came before the CAB in 1979 
was from United Airlines, which we denied. I feel very much at 
home with many of the themes expressed by all the Senators here 
today, and I am honored to be here.
    I think the common theme is none of us is here because we 
want reregulation. In fact, 20 years of my life would be a 
nullity if that were the case. Like any Government policy, 
there are unanticipated problems. I think the chairman's 
opening statement pointed to the complexity of the industry.
    The fact of the matter is, gentlemen, that the industry is, 
indeed, far more complex than we thought it was 20 years ago, 
and, in fact, we were wrong about many of the basic assumptions 
that we had 20 years ago. That does not mean that our policy 
was wrong. I contend that it was right. But it does mean that 
it is appropriate for us to be here and talk about what has 
happened since.
    I am a representative of a small carrier and its 840 
employees. We are among the oldest of the smaller carriers. We 
were always profitable from founding in 1989 through 1996, and 
I am happy to say that we are profitable today. Primarily I 
would like to think because of hard work, but also--and I think 
this is the area which is of some concern to public policy--
because we have consciously determined to reposition our 
operations away from competition with the major carriers. In my 
testimony, I first describe the problems of airport access, and 
specifically the well-known, well-described problems of gates 
and slots.
    Gentlemen, there is no downside. There is no possibility 
that the cure will be worse than the disease if the Government, 
the legislative branch and the executive branch, attacks the 
problems of airport access. I hope we will have a chance to 
talk about that.
    Now, on our part we are seeking to serve some of the high-
density airports from some small communities. We have some 
applications pending. I certainly hope that those will be 
granted so we will have an opportunity to bring some service 
from small communities to some of the high-density airports. If 
you cannot get gates, if you cannot get slots, if you cannot 
take off or land, you cannot operate an airline no matter how 
good your airplanes or how good your management. I hope we will 
have a chance to talk about that.
    Much of my testimony is devoted to the area of predatory 
practices because that is the difficult part, that is the 
controversial part, that is the thing that worries legislators. 
They want to make sure that, indeed, the cures are not worse 
than the disease. I understand that.
    In my testimony, I try to give you the facts, what happened 
when Spirit, a profitable and successful carrier, attempted to 
contest at its Detroit hub with the monopoly carrier in two 
markets and what happened, the kind of tactics that were used 
and the case that we make is that no carrier no matter how well 
managed could have made it under the circumstances that we were 
put under.
    The question for public policy is whether that is OK. In 
which case, there will not be any competition in those kinds of 
markets or whether we want to take a hard look at it, first, 
the antitrust laws and fine tune such policy as is necessary to 
be fine tuned. I am glad that Senator Faircloth brought up the 
question of subsidies.
    Senator, I contend that at hub airports all the subsidies 
go into a different direction. The monopoly carrier at Detroit 
pays lower landing fees than we do. It has Government-conferred 
monopolies in terms of routes to places like Tokyo and London 
in all kinds of ways where they are capable by fine tuning the 
governmental process and by employing people whose whole reason 
in life is to game the Government process to lower their cost 
and increase our costs. I look forward to that discussion with 
you, Senator.
    I see that my time is coming up.

                           prepared statement

    Mr. Chairman, we are not here to whine. We are going to do 
what is in the interest of our owners and employees. It is up 
to Government to help protect the public interest in low fares 
and service to small communities. We are pleased that public 
attention is focusing on this issue today. I agree with you it 
is complex. My warning is, indeed, one or two hearings is not 
going to solve the problem, one or two DOT orders is not going 
to solve the problem. I hope that 6 months from now, 1 year 
from now we have made some progress.
    Thank you very much.
    [The statement follows:]

                  Prepared Statement of Mark S. Kahan

    Mr. Chairman, my name is Mark Kahan. I had the privilege of coming 
from New York to the Civil Aeronautics Board in 1977 with Chairman 
Alfred E. Kahn to assist in deregulating the airlines, and am honored 
to be appearing before you today as Vice Chairman and Chief Operating 
Officer of Spirit Airlines, Inc. Spirit is among the oldest of 
currently operating post-deregulation carriers. We began service in 
1989 and, until 1996, were profitable every quarter.
    As the Airline Deregulation Act reaches the ripe age of 20 this 
year, the nation can look back with pride on a truly bipartisan reform. 
How many today argue that Washington bureaucrats are better equipped 
than the marketplace to decide precisely which city pairs deserve 
airline service, the efficient number of carriers that can fly a route, 
or the exact price to be charged? Most analysts have concluded that the 
net benefits of deregulation outweigh the costs, and that the average 
traveler is much better off. Having been part of the deregulation 
process, I am proud of this result.
    We cannot, however, ignore some serious adverse industry trends, 
including loss of service to smaller communities, extreme price 
differentials between business and leisure travelers, and actions by 
established carriers to eliminate low fare competitors. Furthermore, 
tangible ``barriers to entry'' are actually getting higher, as time has 
marched on. When essential resources such as airport slots and gates 
are scarce, entrenched, politically savvy companies, with entire staffs 
whose purpose is to game the regulatory system in their favor, have an 
undeniable advantage over new entrants.
    All of these problems, which combine with particular intensity at 
single carrier dominated ``fortress hubs,'' have been well documented 
in the economic literature and in any number of GAO and DOT reports. 
There is nevertheless frustration as Executive Branch spokesmen have 
expressed understanding and concern, but with little action. We at 
Spirit are pleased that the logjam seems to be breaking. The 
Departments of Transportation and Justice are to be commended as they 
begin what should be a serious effort to find practical solutions for 
current problems, cures which are not ``worse than the disease'' and 
which actually help travelers and communities.
    Several of the major carriers argue that current Congressional 
initiatives such as this hearing--designed to improve competitive 
conditions in the airline marketplace--are a de facto effort to re-
regulate the industry. Mr. Chairman, this kind of diversionary thinking 
should be firmly rejected. These carriers overlook that the actions 
under consideration are themselves substantially deregulatory in 
nature. To understand this, we might reflect on how Delta Airlines and 
US Airways can charge $404.00 for an unreserved round trip coach ticket 
between New York and Washington, while a comparable ticket between San 
Francisco and Los Angeles costs $237.00. The answer does not lie in 
differing costs. The New York-Washington trip, 216 miles, is actually 
much shorter than San Francisco-Los Angeles, at 338 miles. All the 
airports in question are highly congested; the passenger volumes are 
ample to exploit the relevant economies of scale. Why are New York-
Washington passengers paying so much more?
    The essential answer is straight-forward: The USAir-Delta duopoly 
faces almost no actual or potential competition in this city pair 
because a regulation, called the High Density Rule (HDR), rigidly 
excludes any new entrants at New York's La Guardia and Washington's 
National Airport, among others. The HDR was designed in 1967 to 
eliminate runway delays, before the advent of wide body aircraft and 
during the era of rigid mileage based price controls. It has long since 
become a tool of monopoly whose anti-competitive consequences have 
managed to evade the level of skepticism that outdated regulations are 
supposed to receive in 1998. If current efforts in Congress have one 
central theme, it is the relaxation of the HDR. That some major 
carriers think such ideas are ``re-regulation'' is more than a little 
ironic.
    It should be understood that the architects of airline deregulation 
did not advocate a simplistic laissez-faire approach to the 
marketplace. They firmly believed in the importance of pro-competitive 
antitrust principles, and clearly intended their enforcement to be a 
Federal executive responsibility shared by the Departments of 
Transportation and Justice.
    Subsequent events have justified this concern for effective 
enforcement. Concentration in the industry continues to increase. In a 
recent report, ``Airline Competition at the 50 Largest U.S. Airports--
Update,'' Salomon Brothers investigated market shares on a route-by-
route basis (rather than by the customary national averages) and 
identified ``an unprecedented degree of concentration in the airline 
business.'' This trend, which helps explain some of the recent real 
increases in airline fares, is worrisome. Though no one knows what the 
efficient market structure of this dynamic industry will ultimately 
turn out to be, this level of increased concentration does suggest the 
need for a modicum of caution before we assume that oversight of anti-
competitive practices is unnecessary.
    The real issue is not re-regulation vs. deregulation but whether 
deregulation can ultimately succeed if there is increasing 
concentration and no new entry into the marketplace. No advocate of 
deregulation ever dreamed that the industry would evolve without the 
discipline of actual and potential competition. Quite the contrary: 
Analysts in 1978 posited extremely low barriers to entry into airline 
markets, believing aircraft to be the most mobile of assets. Now, as 
Salomon Brokers and others have shown, concentration has increased to 
the point where actual competition on most non-stop routes is limited 
to carriers with a hub at one end, leaving most consumers with a 
maximum of one or two choices. Many small-to-medium sized communities 
have lost service altogether. Under these circumstances, passengers 
with relative inelastic demand, primarily business travelers, and 
travelers from smaller communities, will pay an enormous fare premium.
    What all analysis has shown is that the single most effective 
competitive discipline arises from entry by a low fare competitor, such 
as Southwest Airlines. (Its competition largely accounts for the low 
fares in the Los Angeles-San Francisco market noted earlier). For a 
while, there were several would-be imitators of Southwest but, since 
the Valujet crash in 1996, and in the wake of predatory practices by 
major carriers, the number of these new entrants is swiftly declining. 
The number of new scheduled passenger carriers certificated by the 
Department of Transportation declined from 8 in 1996 to 3 in 1997. Only 
a few of these ever began operating and even fewer continue to do so. 
This is an unprecedented situation which should be a source of genuine 
concern.
    Can public policy help? To an unreconstructed deregulator like 
myself, the prospect of real re-regulation is dismaying. But, relaxing 
the High Density Rule and taking other steps to increase competitive 
access for new airlines who did not receive ``grandfathered'' airport 
slots and gates simply cannot be construed as re-regulation. We should 
be suspicious when entrenched carriers defend these entry barriers as 
their unique entitlement.
    The more difficult question is whether public policy should 
intervene to defend smaller carriers from predatory activities, 
particularly in the pricing area. Again, it is difficult to see how 
actual enforcement of antitrust standards on a timely basis, which is 
all current legislative proposals would require, can be deemed re-
regulation. Indeed, Section 102 of the Airline Deregulation Act (now 49 
U.S.C. Sec. 4101(a)(7)) expressly requires ``the prevention [by the 
Department of Transportation] of unfair, deceptive, predatory, or anti-
competitive practices in air transportation.''
    It should be clearly understood that there is no doubt as to 
whether predatory pricing and capacity dumping actually occurs, only 
whether there is anything that can usefully be done about it. In fact, 
predatory conduct can be remarkably blatant. At Spirit, we are most 
familiar with competitive conditions at Detroit, our home base. On 
December 15, 1995 we began a single DC-9 (about 100 passengers) daily 
roundtrip flight from Detroit to Philadelphia offering fares as low as 
$49 one-way and extending in tiers to $139.00. Northwest, the dominant 
carrier at Detroit, did not ``match'' immediately. Instead, it 
continued on a previous strategy to raise its fares in that market.
    According to DOT statistics, Northwest's Detroit-Philadelphia yield 
in the first quarter of 1996 was 42.82 cents per mile (cpm), 11 percent 
over the previous year. This route was profitable, and our low fares 
developed a passenger base which otherwise would not have traveled. 
Encouraged by this success, on April 15, 1996, Spirit began a single 
DC-9 roundtrip from Detroit to Boston. The introductory fare was $69.00 
one-way, with our highest fare $159.00. Northwest had, however, 
evidently decided to ensure that our success at Philadelphia not be 
repeated. It immediately ``matched'' by making the $69.00 introductory 
fare available on all of its eleven daily flights and on virtually all 
coach seats. Northwest's cent per mile in the second quarter of 1996 in 
the Detroit-Boston market fell to 17.09 cpm, 52 percent below the 
previous year.
    On May 11, 1996, the Valujet tragedy unfolded in the Everglades. As 
the Committee is aware, the publicity surrounding the crash and the FAA 
response to it had a short run, debilitating affect on public 
confidence in smaller airlines. In June 1996, we began hearing rumors 
that ``Northwest will unload on Spirit'' in the Detroit-Philadelphia 
market. And that is what happened. On June 30, 1996 Northwest 
``matched'' Spirit's $49.00 fare in the Detroit-Philadelphia market on 
all flights and simultaneously increased its capacity by more than 15 
percent over the previous year. Its yield dropped from 37.85 cpm in the 
third quarter of 1995 to 17.59 cpm, a drop of more than 54 percent. The 
story is detailed on Charts 1-2 (Philadelphia) and 3-4 (Boston).
    It is probable that Northwest sacrificed out-of-pocket not less 
than $10 million because of its fare decreases and capacity increases 
in the Detroit-Boston and Detroit-Philadelphia markets in the third 
quarter of 1996 alone. These actions clearly made no sense unless 
Northwest was confident that Spirit would be obliged to exit the 
market. And they were correct. On September 8, 1996 Spirit flew its 
last flight to Boston. On September 30, 1996, we flew our last flight 
to Philadelphia. Within a few months, a passenger traveling from 
Detroit to Boston would pay a one-way fare of $460.00, an increase in 
excess of 500 percent. The lowest, heavily restricted discount fares 
were $263.00 roundtrip (Thursday through Monday) and $219.00 (Tuesday 
and Wednesday, only). A passenger flying from Detroit to Philadelphia 
on Northwest paid a one-way fare of $381.00. The heavily restricted 
Thursday through Monday roundtrip fare would have been $181.00 and the 
Tuesday and Wednesday fare $151.00. The loser was first and foremost 
the traveling public, and of course Spirit as well.
    As we studied the matter more closely, it became clear that 
Northwest was not taking extraordinary actions only in the few East 
Coast markets in which we attempted to compete. In the fall of 1994, 
Spirit entered into the Detroit-Orlando market. Again, it met initial 
success. However, as you can see from the accompanying graph (Chart 6), 
Northwest subsequently flooded the market with seats, During the third 
quarter, 1994, Northwest had offered 150,000 seats. After our entry, 
during the third quarter of 1996, its capacity exceeded 275,000 seats, 
an amazing 40 percent rise for a mature market such as Detroit-Orlando. 
(During this entire period, as set forth on Chart 7, Northwest's 
overall domestic system was exceedingly stable from both a capacity and 
yield standpoint.) The carrier simultaneously dropped its average yield 
to 9.22 cpm, the lowest it has been in recent history and plainly below 
a remunerative level (Chart 5). You will pardon us for believing that 
Northwest tried to put Spirit out of business in the third quarter of 
1996.
    Charts 1-4 confirm that in the Detroit-Boston and Detroit-
Philadelphia markets, Northwest has reduced its capacity since Spirit's 
exit and, of course, raised fares drastically. A slightly different but 
no less ominous picture emerges in Detroit-Orlando, where we have 
chosen to draw the line and attempted to defend ourselves. Northwest 
has steadily poured on capacity so that it now offers almost 350,000 
seats in the most current quarter, almost doubling its schedule over a 
two-year period. Mr. Chairman, these tactics only make sense if the big 
guy is trying to tell the little guy that no step is too extreme, no 
matter how unprofitable or costly, in order to ``hold on to our 
passengers.'' With all deference, some steps are indeed too extreme and 
do cross the line into illegality. If there is going to be a low fare 
industry in this country alongside hub dominating ``fortress 
carriers,'' then it is important to define the line between legitimate, 
hard-nosed pricing and predatory tactics. Unless public policy does not 
want competition in markets like Detroit-Philadelphia, this work must 
be done. There is now no choice.
    Even in the absence of predatory pricing and capacity dumping, 
issues previously identified by GAO and DOT as barriers to entry need 
urgently to be addressed. Mr. Chairman, Spirit Airlines enplaned over 
19,000 passengers from Detroit in December, 1997, without a gate. We go 
from one carrier to the next seeking unused space for which we may 
contract at odd times of the day. Because we lack a gate, we are not 
entitled under the rules of the local airport authority to be a 
``signatory airline.'' Because Spirit is not a signatory airline, we 
are assessed a 25 percent surcharge over the rates charged to other 
carriers including, obviously, our major competitor.
    Aside from totally constraining our ability to grow any further, 
this Catch-22 situation violates the following basic economic and legal 
principles.
    1. It is discriminatory.--When a Spirit MD-80 lands, it certainly 
costs no more than a MD-80 operated by our competitor. In fact, it 
costs less. The costs of a hubbing airport like Detroit are largely 
driven by the need to have enough facilities available to meet the 
intense demands of the connecting banks which occur sporadically 
throughout the day. We at Spirit are more than willing to schedule 
around the peaks of Northwest's hub system, if we have the gates and 
flexibility to do so. Charging more when costs are less is the very 
essence of economic discrimination.
    2. It degrades our service.--Because we are obliged to obtain such 
gate space as is available from other carriers during periods of their 
slack use, our passengers can be delayed through no fault of our own. 
If the carrier with which we are dealing has a delay, our plane and 
passengers must wait until space becomes available.
    3. It raises our costs.--Not only do we have to pay the 
discriminatory landing charge, we must pay very high gate use fees. The 
carriers who accommodate us are not charitable institutions. We pay 
handsomely as these carriers quite understandably take advantage of our 
predicament. No one at Detroit, however, has ever charged us as much as 
Northwest.
    Interestingly, although Northwest has always taken the position 
that it is fully utilizing its gates at Detroit, it permitted Spirit to 
use one of these gates for our flight to Atlantic City, a route where 
we do not compete with them. We were recently obliged, against our 
strongest wishes, to move even this flight because of obligatory 
``tied'' de-icing charges which ranged up to 10 times higher than those 
imposed by other suppliers. It is well recognized in the economic 
literature that deliberately raising a rival's costs, particularly with 
respect to an essential facility like gates, is itself predatory.
    Mr. Chairman, I have elaborated primarily on predatory practices, 
gates and airport slots because they are the most fundamental and 
direct barriers to entry. They are not the only ones. To the extent 
requested by the Committee and staff, we will be pleased to offer for 
the record our real world experiences with respect to computer 
reservation systems, frequent flyer programs, commission overrides, and 
kindred practices.
    In conclusion, I wish to emphasize that Spirit and its 881 
employees seek no special favors from anyone. For the last eight years, 
we have competed in the marketplace each and every day and we are 
committed to the success of Airline Deregulation. We commend the 
Committee on its initiative in fostering this hearing. The competitive 
issues we have discussed are fixable if the nation has the will and 
desire to make the deregulation process work to its fullest potential.

                              CHART 1.--QUARTERLY STATISTICS FOR DOMINANT CARRIER FLIGHTS BETWEEN DETROIT AND PHILADELPHIA
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                 1q95      2q95      3q95      4q95      1q96      2q96      3q96      4q96      1q97      2q97      3q97       Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
Onboard Passengers...........    77,984    96,728   100,965    93,403    75,290    98,618   132,018   114,400    76,321    95,173    88,156    1,049,056
Total Seats..................   133,100   148,035   149,507   147,794   133,243   146,016   170,675    190,37   151,713   157,843   153,434    1,681,731
                              ==========================================================================================================================
Load Factor (percent)........      58.6      65.3      67.5      63.2      56.5      87.5      77.4      60.1      50.3      60.3      57.5         62.4
O&D Passengers...............    40,520    45,850    47,760    46,650    36,350    43,140    68,510    62,540    39,700    47,710       N/A      478,730
Market Share (percent).......      68.0      69.0      69.1      67.6      58.2      53.2      62.2      69.8      65.7      62.6       N/A         64.4
Average Fare.................   $163.73   $175.23   $166.12   $170.46   $222.23   $196.97    $79.07   $128.67   $230.64   $196.32       N/A      $165.26
Yield per CPM ( cents).......     36.23     38.64     36.70     37.63     49.03     43.47     17.45     28.41     50.81     43.29       N/A        36.44
--------------------------------------------------------------------------------------------------------------------------------------------------------

                                Chart 2
[GRAPHIC] [TIFF OMITTED] T12SMA05.033


                                 CHART 3.--QUARTERLY STATISTICS FOR DOMINANT CARRIER FLIGHTS BETWEEN DETROIT AND BOSTON
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                 1q95      2q95      3q95      4q95      1q96      2q96      3q96      4q96      1q97      2q97      3q97       Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
Onboard Passengers...........   139,756   188,508   212,719   167,522   127,520   224,353   252,734   173,347   123,179   172,014   188,938    1,970,590
Total Seats..................   232,523   281,545   319,662   256,464   235,878   327,974   322,039   268,449   232,077   284,895   306,550    3,068,056
                              ==========================================================================================================================
Load Factor (percent)........      60.1      67.0      66.5      65.3      54.1      68.4      78.5      64.6      53.1      60.4      61.6         64.2
O&D Passengers...............    40,140    60,280    67,900    59,700    45,250    97,340   119,060    76,080    48,240    65,540       N/A      679,530
Market Share (percent).......      84.3      89.4      90.6      87.4      89.3      91.7      91.5      89.2      89.1      90.0       N/A         89.7
Average Fares................   $230.70   $206.20   $191.84   $209.42   $258.83   $106.05   $100.01   $169.52   $267.54   $218.14       N/A      $178.45
Yield per CPM ( cents).......     36.38     32.56     30.31     33.15     40.92     16.78     15.84     26.80     42.36     34.48       N/A        28.21
--------------------------------------------------------------------------------------------------------------------------------------------------------

                                Chart 4
[GRAPHIC] [TIFF OMITTED] T12SMA05.034


                                 CHART 5.--QUARTERLY STATISTICS FOR DOMINANT CARRIER FLIGHTS BETWEEN DETROIT AND ORLANDO
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                 1q95      2q95      3q95      4q95      1q96      2q96      3q96      4q96      1q97      2q97      3q97       Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
Onboard Passengers...........   180,135   167,937   162,153   218,920   275,973   248,504   208,217   236,224   258,318   243,489   205,867    2,405,737
Total Seats..................   213,242   189,653   197,602   282,954   320,956   294,556   275,834   312,947   311,078   287,125   266,297    2,952,244
                              ==========================================================================================================================
Load Factor (percent)........      84.5      88.5      82.1      77.4      86.0      84.4      75.5      75.5      83.0      84.8      77.3         81.5
O&D Passengers...............    81,120    75,060    73,340   103,070   140,190   128,280   105,110   105,420   113,590   109,390       N/A    1,034,570
Market Share (percent).......      60.3      60.2      67.5      75.4      76.6      75.5      79.7      76.2      70.4      74.2       N/A         72.0
Average Fare.................   $113.42   $111.00    $96.70    $96.09   $105.83    $99.02    $88.33    $98.88   $127.78   $108.13       N/A      $104.51
Yield per CPM ( cents).......     11.78     11.49     10.07     10.02     10.99     10.30      9.22     10.34     13.31     11.28       N/A        10.90
--------------------------------------------------------------------------------------------------------------------------------------------------------

                                Chart 6
[GRAPHIC] [TIFF OMITTED] T12SMA05.035


                                                                           CHART 7--NORTHWEST AIRLINES--U.S. DOMESTlC
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                       951          952          953          954          961          962          963          964          971          972          973
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Onboard Passengers...............................    9,732,731   10,902,331   11,441,401   10,454,422   10,288,362   11,548,677   12,041,123   10,907,414   10,766,006   11,763,243   12,371,706
Seats............................................   16,047,032   16,730,609   16,961,857   16,746,153   16,491,412   17,236,219   17,816,378   17,447,384   17,003,030   17,406,703   17,736,261
                                                  ==============================================================================================================================================
Load Factor (percent)............................         66.2         70.5         72.5         66.4         67.6         70.9         71.8         66.8         66.6         72.0         73.8
O&D Passengers...................................   12,576,520   13,617,000   14,072,760   13,737,600   13,341,340   14,794,720   15,195,520   14,343,840   14,197,360   15,294,960          N/A
Market Share (percent)...........................         7.38         7.39         7.45         7.52         7.36         7.43         7.65         7.48         7.61         7.54          N/A
Average Fare.....................................      $167.15      $170.71      $170.14      $165.47      $184.50      $183.91      $177.68      $169.95      $184.92      $173.32          N/A
Yield per CPM ( cents)...........................        14.28        14.54        14.18        14.68        15.71        15.78        14.96        14.73        15.58        14.85          N/A
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STATEMENT OF MIKE BOYD, THE BOYD GROUP, EVERGREEN, CO
    Senator Shelby. Mr. Boyd.
    Mr. Boyd. Mr. Chairman, thank you very much. I appreciate 
the opportunity of being here.
    My name is Michael J. Boyd. I am with the Boyd Group/
Aviation Systems Research, a consulting and planning firm based 
in Evergreen, CO. My background is in the airline business. I 
grew up in the airline business. I have been with new entrant 
carriers on both sides. I have worked at new entrant carriers 
as a vice president of planning. Our firm has worked with new 
entrant carriers to begin operations. I know what they face. I 
know small community air service.
    Framing this issue, I think what Senator Lautenberg said, I 
think, perfectly frames the issue in a manner that as a 
template I think we should follow as we look into these issues 
of barriers to competition. There are three things. You have 
airline failures. No question they have taken place in the last 
20 years. We have lost competition. There is no question about 
that, enormous amounts of lost competition. Small communities 
have lost air service. There is no doubt about that, either.
    I think what we need to do is sort of look at the problem 
and try to define the problem rather than define some of these 
misconceptions people have. For example, I have looked at 
Senator Frist's bill and we have looked at Senator McCain's 
bill, and neither one will fix the problem. As a matter of 
fact, it will probably make it worse because it does not 
understand the nature of the problem.
    Let me talk about a few things. First of all, let me just 
say at the outset I am a contrarian. I appreciate bureaucrats 
and I appreciate bureaucracy. We would not be sitting here 
otherwise. I appreciate the people who work at the Department 
of Transportation like Patrick Murphy who try to make a system 
work. Although the system I think is broke, people like that 
try to keep it up and running.
    Let us look at why we have a lack of competition out there. 
Let us go back 20 years--not 20 years, let us go back to about 
the mid-1980's. There were three mergers there: Ozark-TWA, 
Republic-Northwest, Piedmont-USAir. All of those merged. Those 
eliminated a number of connecting hubs. They eliminated three 
good airlines that were not failing.
    In all of those cases, the Department of Transportation 
said that would not reduce competition. That does not make any 
sense. We did not have a good understanding of the situation 
then. There was no competitive problem with that? There 
certainly was. Today, the Department of Transportation is not 
working with the right tools. Just recently, we worked with the 
cities of Moline, a quad city--or the airports of Moline, a 
quad city, and Bloomington, IL, on an application for an 
exemption to fly to LaGuardia Airport. It was rejected mainly 
on the basis that the DOT found that there were only about 
8,100 people in those combined cities of over almost 2 million 
people that flew to New York.
    Those numbers were not accurate. Their O&D data is not 
accurate. Yet, planning has been done on the basis of that 
data, data that now that apparently the DOT inspector general 
last week came out and said is inaccurate. We cannot plan an 
aviation system or define an aviation system until we have 
those tools.
    I can get also into the issue of the study done 2 years ago 
that defined the low-fare revolution. That document was 
shameful. It talked about the savings that low-fare airlines 
had done. But when you took out Southwest, the remaining of 
those carriers had a very small impact, not a sufficient impact 
to make much of a hit on the consumer, but what the worst part 
was they said all of those airlines were safe. That is the 
outrage.
    The No. 1 carrier, ValuJet, they knew at the time to be 
unsafe, and to convince the public that it was safe is an 
outrage. After the ValuJet crash when there was a material 
reduction in traffic on startup carriers, the public should not 
be blamed for that because the reality is they were told those 
airlines were safe and we found out later in other hearings 
that the major one of those airlines was not safe. I do not 
find that to be something that really will fix this problem.
    I looked at the McCain bill and we looked at the Frist 
bill. Basically, they assume that if you increase service to 
four slot-controlled airports small communities will have 
better air service. It will not happen. It just does not make 
any sense.
    Senator Shelby. Say that again.
    Mr. Boyd. Well, they assume that if you open up additional 
access to LaGuardia, Kennedy, Washington National, and O'Hare, 
suddenly small communities will have better air service. In the 
system we have today, which is not an interline system it 
probably would not. Startup carriers like Frontier would have 
no business trying to fly from Lexington, KY, to, let's just 
say, Chicago O'Hare nonstop because there is not enough traffic 
there to keep them up and running. That would not fix the 
problem.
    How do we fix this problem? Let us talk about things we can 
do right here without reregulating, without changing things, 
without upsetting the entire system. Do you want to reregulate 
the system? We do not. Do we want to deregulate it further? 
Good, let's do it. Let's start with some things. The Wright 
amendment at Love Field.
    Why that is still there is an outrage. The Wright amendment 
should be eliminated as quickly as possible. Now, will that 
change DFW and make it, as Mr. Crandall says, some sort of a 
juggernaut that will destroy service to South America? The man 
needs a vacation if he thinks that. The reality of this is that 
the Wright amendment right now if it were eliminated would 
allow a lot of fare competition East and West, so let's just 
start with that.
    Second, the perimeter rule out of LaGuardia and Washington 
National, get rid of those; they are anachronistic. Fourth, 
free flights, implementing an air traffic control system that 
makes a lot more sense. Airlines are losing about $5 billion in 
excess cost because of an air traffic control system that I do 
not think--not I do not think--that is not particularly safe 
and, indeed, is a system that does not make any sense left out 
of the 1950's.
    The fifth is we need airport capacity, but we need it built 
where it is necessary, not just new airports that cost too much 
for airlines to fly to like the one in West Virginia or like 
what happened in Denver. We need airport capacity where it is 
needed and done in an efficient way. Those are options that I 
think this committee should look into. I think the framework 
that Senator Lautenberg brought up is the one, or the template 
that we should follow through.
    Thank you very much, sir.
    [The statement follows:]

                 Prepared Statement of Michael J. Boyd

                    barriers to airline competition
    Mr. Chairman, I appreciate the opportunity of providing input to 
your committee today regarding the important issue of airline 
competition.
    I have attached to my testimony my bio which provides my background 
in the airline and aviation industries.
    The Boyd Group has worked with a number of new-entrant carriers.
    I am no stranger to the issue of new entrant carriers and the 
barriers that they face in today's market place. In my 27 years in this 
industry, I have held management and planning positions at all three 
general types of airlines--major, commuter, and new-entrant start-up 
carriers, including experience as Vice President of Marketing and 
Planning for a new entrant. Since co-founding The Boyd Group I have 
worked with a number of new-entrant airlines.
    We accomplished the original Colorado Springs feasibility study for 
what became Western Pacific Airlines. We accomplished the original 
business plan for Northern Airlines, a potential new entrant seeking 
funds to begin service. Just recently, we have assisted Pro Air, a new 
entrant at Detroit, with preparing a slot request for access to New 
York/LaGuardia.
    In our air service development work with airport clients, we have 
been successful in marketing efforts to new entrants. We helped 
Bloomington/Normal, Illinois become the fastest-growing airport in 1997 
by helping them attract two new entrant airlines, Frontier and AirTran 
Airways.
    In January, I was honored to facilitate the National Air Service 
Roundtable, which aired the challenges facing small community air 
service. I believe that this experience gives me a wide and I believe 
objective insight into the issue of air service issues and barriers to 
competition.
    Myself and my firm have gained a reputation for telling the facts 
as we see them, as-is and where-is. Unlike many consultants, we provide 
our clients with what they need know, not necessarily what they want to 
hear. Today, I am providing your subcommittee with some insight that is 
factual, but in many ways may not coincide with ambient thinking about 
the airline industry. We need to recognize that a lot of the realities 
we face in the matter of airline competition and air service are not 
pleasant. And a lot of the solutions will not be pleasant, either.
    I also have a reputation--of which I am proud, by the way--of being 
often blunt and to the point. My time is valuable, our client's time is 
valuable, and certainly, your time and that of this Subcommittee are 
valuable. My comments and written testimony today will adhere to that 
template.
    We are witnessing a period where immediate pre-determined solutions 
are demanded for problems that are not properly understood.
    On that note, let me start by outlining the key points in my 
testimony:
    I am very concerned that the tenor of the discussion on the matter 
of air service and airline competition is beginning to resemble that of 
an angry lynch mob. Take action now and ask questions later. Act less 
on hard data than on innuendo, anger, and bravado. Lynch the villains 
and pirates right now. Assume easy explanations to difficult questions 
and propose easy, mom-and-apple-pie ``solutions.'' It is a situation of 
``ready, aim, fire.''
    The symptoms are obvious. But the causes are sometimes issues that 
people do not want to face.
    We do have issues facing us regarding barriers to entry into the 
airline industry. This affects the levels of competition consumers 
face, and also the levels of air service that is offered at many mid-
size and smaller cities. There is no argument regarding what we have 
seen in the past several years:
    1. Airline Failures.--Dozens of new entrant passenger jet carriers 
have failed in the last 20 years. Indeed, of those started between 1978 
and 1992, only two survive today. One had to go through bankruptcy to 
get here, and the other was not even a low-cost airline.\1\
---------------------------------------------------------------------------
    \1\ The first is America West. The second is Midwest Express.
---------------------------------------------------------------------------
    2. Materially reduced competition.--The number of airlines has 
declined in the last 15 years. This has resulted in 14 fewer 
connecting-hub operations today compared to the mid 1980's.
    3. Reduced service to small communities.--Our studies indicate that 
as many as 100 smaller communities will lose scheduled air service in 
the next decade.\2\
---------------------------------------------------------------------------
    \2\ ``The Future or Regional Air Service--The challenge of the New 
Realities.'' Published by The Boyd Group/ASRC, 1997.
---------------------------------------------------------------------------
    These are not arguable observations. It is a fact that new entrant 
airlines have gone down like flies. It is a fact that we've lost 
existing airlines like Piedmont, Republic, and Ozark, along with their 
connecting hub operations. And it is an unfolding dynamic that smaller 
communities are losing service at their local airports.
    What is arguable is the way that these facts are being interpreted, 
and the conclusions--mostly incorrect--that many people are assuming 
regarding their causes and their solutions.
    I have seen some very disturbing suggestions regarding approaches 
to ``fixing'' these problems. One general thread flows through most of 
them: they have little understanding of the causes of the problems, and 
less understanding of the dynamics of airline operations.
    There are a lot of people that believe that the causes of this 
current situation are simple and the solutions are simple. They are 
not. And if we jump on trendy, high-horse ``solutions'' such as some 
proposed in Congress, the result will be worse air service, not better.
Defining the Challenges Accurately
    I am concerned that some of the agencies that are attempting to 
define the issue of competition have no real understanding of today's 
airline system.
    Furthermore, the problems are being ``broad brushed'' with 
assumptions that do not stand up to reality. If we are to solve the 
problems at hand, we must first understand what they are. In the past 
several weeks I have again heard a host of misconceptions regarding 
airline competition. We can fix problems, or we can chase 
misconceptions. Unfortunately it is the latter that is being all too 
often pursued. These include.
    ``Major Airlines Unfairly Dominate Hubs'' is a common complaint. 
But it is based on an incredible lack of knowledge of our air 
transportation system. What needs to be understood is that no airport 
is a hub. An airline creates a connecting hub by making the conscious 
decision to focus resources at a given airport. Charlotte is not a hub, 
but US Airways operates a connecting operation there. It is more 
correctly a hub-site. Denver is not a hub, but United has decided to 
operate a connecting hub there. Airlines, not airports, create hubs. 
They also eliminate hub-sites, such as happened at Dayton. Therefore, 
discussions of airport traffic dominance and facility constraints at 
these airports must be carefully weighed. The fact that US Airways has 
most of the leaseholds at Charlotte, for example, is not prima face 
evidence that the airline is intentionally gobbling up gates to keep 
out competitors. On the other hand, if American Airlines or its parent 
company has leaseholds on most of the facilities at DFW, including 
those that it does not use, perhaps that might be an issue.
    The hub operation and the airline which creates it are not mutually 
exclusive. This doesn't mean that a given airline can't use this 
position to unfairly keep out competitors, but dominating the business 
that it creates is not by itself anti-competitive. Criticizing an 
airline for dominating its own connecting hub-site is like complaining 
that Sears Roebuck is unfairly dominating Sears stores.
    Fare Levels at Hub-site Airports.--There have been studies to 
``prove'' that fares are higher at hub-site airports. That type of data 
must be weighed carefully. First, many of the routes are those that 
would have no service at all into the hub-site airport if the airline 
did not operate connecting flights there. There is likely little local 
traffic between Lexington, KY and Cincinnati. It is likely that Delta's 
published fares in that market are very high. One reason is that there 
isn't much demand. The second is that the reason Delta serves the 
market is to feed traffic from Lexington to the rest of its system. 
They want the seats to be occupied by consumers connecting to their 
other flights, and hence the seat has more value than what some few 
consumers may be willing to pay just to get to Cincinnati.
    Monopoly markets always means sky-high fares.--In general, it is 
accurate to state that where only one carrier provides service, lack of 
competitive pressure means fares will be high. But even here, a broad 
brush cannot be applied. Recently I booked a one-day mid-week trip from 
Denver to Rockford, Illinois, a routing where only one carrier exists, 
Northwest, and where there is limited service. The round trip fare was 
$240, much less than the fare I was quoted from Denver to O'Hare, a 
market that has competition and where the sky is nearly black with 
frequency.
    There is high consumer demand for additional airline competition.--
This is generally accurate, but not in all places at all times. 
Recently I attempted to fly AirTran Airlines (nee ValuJet) from Flint, 
Michigan to Atlanta, a market where that carrier alone offers nonstop 
service and very attractive fares. The flight was cancelled, with less 
than 20 people booked. At Akron/Canton, another market where this low 
fare airline has nonstop monopoly to Atlanta, the load factors are less 
than 60 percent. Both Flint and Akron/Canton serve populations of over 
1 million, and both were in the top five fastest growth airports in 
1997. Yet a carrier like AirTran, offering a reasonable product at very 
attractive fares, and the only nonstop service to Atlanta has 
difficulty in winning over the consumer.
    Major airlines will price their product below cost to match a 
competitor.--This is accurate. But it has always been accurate, even 
when competing with each other. The question is whether these pricing 
actions are intended to be predatory, or merely a response to 
competition. This can only be determined on a case by case basis. A lot 
of new entrants do not have clean hands in this regard, either. At 
Denver, Western Pacific tried to buy market share by consistently 
pricing its product well below cost. In that case, United was the 
victim, and so, too was Frontier.
                    airline competition--the context
    Let me move on to some of the issues at hand directly affecting 
airline competition. Since 1978 over 40 new entrant jet airlines have 
failed.
    In most cases, predatory competition was not the reason.
    Airline Failures.--The assumption seems to be gaining currency that 
failures of new entrant airlines are due to some sinister anti-
competitive actions on the part of existing airlines. That is another 
trendy, easy conclusion. It is also wrong. This is not to say that 
there are instances of a major carrier stepping over the line, as 
Professor Dempsey has noted.
    The DOT is questioning the ``dominance'' of Northwest at Detroit 
and Minneapolis/St. Paul. That's like an arsonist complaining about 
fire.
    But we have extensively studied new entrant carriers, and the 
causes of failure of each. I daresay that most analysts who pass 
judgement on this have not done this. As noted in a subsequent section, 
in most cases the causes of failure were not due to predatory 
competition, as many would like to believe.
    The Department of Transportation is attempting to have us believe 
that the ValuJet crash is the reason for the lack of new carrier 
entrants in the past year. That is sheer nonsense. True, the crash did 
not encourage new capital for start-ups, but the track record of 
failure and financial loss by this genre of carrier was in place and 
documented before that unfortunate--and avoidable--incident.
    Materially reduced competition.--I understand that the second panel 
today includes the DOT. I think it should be kept in mind that one of 
the major causes of lost airline competition in the last dozen years 
has been due to the ineptitude of the Department of Transportation, 
which in the mid 1980's blithely allowed a number of mergers between 
perfectly healthy carriers, and in each case assured the public that 
competition would not be materially reduced.
    They allowed TWA to acquire Ozark, which eliminated the latter 
carrier's competitive hub operation at St. Louis.
    They approved the Northwest acquisition of Republic, eliminating 
competitive hubbing operations at Detroit and Minneapolis/St. Paul, not 
to mention the eventual elimination of significant former Republic 
operations at both Atlanta and Phoenix.
    The DOT approved the acquisition of Piedmont by USAir, reducing 
competition in areas such as Upstate New York, and causing the eventual 
elimination of Piedmont's former Dayton hubbing operation.
    Incredibly, it was the Department of Transportation that declared 
in each of these cases that competition would not be adversely 
affected, a conclusion that a semi-literate school child could have 
successfully questioned. Anyone with a modicum of understanding of 
airline economics knew that in allowing these carriers to merge, there 
would be increased concentration, less competition, and there was 
little chance that new carriers would grow to replace those eliminated 
by the mergers.
    It is almost Kafka-esque to now hear the DOT call for an 
investigation into Northwest's dominance at Detroit and Minneapolis/St. 
Paul, when it was that very organization that declared the merger that 
immediately created that dominance would not reduce competition. First 
they allow and bless Northwest's acquisition of Republic, and now blame 
that airline for dominating the airports where the two carriers were 
the major players. This type of double-bind decision making on the part 
of the DOT couldn't housetrain a puppy, let alone provide the type of 
expertise we need today to accurately analyze the nature of airline 
competition. If there is a problem here, the cause is not in 
Northwest's corner.
    Reduction in air service at smaller communities.--This is not due 
to uncaring actions by nasty robber-baron airlines, as some would have 
us believe. Nor is it due to deregulation. It is due mainly to 
economics.
    The loss of scheduled air service at many smaller airport is the 
result of economics that legislation can't reverse.
    Airlines operate to make money, like any other business. Whether it 
be a major carrier like Delta or a new entrant like Frontier, profit is 
the goal. The fact is that many smaller communities just don't have the 
traffic to support scheduled air service which local consumers will 
use. Today, consumers are increasingly reticent to utilize flights 
operated with turboprop aircraft, particularly 19-seaters. As a result, 
at many smaller communities, it is the local consumer who makes the 
decision to decline use of the local airport. But in many cases, the 
consumer still has access to air service, usually within 90 minutes or 
less from a larger airport.
    Trying to keep air service at communities that cannot support it, 
when there are alternatives nearby, is a waste of resources. Today, for 
example, tax dollars are subsidizing passengers at McCook, Nebraska to 
the tune of over $300 each, when unsubsidized air service is available 
just 45 minutes away.
Brief Summary of Competitive Situation
    I now like to summarize the facts as I see them. Then I'd like to 
outline some solutions.
    The failure of New-Entrant Carriers has not been primarily due to 
predatory behavior by major carriers. New-entrant carriers have largely 
failed in the past 20 years for reasons other than the effects of 
predatory competition. As I will note below, to blame unfair 
competition for the failures of most of these carriers is to engage in 
trendy nonsense. Most have died from internal causes, as we have 
recently witnessed at Denver with Western Pacific, and at Miami with 
the ``new'' Pan Am. Both airlines had business plans that, competition 
notwithstanding, doomed them.
    Examples of Predatory Behavior do exist, however. There certainly 
are clear examples of predatory actions on the part of major carriers 
against new entrants, as the testimony of Professor Dempsey clearly 
shows. I believe that United Airlines has stepped over (at least) an 
ethical line in their activities at Denver in dealing with Frontier.
    And ``predatory behavior'' is not the sole province of major 
carriers. It is clear that Western Pacific--a new entrant itself--
attempted to flood markets at Denver with excess seats at below-cost 
fares in an attempt to kill Frontier. Luckily, the incompetence of 
Western Pacific management caused the carrier to self-destruct. At Las 
Vegas, Sunworld failed after entry by other low-cost airlines, not 
major carriers.
    Airline competition has been adversely affected more by actions or 
inaction from Washington than from unfair competition. Consumers across 
America should be very concerned to hear that the Department of 
Transportation is considering action to address the need to increase 
competition.
    Mr. Chairman, I will put this as bluntly as I can: the DOT must 
first gain an understanding of how airlines work before they apply 
their heavy and unskilled hands on fixing the industry.
    The DOT's ``Low Fare Revolution'' study is a shocking example of 
how key statistics are sometimes withheld or masked from the public.
    The report claimed ValuJet was safe, when the data clearly 
indicated otherwise.
    As an example--a shameful one--I would point to the DOT's 1996 
``study'' entitled ``The Low Fare Revolution.'' Many have quoted this 
document as if it had professional credibility. It does not. It claimed 
that low fare airlines had saved the consumer $6 billion and inferred 
that new entrant carriers were a major part of this, and they were as 
safe as the major carriers. The Department lumped the statistics of 
Southwest Airlines, a billion-dollar airline that is a quarter of a 
century old, into the data. The numbers from this large and well-run 
established airline successfully masked some key data from the public 
view.
    When that long-established carrier was removed from the mix, two 
factors became immediately apparent. The first was that the ``savings'' 
were much less. But the second was more shocking: the ``safety'' claims 
made by the report were inaccurate and covered up important statistics 
that the public had a right to know. Indeed, after Southwest was culled 
out, the single largest new-entrant, ValuJet, clearly had an abominable 
safety record, contrary to the claims made by the DOT.
    Furthermore, in addition to the statistics, there was internal data 
also covered from public view. it has now come to light that this 
airline was so bad that prior to the issue of the ``Revolution'' 
report, an FAA inspector recommended that ValuJet be shut-down and 
undergo re-certification.\3\ (The inspector testified that he was 
ordered to bury his report. In May 1996, 110 people died because 
ValuJet employees were not trained properly in hazardous materials 
handling.) This ``Revolution'' report should be ample evidence that the 
Department of Transportation at best does not have the expertise to 
deal with the issue of airline competition, and at worst is subject to 
political intervention.
---------------------------------------------------------------------------
    \3\ This was discovered at the NTSB hearings subsequent to the 
ValuJet crash.
---------------------------------------------------------------------------
    Small community air service has dropped off in most cases because 
of economic realities, not deregulation. The real cause is evolving 
airline operating economics. Furthermore, many of the communities that 
are seeing service decline or eliminated are not losing access to air 
service, which in many cases is an hour or less drive away. And in many 
of these cases it is the consumer who has made the decision not to use 
the air service that the local airport can support.
    Proposed Senate Legislation to increase small community air service 
will fail. We have reviewed both Senate Bill 1331 and Bill 1353. The 
only real benefit is the suggestion to dump the perimeter rules at 
LaGuardia and Washington National. The rest of the contents of these 
Bills would be ineffective in their aims, and are woefully inconsistent 
with economic and operational realities of the airline industry. These 
two bills will not only fail to enhance either competition or small 
community air service, but they will--not may, but will--make matters 
worse.
    These Bills are reviewed below.
              a review of bills to ``improve'' competition
Well Meaning Legislation That Will Only Make Things Worse
    Two Bills have been developed in the U.S. Senate, both ostensibly 
designed to reverse the decline in air service at smaller airports.
    Opening just four airports--three of which are not hub-sites--to 
new entrants, even if successful, would not materially improve access 
the air transportation system.
    Both Senators involved with these Bills have good intentions. But 
the contents of the proposed legislation are way off the reality meter. 
They sound good. They have high sounding titles. They are touted as 
solutions to consumer malaise at smaller communities. But beneath this 
hype there is little substance. With due respect to the Senators 
involved, it is Bills like these that only make matters worse, because 
they distort the realities of air service to the consumer. And if 
passed, they will--not might, but will--hurt the consumer.
    These Bills have wonderfully-worded titles that any red-blooded 
American could support: Aviation Competition Enhancement Act of 1997, 
and the Air Service Improvement Act of 1997. Now, everyone is for more 
competition. And everyone wants to improve air service. But these Bills 
make assumptions that are wrong.
  --They assume that simply opening four airports to new entrants will 
        create both new air service and new competition;
  --They assume that there are new entrant carriers that want to place 
        scare resources into small markets;
  --One Bill assumes that loan guarantees on new airplanes will get 
        carriers to invest millions to serve communities where the 
        returns on such investment may be small or non-existent.
    However, the Bill introduced by Senator McCain does address the 
issue of the perimeter rule. That part is viable and positive. The rest 
of the contents of these Bills are essentially either non-effective or 
detrimental to enhancing air service.
    It assumes that just launching airplanes from small cities into 
four slot-controlled airports will instantly result in lots of 
passengers for the airlines involved.
    Let's look at each.
Senate Bill 1353--``Air Service Improvement Act of 1997''
    Introduced by Senator Frist of Tennessee, the Bill proposes
  --Airports ``not receiving sufficient service'' be given slots at 
        high density airports.
  --Loan guarantees for airlines who buy small jets to serve 
        ``underserved'' airports.
    Defining ``underserved'' will be a political football. All of this 
sounds nice, but not only will it not achieve the intended ends, but 
could actually hurt air service levels. Let's look at the specifics:
    The Bill focuses only on accessing ``high density'' airports. This 
means ORD, LGA, DCA, and JFK. This brings up several issues:
    The Bill assumes that flights to these four airports gives access 
to air service.--Nope. It would give only access to those four 
airports, three of which are not really connecting hubs. In the case of 
ORD, unless the airline involved is American or United (or one of their 
regional partners) such service from ``underserved'' airports would be 
merely to Chicago, with little or no connectivity to the hub systems of 
AA and UA. At the other three, service by Air Fred wouldn't do diddly, 
and in fact, there is no guarantee that the consumer would want to use 
an independent airline. Even if US Airways was the carrier, say to LGA 
or JFK, there would be little or no connectivity. For all those folks 
in Dickinson, ND who have a hankering to visit Queens, this Bill would 
be a godsend.
    There is limited traffic to these points from ``Underserved'' 
airports.--Service to JFK, LGA, and DCA--none of which are true 
connecting hub-sites--would only result in access to the specific 
cities of Washington and New York. It is questionable if an airline 
would want to apply scarce and expensive resources to serve very small 
markets into these major airports, when other opportunities can give 
them higher revenues. Slots at LaGuardia are nice, but there still must 
he enough traffic on the airplanes that use them.
    Airports that may need more competition into New York and 
Washington would not benefit.--Cities with high need for frequent 
service to New York, like Syracuse and Rochester, might even lose some 
access if slots at LGA are re-allocated for use at ``underserved'' 
points. (And there is no way that cities such as SYR or ROC would be 
declared by the DOT as ``underserved.'') So larger, more viable cities 
may lose out to smaller ones where traffic demand is much less.
    Higher fares could result at airports that lose access to these 
airports as a result of re-allocation. Loss of slots for use at SYR, 
ROC and some other airports would be further barriers to getting fare 
levels down.
    Where's the consensus on the term ``underserved?'' The process of 
determining what airports are ``underserved'' will be a political 
football of Super Bowl dimensions. Does that mean number of flights? 
Does it mean ``not enough jets'' or ``too many turboprops?'' Does it 
mean not enough airlines? Does it mean high fares? This will be a field 
day for paid consultants and politicians at cities that can barely 
support a 7-11, let alone jet service.
    And for an encore, the Bill has loan guarantees. These won't 
achieve the desired ends, either.
    The second part of the Bill--``Regional Air Service Incentive 
Program'' essentially proposes loan guarantees for airlines who 
purchase small jets and use them in ``underserved'' markets.''
    Are airlines going to apply $15 million assets to markets where 
traffic and revenue generation are non-co mpetitive. Loan guarantees 
cannot create traffic.
    Aside from trying to determine how these jets must be used 
(entirely in such markets? Ten hours a day? One flight a day?), we need 
to get some reality on aircraft economics. Let's think about this. 
Small jets will cost between $11 and $18 million. Payments on these 
machines would tend to run between $120,000 and $200,000 per month just 
to own or lease. Add operational costs of between $1,200 and $2,000 per 
hour--give or take--and some reality comes into the picture: These 
aircraft require a lot of revenue to be economically viable. They need 
passenger traffic at relatively high levels and--note this--at 
relatively high fares. Ownership costs are only one part of the cost 
mix. Revenue is another important part. Assuming that some loan 
guarantee will get airlines to operate multi-million dollar aircraft in 
markets where there is limited revenue is, to put it directly, 
nonsense.
    ``Underserved'' markets (if that is defined by low traffic 
generation) are by and large that way not because airlines have made 
them that way. It's because they generally have insufficient traffic to 
support higher traffic levels. ``Loan guarantees'' will not be 
sufficient to offset losses in markets that cannot support such 
service. And one point missed is that if the carrier has to fall back 
on that loan guarantee, it means that its credit rating will go right 
into the fixture.
    Conclusion: S. 1353 has great intentions. But it's naive and is not 
going to have a material effect on bringing air service to airports 
where traffic is no longer sufficient to support the relatively high 
costs of jet service. It focuses on access to four large airports, and 
not access to the air transportation network. Finally, ``loan 
guarantees'' are not a way of attracting jet service where there is 
insufficient traffic to support it.
Senate Bill S. 1331--Aviation Competition Enhancement Act of 1997
    The best part of this Bill is in removal of perimeter rules. Beyond 
that, it is based on assumptions that have little connection to 
reality.
    Introduced by Senator McCain of Arizona, the Bill has a wonderful 
but misleading title, but like the Frist Bill, is essentially inept. 
The Senator's office has claimed that its intent is not to re-regulate, 
but in fact it does just that, and not in a particularly efficient way.
    It is based again on the assumption that if slots at the four high 
density airports (ORD, LGA, JFK, DCA) are re-allocated, it will 
magically make massive improvements in air service at smaller 
communities and result in more competition. Incredibly, the Bill 
assumes this also for airports that today have no air service. Like, 
AA, UA, and other airlines simply would fly to airports where there is 
no traffic just to get LGA slots. This may make good theater, but it 
won't result in better air service.
    The Bill would require that slots at these airports be reallocated 
by first taking those that are unused, and then taking 10 percent of 
existing slots and auction them off for service that will be only to 
smaller deserving airports that meet some ``underserved'' criteria. On 
a time table no more frequent than every two years, 5 percent of the 
slots at these high density airports would again be re-allocated.
    The bill would direct the Secretary of Transportation to use safe 
guards (whatever that means) to promote increased competition to rural 
areas and to keep competitive rates (what ever that means.) Again, 
there is a credibility gap here: putting service into some of the 
nation's most expensive airports, from airports where there's hardly 
enough traffic to fill a 4-door Yugo, and then make sure that the fares 
are low.
    Bidders on these reallocated slots must be ``new entrants or 
limited incumbents.'' Again, it is assumed that there are ``new 
entrants'' (the Senator might want to check on this) and ``limited 
incumbents' that are interested in serving such communities. If it's a 
new entrant (what few they are), they need to fly in markets where they 
can generate strong revenue. Flying to communities with low traffic 
demand isn't going to make the payroll. And a ``limited incumbent'' at 
ORD would be one that would only access Chicago traffic. Ditto for 
almost any carrier at the other three airports.
    There are major side effects of this Bill:
    It would hurt the consumer.--By taking slots away from incumbents, 
and requiring that they be used only for service to smaller airports, 
it is highly likely that the net result will be worse access to these 
large airports, by using slots to serve fewer consumers.
    Re-allocation of slots will surely result in less access to smaller 
communities which today have connectivity to these four airports.
    It would cause a legitimate firestorm from other communities. It 
could cause major problems at other cities. For example, is Syracuse 
going to be happy if the result of this political grab bag reduces LGA 
or DCA service? Probably not.
    It would materially harm communities that depend on Chicago as a 
gateway. Ponder for a moment the fact that dozens of small and mid-size 
communities depend on AA and United service into Chicago as a gateway. 
Now consider the decisions facing these airlines when they are told to 
give up 10 percent of their slots (not to mention another 5 percent 
every two years.) When faced with loss of slots, what cities do you 
think the planners at the AA and UA systems would reduce service to? 
Miami or Moline? Los Angeles or Albany? It doesn't take an MBA degree 
to figure this out.
    The supporters of this Bill might counter that the recipients of 
these re-allocated slots would just replace service lost at MLI and 
ALB, and other airport victims of this Bill. That assumes that their 
are such airlines (which there are not) and that such service would 
offer the same connectivity to the rest of the world as the AA/UA 
service (which it would not.) Take this one to the bank: this Bill 
would result in worse overall air service, not better. Again, this is a 
proposal that is built around a type of airline industry that does not 
exist.
    It would reduce access to these high-density airports. For example, 
what if TWA loses some LGA slots, seeing them re-allocated to new 
entrants, assuming--dangerously--that there are any that want to 
operate to ``underserved'' airports. The proponents of this Bill would 
probably show their ignorance by saying that would be okay, and would 
result in more competition and better consumer access. Wrong again. 
What that means is that all those smaller communities that TWA feeds to 
LGA over its STL hub will be adversely affected. That's not what near-
failing airports dependent on TW for access to New York need. As an 
example, if Springfield, Illinois (whose major carrier is TW) loses 
some access to LGA, it could encourage more leakage to other airports 
in its region. What this Bill would do is help create ``underserved'' 
airports.
    It would not engender additional air service for the smaller 
airports affected. Access to New York, Chicago, and Washington is not 
necessarily a panacea to viable air service. Trying to force service to 
four airports from a lot of smaller ones may improve service to those 
four cities, but--especially in the case of LGA--it won't improve 
access to the rest of the air transportation system. This is no longer 
an interline system. If Air Fred gets slots to O'Hare, it will have 
very little connectivity to other airlines.
    Conclusion: The Bill sounds very consumer-friendly, but in the real 
world of airline economics it would have a detrimental effect on air 
service. The blind assumptions made in this Bill are (a) there are 
airlines interested in this stuff, and (b) there will be enough traffic 
to support such service. Neither of these points are not consistent 
with reality.
Legislating Air Service Won't Work
    What is really needed is to first gain some understanding about 
future airline industry dynamics. Then comes the hard part--facing 
those realities. One of these realities is that many airports are 
``underserved'' or not served at all because of economics and consumer 
preferences. Legislation can't change economics. And only brain surgery 
will change consumer preferences.
    Both of these Bills are based on inaccurate and/or outdated 
assumptions. Just access to ``high density'' airports is not 
necessarily an improvement, nor is it any guarantee of economic success 
for the carriers involved. To believe that just giving an airline slots 
at a high-density airport will magically create lots of traffic at a 
small airport is foolish. Worse, it takes energy away from facing the 
hard decisions that must be made at many smaller airports. For many, it 
will be to cooperate on a regional basis or lose all access to air 
service.
              suggested solutions to enhancing competition
    I believe that there is a problem with the competitive picture in 
the U.S. And, I believe that there are solutions more effective then 
the legislation suggested.
    I would strongly suggest the following actions--most of which are 
within the realm of Washington--to enhance competition.
    Eliminate the Wright Amendment at Love Field.--This will have an 
enormous effect particularly in east-west traffic flows. No, it won't 
turn Love into some giant juggernaut to which lots of airlines will 
flock. D/FW Airport is a much better access point to the Metroplex, 
simply because it accesses all of the region, including the fast-
growing I-35 corridor, which Love does not. But it will allow Southwest 
to flow passengers to more destinations over the airport. Midland/
Odessa, Little Rock, Corpus Christi, and a host of other cities will 
see airfares drop to distant destinations. And without getting into the 
specifics, Mr. Chairman, repealing the Wright Amendment won't torpedo 
D/FW. American's PR blitz opposing the repeal is laughable. If Mr. 
Crandall thinks that fights from Love to Cleveland will kill off 
American's D/FW-Peru service, it is time for him to take a much needed 
vacation.
    Eliminate the Perimeter Rule at Washington National and New York 
LaGuardia.--This has no real value except to restrict access to these 
important airports. Dulles Airport does not need protection any longer. 
And the LaGuardia restrictions are left over from the 1950's.
    Eliminate Slots at All Four High Density Airports.--Agreed, this 
tends to send the FAA into an episode, but it is time that the market 
made the decisions regarding how these airports are utilized. Airlines 
will adjust their schedules to accommodate the capacity at these 
airports. Furthermore, the value of O'Hare slots tend to make the 
hubbing airlines ignore smaller airports that depend upon American and 
United hubs there as gateways to the rest of the world.
    Move Rapidly Toward Free Flight Air Traffic Control.--Airline 
operating costs can be reduced by up to $5 billion annually if a true 
Free Flight system is implemented.\4\ The technology is there, and the 
system can be implemented within 5 years for less than $1 Billion. The 
FAA is dithering and is acting as a bureaucratic barrier, not a 
facilitator.
---------------------------------------------------------------------------
    \4\ Source: ``Free Flight--The Economic Impact,'' RMB Associates & 
ASRC, 1994.
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    Plan Airport Capacity Within The Context of Airline Economics.--
Airport costs are critical to competition. High airport costs drive 
competition away, and at the least make it expensive for airlines to 
operate.
    Despite the nonsense put out by the FAA, Denver's new airport has 
costs that are clearly detrimental to new competition. Forget the hype. 
Here are the competitive facts: In the three short years since it 
opened, five--count them, five--airlines have gone bankrupt trying to 
focus service at this new and expensive airport. Two of these were low-
fare airlines. Three others were regionals.\5\ Another low-fare 
airline--Reno--just moved its flights out of Denver because of the high 
costs. And no, Mr. Chairman, these costs are not offset by fewer 
delays. In 1996, Denver's new airport had a higher percentage of 
departures delayed than in the last year of the airport it replaced. As 
for small communities that can only support 19-seat aircraft, the 
burden is nearly obscene. The costs of departing this size aircraft at 
Denver International is over $300, which equates to over $30 per 
passenger with a typical 50 percent load factor.\6\
---------------------------------------------------------------------------
    \5\ MarkAir, Western Pacific were low fare carriers attempting to 
hub at Denver. Maverick, GPExpress/Continental, and Mountain Air 
Express filed bankruptcy.
    \6\ Source: United Express/Great Lakes.
---------------------------------------------------------------------------
    If the goal were to reduce competition, the way to do it is to have 
expensive airport facilities. Where airport costs are high, service and 
fares will be affected. Unfortunately, we have a number of such 
projects in the planning stages, including one in West Virginia and one 
in Northwest Arkansas. We need to spend scarce dollars on airport 
infrastructure where it is needed, not where special interests armed 
with integrity-short ``feasibility'' studies may want it.
                 start-up airlines and new competition
    For the purposes of this hearing, I think it is important that the 
members of the subcommittee get some background on the history of new 
entrant airlines since the advent of deregulation.
    We'd like to share with you the results of a study we completed in 
1996--back when ValuJet was flying high, worshipped by Wall Street. It 
revealed that regardless of the hype, new jet start-up airlines have 
never been much of a factor since deregulation. Note that this analysis 
was done well before the ValuJet crash, which is the event that the DOT 
claims ended the ``Revolution'' in start up airlines.
    Is there a role for new entrants. The success of Midwest Express, 
America West, and the experience with Frontier prove that there is. But 
it also proves that the airline industry is one that has limited room 
for such carriers.
The Impact Of Start-Ups
    There has been a great deal of confusion regarding the effects that 
start-up airlines have had upon the air transportation system in 
general and upon the consumer in particular. Simply stated, start-up 
airlines have not had, and most likely will not have, a significant 
effect upon the U.S. air transportation system.
    The fact is, of all the new carriers between 1978 and 1992 that 
attempted to break into large scale scheduled airline service, only 
two--count them, two--survive today. One is America West, which 
detoured through Chapter 11 to get here, and the other is Midwest 
Express, which never was a low fare airline. Over 40 start-up passenger 
carriers have failed since 1978.
    Since 1993 only one has clearly broken into the success column--
Reno Air. Other than Reno, Frontier and Air Tran Airways (the latter of 
which was acquired by ValuJet) have what might be a viable niche 
strategy. ValuJet--now renamed AirTran Airlines--might have a chance 
with its new name.
    There are a lot of reasons for this situation, and it varies in 
each case. But the fact is that most have gone to venture capital 
heaven. In a few cases, there has been what can only be described as 
predatory actions on the part of existing airlines. But in most cases, 
the proximate cause of start-up failure is the fact that the carriers 
had no business being in business, i.e., bad management. We could go 
into the silly stories of Air South. Or of Prestige. Or JetTrain. Or 
Western Pacific. Or Pan Am. Bad management, poor planning, and dimbulb 
business plans killed off most of these airlines.
Start-Up Airlines They've died for a reason.
    Let's cover some realities of the airline business.
    Understanding One: Start-ups cannot take on established mega-
carriers.--There are a limited number of markets where a new jet 
carrier can compete successfully on a large scale with established 
airlines like American, United, Southwest, Delta, etc. This doesn't 
mean that such entrenched competition is (necessarily) unfair. It means 
that in the best of circumstances, it takes a lot of money to compete 
with established operators.
    We could get into the specifics of this, but the last ten years 
proves it, as did Western Pacific's recent failure at Denver. It 
doesn't take ``predatory'' competition, either. Breaking into a new 
market with a new name is very expensive, and it is logical for 
existing carriers to match fares. From that point, there is no 
guarantee that consumers will use the new airline.
    Understanding Two: Start-ups are most ``successful'' in price-
sensitive, high-density markets.--Florida markets are typical, but even 
here, it has been proven to be a graveyard for start-ups. The concept 
of Senate legislation to have these carriers fly in small 
``underserved'' markets is fantasy.
    Understanding Three: A demonstrable and defendable niche is 
critical.--Just having low fares is not enough. AirTran Airways has a 
niche--low frequency service from smaller cities to Orlando. Frontier 
has a niche in scheduling low frequency in key markets from Denver, 
making it a small (but not invisible) target for major carriers. 
Another ``niche'' developed by Frontier is something lacking at many 
start-ups--service that makes the consumer want to come back.
    Understanding Four: There is but one Southwest.--The chances of 
becoming ``another Southwest'' are very slim. Too many analysts and 
journalists lump Southwest into the start-up category. The reality is 
that Southwest is old enough to vote, and is a billion-dollar company.
    What most of these people miss is the reason for Southwest's 
success. It is not because of low costs or low fares. If these were the 
main ingredients for success, we'd all be flying Air South, Prestige, 
JetTrain, Florida Express and Air21. (Which, unless one has access to 
the nether world, we're not.) Instead, the success of Southwest is due 
to something that most start-ups have failed to produce: excellence in 
customer service. On-time flights, dependability, and employees who 
view passengers as more than just interruptions of their day.
    Understanding Five: Failure of start-ups in most cases has not been 
due to unfair competition from major airlines.--The main reason is that 
they fly places where they simply cannot gain enough consumer support 
for their service. Period. True, there are some exceptions. United in 
Denver has been hitting Frontier below the belt, flooding markets with 
capacity, and in some cases bringing in lower paid staff (aka United 
Shuttle) to compete, among other things. But again, this is the 
exception.
    Understanding Six: A lot of start-ups sell their product well below 
their costs.--One key example: ValuJet had no real case in claiming 
Delta competes unfairly, because it's ValuJet that's been selling its 
product under cost, not Delta. WestPac, ditto. It was selling transcon 
tickets for $99 bucks--that's about half of what their costs were. This 
is because the only way many start-ups can get passengers is by 
offering fares that don't cover costs.
    Understanding Seven: Most start-ups are their own worst enemy by 
offering shoddy service.--Air South killed itself by not having a 
schedule strategy that lasted longer than a rerun of Wild Kingdom. 
MarkAir raised bad service to an art form. Air21 had schedule 
dependability similar to lottery odds. JetTrain tried to operate with 
just one airplane. One bird strike, or a snowstorm at Newark, and the 
airline was out of business. And these are just for starters.
    Understanding Eight: Return on Investment is Terrible.--In 1997, 
one of the most profitable years, major airlines barely made a 5 
percent profit margin. For start-ups it takes a lot of capital to get 
to the point where they can earn these low margins. Yes ValuJet was an 
exception. But it also saved money by not maintaining its aircraft 
properly, not training its employees, and paying them wages that would 
embarrass a Third World bus company.
                  a not so short history of start-ups
Start-ups Prior To 1993
    After thousands of years, mankind has learned that there are two 
ways to ensure near-certain financial disaster. The first is to write 
an insulting letter to the IRS. The second is to start an airline.
    There are very few industries that can eat money faster with lower 
potential returns than the airline business. First, it is of value to 
look at the track record of carriers which began operations between 
1978 and 1992. It is not encouraging.
    There were several dozen planned jet start-up airlines during this 
period. However, of the start-ups that actually attempted primarily 
scheduled service, there were approximately 30 start-up jet carriers 
that were established prior to the end of 1992:

Air Atlanta
Air One
Air Niagara
American International
America West *
Best 7
Braniff ``III''
Discovery Airlines
Jet America
Hawaii Express
Kiwi *
MarkAir
MGM Grand
McClain Air
Midway ``I''
Midway ``II'' *
Morris Air
Midwest Express *
Muse Air
Northeastern International
New York Air
Pacific Express
PeoplExpress
Presidential
Pride Air
Regent Air
Reno *
Sunworld
USAfrica
UltrAir

    Of these carriers, all but five (those with an *) are gone, in most 
instances taking enormous amounts of investors' and consumers' money 
with them.
    Of those still operating only two are now consistently profitable. 
Even here, one of the two--America West--had to undergo Chapter 11 
bankruptcy reorganization, causing investors and employee stock holders 
to lose millions. It is clear from this track record that there has not 
been a market need for a large number of new airlines.
    The experience of these airlines is clear: over nearly 15 years, it 
has been shown that there is not a huge need for new jet carriers. 
Furthermore, it also shows that low-costs are not a stand-alone success 
formula.
    To be sure, there have been a few successes, and there are some 
opportunities that still exist for new jet carriers. Without doubt, a 
few are likely to be very successful. But as the track record since 
1978 indicates, these carriers will not become major factors in the 
U.S. air transportation system.
Selected Carrier Histories
    Each of the carriers noted above had a ``story''--one that in many 
cases some financial analysts strongly supported in order to sell 
stock. But the fact is that all but six of them failed, and of the 
survivors, only one--Midwest Express--has been consistently healthy. It 
is not without significance that this airline steadfastly has avoided 
rapid expansion, and even today accounts for only 25 percent of the 
traffic at its home base airport, Milwaukee. And it is again noted that 
Midwest Express is not a low-cost carrier.
    Looking at brief histories of some of the above airlines is highly 
informative. Of the failed carriers, one common thread can be found: 
they failed because the market need--i.e., passenger traffic--was 
simply not there. Regardless of how low their costs were, they could 
not generate enough revenue to stay alive. By and large, this situation 
still exists.
    Air Atlanta.--Established 1984. The carrier offered very high 
levels of amenities, seeking to compete with Delta and Eastern at ATL. 
Like a moose charging a locomotive. Daring, but dumb. No predation 
here--Air Atlanta was not a low-fare carrier.
    Air One.--Established 1982. The intent was to capture traffic from 
TWA at St. Louis by offering all first class service with 727's. It 
failed in 1984 because it could not win enough traffic away from ``high 
labor cost'' TWA.
    Air Niagara.--Established 1982, the carrier attempted to provide 
service between Niagara Falls and Newark. Not exactly two of the 
world's great destinations. Honeymooners quit going to Niagara Falls 
before Ralph Cramden drove a bus. Despite low costs, the airline was 
unable to generate sufficient business at Niagara Falls. The traffic 
simply did not exist. After 1983, neither did Air Niagara.
    American International.--Established scheduled services in 1982, 
with a hub at Atlantic City, and later at Philadelphia. Low cost (and 
real low class) services were intended to compete directly with high-
cost USAir. American International was a darling of Wall Street, which 
promoted its stock heavily in a 1983 public offering that provided $20 
million in capital. Sheer mis-management and inability to maintain a 
schedule pattern for more than a week finally killed off the carrier a 
year later. The chairman did have a nice limo, though, and did a nice 
job of lavishing money on refurbing his office.
    America West.--Established in 1982. As a low-fare, low-cost, non-
union 737 carrier, America West had some initial success as the 
dominant carrier at Phoenix. Employees were required to purchase stock 
in the company. America West over expanded, added 747's and service to 
Nagoya, Japan. (?) During this time, It encountered growing competition 
from Southwest expanding at Phoenix. Filed for bankruptcy in 1992. It 
emerged from Chapter 11, and is today profitable.
    Braniff III.--Established in 1990, Braniff III had no corporate 
ties with the prior airlines of the same name. An airline that 
redefined sleaze management, some of which are now convicted felons. It 
attempted low-cost service from a number of cities. Ran out of cash and 
shut down after pre-selling millions of dollars in tickets prior to 
July 4th week-end in 1992, stranding and defrauding thousands of 
consumers.
    Discovery Airlines.--This airline was planned to be a third intra-
Hawaiian carrier, offering a low cost jet alternative to Hawaiian and 
Aloha. It received support from British Aerospace, which was to supply 
a fleet of BAe-146 jets to the airline. Was shut down by the DOT when 
they found out that the carrier's real owner was some guy in Taipei.
    Jet America.--Established in 1980. Provided service from noise-
sensitive Long Beach to DFW, ORD, and STL, using MD-80's, which major 
carriers did not yet operate. This very limited niche was invaded when 
American obtained MD-80's. Despite Jet America's lower labor costs, the 
carrier simply could not find enough niche markets, and ultimately was 
merged into Alaska Airlines.
    Kiwi.--This 727 operator established operations at Newark in 1993. 
Gained notoriety for providing good customer service and extra leg 
room. Despite low costs, it has found that competing against 
established airlines at Newark is very difficult. At one point signed a 
financing deal with a Romanian aircraft manufacturer. Later, constant 
management shake-ups literally left confusion regarding who was running 
the company. Has not been consistently profitable, in part due to 1996 
Gestapo-like treatment by an FAA eager to shut something down after its 
cover up of ValuJet's problems. Currently operating but future is very 
unsure.
    MarkAir.--An outgrowth of a pre-deregulation airline, MarkAir 
expanded within Alaska relatively successfully with a fleet of 737's, 
using the code of Alaska Airlines. In early 1990's, the carrier ended 
its code share agreement and began to compete directly with Alaska 
Airlines. It slashed fares to gain market share, and ultimately went 
into Chapter 11. It eventually emerged in 1994, but promptly began to 
break payment plans to creditors that were made with the bankruptcy 
court. Attempted to expand into lower 48 with a ``hub'' at Denver, but 
high costs there and really bad service killed it. When it finally shut 
down in 1995, it left a huge number of large creditors including 
economic development agencies in Alaska, which had loaned the airline 
money in exchange for ``creating jobs''.
    MGM Grand Air.--MGM Grand attempted ultra first class service 
between New York and LAX, using 34-seat 727-100's. Had neat stuff on 
board including stand-up bar, and secretarial staff. Trouble was that 
it needed to fill all 34 chairs with high rollers. Later tried service 
with mixed first and coach service. Both programs failed. Carrier 
assets sold off to a freight operator in 1994.
    McClain Air.--After a long period of gestation, attempted service 
from ORD in 1984, claiming that it would need only a small share of 
traffic from AA and United to survive. Operated for a very short time 
before being shut down for lack of cash.
    Midway ``I''.--Established low-fare service at Chicago/Midway in 
1979. The carrier was limited in that at Midway Airport it could not 
gain a sufficient share of the local Chicago market from American and 
United. Furthermore, it was unable to compete for connecting traffic 
through Chicago. It then tried to become an all-business class airline. 
Subsequent to that, Midway attempted to interest American in a merger. 
It tried to expand with a hub at Philadelphia, taking over aircraft and 
facilities from Eastern. There, traffic didn't materialize. Finally, it 
tried last minute merger with Northwest. Filed bankruptcy and ceased 
service in 1992.
    Midway ``II''.--Attempting to repeat the ``success'' of the earlier 
carrier of the same name, Midway ``II'' could only lease a limited 
number of gates at MDW, and competition with Southwest doomed the low-
cost carrier's Chicago operations. In 1994, made decision to move to 
Raleigh/Durham, in concert with American Airlines' pulldown there. In 
1997 re-equipped its fleet by downsizing to 50-seat jets. Today, a good 
chance of survival.
    Midwest Express.--For airports seeking additional airlines, there 
are two home runs. One is getting Southwest. The other is getting 
Midwest Express. Established in 1984, Midwest Express built a small 
hubbing operation at Milwaukee, focusing on all first class service. 
With support of parent company, Kimberly-Clark, the airline expanded 
very slowly, and has been profitable. This airline has survived with 
ASM costs that are 75 percent higher than those at Southwest. In 1995, 
was spun off by the parent, but with same management in place. It is 
highly likely that Midwest Express will be one of the few long-term 
players. Has built business on basis of excellence in customer service.
    Muse Air.--Muse Air was started in 1982 essentially as a ``grudge'' 
airline by the ousted founder of Southwest. Was going to teach the 
ingrates at Southwest a lesson. Unfortunately, Muse Air failed the 
course. The program failed miserably and Muse was eventually taken over 
by Southwest in 1986-1987. It operated for a time as TranStar, before 
being shut down completely.
    Northeastern International.--A low-fare, low-cost, airline 
established in 1981 initially to carry traffic to Florida from airports 
peripheral to the New York metro area. Expanded rapidly in all 
directions adding widebodies. Undercapitalized and on the edge 
financially, it ceased service in 1985.
    New York Air.--A product of Frank Lorenzo and Texas Air, NYA began 
service in 1980 as a direct competitor to the Eastern Shuttle in the 
NYC-BOS/WAS markets. Failed at attempts at building hub operations at 
IAD and RDU. Assets were merged into Continental in 1986.
    Pacific Express.--Pacific Express attempted low-fare service on the 
West Coast, starting in 1981. Received support from British Aerospace 
in exchange for ordering BAe-146 jets, which it never got. It could be 
argued that United drove Pacific Express out of its markets and into 
bankruptcy in 1984. One possible case of predatory activities, but it's 
ancient history now.
    PeoplExpress.--In the early to mid-1980's, this airline was revered 
on Wall Street. Its growth and ``unique'' employee culture made 
PeoplExpress a favorite among airline analysts and investment houses. 
Employees were all ``managers'' and were required to buy stock, with 
the company loaning them the money on a payroll-deduction basis. This, 
analysts reasoned, would make employees more ``loyal''. (Read: keep 
them non-union.)
    Founded in 1981, the carrier originally was a 737 operator flying 
under-served markets from Newark. Initial success led the carrier to 
expand rapidly. Its huge ``profits'' fueled acquisitions that made no 
business sense at all. It purchased a large commuter in the Midwest, 
Brit Air. This airline had good feed into ORD, but PeoplExpress had 
very little presence there. It also bought a large bankrupt commuter in 
Florida--another investment that gave PeoplExpress no synergies. But 
these did give the stock brokers an exciting story to tell unwary 
investors.
    It purchased the original Frontier Airlines and within a year had 
it heading into bankruptcy. With 747's flying routes like Newark--
London, and Brussels--Los Angeles, the carrier impressed financial 
analysts but was running itself into the ground.
    In 1986-1987, financial realities set in, and PeoplExpress began to 
very quickly implode. It was acquired by Frank Lorenzo's Continental 
Airlines.
    Presidential.--Founded by a another former partner of Frank 
Lorenzo. (This guy had more clones than the Stepford Wives.) 
Presidential attempted a hub at Washington/Dulles. It depended on the 
same template as many other start-ups, i.e., low fares intended to 
generate high revenues. Tried 737-200's and BAe-146's on a variety of 
routes. Matter of fact, it took a scorecard to figure out this carrier. 
Changed fleets. Bought a commuter partner. Became a Continental code-
sharer. Then became a United code-sharer. Went to airline heaven in 
1989.
    Pride Air.--Founded in 1984 by a group of former Continental 
pilots, Pride Air operated 727's between Florida and western 
destinations, with headquarters at New Orleans. Had no success in 
breaking into traffic carried by major carriers, and shut down in 1986.
    Regent Air.--Tried ultra first class service with 34-seat 727's 
(these same aircraft were later taken over by MGM Grand Air, with 
similar results). Could not compete on transcon routes with first class 
service offered by American, United, and TWA.
    Reno Air.--Originally planned to have a hub at Reno, the carrier 
has had several major route re-alignments since beginning service in 
1992. Only start-up since that time that is now fundamentally 
profitable.
    Sunworld.--Started at Las Vegas in 1980, the airline was owned by a 
bus company on the East Coast. Low costs and low fares allowed the 
airline to compete on initial routes with DC-9's. In 1984, acquired 
737-300's, and expanded into the Midwest from Las Vegas. Poor traffic, 
low fare yields, and expansion at LAS by other low-fare carriers (not 
majors) had Sunworld heading out of business by 1988.
    UltrAir.--Intended as an all-first class airline serving New York 
and Los Angeles from Houston, UltrAir began service in 1991. Competing 
directly against Continental resulted in very poor passenger loads. Its 
basic product was confused by a high-priced ``premium'' cabin, and a 5-
abreast ``first class'' cabin on the carrier's fleet of 727's. Ceased 
operations in 1993. It briefly re-surfaced as a high-density, low-cost 
carrier between Newark and Florida. Ceased service in 1994.
More Recent Start-ups
    We can look at some other passenger start-ups that have been 
established in the last three years. The picture is not encouraging.

Air South
AirTran
Frontier ``II''
Spirit
Vanguard
ValuJet
Western Pacific

    On a long-term basis, only two of the above, Frontier and AirTran, 
appear to have a strong chance of survival. Three--Western Pacific, Air 
South, and Pan Am are already dead.
    Air South.--Air South, instead of being a response to a market 
need, was first formed as an airline, and then its founders looked 
around to find someplace that needed it. Civic hubris in South Carolina 
resulted in a $17 million financing commitment by the state in exchange 
for the airline basing itself at Columbia. Ran through money like 
Sherman through Georgia. The results were predictable. It's now gone, 
along with the State's money and about $30 million more.
    AirTran/ValuJet.--AirTran was a small airline with a small niche. 
Focused only on service to Orlando with single daily flights from 
secondary cities such as Albany, Richmond, and Syracuse. Was purchased 
by ValuJet, which acquired the name. Combined entity has some chance of 
profitability.
    Frontier ``II''.--Frontier ``II'' has now re-focused on low-
frequency service between Denver and large population centers such as 
Los Angeles and Phoenix. A strategy along with good service that should 
provide a reasonable niche and a strong future.
    Spirit.--A small DC-9 operator attempting to provide service from 
Detroit/Metro. Going head-on with hubbing carrier Northwest will be 
very difficult. NW typically matches fares with invading start-ups. The 
potential for long term success--unknown.
    Vanguard.--Established at Kansas City in 1994, Vanguard has revised 
its route system repeatedly, looking for markets where it can make 
money. In 1995, Vanguard had an initial stock offering that provided 
the airline approximately $14 million. However, much of this was needed 
to pay overdue bills and fund aircraft maintenance reserves. The 
prognosis is that low-cost Vanguard is an airline eating cash while it 
looks for a reason to be in business.
    Western Pacific.--Had a niche at Colorado Springs. Its board wanted 
faster results, and hired a messiah management team to part the 
financial seas. Instead they just raised the water table. Tried head-on 
competition with United at Denver. Lost $80 million in 1997. Say Good-
bye.
    Pan Am.--No connection with the earlier airline of the same name, 
the airline attempted service with widebody aircraft, intending to 
connect with second tier international airlines at JFK and MIA. 
Physically and economically, the plan had no chance of working. Lost 
millions. Bankrupt in February 1998.

                       STATEMENT OF SENATOR REID

    Senator Shelby. Thank you.
    Senator Reid, do you have an opening statement?
    Senator Reid. I do, Mr. Chairman. I will ask permission to 
make that part of the record.
    Senator Shelby. Without objection, so ordered.
    Senator Reid. I would also say I hope Crandall takes a 
vacation to Las Vegas.
    Senator Shelby. Thank you. [Laughter.]
    And brings money. We do not have that and Mississippi is 
not here today, right.
    Initially, Mr. Boyd, I want to compliment you and others on 
your testimony in particular for noting that one way to reduce 
airline operating cost is to move forward, not backward toward 
a free-flight air traffic system. I share your view that there 
are investments that we can make and that will make the entire 
system more efficient and which will translate into lower 
operating cost, increased capacity and ultimately lower fares 
for the American traveling public.
    I am not sure that I share the FAA's vision of free flight 
or that they have even fully articulated it yet, but I am 
convinced that at least a portion of the answer to maintaining 
a competitive aviation environment is to enhance the 
efficiencies of the air traffic control system.
    Now, would you comment, Mr. Boyd, on the problems that 
Frontier and Spirit have faced and whether you view the source 
of their difficulties as predatory or anticompetitive actions 
by network airlines?
    Mr. Boyd. OK. Is that somebody's pacemaker going off I 
hope?
    Actually, we have done a study of startup airlines. We are 
probably the only people that have. We have looked at virtually 
every one. The reality is, like Professor Dempsey said, the 
majority have gone out of business at their own hand. Dembold 
plans, bad marketing, bad ideas, terrible air service. But 
there are exceptions to that. Frontier is one, I believe. I am 
not familiar with the Spirit situation. I do know Frontier in 
Denver, it is very obvious what has happened in Denver.
    It is one thing, I have been with the airlines, when a 
competitor comes in you match the fare. That is good, there is 
nothing wrong with that. But when you only flood the markets 
that your competitor is in with fares, like that lucrative 
Omaha-Denver market gets suddenly wide-body airplanes, I think 
we have an indication. Then when we have a situation where that 
same carrier goes to major companies and says, ``We will give 
you a deal on fares, but do not fly somebody else,'' I think 
that is a problem.
    Then the third part of it is bringing in lower-paid 
employees, a/k/a the United Shuttle, to compete in markets just 
where Frontier is, I think there is more than a prima facie 
case that United Airlines probably has stepped over the line.
    Let me say that we have advised major carriers on how to 
deal with startups. My example or my advice has always been, 
Mr. Chairman, to these major carriers, ``Let them go. They will 
go out of business on their own. They are their own worst 
enemy.'' I told Delta that, ``Don't worry about ValuJet, it's a 
bottle rocket.''
    I did not know that was prophetic at the time, but is what 
has happened. The fact of the matter is I thought they would 
collapse under their own financial weight. They may have 
anyway. These startup carriers are not a real threat to major 
carriers. I think the paranoia was there at United Airlines for 
sure.
    Senator Shelby. Mr. Dempsey, in your view how do the 
network airlines compete with the new entrant airlines, and do 
the network airlines compete with each other the same way that 
they compete with new entrant airlines?
    Mr. Dempsey. Well, in answering your later question first, 
they do not.
    Senator Shelby. OK.
    Mr. Dempsey. We have taken a look at major carriers in 
terms of how they respond to other major carriers entering 
their market, both in terms of capacity and in terms of 
pricing, and we found some very interesting things.
    Delta, let's say, enters a market where Northwest is 
competing and the DOT historical data will reveal that 
Northwest will maintain its capacity levels about where they 
were as Delta ramps up into the market, OK, with pricing. Delta 
would come in with a low fair in order to ramp up the market 
and fill some seats. Northwest would maintain its fairs pretty 
much where they were until Delta met those fairs and the two 
carriers lived in peaceful coexistence.
    Then we looked at what happens when Southwest enters a 
major airline market. Southwest comes in with capacity. How 
does the incumbent airline respond, the major airline? The 
answer is they do not tend to add lots of new seats and new 
flights; OK.
    What about pricing? Southwest comes in with a new price. 
Now, there have been exceptions to this. There has been pricing 
competition in places like Baltimore and on the west coast, but 
in many, many markets what we see is Southwest coming into the 
market with a very low price and the incumbent carrier 
maintains its price where it was; OK.
    Now, what happens when a carrier like Spirit or Frontier 
comes into a market that is dominated by a major airline? We 
see radically different behavior. What we see is the major 
carrier drops--no, adds capacity to the market. When Frontier 
made the unfortunate decision to announce its second 
consecutive quarterly profit, United Airlines added 8,600 seats 
a week in the Denver-Los Angeles market summer over summer, 
year over year. We see an increase in capacity when a post-1990 
low-fare entrant enters the market.
    What about pricing? Well, what we see is the major carriers 
tend to drop their price down to the new low-fare entrant's 
price, and that is an average fare, OK, the average fare data 
of the Department of Transportation which includes a first-
class component, which the new entrant airlines typically do 
not have. They are engaging in below-cost pricing, and they 
maintain those levels of lock-step pricing until the low-fare 
entrant exits the market and then they raise prices up 
typically to levels that are higher than they were before the 
new entrant entered.
    Now, why does the major carrier respond one way when a 
major airline enters its market, the same way when Southwest 
enters its market, but a radically different way when a low-
fare, post-1990's carrier enters the market? I think the answer 
is that they perceive that the new up-start airlines are less 
capitalized and have a lower pain threshold and they can be 
driven from the market.
    You know, it is a question of whether or not you can engage 
into a bleeding contest with the American Red Cross. Any of us 
would lose that contest very quickly. As for the other network 
advantages, one need only look in telecommunications. If we had 
the same regime in telecommunications that we have in air 
transportation, Bell South would determine that you, Senator, 
would only be allowed to connect with MCI; and if you wanted 
AT&T or Sprint, you could not have it.
    Senator Shelby. Mr. Kahan, do you have any comments?
    Mr. Kahan. Only that as an executive of a smaller airline 
it is part of my job and my colleagues to understand that large 
carriers may react aggressively, and that is their right, when 
we go into their rights. We have our own strategies for dealing 
with that.
    In particular, we go in with very, very low capacity. We 
are looking to offer low fares to a segment of the marketplace 
that wants low fares. We try to set things up so that it is 
highly irrational for the large carriers to drop nuclear bombs 
on us, unless their sole objective is to put us out of the 
market entirely. In my testimony, I talk about that.
    Senator Shelby. As far as lack of access to gates, Mr. 
Kahan, would you please recount how a lack of access to 
underutilized gates presents operational and financial barriers 
to carriers such as yours and other small airlines?
    Mr. Kahan. Senator, we are in a deplorable situation at 
Detroit, our home base. We enplaned 20,000 passengers in 
December without a gate. We have to go from one carrier to the 
next finding out when they might have some spare space on their 
gates so that we can operate. We are in a catch-22 situation.
    Senator Shelby. Why? Why do you have to do that?
    Mr. Kahan. We have to do that because the monopoly carrier 
at the airport has 85 percent of the gates. To my amazement and 
to my sorrow over the last 18 months as 6 new gates were being 
built at the airport with PFC funds, they all went to the 
monopoly carrier. Because we did not have any gates and we were 
not the signatory carrier, we did not even get noticed under 
the FAA regulations that that plan was afoot.
    I do not have that in my testimony. Sir, I uncovered it as 
I was preparing for the hearing today. I, frankly, am going to 
take that up with the FAA. It is just outrageous that we cannot 
get any gates----
    Senator Shelby. We will help you take it up.
    Mr. Kahan. Thank you, sir.
    Senator Shelby. Senator Lautenberg.
    Senator Lautenberg. Thanks, Mr. Chairman.
    One of the things that puzzles me is whether or not pricing 
below cost is exclusively a tool of the majors. Because when we 
see new entrants come in, they will come in with absurdly low 
fares and break into a new market. When airlines drop their 
prices below their costs, is there an automatic assumption that 
that is predatory pricing, or is it a tactic that is commonly 
used to boost traffic?
    Mr. Boyd. I think it is common. Airlines do that all the 
time. Major airlines have done it from time to time. As I put 
in my testimony, startup airlines have done this as well. I 
mean, when West Pacific came into Denver, they just slashed 
fares well below their cost. That is why they are not in 
business today. Pricing alone I do not think is a yardstick of 
predatory behavior, it has to be attached to something else 
usually, and it is usually is.
    Senator Lautenberg. Dr. Dempsey.
    Mr. Dempsey. Senator, every carrier when it enters the 
market or virtually every carrier when it enters the market is 
going to ramp up the market. It starts out with a zero load 
factor and it is going to have a lot of available capacity 
there until consumers are acquainted with the new operations. 
It is quite common for any carrier to open the market with 
below-cost pricing for a period of time and to gradually step 
its prices up over time.
    The question, the Justice Department has addressed this and 
they said, ``Well, for us to believe that it is predatory, we 
want to see it in conjunction with some other activity like, 
for example, lots of new seats or lots of new flights or some 
other anticompetitive activity to suggest that more is going on 
than just meeting the fare of the new entrant. At least in our 
markets, what we have seen is that the pricing behavior of the 
United Airlines changed profoundly only after Frontier 
announced it was profitable.
    Senator Lautenberg. Do you have any comment, Mr. Kahan, on 
that?
    Mr. Kahan. Only, sir, that to some degree New Jersey is the 
beneficiary of some of the carriers' predatory tactics. As you 
may know, we have put a large part of our operation in Atlantic 
City, sir. We are offering low-fare service out of Atlantic 
City. I think if you take a look at what happened in the 
Detroit-Philadelphia market, which we went into in December 
1995, you can see very clearly what happened.
    It was not in the interest of the big carriers, USAir or 
Northwest--Northwest being the dominant carrier--to immediately 
lower their fares. It would be crazy. They would lose millions 
of dollars a month by doing so, because we had such a small 
amount of capacity in the market. Just 87 seats to begin with.
    Our fares covered our cost. We were very happy with that 
market. I guess we got too uppity because in the third quarter 
of 1996 Northwest determined that they were going to train all 
of their guns on us, and you can see it in Chart 2 of my 
testimony, how they went from a situation where there had been 
140,000 seats per quarter in the market, for several years it 
was a very stable market, they went in one quarter from 140,000 
to 190,000 seats. In a quarter, 50,000 seats was about 5 times 
more than the seats that we had put in the market.
    Sir, there is nothing we can do when that happens. It is 
the combination, a combination of very, very low pricing 
together with such dramatic increases in capacity that the new 
traffic stimulator is all soaked up by the big carrier. That is 
the problem. It is a common tactic, and it is something which I 
hope the Department of Justice will be looking at in their 
current investigation.
    Senator Lautenberg. Pricing is only one part of the 
configuration of things. Because if you add seats and do not 
fill those seats right away, I assume if an airline wants a 
better chunk of the market, that they are willing to add seats 
even if they do not fill those seats just to be able to provide 
more service? Is that a fair----
    Mr. Dempsey. I think, yes; to get back to the Detroit-
Philadelphia market, we had one flight eastbound in the 
morning, at about 7:30 in the morning. I think it would be 
normal aggressive competition for Northwest to match our price 
on the flights right around our flight; OK. That is fine, that 
is fine. What the problem is if they offer the price on all of 
the flights and they add 50 percent more capacity to the 
market, a combination of the two that makes it impossible for 
us to compete. I would never as an airline executive or as an 
antitrust analyst just look at pricing in isolation. It is a 
complicated subject and we do have to be careful.
    Senator Lautenberg. What do you think we ought to try to do 
in Government to level out the field? You have got slot 
controls in some places. Most of them are spoken for. They add 
seats or add service. That can be considered a predatory 
practice. Fares below cost, a predatory practice.
    At what point do we get to either Government interference 
or forcing what might be a freer market, which I think is OK. I 
mean, I would love to see competition wherever it goes. I 
noticed one thing. When the new entrants come in, usually the 
service is pleasanter, seating capacity is a little more 
generous or prices are lower. I mean, there are inducements 
that follow a new entrant's position in the market. What can we 
do, Mr. Boyd, without overlaying the hand of Government and, in 
effect, reregulating the industry?
    Mr. Boyd. Senator, I think it is not what you do, it is 
what you take away. Like I said, the Wright amendment, now that 
is not going to change the world but doing away with the Wright 
amendment in Love Field would open up some fare discipline east 
and west and in other markets. You take that, the hand of 
Government, away.
    The high-density rule at some airports does not make any 
sense. I believe the high-density rule at O'Hare hurts smaller 
communities. Getting rid of that and working to get rid of that 
would be something. The issue of airport capacity, adding it 
where it is needed and making sure people can use it. I mean, 
building more gates at Detroit and giving it to the incumbent 
carrier does not encourage new competition, so maybe the 
application of PFC's. I think in the near term it is what 
Government can do to take away existing regulation, that will 
work, rather than new regulation.
    Mr. Kahan. Senator, could I just add? I think there are two 
separate problems. There is a small community problem and there 
is the problem of price competition at hub airports.
    Senator Lautenberg. We are discussing the voting situation. 
That is what the alarm was. It says,'' Fly down here and do 
your voting before we get a bad report card.'' What I am going 
to do is temporarily--that is to remind me to get to the floor. 
What I am going to do is temporarily adjourn. If you will, hold 
your place. It will take us about 5 to 10 minutes to turn 
around and we would like to continue at the chairman's 
disposal.
    [A brief recess was taken.]
    Senator Shelby. We are back in order. We apologize. I will 
on behalf of my colleagues and myself. We had two back-to-back 
votes on the floor of the Senate. We have to do those things, I 
hope you understand. It does disrupt hearings, though.
    Mr. Boyd, price competition by the network airlines among 
themselves and with a few entrants is not new. Is it realistic 
to expect that any carrier would not match the lowest fares 
offered in any market that they intend to serve; and in your 
view, what distinguishes additional aggressive price 
competition from pricing action that you would characterize as 
predatory? In other words, it is my understanding, it has been 
always, that predatory pricing was illegal basically. Is that 
correct?
    Mr. Boyd. I am not a lawyer; I assume so.
    Senator Shelby. I thought it was. I am not an expert on it. 
Go ahead.
    Mr. Boyd. Well, typically we have a competitor that comes 
in with a lower fare and you will match that fare.
    Senator Shelby. Absolutely.
    Mr. Boyd. That is not a problem. But when you have a 
competitor, let us just say it is a small airline, and I have 
been with one of these, where the competition decides that, 
``Wait a minute, this airline is on the ropes financially. A 
bird strike or an engine change could put them out of business, 
so let's just keep lowering the fare on our own.''
    When they match the new entrant's fare, that is OK. But 
when they lower it below that, that is when you have a problem. 
Or, when you do it through the back door by flooding the market 
with seats, then you have a problem. That is predatory in my 
mind.
    I mean, I was with a startup airline, very similar to the 
Spirit, in Philadelphia and USAir was a major competitor. All 
USAir ever did was just match our fares, and they let us put 
ourselves out of business very successfully. That is the way 
major carriers and network carriers really should deal with 
startup carriers. Let the consumer put your competitor out of 
business, not fares.
    Senator Shelby. Mr. Kahan, you have had experience in it 
both ways, as a regulator and as a deregulator and also in the 
business you are today. Go ahead.
    Mr. Kahan. Yes; I think that matching fares is not a 
problem. I fought for a carrier's right to be able to match 
fares, and I stand by that. If we put 100 seats on the market 
between Detroit and Philadelphia, if our hub competitors want 
to match our lowest fare, a fare that we are offering on a 
finite number of seats, then that is one thing. However, if we 
put 100 seats on the market at a certain price, and they put 
1,500 seats in the market at that same price and add more seats 
to make sure that the additional demand created by the lowest 
prices can now be accommodated on them, I believe that that is 
more often than not predatory, sir.
    Senator Shelby. Mr. Dempsey.
    Mr. Dempsey. Senator, every carrier will likely offer every 
other carrier's fare on the market. The question is over how 
many seats. The carriers are able to expand the bucket of seats 
in order to sop up low-fare demand when they want to engage in 
predation and drive the competitor out of the market.
    As I said earlier, that behavior seems to be focused on 
carriers which are less well capitalized than Southwest or than 
the major airlines, where there is peaceful coexistence. 
Moreover, it is not just pricing, predatory pricing. It is 
monopolistic practices at hub airports, and it is monopolistic 
practices----
    Senator Shelby. Expand on that, monopolistic practices at 
hub airports.
    Mr. Dempsey. Monopolistic practices at hub airports.
    Senator Shelby. Now, tell me how that works?
    Mr. Dempsey. How does that work?
    Senator Shelby. Yes.
    Mr. Dempsey. Well, unlawful monopolization under section 2 
of the Sherman Act, under most of the case law, exists when a 
company has more than 70 percent of a market and engages in 
activities designed to suppress competition.
    Senator Shelby. OK.
    Mr. Dempsey. Typically, what goes on there is the major 
carrier does not want to see a low-fare carrier in its 
backyard. This is particularly true since ValuJet grew to more 
than 50 aircraft in Delta's backyard.
    Senator Shelby. In other words, they do not care about 
having real market forces working, do they?
    Mr. Dempsey. No; they do not. They obviously do not want 
market forces working. That has a pernicious impact both in 
terms of the people who begin or end their trip at the hub, but 
also the small and medium-sized communities that are served 
from the hub. It is the ability to monopolize the hub that 
makes it very difficult for a low-fare carrier to go in and 
provide competition. It is through a variety of means, not just 
pricing and capacity, which we have talked about.
    Senator Shelby. Go ahead and elaborate on those means.
    Mr. Dempsey. OK. Travel agent commission overrides, where 
they take the larger travel agencies and they effectively bribe 
them to give them business and dissuade them from giving 
business to their competitors.
    Senator Shelby. How do they dissuade or persuade them?
    Mr. Dempsey. They give them a monthly check based on 
meeting certain quotas.
    Senator Shelby. OK.
    Mr. Dempsey. The travel agency, usually it is a large 
travel agency, has to book a certain number of seats on the 
major airlines' flights in order to receive what can be a very 
significant check at the end of the month. That check is even 
more important since the major carriers have rolled back 
commissions by 20 percent.
    Senator Shelby. OK.
    Mr. Dempsey. We also have refusals to connect. We have 
major carriers that will not engage in ticketing and baggage 
agreements, for example, requiring the passenger, now, to go 
and pick up the bag and recheck it at the hub airport if they 
want to connect on that little low-fare carrier.
    Senator Shelby. Is that widespread?
    Mr. Dempsey. Well, we have certainly found it with United. 
I think virtually we had a very difficult time getting United 
to give us a ticketing and baggage agreement. It wasn't really 
until the Department of Transportation jawboned United into 
giving us one that we got it.
    Senator Shelby. Does the FAA have any play in that?
    Mr. Dempsey. No; but the Department of Transportation does. 
If we had in air transportation what we have in 
telecommunications today, which is a requirement of 
nondiscriminatory connections, Senator, there might be low-fare 
carriers that could open up service between Atlanta and 
Huntsville and make it viable. The people in Huntsville do not 
want to just go to Atlanta, they want to go to Charleston and 
they want to go to Raleigh and they want to go to other places 
beyond Atlanta. Without the ability to connect, and it is done 
in a variety of ways, computer reservation system bias, they 
assure that a carrier that does not enjoy a code share with 
them, and they will not give a code share to a low-fare jet 
carrier----
    Senator Shelby. What does that mean to the layman?
    Mr. Dempsey. Well, Senator, if you order a ticket, you will 
probably call a travel agent. The travel agent will ask you 
when you want to fly and will ask you at what time you want to 
fly. The computer has to figure out how it is going to order 
these flights.
    A computer is going to say, ``Well, the Senator wants to 
fly at 10 a.m. on Thursday. What is the closest flight and time 
proximity to that departure because obviously he wants to fly 
at 10 a.m?'' The second question it will ask is, ``What is the 
elapsed time from origin to destination because we want to get 
the Senator from A to C most quickly?'' That is what he would 
want. The third question is, Is it an online flight, or is it a 
connecting flight with some other airline? All of the code-
sharing arrangements, that is, a carrier--I do not know what 
Delta has, but in our part of the world, Delta has a bunch of 
carriers called--excuse me, United has a bunch of carriers that 
they call United Express. These are companies like Air 
Wisconsin.
    Senator Shelby. What we call feeders?
    Mr. Dempsey. Yes; if those connections are in the computer 
reservation system, no additional elapse time is added to the 
display; but it if is a connection from a megacarrier to a 
nonrelated independent airline, the algorithm in the computer 
reservation system adds the equivalent of 24 hours to the 
display. In the United system, it is 1,440 minutes.
    Now, why do they do that? The answer is the first page of 
the computer reservation screen is the most important shelf 
space in this business; OK. It is like grocery store shelf 
space; and if you do not have it, you do not get sold. Of all 
flights, 85 percent are sold off the first page of the screen.
    If they add all of this time to your connection, you are 
not going to be on the first page of that screen and your 
connection is likely not to be sold. They do that in order to 
monopolize the connecting traffic. By monopolizing the 
connecting traffic, they assure that in thin markets there will 
be no competition.
    Now, we have asked the Department of Transportation to do 
something about that. They promulgated a rule here in December, 
but it is not very helpful. What it does is it says you have 
got to offer, all of the computer reservation systems have to 
offer, at least one display that is not biased about noncode-
shared connections. All of the other displays can be biased, 
and generally are biased, and so it is not very helpful.
    If we want to resolve the problem of small-community 
service, if we want to have competition to more small 
communities, if we want to have jet service to more small 
communities and lower prices and lower fares and lower costs, 
we need to have the same regime we have in telecommunications, 
which is no local telephone company can monopolize the market.
    If a competitor wants to choose a long-distance carrier of 
its choice, it should be free to do that. You know, Bell South 
should not be allowed to enter into a preferential agreement 
with AT&T if consumers want MCI or Sprint. If we had that in 
air transportation, we would have a lot more competition, 
Senator.
    Senator Shelby. Well, maybe that is something we can have a 
subsequent hearing, the specifics of.
    Mr. Kahan, do you have any comments on that?
    Mr. Kahan. No; I thought that was a very good answer, sir.
    Senator Shelby. Mr. Kahan, your testimony outlines the 
concern that although no one knows what the efficient market 
structure of the aviation industry will ultimately, ultimately 
turn to be, and you know from your work with the other, Dr. 
Kahan, we should be very concerned about the lack of new 
entrants in the marketplace, given the degree of increased 
concentration in the industry.
    Under that assumption, is it enough to have new entrants, 
or is it fair to say that any new entrant must be sufficiently 
capitalized to weather the inevitable competitive pressures and 
attendant barriers to competition that is endemic to this 
industry?
    Mr. Kahan. I absolutely agree that any new entrant in this 
industry must be well capitalized. Certainly, we at Spirit do 
not expect subsidies or any free lunches or any help from the 
Government that is going to get us out of problems.
    Senator Shelby. You want help from the Government to make 
sure that there is a competitive environment, do you not?
    Mr. Kahan. We want to have an opportunity to succeed, sir.
    Senator Shelby. That is what I mean, yes. No guarantee you 
will succeed, but you will never succeed if you do not have an 
environment that you can succeed in--in other words, real 
competition--do you?
    Mr. Kahan. Yes, sir; the airline industry is the last 
industry that I would say there are any guarantees of success, 
sir. At a minimum, we have to have an opportunity to do so.
    Senator Shelby. Describe, Mr. Kahan, an ideal market for an 
airline such as yours or others to initiate service into. What 
passenger or community profile would you look at? Is that too 
proprietary?
    Mr. Kahan. Well, that is an interesting question, and I 
think I can take a shot at it, sir.
    Senator Shelby. OK.
    Mr. Kahan. Clearly, under prevailing Government policy and 
given the pattern of predatory behavior at hub airports, we are 
looking for underserved markets, where the communities involved 
are looking for low-priced reliable transportation. We are 
working with the community, Melbourne, FL, right now, which 
actually has, I was thinking about it, some similarities with 
Huntsville because it is space-based there, right near Cape 
Kennedy. The main way out of Melbourne is seven flights a day 
through Atlanta, which might sound familiar.
    We are working very hard with them right now. We are 
convinced that that is a market which combines leisure and 
business traffic, because there is a large Government 
contractor coming down there which wants to come to Washington 
and New York. Right now, we are waiting for the Department of 
Transportation to tell us whether we are going to have access 
to airports up in the North.
    Senator Shelby. Mr. Boyd, what are the biggest hurdles that 
underutilized airports in communities that are seeking 
increased service must overcome to increase airline service? 
Your statement implies that airline competition is an evolving 
dynamic currently characterized in part by the willingness of 
people to drive an hour for better service or lower fares. What 
can a midsized community within a couple of hours drive of a 
network carrier's hub do to improve the level of service to the 
airport?
    Mr. Boyd. Two issues here. A midsized community, that is a 
valid comment. Smaller communities like McCook, NE, as I put in 
my testimony or Mattoon, IL, has no business having air service 
because they are too close to larger ones. Let us deal with 
things near Huntsville, for example. How many people drive 
today from Huntsville to Atlanta? A lot. How many are driving 
from Gainesville to Jacksonville? A lot.
    Now, why is that? It is not necessarily because they do not 
like the local airport. We do a lot of air service development 
work with a lot of communities. There are airlines out there 
that beg us to get into their communities. They beg us to call 
ComAir, they beg us to call Sky West. There are other airlines 
that give such bad service to midsized communities, that people 
will not fly from that midsized airport; they will drive.
    Our suggestion has been to these communities, and some of 
us have taken it up already, do not accept that. When you have 
an airline system like Delta who has a commuter partner or a 
regional partner that may give bad service, you need to stand 
up and do something about it.
    The biggest challenge today to midsized air service--I mean 
aside from the competitive issues, which is another whole 
smoke--the problem you have in a lot of midsized communities 
like Huntsville, like Montgomery, like Gainesville is that some 
of the service these megacarriers are giving them in terms of 
getting to the hub is so bad no willing consumer will get on 
it.
    I will not put my 85-year-old mother on a Delta flight that 
involves ASA, for example, because I would not want to abuse 
her that way. That is one of the ways you have to deal with 
this. Communities have to get up and say, ``You are the only 
game in town. You are killing my airport, stop it.''
    You do not do it with ASA. You go to the president of Delta 
and raise hell with him. That is the biggest challenge right 
now to midsized communities is the bad service, which is 
killing traffic. When traffic goes down, airlines say I am not 
going to fly there. It becomes a self-fulfilling philosophy.
    Senator Shelby. Mr. Boyd, you mentioned in your earlier 
testimony the perimeter rules and also the Wright amendment. 
Would you comment on, first, the perimeter rule, why it needs 
to go, and then the Wright amendment and what it has done to 
competition?
    Mr. Boyd. Well, the perimeter rule has no real value 
anymore. I mean, original LaGuardia was supposed to get long-
haul traffic into John F. Kennedy. That is not necessary 
anymore. Now, having a four-engine rule or whatever at 
LaGuardia because it constrains, I have no problem with; but a 
perimeter rule does not serve any real value for anyone. The 
same thing at Washington National, we do not need to defend or 
protect Dulles Airport anymore. A lot of people, folks, have 
moved out there. It can stand on its own very well.
    The Wright amendment, and I just understood from one of the 
people here, that Dallas and Fort Worth are trying to get 
together to do a new mini-Wright amendment, which takes away 
the Wright amendment----
    Senator Shelby. Elaborate on that. Elaborate on what a 
mini-Wright amendment would do? Would that still impede 
competition?
    Mr. Boyd. Oh, absolutely. What they are talking about is 
allowing through ticketing, but only allowing nonstop flights 
to where you can have it today. That does not fix anything 
really, because people are doing it. There are today, as I 
remember, something like 100----
    Senator Shelby. It is just a fraud in a sense?
    Mr. Boyd. Bingo. It is a fraud. What you have is a 
situation----
    Senator Shelby. A fraud on the traveling public?
    Mr. Boyd. A fraud on the traveling public. How many people 
do you have today between Birmingham and New Orleans on 
Southwest? Maybe 120,000 people. Well, guess what? About one-
half of those people are crossing the aisle buying a ticket and 
flying to Love Field. What we need to do is eliminate the whole 
thing and not go with these halfway measures that are really 
just meant to pull the wool over the consumer's eye.
    If the Wright amendment is removed, Midland and Odessa will 
have much lower fares east and west, so will Corpus Christi, so 
will Birmingham. Everybody will benefit. Again, if Mr. Crandall 
has an out-of-body experience over this, but it will make him a 
better airline to have that kind of competition.
    Senator Shelby. They create a mini-Wright amendment, in 
other words, a ploy to get around real competition? That is 
what you are saying, is it not?
    Mr. Boyd. That is all that is. It is hypocritical on the 
part of Fort Worth. It tries to make us believe that if they 
take away the Wright amendment it will hurt DFW, then they go 
on and let Ross Perot build a cargo airport just north of 
there. The fact is we have too much politics here and too 
little concern for the consumer.
    Senator Shelby. Anybody that can see, can see right through 
that, couldn't they?
    Mr. Boyd. Ray Charles could see this one coming. 
[Laughter.]
    Senator Shelby. OK. Thank you.
    Do any of you gentlemen have any comments on the perimeter 
rule or the Wright amendment or the mini-Wright amendment, 
Wright amendment II, or whatever it is, junior?
    Mr. Dempsey. I agree with Mr. Boyd. The Wright amendment is 
an anachronism. The perimeter rules are unnecessary and 
competition would be much enhanced if they went away.
    The other thing I want to say in Mr. McCain's bill, which I 
think would be helpful, is that he proposes that the Department 
of Transportation decide complaints brought for predatory 
practices within 30 days. I think that would be very helpful.
    Senator Shelby. Mr. Kahan.
    Mr. Kahan. I cannot see a case to be made for protecting 
the Dallas-Fort Worth Airport, sir, not 20 years later after 
the Wright amendment, and I think that should be seriously 
looked at.
    Senator Shelby. What has the Wright amendment in the last 
few years done to run up the price of the traveling public, 
interstate commerce people, traveling West? It costs money?
    Mr. Kahan. I am not an expert on that. I think that may be 
a complicated question because people talk a lot about 
Southwest, sir. Perhaps, the secret of Southwest's success is 
that they enjoyed some protection from the competition in the 
early part of their company and were able to develop that big, 
fat balance sheet that makes them uniquely successful today. I 
think that overall we have to say that perhaps the Wright 
amendment succeeded in helping Southwest become the important 
source of competition that it is, but that does not mean that 
what was right 20 years ago makes sense today.
    Senator Shelby. Whether it is the Wright amendment, it is 
the mini-Wright amendment, or junior, or whatever, the third, 
or Wright amendment, III, it has no place in real competition 
does it, gentlemen? Is that right?
    Mr. Boyd. No.
    Mr. Kahan. No, sir.
    Mr. Dempsey. That is right.
    Senator Shelby. Thank you. I thank you. I appreciate your 
coming. I appreciate your contributions. Thank you.
    Mr. Kahan. Thank you, Mr. Chairman.
                                Panel 2

                       GENERAL ACCOUNTING OFFICE

STATEMENT OF JOHN ANDERSON, DIRECTOR, TRANSPORTATION 
            ISSUES, RESOURCES, COMMUNITY AND ECONOMIC 
            DEVELOPMENT DIVISION

                      DEPARTMENT OF TRANSPORTATION

STATEMENT OF PATRICK V. MURPHY, DEPUTY ASSISTANT 
            SECRETARY, AVIATION AND INTERNATIONAL 
            AFFAIRS

                       Introduction of Witnesses

    Senator Shelby. Our second panel will be John Anderson, 
Director of Transportation Issues, General Accounting Office 
and Patrick Murphy, Deputy Assistant Secretary, Office for 
Aviation and International Affairs.
    Gentleman, your written statements will be made a part of 
the record in their entirety.
    Mr. Anderson, do you want to proceed first?
    Mr. Anderson. Mr. Chairman, we appreciate the opportunity 
to testify today on competition in the domestic airline 
industry. With me is Marnie Shaw, who is an assistant director 
who overseas our work concerning airline competition issues.
    Our work has consistently shown that airline deregulation 
has led to lower fares and better service for most air 
travelers. This is due largely to increased competition spurred 
by the entry of new airlines into the industry and established 
airlines into new markets. However, as others have testified 
today, the benefits of deregulation have been uneven and 
pockets of pain exist, especially in small and medium-sized 
communities in the East and upper Midwest.
    For example, in Huntsville, AL; Charleston, WV; and 
Pittsburgh, PA, fares in real terms have increased over 20 
percent since deregulation. A combination of factors have 
limited competition at these airports and adversely affected 
fares and service. These factors include slow economic growth 
and the dominance of routes to and from these airports by one 
or two traditional hub and spoke airlines.

                           barriers to entry

    In addition, restrictive gate leases, slot controls and 
perimeter rules continue to block entry at key airports in the 
East and upper Midwest. These operating barriers combined with 
certain marketing strategies by established airlines, such as 
frequent flier plans, have deterred entry by new airlines and 
fortified established airlines' dominance at these airports.
    For example, we identified several airports in which entry 
was limited because of long-term, exclusive-use gate leases 
with one airline. The vast majority of gates at Charlotte, 
Cincinnati, Detroit, Minneapolis, Newark, and Pittsburgh are 
exclusively leased usually to one established airline.
    For example, nearly 90 percent of the gates at Pittsburgh 
are leased to USAir until 2018. As a result, it is extremely 
difficult for other airlines to gain competitive access to 
these airports.

                      actions to address problems

    Because a variety of factors have contributed to the fare 
and service problems that some communities have experienced 
since deregulation, no single action will solve these problems. 
Instead, addressing them will require a combination of Federal, 
regional, local and private-sector initiatives.
    At the Federal level, DOT shares our concerns about limited 
competition in some markets, and DOT is formulating a policy to 
identify anticompetitive behavior that could be subject to 
formal enforcement action. DOT is also evaluating how 
effectively slots are being used at the four slot-controlled 
airports. In addition, to address the slot problem that we 
identified, DOT has granted several additional slots for new 
entrant airlines at O'Hare and LaGuardia.
    Several bills have been introduced in the Congress to 
promote domestic competition and improve fares and service. The 
proposals include increasing access to slot-controlled 
airports, limiting the time that DOT has to respond to 
complaints of predatory behavior and providing loan guarantees 
to commuter air carriers to purchase regional jets to use in 
their underserved markets.
    Regardless of the outcome of these proposals, Federal 
actions alone cannot solve the problems. Community leaders in 
the Southeast and Appalachia have initiated a coordinated 
effort to improve air service in their regions. Their efforts 
include periodically convening national roundtables to bring 
together Federal, State and local officials, as well as 
airline, airport and business representatives to explore 
potential solutions to their air service problems. Businesses 
concerned about the high fares they are paying in markets 
dominated by one established airline need to continue to work 
together to find market-based solutions and focus attention on 
the problems.
    Economic forces in the private sector appear to be creating 
opportunities for air carriers to use 50- to 70-seat regional 
jets. Regional jets can improve the quality of air service on 
existing routes when carriers substitute them for turboprops, 
and can provide new service for routes that turboprops cannot 
economically serve. Although regional jets currently make up 
only a small portion of commuter aircraft, as commuter carriers 
continue to order them, the air service problems of some of the 
communities might be mitigated.

                           prepared statement

    In conclusion, our work has identified pockets of pain in a 
number of small and medium-sized communities, and a growing 
number of business travelers seem to be increasingly concerned 
about the air fares they are paying. This underscores the 
importance of congressional hearings like this to examine 
potential solutions to the problems.
    That concludes my statement. I would be happy to answer any 
questions.
    [The statement follows:]

                 Prepared Statement of John H. Anderson

   airline competition: barriers to entry continue in some domestic 
                                markets
    Mr. Chairman and Members of the Subcommittee: We appreciate the 
opportunity to testify on the air service problems that some 
communities have experienced since the deregulation of the industry in 
1978. Airline deregulation has led to lower fares and better service 
for most air travelers largely because of increased competition spurred 
by the entry of new airlines into the industry and established airlines 
into new markets. As we reported in 1996 and 1997, however, some 
airports have not experienced such entry and thus have experienced 
higher fares and/or less convenient service since deregulation.\1\ Our 
testimony today summarizes the findings from our prior work on these 
fare and service trends, factors contributing to the problems, and the 
initiatives by the Department of Transportation (DOT) and others to 
address these problems. In summary:
---------------------------------------------------------------------------
    \1\ ``Airline Deregulation: Changes in Airfares, Service, and 
Safety at Small, Medium-Sized, and Large Communities'' (GAO/RCED-96-79, 
Apr. 19, 1996), ``Airline Deregulation: Barriers to Entry Continue to 
Limit Competition in Several Key Domestic Markets'' (GAO/RCED-97-4, 
Oct. 18, 1996), ``Airline Deregulation: Addressing the Air Service 
Problems of Some Communities'' (GAO/T-RCED-97-187, June 25, 1997), and 
``Domestic Aviation: Barriers to Entry Continue to Limit Benefits of 
Airline Deregulation'' (GAO/T-RCED-97-120, May 13, 1997). Related GAO 
products are listed at the end of this statement.
---------------------------------------------------------------------------
    --Not all communities have benefited from airline deregulation. 
Certain airports--particularly those serving small and medium-sized 
communities in the East and upper Midwest--have experienced higher 
fares and/or poorer service since deregulation. There are several 
reasons for the substantial regional differences in fare and service 
trends, including the dominance of routes to and from these airports by 
one or two traditional hub-and-spoke airlines \2\ and operating 
barriers, such as long-term exclusive-use gate leases at hub airports. 
In contrast, the more widespread entry of new airlines at airports in 
the West and Southwest since deregulation--and the resulting geographic 
differences in fare and service trends--has stemmed largely from the 
greater economic growth in those regions as well as from the absence of 
dominant market positions of incumbent airlines and barriers to entry.
---------------------------------------------------------------------------
    \2\ These airlines include the nation's seven largest: American 
Airlines, Continental Airlines, Delta Air Lines, Northwest Airlines, 
TWA, United Airlines, and US Airways.
---------------------------------------------------------------------------
    --Operating barriers--slot controls, restrictive gate leases, and 
perimeter rules \3\--continue to block entry at key airports and 
contribute to fare and service problems in the East and upper Midwest. 
To minimize congestion and reduce flight delays, the Federal Aviation 
Administration has set limits since 1969 on the number of takeoffs or 
landings--referred to as ``slots''--that can occur during certain 
periods of the day at four congested airports--Chicago O'Hare, Ronald 
Reagan Washington National, and New York's Kennedy and LaGuardia. A few 
airlines control most of the slots at these airports, which limits new 
entrants. In 1996 we reported that the vast majority of gates at six 
airports in the East and upper Midwest were exclusively leased to 
usually one airline, making it very difficult to gain competitive 
access to these airports. In addition, perimeter rules at LaGuardia and 
National airports limit the ability of airlines based in the West to 
compete at those airports. These operating barriers, combined with 
certain marketing strategies by established carriers, have deterred new 
entrant airlines while fortifying established carriers' dominance at 
key hubs in the East and upper Midwest.
---------------------------------------------------------------------------
    \3\ Rules that prohibit flights to and from airports that exceed a 
certain distance.
---------------------------------------------------------------------------
    --Increasing competition and improving air service at airports 
serving communities that have not benefited from deregulation will 
likely entail a range of federal, regional, local, and private-sector 
initiatives. DOT is undertaking several efforts to enhance competition, 
such as granting slots to new entrants at 2 airports and formalizing a 
policy that will identify anticompetitive behavior and factors DOT will 
consider if it pursues formal enforcement actions to correct such 
behavior. In addition, recently proposed legislation would address 
several barriers to competition: slot controls, the perimeter rule, and 
predatory behavior by air carriers. Recent national and regional 
conferences exemplify efforts to pool available resources to focus on 
improving the airfares and quality of air service to such communities. 
Other steps--such as improving the availability of gates--may also be 
needed to further ameliorate current competitive problems.
               benefits of deregulation have been uneven
    Our April 1996 report found that since deregulation, as expected, 
fares had fallen and service had improved for most large-community 
airports. However, without the cross-subsidy that was present when the 
industry was regulated, experts also expected fares to increase 
somewhat at airports serving small and medium-sized communities and 
expected service to decline. We found, in fact, that since 
deregulation, substantial regional differences have existed in fare and 
service trends, particularly among small and medium-sized community 
airports. A primary reason for these differences has been the greater 
degree of economic growth that has occurred over the past two decades 
in the West and Southwest and in larger communities nationwide. In 
particular, we noted that most low-fare airlines that began interstate 
air service after deregulation, such as Southwest Airlines\4\ and Reno 
Air, had decided to enter airports serving communities of all sizes in 
the West and Southwest because of these communities' robust economic 
growth. By contrast, low-fare airlines had generally avoided serving 
small- and medium-sized-community airports in the East and upper 
Midwest, in part because of the slower growth, harsher weather, and 
greater airport congestion in these regions.
---------------------------------------------------------------------------
    \4\ Before deregulation, Southwest provided intrastate air service 
within Texas.
---------------------------------------------------------------------------
    Our review of the trends in fares between 1979 and 1994 for a 
sample of 112 small-, medium-sized, and large-community airports 
identified 15 airports where fares, adjusted for inflation, had 
declined by over 20 percent and 8 airports where fares had increased by 
over 20 percent.\5\ Each of the 15 airports where fares declined was 
located in the West or Southwest, and low-fare airlines accounted for 
at least 10 percent of the passenger boardings at all but one of those 
airports in 1994.\6\ On the other hand, each of the eight airports 
where fares had increased by over 20 percent since deregulation was 
located in the Southeast and the Appalachian region.
---------------------------------------------------------------------------
    \5\ Our sample of 112 airports included 49 airports serving small 
communities, 38 serving medium-sized communities, and 25 serving large 
communities. In 1994, these airports accounted for about two-thirds of 
all domestic airline departures and passenger enplanements in the 
United States. We defined small communities as those with a 
metropolitan statistical area population of 300,000 or less, medium-
sized communities as those with a metropolitan statistical area 
population of 300,001 to 600,000, and large communities as those with a 
metropolitan statistical area population of 1.5 million or more.
    \6\ Of the 15 airports, 5 serve small communities, 5 serve medium-
sized communities, and 5 serve large communities.
---------------------------------------------------------------------------
    Our April 1996 report also discussed similar trends in service 
quantity and quality since deregulation. Large communities, in general, 
and communities of all sizes in the West and Southwest had experienced 
a substantial increase in the number of departures and available seats 
as well as improvements in such service quality indicators as the 
number of available nonstop destinations and the amount of jet service. 
Over time, however, smaller- and medium-sized communities in the East 
and upper Midwest had generally experienced a decline in the quantity 
and quality of air service. In particular, these communities had 
experienced a sharp decrease in the number of available nonstop 
destinations and in the amount of jet service relative to turboprop 
service. This decrease occurred largely because established airlines 
had reduced jet service from these airports and deployed turboprops to 
link the communities to those airlines' major hubs.
airline barriers to entry persist and predominantly affect competition 
                     in the east and upper midwest
    We reported in October 1996 that operating barriers at key hub 
airports in the upper Midwest and the East, combined with certain 
marketing strategies of the established carriers, had two effects on 
competition. The operating barriers and marketing strategies deterred 
new entrant airlines and fortified established carriers' dominance of 
those hub airports and routes linking those hubs with nearby small- and 
medium-sized-community airports. In the upper Midwest, there is limited 
competition in part because two airlines control nearly 90 percent of 
the takeoff and landing slots at O'Hare, and one airline controls the 
vast majority of gates at the airports in Minneapolis and Detroit under 
long-term, exclusive-use leases. Similarly, in the East, one airline 
controls the vast majority of gates under exclusive-use leases at 
Cincinnati, Charlotte, and Pittsburgh and a few established airlines 
control most of the slots at National, LaGuardia, and Kennedy. 
Perimeter rules at LaGuardia and National further limit the ability of 
airlines based in the West to compete in those markets.
    Particularly for these key markets in the upper Midwest and East, 
the relative significance of these barriers in limiting competition and 
contributing to higher airfares has grown over time. As a result, our 
October 1996 report recommended that DOT take action to lower the 
operating barriers and highlighted areas for potential congressional 
action. Our 1996 report also discussed the effects of some marketing 
strategies of incumbent airlines on competition.
Slots
    To reduce congestion, the Federal Aviation Administration (FAA) has 
limited since 1969 the number of takeoffs and landings that can occur 
at O'Hare, National, LaGuardia, and Kennedy. By allowing new airlines 
to form and established airlines to enter new markets, deregulation 
increased the demand for access to these airports. Such increased 
demand complicated FAA's efforts to allocate takeoff and landing slots 
equitably among the airlines. To minimize the government's role in the 
allocation of slots, in 1985 DOT began to allow airlines to buy and 
sell them to one another. Under this ``Buy/Sell Rule,'' DOT 
``grandfathered'' slots to the holders of record as of December 16, 
1985. Emphasizing that it still owned the slots, however, DOT reserved 
the right to withdraw slots from the incumbents at any time. In 
addition, to mitigate the anticompetitive effects of grandfathering, 
DOT retained about 5 percent of the slots at O'Hare, National, and 
LaGuardia and in 1986 distributed them in a random lottery to airlines 
having few or no slots at those airports.
    Even with the lottery, we found that the level of control over 
slots by a few established airlines had increased over time. By 
contrast, the share held by the airlines that started after 
deregulation has remained low. (See app. I.) To address this problem, 
in October 1996, we recommended that DOT redistribute some of the 
grandfathered slots to increase competition, taking into account the 
investments made by those airlines at each of the slot-controlled 
airports. We were envisioning that a small percentage of slots would be 
redistributed. In response to our report, DOT has begun to use the 
authority that the Congress gave it in 1994 to allow additional slots 
for entry at O'Hare, LaGuardia, and Kennedy.\7\ In October 1997, DOT 
awarded Reno Air and Trans States Airlines exemptions from slot 
limitations at O'Hare, while Frontier Airlines, ValuJet Airlines,\8\ 
and AirTran Airways were granted exemptions at LaGuardia. These 
exemptions should help to enhance service in the East and upper 
Midwest. For example, Trans States Airlines received 8 exemptions to 
provide service between O'Hare and its choice of Asheville, North 
Carolina; Chattanooga, Tennessee; Roanoke, Virginia; and Tri-Cities, 
Tennessee/Virginia.\9\
---------------------------------------------------------------------------
    \7\ The FAA Authorization Act of 1994 (Public Law 103-305, section 
206) created an exemption provision to allow additional slots at 
O'Hare, LaGuardia, and Kennedy when DOT ``finds it to be in the public 
interest and the circumstances to be exceptional.'' The number of 
flights at National Airport is further limited by federal law to 
address local concerns about noise. As a result of these additional 
limits, the Congress chose not to extend DOT's exemption authority to 
include National.
    \8\ ValuJet is now AirTran Airlines.
    \9\ Each exemption is one arrival or departure.
---------------------------------------------------------------------------
Long-term, Exclusive-use Gate Leases
    Our reports have also identified restrictive gate leases as a 
barrier to establishing new or expanded service at some airports. These 
leases permit an airline to hold exclusive rights to use most of an 
airport's gates over a long period of time, commonly 20 years. Such 
leases prevent nonincumbents from securing necessary airport facilities 
on equal terms with incumbent airlines. To gain access to an airport 
where most gates are exclusively leased, a nonincumbent must sublet 
gates from the incumbent airlines--often at nonpreferred times and at a 
higher cost than the incumbent pays.
    While some airports, such as Los Angeles International, have 
attempted to regain more control of their facilities by signing less 
restrictive, shorter-term leases once the exclusive-use leases expired, 
our October 1996 report identified several airports where entry was 
still limited because of long-term, exclusive-use gate leases with one 
airline. We identified six airports in particular where this occurred: 
Charlotte; Cincinnati; Detroit; Minneapolis; Newark, New Jersey; and 
Pittsburgh. The vast majority of gates at each airport are exclusively 
leased, usually to one established airline. (See app. II.) As a result, 
it is extremely difficult to gain competitive access to these airports, 
according to executives at many airlines that started after 
deregulation.
    Although the development, maintenance, and expansion of airport 
facilities is essentially a local responsibility, most airports are 
operated under federal restrictions that are tied to the receipt of 
federal grant money from FAA. To address the gate lease problem, we 
recommended that when disbursing airport improvement grant moneys, FAA 
give priority to those airports that do not lease the vast majority of 
their gates to one airline under long-term, exclusive-use terms. DOT 
did not concur with this recommendation. According to DOT, because the 
number of airports that we identified as presenting gate access 
problems is sufficiently small, the agency would prefer to address 
those problems on a case-by-case basis. DOT emphasized that in cases 
where incumbent airlines are alleged to have used their contractual 
arrangements with local airport authorities to block new entry, the 
agency will investigate to determine whether the behavior constitutes 
an unfair or deceptive practice or an unfair method of competition. If 
so, the agency noted that it will take appropriate action.
Perimeter Rules
    At LaGuardia and National airports, perimeter rules prohibit 
incoming and outgoing flights that exceed 1,500 and 1,250 miles, 
respectively. The perimeter rules were designed to promote Kennedy and 
Dulles airports as the long-haul airports for the New York and 
Washington metropolitan areas. However, the rules limit the ability of 
airlines based in the West to compete because those airlines are not 
allowed to serve LaGuardia and National airports from the markets where 
they are strongest. By contrast, because of their proximity to 
LaGuardia and National, each of the seven largest established carriers 
is able to serve those airports from its principal hub.
    While the limit at LaGuardia was established by the Port Authority 
of New York & New Jersey, National's perimeter rule is federal law.\10\ 
Thus, in our October 1996 report, we suggested that the Congress 
consider granting DOT the authority to allow exemptions to the 
perimeter rule at National when proposed service will substantially 
increase competition. We did not recommend that the rule be abolished 
because removing it could have unintended negative consequences, such 
as reducing the amount of service to smaller communities in the 
Northeast and Southeast. This could happen if major slot holders at 
National were to shift their service from smaller communities to take 
advantage of more profitable, longer-haul routes. As a result, we 
concluded that a more prudent course to increasing competition at 
National would be to examine proposed new services on a case-by-case 
basis.
---------------------------------------------------------------------------
    \10\ The Metropolitan Washington Airports Act of 1986 (49 U.S.C. 
Sec. 49109).
---------------------------------------------------------------------------
Marketing Strategies
    Our October 1996 report also emphasized that certain marketing 
strategies of incumbent airlines, taken together, had created strong 
loyalty among passengers and travel agents, making it difficult for 
nonincumbents to enter markets dominated by an established airline. Two 
strategies in particular--booking incentives to travel agents and 
frequent flier plans--have encouraged business flyers, who represent 
the most profitable segment of the industry, to use the dominant 
carrier in each market. Because about 90 percent of business travel is 
booked through travel agencies, airlines strive to influence the 
agencies' booking patterns by offering special bonus commissions as a 
reward for booking a targeted proportion of passengers on their 
airline. Similarly, frequent flier programs have become an increasingly 
effective tool to encourage customers' loyalty to a particular airline. 
As such, entry by new and established airlines alike into a market 
dominated by one carrier is very difficult. This is particularly true 
given that to attract new customers a potential entrant must announce 
its schedule and fares well in advance of beginning service, thus 
giving the incumbent an opportunity to adjust its marketing strategies. 
Such adjustments by the incumbent may include matching low fares 
offered by new entrant airlines and selling far more seats at these low 
fares than are being offered by the new entrants. In many cases, we 
found that airlines chose not to enter or to quickly exit markets where 
they did not believe they could overcome the combined effect of these 
marketing strategies.
    In October 1996, we reported that the effect of these and other 
marketing strategies tends to be the greatest--and fares the highest--
in markets where the dominant carrier's position is protected by 
operating barriers. However, we also noted that the marketing 
strategies produced consumer benefits, such as free frequent flier 
trips, and concluded that short of an outright ban, few policy options 
existed that would mitigate the marketing strategies' negative impact 
on new entry.
   range of initiatives will likely be needed to address air service 
                                problems
    Because a variety of factors has contributed to higher fares and 
poorer service that some small and medium-sized communities in the East 
and upper Midwest have experienced since deregulation, a coordinated 
effort involving federal, regional, local, and private-sector 
initiatives may be needed. Recent efforts by DOT and proposed 
legislation are aimed at enhancing competition. Additional public and 
private activities are currently under way to address regional and 
local air service problems. If successful, these initiatives would 
complement, and potentially encourage, the increasing use of small jets 
by the commuter affiliates of established airlines--a trend that has 
the potential for increasing competition and improving the quality of 
service for some communities.
DOT has Begun Efforts to Increase Competition
    In response to our October 1996 report, DOT stated in January 1997 
that it shared our concerns that barriers to entry limit competition in 
the airline industry. As we mentioned earlier in this testimony, in 
October 1997, DOT granted slots to two new entrants at O'Hare and three 
new entrants at LaGuardia. At the same time, DOT set forth its new 
policy on slot exemptions, which has been expanded to take into account 
the need for increased competition at the slot-controlled airports. DOT 
is currently considering other slot exemptions but acknowledged that 
there are only a limited number of exemption opportunities. Because 
some in government and academia believe that slots at some airports may 
be underutilized, DOT is also evaluating how effectively slots are 
being used at these airports.
    In addition, DOT has expressed concern about potentially 
overaggressive attempts by some established carriers to thwart new 
entry. According to DOT, over the past 2 years, there has been an 
increasing number of alleged anticompetitive practices--such as 
predatory conduct--aimed at new competition, particularly at major 
network hubs. DOT is formulating a new policy to clearly delineate what 
is acceptable and unacceptable behavior in the area of competition 
between major carriers at their hubs and smaller, low-cost competitors. 
The policy will indicate those factors that DOT will consider if it 
pursues formal enforcement actions to correct unacceptable behavior.
Proposed Legislation Would Address Competition Issues
    Over the past several months, a number of bills have been proposed 
to promote aviation competition and address some of the problems we 
identified.\11\ The proposals include creating a mechanism by which DOT 
would increase access to the slot-controlled airports by periodically 
withdrawing a small portion of the slots that were grandfathered to 
incumbent airlines and reallocating them among new entrant and limited 
incumbent air carriers. The proposals also include requiring DOT to 
grant exemptions to the perimeter rule at National under certain 
circumstances, limiting the time that DOT has to respond to complaints 
of predatory behavior, and providing loan guarantees for commuter air 
carriers to purchase regional jet aircraft for use in underserved 
markets.
---------------------------------------------------------------------------
    \11\ For example, see H.R. 2748 (sponsored by Representative J. 
Duncan), H.R. 3160 (sponsored by Representative C. Schumer), H.R. 3179 
(sponsored by Representative T. Manton), S. 1331 (sponsored by Senator 
J. McCain), and S. 1353 (sponsored by Senator B. Frist).
---------------------------------------------------------------------------
Regional, State, and Local Initiatives Undertaken to Improve Service
    Recognizing that federal actions alone would not remedy their 
regions' air service problems, several airport directors and community 
chamber of commerce officials in the Southeast and Appalachian regions 
have begun a coordinated effort to improve air service in their region. 
As a result of this effort, several Members of Congress from these 
regions in turn organized a bipartisan caucus named ``Special Places of 
Kindred Economic Situation'' (SPOKES). Among other things, SPOKES is 
designed to ensure sustained consumer education and coordinate federal, 
state, local, and private efforts to address the air service problems 
of communities adversely affected since deregulation. Two SPOKES-led 
initiatives include establishing a Website on the Internet and 
convening periodic ``national air service roundtables'' to bring 
together federal, state, and local officials and airline, airport, and 
business representatives to explore potential solutions to air service 
problems.
    The first roundtable was held in Chattanooga in February 1997. The 
roundtable concluded that greater regional, state, and local efforts 
were needed to promote economic growth and attract established and new 
airlines alike to serve small and medium-sized markets in the East and 
upper Midwest. Suggested initiatives included (1) creating regional 
trade associations composed of state and local officials, airport 
directors, and business executives; (2) offering local financial 
incentives to nonincumbent airlines, such as guaranteeing a specified 
amount of revenue or providing promotional support; and (3) targeting 
aggressive marketing efforts by communities toward airlines to spur 
economic growth. A second roundtable was held in Jackson, Mississippi, 
in January 1998.
    A regional conference, held in West Virginia in December 1997, 
brought together federal and state officials, airport representatives, 
and local businesses to discuss ways to restore quality air service to 
small communities in the state. In West Virginia, for example, 
Wheeling, Elkins, and Martinsburg have lost all scheduled air service 
since deregulation. Throughout the state, communities have experienced 
declines in the number of nonstop flights, the number of seats 
available, and the number of jet flights. Regional concerns about air 
service have extended to other states and conferences were recently 
held in Iowa and Arizona.
Private-Sector Initiatives are Addressing Air Service
    To grow and prosper, businesses need convenient, affordable air 
service. As a result, businesses located in the affected communities 
have increasingly attempted to address their communities' air service 
problems. Perhaps the most visible of these efforts was the formation 
of the Business Travel Contractors Corporation (BTCC) by 45 
corporations, including Chrysler Motors, Procter & Gamble, and Black & 
Decker. These corporations formed BTCC because they were concerned 
about the high fares they were paying in markets dominated by one 
established airline. BTCC held national conferences in Washington, 
D.C., in April and October 1997 to examine this problem and explore 
potential market-based initiatives. At the October conference, 
attendees endorsed the concepts of (1) holding periodic slot lotteries 
to provide new entrant airlines with access to slot-controlled 
airports, (2) allowing new entrants and other small airlines to serve 
points beyond National's perimeter rule, and (3) requiring DOT to issue 
a policy addressing anticompetitive practices and specifying the time 
frames within which all complaints will be acted upon. While BTCC 
suspended operations in January 1998, its lobbying arm--the Business 
Travel Coalition--plans to continue efforts to increase competition.
Airlines' Use of Regional Jets is Improving Service
    In addition to public and private-sector initiatives, the 
increasing use of 50- to 70-seat regional jets is improving the quality 
of air service for a growing number of communities. Responding to 
consumers' preference to fly jets rather than turboprops for greater 
comfort, convenience, and a perceived higher level of safety, commuter 
affiliates of established airlines are increasingly using regional jets 
to (1) replace turboprops on routes between established airlines' hubs 
and small and medium-sized communities and (2) initiate nonstop service 
on routes that are either uneconomical or too great a distance for 
commuter carriers to serve with slower, higher-cost, and shorter-range 
turboprops.
    Because regional jets can generally fly several hundred miles 
farther than turboprops, commuter carriers will be able to link more 
cities to established airlines' hubs. To the extent that this occurs, 
it could increase competition in many small and medium-sized 
communities by providing consumers with more service options.
    Mr. Chairman, this concludes our prepared statement. We would be 
glad to respond to any questions that you or any Members of the 
Subcommittee may have.

                               Appendex I

    PERCENTAGE OF DOMESTIC AIR CARRIER SLOTS HELD BY SELECTED GROUPS
------------------------------------------------------------------------
            Airport                Holding entity     1986   1991   1996
------------------------------------------------------------------------
O'Hare.........................  American and           66     83     87
                                  United.
                                 Other established      28     13      9
                                  airlines.
                                 Financial           .....      3      2
                                  institutions.
                                 Post-deregulation       6      1      1
                                  airlines.
Kennedy........................  Shawmut Bank,          43     60     75
                                  American, and
                                  Delta.
                                 Other established      49     18     13
                                  airlines.
                                 Other financial     .....     19      6
                                  institutions.
                                 Post-deregulation       9      3      7
                                  airlines.
LaGuardia......................  American, Delta,       27     43     64
                                  and US Airways.
                                 Other established      58     39     14
                                  airlines.
                                 Financial           .....      7     20
                                  institutions.
                                 Post-deregulation      15     12      2
                                  airlines.
National.......................  American, Delta,       25     43     59
                                  and US Airways.

                                 Other established      58     42     20
                                  airlines.
                                 Financial           .....      7     19
                                  institutions.
                                 Post-deregulation      17      8      3
                                  airlines.
------------------------------------------------------------------------
Notes: Numbers may not add to 100 percent because of rounding. Some
  airlines that held slots have gone bankrupt, and as a result,
  financial institutions have acquired slots.
Source: GAO's analysis of data from the Federal Aviation Administration.

                              Appendix II

   AIRPORTS WHERE POST-DEREGULATION AIRLINES REPORTED DIFFICULTY GAINING COMPETITIVE ACCESS TO GATES, AND THE
                                  LEASING ARRANGEMENTS AT THOSE AIRPORTS, 1996
----------------------------------------------------------------------------------------------------------------
                                                Total     Gates under
                  Airport                     number of    exclusive-   Percent    Major lease holders and dates
                                              jet gates    use leases                   of lease expiration
----------------------------------------------------------------------------------------------------------------
Charlotte..................................           48           43         90  34 gates leased to USAir until
                                                                                   2007.
Cincinnati.................................           67           67        100  50 gates leased to Delta with
                                                                                   9 leases expiring in 2015 and
                                                                                   41 expiring in 2023.
Detroit....................................           86           76         88  64 gates leased to Northwest
                                                                                   until the end of 2008, with
                                                                                   all but 10 under exclusive-
                                                                                   use terms.
Minneapolis................................           65           65        100  49 gates leased to Northwest
                                                                                   with 16 leases having expired
                                                                                   as of 1996 and on month-to-
                                                                                   month basis, and remainder
                                                                                   expiring at various times
                                                                                   ranging from the end of 1997
                                                                                   to 2015.
Newark.....................................           94           79         84  43 gates leased to Continental
                                                                                   until 2013, 36 gates leased
                                                                                   to the other established
                                                                                   airlines until 2018, and 15
                                                                                   gates reserved primarily for
                                                                                   international use.
Pittsburgh.................................           75           66         88  50 gates leased to USAir until
                                                                                   2018.
----------------------------------------------------------------------------------------------------------------
Source: GAO's presentation of the airports' data, from ``Airline Deregulation: Barriers to Entry Continue to
  Limit Competition in Several Key Domestic Markets'' (GAO/RCED-97-4, Oct. 18, 1996).

                          related gao products
    ``Domestic Aviation: Barriers Continue to Limit Competition'' (GAO/
T-RCED-98-32, Oct. 28, 1997).
    ``Airline Deregulation: Addressing the Air Service Problems of Some 
Communities'' (GAO/T-RCED-97-187, June 25, 1997).
    ``Domestic Aviation: Barriers to Entry Continue to Limit Benefits 
of Airline Deregulation'' (GAO/T-RCED-97-120, May 13, 1997).
    ``Airline Deregulation: Barriers to Entry Continue to Limit 
Competition in Several Key Domestic Markets'' (GAO/RCED-97-4, Oct. 18, 
1996).
    ``Changes in Airfares, Service, and Safety Since Airline 
Deregulation'' (GAO/T-RCED-96-126, Apr. 25, 1996).
    ``Airline Deregulation: Changes in Airfares, Service, and Safety at 
Small, Medium-Sized, and Large Communities'' (GAO/RCED-96-79, Apr. 19, 
1996).
    ``Airline Competition: Essential Air Service Slots at O'Hare 
International Airport'' (GAO/RCED-94-118FS, Mar. 4, 1994).
    ``Airline Competition: Higher Fares and Less Competition Continue 
at Concentrated Airports'' (GAO/RCED-93-171, July 15, 1993).
    ``Airline Competition: Options for Addressing Financial and 
Competition Problems, testimony before the National Commission to 
Ensure a Strong Competitive Airline Industry'' (GAO/T-RCED-93-52, June 
1, 1993).
    ``Computer Reservation Systems: Action Needed to Better Monitor the 
CRS Industry and Eliminate CRS Biases'' (GAO/RCED-92-130, Mar. 20, 
1992).
    ``Airline Competition: Effects of Airline Market Concentration and 
Barriers to Entry on Airfares'' (GAO/RCED-91-101, Apr. 26, 1991).
    ``Airline Competition: Weak Financial Structure Threatens 
Competition'' (GAO/RCED-91-110, Apr. 15, 1991).
    ``Airline Competition: Fares and Concentration at Small-City 
Airports'' (GAO/RCED-91-51, Jan. 18, 1991).
    ``Airline Deregulation: Trends in Airfares at Airports in Small and 
Medium-Sized Communities'' (GAO/RCED-91-13, Nov. 8, 1990).
    ``Airline Competition: Industry Operating and Marketing Practices 
Limit Market Entry'' (GAO/RCED-90-147, Aug. 29, 1990).
    ``Airline Competition: Higher Fares and Reduced Competition at 
Concentrated Airports'' (GAO/RCED-90-102, July 11, 1990).
    ``Airline Deregulation: Barriers to Competition in the Airline 
Industry'' (GAO/T-RCED-89-65, Sept. 20, 1989).
    ``Airline Competition: DOT's Implementation of Airline Regulatory 
Authority'' (GAO/RCED-89-93, June 28, 1989).
    ``Airline Service: Changes at Major Montana Airports Since 
Deregulation'' (GAO/RCED-89-141FS, May 24, 1989).
    ``Airline Competition: Fare and Service Changes at St. Louis Since 
the TWA-Ozark Merger'' (GAO/RCED-88-217BR, Sept. 21, 1988).
    ``Competition in the Airline Computerized Reservation Systems'' 
(GAO/T-RCED-88-62, Sept. 14, 1988).
    ``Airline Competition: Impact of Computerized Reservation Systems'' 
(GAO/RCED-86-74, May 9, 1986).
    ``Airline Takeoff and Landing Slots: Department of Transportation's 
Slot Allocation Rule'' (GAO/RCED-86-92, Jan. 31, 1986).
    ``Deregulation: Increased Competition Is Making Airlines More 
Efficient and Responsive to Consumers'' (GAO/RCED-86-26, Nov. 6, 1985).

                     statement of patrick v. murphy

    Senator Shelby. Thank you.
    Mr. Murphy, welcome again to the committee.
    Mr. Murphy. Thank you, Mr. Chairman.
    In this the 20th anniversary year of airline deregulation, 
the Department of Transportation continues to view deregulation 
as a great success. The positive benefits for the country from 
airline deregulation, I think, are unmistakable: average fares 
that are one-third lower after we adjust for inflation, more 
useful service for more cities, more innovation, greater 
efficiency, more employment, and many other benefits.
    Nevertheless, not all of our cities and our regions have 
shared in the full benefits of deregulation. It has become 
increasingly clear over the past 2 years that some of these 
inequities are growing. We have known, for example, that 
average fares at hub airports where one airline dominates have 
tended to be high, especially if low-fare airlines have not 
been able to enter these airports. Premiums, that is, the 
difference between average fares at dominated hubs and at other 
airports, have increased substantially in recent years. These 
high fares affect more than just the hub cities.
    Spoke cities served primarily by a dominant airline to the 
respective hubs likewise have high average fares. These facts 
lead us to conclude that new entry and expansion by low-fare 
airlines is the key to the competitive vigor of the U.S. 
domestic airline industry, particularly in markets that involve 
dominated hub airports.
    We also know based on our data that the level of 
competition nationally is declining when measured by the number 
of competitors in all markets around the country. For the time 
being, Mr. Chairman, new entry has virtually stopped and most 
low-fare carriers are struggling financially. Therefore, 
barriers to entry faced by low-fare airlines deserve careful 
study.
    The Department has come to the view that the single most 
important impediment to new entry may be unfair actions taken 
by major airlines against new entrant airlines, particularly in 
markets that involve a major's hub airport. These actions 
typically involve fare cuts and capacity increases. Therefore, 
DOT has developed a competition policy statement that it plans 
to release in the near future.
    The policy statement will set forth a proposal for a broad 
competition standard and proposed guidelines that will identify 
the types of behavior that are likely to cause DOT to initiate 
an enforcement proceeding. The guidelines are designed to allow 
normal competitive responses and only prohibit extreme 
exclusionary behavior.
    Secretary Slater will be calling for a full and honest 
discussion on the proposed guidelines in an effort to work with 
industry, lawmakers, consumers, city leaders, State officials, 
and others affected by the airline industry. The end result, we 
hope, will be a clear informed policy that preserves 
competition and protects consumers.
    In addition to unfair behavior, Mr. Chairman, I have also 
identified in my testimony other barriers to entry. Without 
going into those, I will just enumerate them here again, and 
they are slots, computer reservation systems, airport gates----

                        slot-controlled airports

    Senator Shelby. Excuse me, sir. Elaborate a little, expand 
on slots and gates or whatever.
    Mr. Murphy. Yes; we have four airports in this country that 
are slot-controlled.
    Senator Shelby. What are these airports?
    Mr. Murphy. Those airports are O'Hare in Chicago, LaGuardia 
and JFK in New York, and National or Reagan National in 
Washington. There are limited number of takeoffs and landings 
at those airports. Those limitations were put in place as a 
temporary measure in 1968. Thirty years later, they remain in 
place. They remain, we believe, a barrier to entry. We have 
been granting some exemptions around those limitations, but 
they do remain in place.
    Gates are an issue that the GAO has identified. The 
Department has done very little in that area. I must say after 
today's hearing and based on comments we have received in the 
last few weeks, I think that the DOT and the FAA need to focus 
more on the issue of airport gates at dominated airports.
    Senator Shelby. Is that not a big barrier from what we are 
hearing here? Mr. Anderson has seemed to indicate it, and the 
others have testified to that.
    Mr. Murphy. Yes.
    Senator Shelby. It seems sort of obvious.
    Mr. Murphy. When we were first alerted to this by GAO, we 
at that time asked small carriers to notify us if this became a 
problem. They are now beginning to notify us. We have heard 
several complaints just in the last few months about 
unavailability of gates at Detroit, Newark, Atlanta to name 
three. I do believe it is time the Department spent more time 
with the FAA on this topic.
    Other barriers, Mr. Chairman, potentially are computer 
reservation systems and travel agent commission overrides, 
which we have heard about today.
    Senator Shelby. What do you mean by an override? Is that a 
bonus?
    Mr. Murphy. Yes, sir; if an airline, a large airline, will 
pay an extra high commission, especially only on one route 
where there is a new entrant airline, then they will double or 
triple the commission on that one route, that certainly sets 
off concern.
    Then, finally, there is even a potential for the very 
popular frequent flier programs to be used as a barrier to 
entry.

                           prepared statement

    In conclusion, Mr. Chairman, I have listed several 
practices which have raised concerns. I must say any 
consideration of action in these areas must be approached 
carefully. The potential for doing more harm than good is real. 
Competition in the real world is never perfect. At this time, 
airline deregulation works reasonably well. While action in 
some areas is in the Department's estimate clearly required, we 
take the view that only careful, measured steps are 
appropriate.
    Thank you, Mr. Chairman.
    [The statement follows:]

                Prepared Statement of Patrick V. Murphy

    Thank you Mr. Chairman, and members of the subcommittee. I 
appreciate the opportunity to discuss the subject of barriers to 
competition in the U.S. domestic airline industry.
    In this 20th anniversary year of airline deregulation, the 
department continues to view deregulation as a great success. The 
positive benefits for the country from airline deregulation are 
unmistakable--average fares that are one-third lower after adjusting 
for inflation, more useful service to more cities, more innovation, 
greater efficiency, more employment, and many other benefits. All the 
while, the airline fleets have been getting quieter and safety has 
increased. And of course, the innovations and efficiencies of U.S. 
airlines make them the global leaders to the benefit of our economy and 
consumers, as well as travelers around the world.
    Nevertheless, not all our cities and regions have shared in the 
full benefits of deregulation, and it has become increasingly clear 
over the past two years that some of these inequities are growing. We 
have known, for example, that average fares at hub airports, where one 
airline dominates, have tended to be high, especially if low-fare 
airlines have not been able to enter these airports. And ``premiums'', 
that is the difference between average fares at dominated hubs and 
other airports, have increased substantially in recent years. And these 
high fares affect more than just hub cities. We know that spoke cities 
served primarily by dominant airlines to their respective hubs likewise 
have high average fares. And we know that even between hub cities where 
more than one of the major network airlines flies, fares tend to be 
high and are only ``competed down'' significantly when low-fare 
competition enters the market.
    These facts led us to conclude that new entry and expansion by low-
fare airlines is the key to the competitive vigor of the U.S. domestic 
airline industry, particularly in markets that involve dominated hub 
airports. We also know, based on our data, that the level of 
competition nationally is declining when measured by the number of 
competitors in all markets around the country. For the time being new 
entry has virtually stopped, and most low-fare carriers are struggling 
financially. Therefore, barriers to entry faced by low-fare airlines 
deserve careful study.
    The types of barriers to entry that I am going to discuss include a 
range of activities--from those that the department has already begun 
to address to others that the department believes do not necessarily 
need to be corrected. Some of these practices have clear consumer 
benefits, and we have seen successful entry by low-fare airlines in 
spite of some of these barriers. In fact, more than 40 percent of 
domestic passengers today travel in markets with low-fare competition.
    On the other hand, a combination of a number of these competitive 
tools if used selectively to impede the entry of low-fare service in 
particular markets could rise to the level of anticompetitive behavior. 
Therefore, I list below practices which may be barriers to entry that 
might require action in particular instances. However, I do not suggest 
industrywide action is appropriate on each of them.
                     unfair exclusionary practices.
    The department has come to the view that the single most important 
impediment to new entry may be unfair actions taken by major airlines 
against new entrant airlines, particularly in markets that involve a 
major's hub airport. These actions typically involve fare cuts and 
capacity increases. Therefore, DOT has developed a competition policy 
statement that it plans to release in the near future.
    The policy statement will set forth a proposal for a broad 
competition standard, and proposed guidelines that will identify the 
types of behavior that are likely to cause DOT to initiate an 
enforcement proceeding. The guidelines are designed to allow normal 
competitive responses and only prohibit extreme exclusionary behavior. 
In investigations triggered by our guidelines, we will also look 
closely at the way other barriers like those mentioned below may have 
been used in an unfair and focused way against a new entrant.
    Secretary Slater will be calling for a full and honest discussion 
on the proposed guidelines in an effort to work with industry, 
lawmakers, consumers, city leaders, state officials, and others 
affected by the airline industry. The end result, we hope, will be a 
clear and informed policy that preserves competition and protects 
consumers.
                                 slots
    Four major airports in the U.S.--O'Hare in Chicago, LaGuardia and 
JFK in New York and Reagan National in Washington--have limits on the 
number of take-offs and landings under an FAA regulation known as the 
high density airport rule. Although in 1985 the regulations 
incorporated a market mechanism to distribute slots known as the buy-
sell rule, the effect of the rule has been to concentrate slots in the 
hands of the larger airlines. It is virtually impossible for a new 
entrant to gain access to a slot controlled airport for domestic jet 
service. Therefore, the department has recently used authority granted 
by Congress in 1994 to grant a limited number of exemptions to the high 
density rule to new entrants as a way of promoting competition. Some 
additional exemption applications are pending, and we hope to act on 
those.
    The GAO has recommended further that slots be periodically 
withdrawn from incumbents and distributed to new entrants. Several 
bills have been introduced that take this approach. The department is 
currently studying whether slots are being effectively used by 
incumbents.
                      computer reservation systems
    Most airlines rely heavily on travel agents to sell their tickets. 
Travel agents use computer reservation systems to obtain information on 
airline services and prices and make reservations. Since each system is 
owned by one or more airlines, it has long been recognized that the 
airline owners have a significant ability to use the systems in an 
anticompetitive way. For this reason, the Civil Aeronautics Board, and 
now the DOT, have established rules that prevent CRS practices that 
prejudice non-owner airlines. In the past year DOT has adopted several 
new CRS rules designed to address practices that we found disadvantaged 
smaller carriers. Because such computer systems and other electronic 
marketing systems are rapidly developing and changing, DOT is now 
undertaking a complete review of the rules.
                           gate availability
    The availability of airport terminal gates, their location at an 
airport and the cost to lease a gate are matters that have the 
potential to be barriers to entry at some busy airports. Incumbent 
airlines may be in a position to use their contractual arrangements 
with local airport authorities to block or otherwise unfairly 
disadvantage new entry. In responding to a GAO report that dealt with 
this issue we encouraged airlines encountering gate problems to advise 
us. We have received a small number of such complaints. We are 
currently considering whether we need to do more in this area.
                   travel agent commission overrides
    ``Commission overrides'' is the term for extra commission paid to 
travel agents by an airline, usually when the agent gives that airline 
a larger share of the agent's total bookings. If these extra high 
commissions are offered in a targeted manner against new entrants, they 
have the potential to do competitive harm. Most commonly, these 
commissions are based on the total volume of business a travel agent 
gives an airline and are not targeted against one carrier. According to 
a GAO report, the Justice Department conducted an investigation of 
override commissions during 1994 to 1996 and could not show at that 
time that they prevented entry into domestic airline markets. The 
European Commission Competition Directorate is now further considering 
this issue.
                        frequent flyer programs
    These very popular programs, which award free trips and service 
upgrades for mileage flown on an airline, are sometimes mentioned as a 
barrier to entry. Clearly, frequent flyer programs give larger 
airlines, which have more destinations for free trips, an advantage 
over smaller airlines. But these programs are very attractive to 
consumers and can be looked upon as a volume discount for loyal 
customers. Having programs that benefit consumers and thereby give a 
competitive edge is not something that should be discouraged, unless 
they are used in conjunction with other practices to unfairly target 
specific competitors.
    In conclusion, I have listed six practices which have raised 
concern for some. Any consideration of action in these areas must be 
approached carefully. The potential for doing more harm than good is 
real. Competition in the real world is never perfect. At this time 
airline deregulation works reasonably well, and, while action in some 
areas is in the department's estimate clearly required, we take the 
view that only careful, measured steps are appropriate.

                       gate constraints and fares

    Senator Shelby. Thank you both.
    Mr. Anderson, at the airports that the General Accounting 
Office has determined that have gate constraints, are fares 
significantly higher than at other airports?
    Mr. Anderson. Clearly, they are.
    Senator Shelby. Well, would you give us some examples, if 
you have any?
    Mr. Anderson. Sure. We identified 10 airports as having 
operating barriers--either slot controls or long-term 
exclusive-use of gate leases. Of the six airports that have 
long-term exclusive-use gate leases, Charlotte, North Carolina, 
leads the pack. Their fares were 88 percent higher than the 
fares of comparable airports in the country.
    There are 43 airports that are in the large hub category. 
At 10 of these airports, overall fares were 31 percent higher 
than at the other 33 airports in the category. At Charlotte the 
fares were 88 percent higher. Another example, in Cincinnati 
the fares were 84 percent higher. At Pittsburgh the fares were 
72 percent higher. These airports are dominated by one airline.
    Senator Shelby. You have not multiplied that into millions 
of dollars or hundreds of millions, have you?
    Mr. Anderson. No; we have not.
    Senator Shelby. It could be done, could it not?
    Mr. Anderson. Yes.
    Senator Shelby. It is possible. In your testimony, you 
mention a potential solution that you suggested in your October 
1996 report. Would you describe the possible solution and how 
the airports, the airlines and other interested parties have 
responded to your suggestion, if they have?
    Mr. Anderson. This is about gates, you mean?
    Senator Shelby. Yes.
    Mr. Anderson. Basically, what we recommended is that when 
the Department gives grants to airports for improvement of the 
airport facilities they give some extra credit for those 
airports that did not have long-term, exclusive-use gate 
leases----
    Senator Shelby. Incentives, in other words?
    Mr. Anderson. Yes; incentives to get out of these long-term 
leases might be something they could do. The Department 
basically did not concur with us on that recommendation. They 
felt that there were other things that they could do in terms 
of investigating specific instances of predatory prices. There 
are a fairly limited number of airports with such leases. We 
identified six airports with long-term, exclusive-use gate 
leases.
    What we heard here today, too, might help; and I wish we 
had thought about it at the time. The PFC route might be 
another way to go because PFC's do have to be approved, so that 
is another angle that you could look at and the Department 
could take into account. When PFC applications come in, make 
sure that they are going to be providing equal access.

                          airline competition

    Senator Shelby. Mr. Anderson, do you have any judgment on 
how many billions of dollars it is costing the consumers of 
America because of lack of competition in the airline industry?
    Mr. Anderson. I do not have any numbers.
    Senator Shelby. There are some studies out there.
    Mr. Anderson. I believe DOT cited that savings as a result 
of airline deregulation were about $10 billion. I do not have 
any idea what the cost is, but I do know that there are pockets 
of pain in the country where fares are higher and/or service is 
worse, and it needs to be addressed.
    Senator Shelby. Mr. Murphy, the witnesses on the first 
panel have described a range of questionable competitive 
tactics by the network airlines. Do you agree with the 
characterization of how network airlines compete with new 
entrant airlines that people testified here about?
    Mr. Murphy. Yes; I generally concur with the difficult time 
that the new entrant carriers have, and that is why we have 
been active in developing these guidelines for unfair, 
exclusionary behavior that we hope to be issuing in the next 2 
weeks, and to start a dialog with the industry and with civic 
and congressional officials about our guidelines.

               improving aviation competition and service

    Senator Shelby. Mr. Murphy, have you thought about a way, 
or Mr. Anderson, ways that Congress and the executive branch 
and the President and others, especially the Justice 
Department, antitrust, could bring about some kind of a 
concerted effort to bring competition in America where it is 
not with the airlines?
    Mr. Anderson. I would like to address that first, if I can?
    Senator Shelby. Yes.
    Mr. Anderson. You know the causes of these problems are 
complex. You heard that with the first panel.
    Senator Shelby. Very complex.
    Mr. Anderson. There are not any real simple solutions.
    Senator Shelby. But there are solutions.
    Mr. Anderson. There are some solutions, and I have got a 
few suggestions that I will mention to you. One of the key 
things in terms of the problems that we are seeing is a lack of 
competition. The only thing that can be done to improve 
competition is to level the playing field, if you will, and 
that would be a good thing. I believe making more slots 
available through the Department's current relaxation of the 
exemption authority is a good thing, but it is going to be 
limited in what you can accomplish there.
    I think you still have to look at some sort of slot 
lotteries or auctions or maybe eventually some sort of 
elimination of the slots, if you can ever get at that point. I 
think it is an excellent step and this is something that should 
pay some dividends in the future, if the Department follows 
through with its policy on defining predatory behavior and 
practices and follows up allegations very quickly to root these 
things out.
    I believe another thing that would be good--and we need to 
look at this some more in terms of the advantages and 
disadvantages--is providing some sort of incentives for the 
regional jets.
    Senator Shelby. OK.
    Mr. Murphy, as the Department of Transportation develops 
its proposed guidelines that would prohibit exclusionary 
competitive tactics, how do you plan at the Department of 
Transportation to address the barriers that have been discussed 
by the witnesses here this morning? Some would characterize 
your activities in this regard as inherently reregulatory in 
nature. How should we distinguish between reregulation and 
actions to enhance airline competition?
    Mr. Murphy. Mr. Chairman, I take the view that when the 
Congress deregulated the airlines 20 years ago they did not 
repeal the antitrust laws. They also----
    Senator Shelby. They have not worked, though, have they?

                      unfair competitive practices

    Mr. Murphy. They also charged, the Congress charged, the 
Department with the responsibility to make sure there were no 
unfair competitive practices. We have not taken a single 
carrier to task for unfair practices in 20 years.
    Senator Shelby. Why?
    Mr. Murphy. We have used informal jawboning.
    Senator Shelby. How has that worked?
    Mr. Murphy. We found, Mr. Chairman, until about 2 years ago 
that we had quite a bit of success there.
    Senator Shelby. OK.
    Mr. Murphy. New entry was occurring at a very healthy pace. 
In the last 2 years, our jawboning efforts have had much less 
success. We have had some limited success, but the larger 
carriers are more intent on competing very vigorously with the 
small carriers. We now take the view that we will put out these 
guidelines. We do not view them as reregulation. We view them 
as trying to set some standards.
    As a matter of fact, we conducted an investigation based on 
the complaints of two small carriers. We went out and received 
boxes of material from the large airlines. When the large 
airlines gave us that material, they took the view that it 
would be unfair for us to come down on top of them after we 
read this material, because we had never set any standards. 
They had been competing in a certain way for decades; and if we 
want to come down on them, we ought to set some guidelines.
    We looked at that material. We were somewhat surprised by 
what we saw. The intensity of what was going on was of concern. 
We decided to develop these guidelines.
    Senator Shelby. Were you surprised or were you appalled?
    Mr. Murphy. I will just stay with surprised for the record.
    Senator Shelby. That is rather mild.
    Mr. Murphy. At the request of some large carriers, we have 
developed these guidelines. Now we are hearing from some of 
these same large carriers that, This is reregulation. You have 
no legal authority. You have no authority at all on airline 
prices.
    The Secretary is calling for everyone to lower their voices 
a little bit. Let us get these guidelines out there. Let us 
take a look at them. I thought that the chairman of Delta 
Airlines, Mr. Mullen, in New York gave an excellent speech a 
week ago when he asked everybody to be reasonable, to do just 
as I suggested, to see what the Government wants to do. The 
Government has a role here. He was willing to have a dialog on 
this. That is what the Secretary is asking for.
    Senator Shelby. You mentioned the role of the Government. 
Isn't the role of the Government in an environment where we 
have deregulated something to let market forces work, to let 
competition work, to make sure that the environment is a level 
playing field, to make sure there is real competition all over 
America everywhere? Isn't that true?
    Mr. Murphy. That is our view, Mr. Chairman. Our role here, 
if any, is to protect competition, not to protect companies.
    Senator Shelby. Absolutely.
    Mr. Murphy. Just to protect the competitive process so that 
it can work.
    Senator Shelby. Senator Lautenberg.

                          enforcement actions

    Senator Lautenberg. Thanks, Mr. Chairman.
    I am sorry that I was away for such a long period of time. 
We had another transportation review that I was called to. If I 
am redundant in anything that I ask or any of the chairman's 
questions, please feel free to say that you have already 
answered.
    I am kind of curious about things about what, if any, 
enforcement actions have been taken by the Department regarding 
the uncompetitive practices that may be around at various 
airports, at various airlines?
    Mr. Murphy. We have some rules in place, Senator, such as 
the computer reservation systems rules that we continue to 
modify, because that is one area where the large carriers who 
own these systems can take advantage of smaller carriers. We 
have just announced a major review over 18 months of all of our 
computer reservation system [CRS], rules. Well, that is one 
area.
    Another area is in the area of slots. We have been granting 
some exemptions, basically allowing carriers to operate above 
the slot ceilings within the last few months. We plan to do a 
limited number of those, but we cannot do too many or it will 
overload the system.
    In addition, as I mentioned to the chairman, we have in the 
past been able to work with carriers informally. We get a 
complaint from a small carrier and we bring in the carrier and 
we ask them what is going on and we ask them to be a little 
more reasonable. Typically, we get some response. We still do 
some of that.
    We recently got some relief from some of our smaller 
carriers at a certain airport when we asked for a little more 
cooperation at that airport. We continue to do that informally. 
The informal process is not as productive as it had been, so 
most of our effort of late has been on developing these 
guidelines after we conducted two very thorough investigations.
    Senator Lautenberg. Are we going to be awaiting the 
publishing of the report before any serious enforcement actions 
occur or are published?
    Mr. Murphy. Well, we have been working very closely in 
developing these guidelines with the Justice Department. They 
have worked with us on every line of these guidelines. I am 
pleased to point out to you that the Justice Department has now 
started, even while we are working jointly on these standards, 
recent investigations of some of the largest carriers and their 
competitive practices. DOT also will not hesitate even while 
developing these dialogs to move against the situation if we 
think that there is clear abuse.

                         airline laws and rules

    Senator Lautenberg. Without, again, waiting for the final 
publication, do you feel, Mr. Murphy, that any of the 
anticompetitive laws ought to be changed or broadened in any 
way?
    Mr. Murphy. At this time, I would say no. I would recommend 
that our guidelines go out there. They will be, I am sure, 
challenged by some; but if they stand scrutiny and if they are 
allowed to operate, we think they can make a contribution. If 
some airline attorneys are correct, and we have no authority in 
this area, and I do not accept that, but if that were true, and 
we were directed by the courts to get out of this area, then 
the Congress might want to think whether more needs to be done. 
But for now, our authority to deal with unfair competitive 
practices and the Justice Department authority on the antitrust 
laws seems sufficient.
    Senator Lautenberg. Do you have evidence that fares, in 
fact, have come down substantially from the point just before 
deregulation, and how does that compare to the expenses, the 
costs, for operating that we had at that time? We know one 
thing. I think it is fair to say that fuel prices are probably 
less than they were then. The passenger had larger seating 
spaces than they have now.
    Much of the service that the passenger endures, and I use 
the word advisedly, is because there is less available. I mean, 
the carry-on baggage thing, I believe, has gotten out of hand 
because the airlines do not enforce whatever their rules are, 
two bags, one bag, something like that. I saw a lady trying to 
stuff an elephant up in the overhead. [Laughter.]
    It was only disguised as a suitcase.
    Mr. Murphy. Did it work?
    Senator Lautenberg. Well, it kind of squealed a little bit 
as it got up there. No; it is not partisan. The other guy put a 
donkey up there. [Laughter.]
    Senator Shelby. He put his----
    Senator Lautenberg. Well, we will let it go at that.
    Senator Shelby. We had better stop. Stop.

                        routine studies of fares

    Senator Lautenberg. I wonder, are you under routine studies 
of fares? Because there is no doubt in my mind from personal 
experience, and some of this is anecdotal stuff that is not 
worth an awful lot, and, therefore, I wonder whether you could 
give us a report on fares in different marketplaces? Also, we 
want to be sure that fares, low fares, are not predatory. We 
want to be assured, if we can be, that prices in monopoly 
situations do not gouge the public's purse.
    Can we get something back from you or your Department, Mr. 
Murphy, or from GAO giving us a comparison of the fares in 
major cities and major routings? For instance, it costs almost 
$400 to fly round trip between Washington and the New York 
area. It costs $400. When People's Express came into being, 
they were charging $19. They did not survive too long, but they 
did establish the efficacy of this kind of shuttle service.
    I would be curious. Because there are a lot of places that 
you can fly roundtrip for $400 that are further than Washington 
to New York. Much of that fare, I think, is decided--not that 
fare only, I am not talking just about Washington to New York 
or Boston to New York--is decided based on market position. We 
can easily find that out if we do a little studying of the 
situation including the expenses that it takes.
    I am not proposing reregulation, but the one thing that we 
know that we had to be wary of was that it changed to an 
unregulated environment did not bring problems for the public 
that did not exist before. I said that expenses were down. We 
know that meal service, and again I am not a proponent of meal 
service, but it is different. I think it is fair to say that 
salaries were, on the relative basis, higher then. Again, I am 
not trying to raise salaries.
    I just would like to see a comparison that includes, Mr. 
Chairman, the cost for doing business as well as the fares that 
the public is paying.
    Mr. Murphy. Thank you.
    Senator Lautenberg. Will you get that, by the way, for me?
    Mr. Murphy. Yes; Senator, we have done a lot of work in 
those areas, and we will be happy to put that together for you.
    Senator Shelby. Will you do this for the committee too?
    Mr. Murphy. Yes; Mr. Chairman.
    Senator Shelby. I want to thank all of the witnesses for 
their testimony today. I think we have had a spirited hearing 
and an interesting one. We have certainly heard some 
provocative things, and it reaffirms my conviction that this is 
an area that requires constant oversight and attention. It is 
clear that the entire area of aviation competition is very 
complicated.
    I am also convinced that the competitive pressures in this 
industry will continue to evolve, creating new competitive 
scenarios and guaranteeing that establishing and maintaining a 
level playing field will remain a tricky business. Complex 
solutions are rarely the best answers to complex problems. We 
have got to work on it.
    Congress and the administration must continue, I believe, 
to approach these issues cautiously, but at least approach them 
with a way and hope to do something about them. Clearly, 
competition benefits--communities and consumers and travelers, 
business travelers and personal travelers--everybody in 
America. I think we in Congress must promote as competitive an 
environment for airline competition as possible. 
Anticompetitive practices and barriers to competition must be 
exposed and eliminated where possible anywhere in America.

                          subcommittee recess

    This hearing of the subcommittee is now recessed. The next 
subcommittee hearing will be a field hearing to be held next 
Monday at 9:30 at the University of Alabama in Birmingham. The 
topic will be the Appalachian Regional Corridor Highways. Any 
of you who want to fly down there competitively, you can see 
it.
    Thank you. The subcommittee is recessed.
    [Whereupon, at 12:05 p.m., Tuesday, March 5, the 
subcommittee was recessed, to reconvene subject to the call of 
the Chair.]



         AIRLINE TICKETING PRACTICES AND ANTITRUST ENFORCEMENT

                              ----------                              


                          TUESDAY, MAY 5, 1998

                           U.S. Senate,    
             Subcommittee on Transportation
                              and Related Agencies,
                               Committee on Appropriations,
                                                    Washington, DC.
    The subcommittee met at 9 a.m., in room SD-192, Dirksen 
Senate Office Building, Hon. Richard C. Shelby (chairman) 
presiding.
    Present: Senators Shelby and Kohl.

                       NONDEPARTMENTAL WITNESSES

STATEMENT OF ALFRED KAHN, PROFESSOR EMERITUS, CORNELL 
            UNIVERSITY

                   Opening Remarks of Senator Shelby

    Senator Shelby. The subcommittee will come to order. I want 
to welcome each of you to the third airline competition hearing 
of the Transportation Appropriations Subcommittee.
    I realize it is a little early for the Senate, but we have 
a full panel, and we needed to move; so I got the hearing 
called for 9 o'clock, which is a little early.
    If I have learned anything as chairman of this 
subcommittee, it is that the aviation industry is extremely 
complex. As a general matter, my philosophy is that the more 
complicated the problems are in the private sector, the less 
the Government should get involved.
    However, there are remaining problems in the airline 
industry, problems, which affect real people every day. These 
hearings are designed to highlight some of those problems and 
to explore possible solutions to some of them.
    In the first hearing we examined the remaining relics of 
regulation still present in the system, such as slots and 
perimeter rules. More recently, we heard from various airline 
executives who explained how the larger established airlines 
compete with each other and with new entrants.
    Today, our focus is on the status of deregulation and 
airline ticketing practices, including yield management 
strategies and on the application of the antitrust laws to the 
aviation industry.
    Before I introduce our witnesses today, I want to make one 
thing very clear. My end goal here is increased competition 
among the airlines. Competition benefits the consumer by 
lowering ticket prices and improving service.
    I am not interested at all in trying to reregulate the 
airline industry. And, in fact, I will oppose any such efforts.
    However, I do want to ensure that competition is maximized, 
and that the antitrust laws we have on the books are being 
enforced so that consumers may benefit from the maximum amount 
of competition possible.
    On our first panel today, we have Dr. Alfred Kahn. Dr. Kahn 
is well-known and is known as the father of airline 
deregulation, and is probably one of the most knowledgeable 
individuals in the world on aviation economics.
    He will give us today a sense of the state of competition 
in the airline industry and what has happened since 
deregulation.
    I hope he will also comment, if he cares to, on the effect 
the potential airline alliances will have on consumers as well 
as the Department's recent guidelines on predatory pricing.
    On our second panel, we will hear from Professor Darryl 
Jenkins, director of the Aviation Institute at George 
Washington University. Professor Jenkins will give us a better 
understanding of how airlines price their tickets and the 
rationale behind the yield management strategy.
    We will also hear from Mr. Larry Darby, an expert in the 
telecommunications industry, who will discuss how lessons that 
were learned from deregulating the telecommunications industry 
could apply to the aviation industry.
    We will also hear from two representatives of the travel 
agents, Mr. Borden Burr from my home State of Alabama, and Ms. 
Lauraday Kelley, who will share some real live stories of 
problems their customers have with airline ticketing practices.
    Last, we will hear from Mr. Patrick Murphy, Deputy 
Assistant Secretary of the Department of Transportation. Mr. 
Murphy is the administration's point man on airline competition 
and has been a very helpful witness at our previous hearings.
    I welcome all of you here today and look forward to an 
informative discussion.
    Dr. Kahn, do you want to come on up?
    Dr. Kahn, you are no stranger to Washington, as we know, or 
anywhere else, but thank you for coming today.
    Dr. Kahn. Thank you, sir. Thank you, Senator Shelby.
    Senator Shelby. Your written statement will be made part of 
the record in its entirety and you may proceed as you wish.

                        Statement of Alfred Kahn

    Dr. Kahn. Thank you. I will attempt only to summarize it.
    Senator Shelby. Yes.
    Dr. Kahn. I want to express my appreciation of your 
invitation. Your initial remarks have taken the words right out 
of my mouth. I am in total agreement with what you said. And I 
want to compliment you on----
    Senator Shelby. Could you bring that mike up closer to you, 
sir?
    Dr. Kahn. Sure. Yes.
    And I want to express my appreciation for the efforts that 
you are making here to see that we continue to enjoy the 
benefits of deregulation.
    I am proud of the role I played in deregulating the 
airlines. Nothing I say today is intended to suggest the 
desirability of reregulation, but I agree with you totally that 
the essential premise of deregulation was that consumers would 
be protected by competition.
    And it is the threats that I see to the continuing 
effectiveness of competition that I think are the proper 
occasion for your inquiry. And I am delighted to see that the 
Department of Transportation feels the same way and the 
Antitrust Division of the Department of Justice.
    With that, I will just summarize briefly my written 
statement and supplement it with one or two additional 
considerations.

                          Reasons for Concern

    I do believe that we are at a critical juncture in the 
development of the airline industry. And I speak to you with a 
great feeling of urgency for two reasons primarily, to which I 
will then add a third, which is the recent announcement of 
proposed alliances in the industry.
    The first is the sharp increases that have occurred in the 
last few years in unrestricted fares. According to the figures 
of the Air Transport Association, they have gone up something 
like 17 percent in the last 3 years.
    I presented in my written testimony estimates that if we go 
back to 1976, which was the first year before the Civil 
Aeronautics Board began to permit competitive discounting, we 
find that average fares, average yields per mile have declined 
something over 39 percent adjusted for inflation.
    That is, in real terms, they have gone down something over 
39 percent, and that I have no reason to quarrel with the 
estimates of the people at Brookings Institution, that that is 
saving travelers over--upward of $10 million a year.
    Senator Shelby. Dr. Kahn, do you mean that they have gone 
down 39 percent over the period of deregulation?
    Dr. Kahn. That is correct.
    Senator Shelby. OK.
    Dr. Kahn. I am going back from 1976 to 1997. And I think it 
is----
    Senator Shelby. And that translates into how much money 
saved per----
    Dr. Kahn. Well, the Brookings estimates--the last I saw 
were that they were saving travelers $12 billion a year in 1993 
dollars. I mean it has been an enormous boon----
    Senator Shelby. Yes.
    Dr. Kahn [continuing]. To the overwhelming majority of 
travelers. What I think is creating this sense of urgency today 
and the hostility toward the industry and indeed incipient 
movements to reregulate has been what has happened to 
unrestricted fares.
    And I cited the case in my testimony that when the 
Department of Transportation was tentatively considering 
inviting me down for the announcement by the Secretary of 
Transportation of their new policy with respect to unfair 
competition, and it was short notice.
    And I called my travel agent. And she quoted me a fare of 
$616--and she is a friend. With that kind of friend, who needs 
enemies? But she quoted me a fare of $616 round trip. That is 
over $1 a mile.
    Now, we have to qualify that, because we know that short 
distances are generally more expensive per mile, traveling to a 
place--from places like Ithaca, NY, which we often refer to as 
a centrally isolated town in western New York, is more costly 
as well.
    But that compares with average unrestricted fares of 40 
cents a mile. This is over $1 a mile. And you have heard 
complaints of the same sort of thing.
    As I say, the 39 percent is a reduction in average fares. 
In real terms, I calculate that over the same period, 
unrestricted fares have gone not down, but up, over 70 percent 
in real terms.

                       Problems with Reregulation

    Now, in these circumstances, I find some sympathy with the 
mounting calls for reregulation, though I disagree with them.
    The point is that I do not see how anybody can object in 
principle to regulation to protect consumers when you have a 
monopoly and increasing monopoly exploitation.
    But I do not begin to know how you reregulate a small 
portion of an industry's fare structure, which is charged to 
less than 10 percent of all the travelers.
    And I do not begin to know how you take into account all 
the ways in which carriers compete for that traffic. When I get 
somebody who is hiring me to pay those fares, I then get 
automatic upgrades to first class. I stand on separate lines. I 
get frequent flyer benefits.
    Reregulation of a portion of a market seems to be almost 
hopelessly difficult. But clearly the ideal way of protecting 
any and all travelers is free entry, competitive entry into the 
business.
    If it is free, it will ensure that no group of travelers is 
charged more than the cost of serving them alone, on a stand-
alone basis.
    And that, by the way, is the standard that the Interstate 
Commerce Commission and the Surface Transportation Board 
adopted for setting ceilings on captive shippers rates, that no 
group of shippers should ever have to pay more than what it 
would cost them to serve them alone on a stand-alone basis, 
because that is the level that would be--set the ceiling under 
competition.
    And as you are well aware, what has happened in recent 
years has been that when those fares have gone up and we have 
had new airlines coming up on the order of 25 to 40 in the 
middle nineties, precisely because they see an opportunity to 
serve these travelers with unrestricted more or less uniformly 
low fares, much lower than they were being charged, the pattern 
is very, very clear time and again, according to the Department 
of Transportation.
    But I would like to cite you just a few examples that----
    Senator Shelby. Go ahead.
    Dr. Kahn [continuing]. Have been presented in which the 
incumbent carriers after jacking their unrestricted fares up 
and up, then when these people come in, just in the markets in 
which they come up, the incumbent carriers cut their fare very, 
very sharply.
    Even more flagrantly, they greatly increase the 
availability of the discount fares, the very low-discount 
fares, which until that point they restrict in the numbers that 
they offer.
    Within a couple of quarters, I have example after example 
in which then the challenger is driven out of the market. And 
then within one or two quarters, fares immediately go back up 
to higher than the previous level.
    And one of the attachments that I have asked Wally to 
distribute is my letter to the Wall Street Journal of a couple 
of weeks ago, in which I was responding to--how shall I say it 
charitably--a stupid Op-Ed piece, which said that 
``Predation''----
    Senator Shelby. You said it well, Dr. Kahn. [Laughter.]
    Dr. Kahn. Well, I am being moderate, as I am accustomed to 
being. [Laughter.]
    Which said, ``Everybody knows that predation never pays.''
    In fact, the Supreme Court has virtually said the same 
thing, because the moment the fares go back up, the companies 
will not be able to recover the cost of predation, because 
someone else will come back in.
    Well, one example that I gave you was presented on behalf 
of Spirit Airlines on what happened when it entered the 
Detroit-to-Boston route.
    The average--the average fares by Northwest when it came in 
were--between Detroit and Boston were $200 and--almost $260. 
Spirit came in with fares in the $69 to $159 range.
    Northwest immediately reduced its average fares from $260 
to $106, that is average. And, of course, it did it mainly by 
making a lot of discount fares available, and then $100, two 
quarters.
    Spirit was driven out. Within two quarters, Northwest fares 
were back up to $200--first to $189 and then the second quarter 
to $267. In other words they were back higher than they were.
    Senator Shelby. And this happened in many other instances 
as well, has it not, Dr. Kahn?
    Dr. Kahn. Well, there are many, many that are cited. I 
presented that one because it was presented----
    Senator Shelby. It was.
    Dr. Kahn [continuing]. I think to this committee, Senator 
Shelby, by Mark Kahn, who is not a relative.
    Senator Shelby. It was.
    Dr. Kahn. But it has not been refuted, so far as I know.
    Senator Shelby. How do we prevent this? You know, you are 
the father of deregulation. Deregulation has helped just about 
everybody. But that small group has not benefited, but--and it 
seems to me because of if you start a new business, you are 
soon run out of the business.
    How do we keep that from happening?
    Dr. Kahn. Well, it is not an easy matter----
    Senator Shelby. Yes.
    Dr. Kahn [continuing]. To distinguish a legitimate 
competitive--defensive competitive response of the incumbents 
from an aggressive one that is clearly intended to drive the 
people out--the challengers out.
    Senator Shelby. Yes.
    Dr. Kahn. And I am not referring simply to psychological 
motive.
    Senator Shelby. Sure.

                           Signs of Predation

    Dr. Kahn. I am referring to what actually happens. And that 
is why I think it is important to look at the cases. The 
Department of Transportation suggests that one--and I have 
suggested in the past--that one sign would be: Are the 
incumbents merely reducing fares to try to retain the business 
that they would otherwise lose defensively, or are they 
aggressively increasing capacity?
    And one of the other examples that I was going to present 
was offered by the General Counsel of the Department of 
Transportation who showed that in a market--this was--oh, she 
did not say what the market was----
    Senator Shelby. Yes.
    Dr. Kahn [continuing]. But within one quarter, the number 
of fares--the prevailing fare was $300 to $350. And the 
incumbent airline was offering something like 30,000 or 50,000 
seats at that level.
    When the entrant came in, the incumbent airline, which had 
been offering less than 1,000 fares of $75 or less increased it 
to 50,000--almost 50,000 fares that they offered at that level.
    Their average fare, therefore, went all the way back down 
from over $300 to something like $100, because they were 
offering almost exclusively $75 fares.
    They did that for two quarters. The entrant went back out. 
The incumbent then raised its fares, not to $300 to $350, but 
from $350 to $400. And the number of discount seats went from 
50,000 to less than 1,000 again.
    Now, that pattern of action tells me that what we clearly 
are witnessing is price discrimination----
    Senator Shelby. Yes.
    Dr. Kahn [continuing]. What Corwin Edwards once called 
discriminatory sharp shooting clearly aimed at driving the 
incumbent out by leaving no room in the market for the 
incumbent, and then not just with the intention but with the 
demonstrated effect of restoring prices and eliminating the 
offerings, virtually eliminating the offerings of discount 
fares.
    Now, I know no substitute for looking at that pattern of 
action and deciding what is the intent and, even more 
important, have they demonstrated the power to drive these 
people out, and the consequence of eliminating competition.
    And I think the simple answer to the view, the simplistic 
view that comes from the University of Chicago and is 
increasingly in disrepute among economists--but I would be 
happy to show you things I wrote in 1954--in which I said 
exactly the same thing when I was a member of the Eisenhower 
administration's Commission on the Antitrust Laws, which 
clearly demonstrate that once you have done that, nobody is 
going to come right back in.
    As I said graphically, a hunter walking past a field with a 
no trespassing sign may pay no attention to the sign, but when 
he sees that the field just beyond the sign is littered with 
the bodies of previous trespassers, then he is going to think 
twice.
    So I am telling you that no matter what these economists 
are saying about industry generally, about the impossibility of 
predation, I am telling you that I see it. The Department of 
Transportation sees it.
    And if it may be difficult to define, I remind you of what 
Justice Potter Stewart said about pornography. ``It may be 
difficult to define, but I know it when I see it.''
    And I suggest that that is what the Department of Justice 
is struggling with and what the Department of Transportation is 
trying to get at. Perhaps, that is enough to begin on that 
subject.

                      Dangers of Airline Alliances

    I do want to allude at least to the problem of alliances. 
That is a source of concern now that was essentially 
nonexistent just a couple of weeks ago when I first testified 
on this subject to--or when you had your initial hearings.
    I must say at the onset that I do not have a confident 
feeling about what one should do about these proposed 
alliances, but that they clearly require antitrust kind of 
scrutiny seems to be indisputable.
    And I will just give you one example. I wrote an article on 
defending the results of deregulation. I have written several 
of those, one in 1989----
    Senator Shelby. Yes.
    Dr. Kahn [continuing]. In which I cited a statement by 
Julius Maldutis, who was a very respected investment analyst. I 
think he is with Salomon Brothers or was. He said that--he 
pointed out the importance of competition over differing hubs--
--
    Senator Shelby. Yes.
    Dr. Kahn [continuing]. As a way of giving us the benefits 
of competition, even though individual hubs have increasingly 
come to be dominated by single airlines.
    He said, as an example, a traveler planning to go between 
Boston and Phoenix had a choice of nine airlines, mostly one 
stop over different hubs.
    Senator Shelby. Yes.
    Dr. Kahn. And you could figure out which they are and 
whether it is over O'Hare or whether it is over Cincinnati with 
Delta or Pittsburgh or Dallas/Fort Worth or St. Louis. There 
were nine.
    I called my travel agent yesterday and I said, ``If I were 
going between Boston and Phoenix, how many choices would I 
have?''
    She said, ``Eight,'' and she listed them for me.
    I think it is worth calling them to your attention. America 
West, Continental, Northwest, that is three.
    Now, America West already has some sort of an alliance with 
Continental. And Continental and Northwest are talking together 
about getting together in some sort of an alliance. So those 
three go down to one, because of what is just threatened in 
these last 2 weeks.
    Next Delta and United, that makes five. That means the five 
are going down to two, if these alliances go down.
    Next is USAir and American. Well, if they get together, 
suddenly instead of seven, we have three. And the last, which 
makes eight, is TWA. And I am not an expert on this, but I 
question the viability of TWA in competing with these gigantic 
alliances. Certainly the rumors are that TWA will have to be 
looking for a partner as well.
    So within just the events of the last few weeks, we are 
confronted with real travelers between Boston and Arizona being 
confronted with alliances, the content of which I am not 
prepared to analyze, but clearly they raise the specter that 
you will not have eight competitors individually vying for your 
patronage, but only four, just with this change--and highly 
likely, only three.
    So all I can really say about the alliances is, I recognize 
the benefits. I recognize that there are efficiencies 
consequent on this.
    I recognize the arguments of the carriers that code-sharing 
is an essential part of the deal for the cooperation and 
integration of schedules. But I think that the Departments of 
Justice and Transportation have simply got to look into this 
and determine whether here is another threat to the maintenance 
of competition, which has been the main source of the benefits 
of deregulation.

                   Deregulation versus Antitrust Law

    Last sentence, Senator Shelby, whenever I mention these 
things to people, newspaper people or wise guy professorial 
colleagues of mine at Cornell, almost invariably I get a smirk.
    The smirk, in effect, says either explicitly or implicitly, 
``I thought you were in favor of deregulation, and now you are 
proposing reregulation.''
    First, I restrain myself in my answer from saying, ``You 
stupid jerk. Do you not know the difference between the 
antitrust laws and direct regulation?''
    The essence of deregulation was a belief that competition 
would protect the public. That makes the application of the 
antitrust laws more important, much more important than before, 
because we no longer are having direct regulation.
    The antitrust laws, therefore, must be applied rigidly. 
They are a form of regulation, I guess you would have to 
concede. But the philosophy is totally different.
    It is to preserve competition from monopolistic practices 
of exclusion of competitors and from collusion or combination 
practices. And I think that your intent--the intent of your 
original remarks--I think are totally admirable and I 
compliment you on what you are doing.
    Senator Shelby. The antitrust laws though, Dr. Kahn, are to 
prevent monopolies from forming, is that correct?
    Dr. Kahn. That is correct.
    Senator Shelby. Monopolies that would forestall all 
competition as we know it. But an administration, this one or 
any other, will need the will to enforce the antitrust laws 
first and foremost, will they not?
    Dr. Kahn. Absolutely.
    Senator Shelby. And that will not be easy. But if we are 
going to benefit from deregulation, it will have to be done, 
will it not?
    Dr. Kahn. That is absolutely true. And I do not have any 
doubt that both the Department of Transportation and the 
antitrust division now are alert to the problem----
    Senator Shelby. I think so, too.
    Dr. Kahn [continuing]. And determined to do what they can 
about it. But I think we have to keep in mind that the Supreme 
Court has virtually written predation out of the antitrust 
laws.
    Senator Shelby. Yes.
    Dr. Kahn. And they have got to have--well, first we begin 
at the district court level and I recognize that. But they have 
to have their noses pushed into these facts.

                     closer Scrutiny for Predation

    And I had duplicated a graph from the testimony of Steven 
Morrison of a couple of weeks ago, in which he said predation 
is just too hard to determine and tended to pooh-pooh the 
attempt to do anything about it.
    In his own testimony, he has a graph, a copy of which you 
have, showing what happened to the fares between Billings, MT, 
and Denver.
    Senator Shelby. I have it.
    Dr. Kahn. That is the one. If you would, just look and see 
what happened. You see that United's fares were running well 
above $200. Frontier entered, those are the triangles at the 
bottom----
    Senator Shelby. Yes.
    Dr. Kahn [continuing]. With fares roughly $100. These are 
averages. United instantaneously went down to $100. Notice the 
triangles last for only two quarters.
    Senator Shelby. Yes.
    Dr. Kahn. Then immediately Frontier is driven out. And look 
at what happens to United's fares.
    Senator Shelby. They go sky high again, do they not?
    Dr. Kahn. Indeed, higher than they were before. And I wrote 
to Steve Morrison, whom I respect, whose work in this is 
authoritative.
    And I said, ``How do you reconcile what you said with what 
you show in your own graph''?
    We have got to combat this essentially ideological 
statement that ``Predation cannot exist because my theory says 
it cannot exist.''
    Look at the facts. It clearly is taking place.
    Senator Shelby. But, Dr. Kahn, wouldn't you agree the 
purpose behind the antitrust laws and its spirit, if not the 
meaning, aim to make competition work, and from this we all 
benefit.
    Dr. Kahn. Absolutely, absolutely.
    Senator Shelby. In your written testimony, Dr. Kahn, I was 
struck by the urgency of your call for action by the 
administration and, to quote, ``to draw the line between 
healthy and predatory competition,'' two entirely different 
things. Although you propose your own acid test, those are your 
words.
    The Department of Transportation has recently submitted 
guidelines toward the same goal of drawing a line between 
acceptable defensive competition response and competition which 
threatens to restore monopoly power, of which you have just 
shown an example.
    In the new Department of Transportation guidelines, has the 
Department created a framework that will permit healthy 
competition and dissuade predatory activity?
    Dr. Kahn. I believe it has.
    Senator Shelby. Yes.
    Dr. Kahn. I believe it remains to be seen how administrable 
its test is. In effect, what the Department is saying is that 
when the incumbent airlines--the airline, in effect, does what 
I have said, floods the market with discount seats and thereby 
incurs the cost of losing all its sale of the full fare 
tickets----
    Senator Shelby. Yes.
    Dr. Kahn [continuing]. And the figures that I have--I have 
given you show--and those presented by, particularly by the 
General Counsel of the Department of Transportation, that their 
sales of the $300 to $350 tickets during the period of putative 
predation----
    Senator Shelby. Yes.
    Dr. Kahn [continuing]. Went down from something like 50,000 
to something less than 1,000. They sold less than 1,000 of 
those full-fare tickets, because they greatly increased the 
availability of the discount fares.
    Then that is really a cost that they are incurring, and the 
Department of Transportation is saying it would not make any 
sense for them to incur that cost except as an investment in 
driving the competitor out, which they then can recoup 
thereafter.
    But how you are going to measure--but how many of those 
full-fare tickets they would have sold in the face of that 
competition had they not flooded the market with discount seats 
is a tough one.
    And that is what I know they are working on, and that is 
what I know the people at antitrust are working on. And I am, 
in my limited way, trying to help them do that.
    Senator Shelby. Dr. Kahn, do you have an opinion at this 
point on the lack of competition in certain areas of the 
market? You know, we are talking about how much that is costing 
the American people in added fares that ordinarily wouldn't be 
paid if there was competition.
    Dr. Kahn. I have not undertaken----
    Senator Shelby. It is in the billions, is it not? It has to 
be.
    Dr. Kahn. I have not undertaken--I have not taken--
undertaken any study.
    Senator Shelby. OK.
    Dr. Kahn. I think what you would have to do--you might use 
as your guidepost the kind of fares that Southwest Airlines is 
capable of charging and then apply that difference to--now, 
observe that the Southwest Airlines kind of operation is not 
feasible between Ithaca and Washington.
    It seems to me it is feasible between Syracuse and 
Washington. And when--which is 60 miles away from me and I 
would be happy to drive it.
    Senator Shelby. Yes.
    Dr. Kahn. But when I got that fare of $616 round trip--and 
by the way, I was going to have to pay it out of my own pocket. 
I asked my travel agent, ``Well, what if I drive to Syracuse 
where there are five major carriers?''
    She said, ``The fares are all $616.''
    Now, I think that you could at least get a rough 
approximation by saying what--out of areas in which that kind 
of operation of Southwest is feasible, what are Southwest's 
fares?
    How does that compare with the unrestricted fares being 
charged? And apply that to the--I do not know whether it is 5 
percent or 10 percent of all travelers who are paying those 
very high fares. That might give you a notion of the order of 
magnitude of the cost.
    Senator Shelby. You also, Dr. Kahn, talked about the 
options between Boston and Phoenix; I believe that was an 
example.
    Dr. Kahn. Yes.
    Senator Shelby. Going from eight to four because of the 
allowances, is that correct?
    Dr. Kahn. That is correct.
    Senator Shelby. Are four options enough to maintain a 
competitive environment?
    Dr. Kahn. Well, I do not think any economist knows the 
answer to that.
    Senator Shelby. Yes.
    Dr. Kahn. You can have markets in which if you have four 
people, you can have effective competition.
    Senator Shelby. Yes.
    Dr. Kahn. But first of all, we are talking about four, 
which probably means three.
    Senator Shelby. Yes.
    Dr. Kahn. Moreover, we are talking about an industry that 
has already demonstrated their propensity to what is--what is a 
polite word? The technical economic term is ``screw'' the 
person who has to travel on short notice because somebody in 
the family is sick or the small businessman who cannot 
negotiate special deals. It has already demonstrated that 
propensity.
    Senator Shelby. Would exploit be too mild a term?
    Dr. Kahn. Thank you.
    Senator Shelby. OK.
    Dr. Kahn. Thank you for that more refined--it is not the 
first that came to my mind. [Laughter.]
    And so I--in those circumstances I think that I would 
regard with real alarm--particularly in the context of not one 
successful case yet against predation.
    Senator Shelby. Dr. Kahn, you indicate also in your 
testimony that the combined factors of rapidly escalating 
unrestricted airfares, incipient efforts to reregulate, and the 
current status and complaints of many of the low-cost, low-fare 
new entrants create a recipe for the greatest threat to airline 
deregulation since we embarked on this path 20 years ago.
    Although, I do not believe myself that efforts to 
reregulate will have many supporters in the final analysis, and 
I trust they will not, I believe that proper attention now, 
from the Departments of Transportation and Justice and 
appropriate attention from the Congress, the House and the 
Senate, may promote, Dr. Kahn, the continued evolution of 
deregulation, which is what we want to keep going.
    Lack of attention from the administration may increase the 
pressure for or make possible a reregulation aviation industry 
that none of us want. Do you share this view at all, or what is 
your opinion?
    Dr. Kahn. Completely and unequivocally, that is my central 
message.
    Senator Shelby. If so, what should Congress focus on 
specifically to foster, to bring about a more competitive 
environment for air travel?
    We have used the committee to try to focus on what is going 
on. Now, how do we go the next step?
    Dr. Kahn. Well, I think at the present stage, what is 
urgently important is that you keep your eye on what the 
Department of Transportation is trying to do and what the 
antitrust division is trying to do.
    Give them all the support you can, morally and 
philosophically.
    Senator Shelby. Yes.
    Dr. Kahn. To the extent that you can, by your own findings 
endorse a finding that predation is possible and predation does 
indeed seem to be occurring, that that may conceivably have 
some influence on the courts--that, who otherwise seem 
disposed----
    Senator Shelby. You are creating a competitive environment 
in a sense, are you not?

                         Preserving Competition

    Dr. Kahn. That is exactly right, and to preserve 
competition.
    Senator Shelby. Right.
    Dr. Kahn. And if I may give you another example?
    Senator Shelby. Go ahead. We appreciate you being here.
    Dr. Kahn. When I was before the Aviation Subcommittee a 
couple of weeks ago, there was a representative of Northwest 
Airlines who was there.
    Senator Shelby. Right.
    Dr. Kahn. And when I talked about what happens when the 
incumbent floods the market with these discount seats, 
eliminating all restrictions, he said, ``Well, you are asking 
us--you are--you are having the Government--you are proposing 
that the Government come in and tell us how many discount seats 
we may offer, rationing the number of discount seats.''
    And I turned to him and said, ``What the hell have you been 
doing all this time?'' That is precisely what you do.
    Senator Shelby. Yes.
    Dr. Kahn. You ration the number of discount seats. 
According to the figures of the General Counsel in this 
particular route, you allowed only 1,000--less than 1,000 
discount seats. Then suddenly, you derationed. And you offered 
50,000 of them. After driving the other people out, you 
reinstated rationing of discount seats.
    Senator Shelby. Yes.
    Dr. Kahn. So, again, I think it is at the present oversight 
and earnest attention that influence the administration 
agencies, who have been lamentably lax in most of the 20 years 
since airlines were deregulated, permitting mergers that the 
Department of Justice itself opposed.
    But now they seem to be really anxious to move--eager to 
move--and supporting them is, at the moment, is all I can think 
of.
    Senator Shelby. Dr. Kahn, are the days of regional carriers 
numbered if the current market dynamics continue?
    Dr. Kahn. Well, the age of truly independent regional 
carriers may already have passed.
    Senator Shelby. Yes.
    Dr. Kahn. I think all we can do--I am sorry. Perhaps I 
should finish that idea.
    What has happened, of course, is that the major carriers 
dominating the hubs have already entered into often exclusive 
code-sharing agreements with regional carriers.
    Senator Shelby. Right.
    Dr. Kahn. And I think one aspect of looking at the effect 
of these alliances that I am eager to see the Department of 
Justice and Transportation undertake is: What is the status of 
independent short-haul carriers, who want to enter on some of 
these spoke markets and their ability to compete with the 
incumbent regional carriers, who have code-sharing agreements 
with the dominant carriers?
    Now, I know that Frontier presented testimony to you----
    Senator Shelby. Yes.
    Dr. Kahn [continuing]. That they were unable to deal with 
United at the Denver hub and have interlining agreements on the 
same terms as the United affiliate, United Express.
    Senator Shelby. Yes.
    Dr. Kahn. So I think keeping open the opportunities for 
independent airlines to operate, to join with the hub-
dominating carriers ought to be a priority and observe that it 
is very similar to what we are doing in telecommunications and 
in the electric power industry.
    As we are proceeding to deregulate those industries--and 
most of my work is in those industries----
    Senator Shelby. Yes.
    Dr. Kahn [continuing]. We recognize that we cannot have 
effective competition unless we make sure that the incumbent 
monopoly utility companies, which control the access to the 
market by their competitors because the wires, the transmission 
lines, and the distribution lines are monopolies.
    We have to make sure that the incumbent companies provide 
equal access by competitors as well as----
    Senator Shelby. Are open----
    Dr. Kahn. Open--open to competitors. And it may be that the 
same analogy ought to be applied to access to interlining 
agreements at the hubs with the hub-dominating carriers.
    Senator Shelby. Yes; Dr. Kahn, there is a great deal of 
attention on the monopoly power exercised by the largest 
players in the airline industry.
    At the same time, profit margins in the industry are low by 
other industry standards. Is a low-profit margin consistent 
with predatory pricing or monopoly power?
    Dr. Kahn. Yes; of course, it is.
    Senator Shelby. Explain.
    Dr. Kahn. The--first of all----
    Senator Shelby. You can explain better than we can.

                     Profit Margins and Competition

    Dr. Kahn. I will try. We do have to recognize that the 
airline industry has never been a highly profitable industry.
    Senator Shelby. Yes.
    Dr. Kahn. That was true under regulation. It clearly has 
been true under deregulation. I do remember, however, compiling 
figures on their profit margins----
    Senator Shelby. Yes.
    Dr. Kahn [continuing]. Before in the 10 to 15 years before 
deregulation. And I am sorry that I do not have the tables at 
my fingertips, but the average was on the order of 2.0 percent, 
a very low margin.
    Senator Shelby. Could you furnish that for the record?
    Dr. Kahn. I would be happy to.
    Senator Shelby. Good.
    Dr. Kahn. Well, will you help me to remember, please? 
Especially at my age, I need help.
    Senator Shelby. All right. [Laughter.]
    [The information follows:]

U.S. Scheduled Airline Industry Consolidated Industry Rate of Return on 
Investment

                                                                 Percent
1955.............................................................. 10.8 
1956..............................................................  8.8 
1957..............................................................  5.1 
1958..............................................................  5.2 
1959..............................................................  6.2 
1960..............................................................  3.2 
1961..............................................................  2.1 
1962..............................................................  5.7 
1963..............................................................  6.5 
1964.............................................................. 10.8 
1965.............................................................. 11.8 
1966.............................................................. 11.0 
1967..............................................................  7.6 
1968..............................................................  4.9 
1969..............................................................  3.3 
1970..............................................................  1.2 
1971..............................................................  3.5 
1972..............................................................  4.9 
1973..............................................................  5.1 
1974..............................................................  6.4 
1975..............................................................  2.5 
1976..............................................................  8.5 
1977.............................................................. 10.2 
1978.............................................................. 13.3 
1979..............................................................  6.5 
1980..............................................................  5.3 
1981..............................................................  4.7 
1982..............................................................  2.1 
1983..............................................................  6.0 
1984..............................................................  9.9 
1985..............................................................  9.6 
1986..............................................................  5.2 
1987..............................................................  7.2 
1988.............................................................. 10.8 
1989..............................................................  6.3 
1990.............................................................. (6.0)
1991.............................................................. (0.5)
1992.............................................................. (9.3)
1993.............................................................. (0.4)
1994..............................................................  5.2 
1995.............................................................. 11.9 
1996.............................................................. 11.5 
1997.............................................................. 14.9 

Source: Air Transport Association.

    Dr. Kahn. The witness from Northwest Airlines said they now 
are earning only 5 percent margin. Well, that is 150 percent 
more. That is two and one-half times the average that I found 
that they earned in the prederegulation period.
    But, look, the industry has been through terribly bad 
times. They lost tremendous amounts of money in the 1990 to 
1993 period. It is highly profitable right now. A monopoly is 
something that exists market by market.
    Senator Shelby. Yes.
    Dr. Kahn. First of all, profit margins are not a good 
measure of profitability.
    Senator Shelby. Yes.
    Dr. Kahn. If you look at the margins of retail grocery 
chains, they are less than 1 percent. The critical thing is 
what are they as a percentage of----
    Senator Shelby. So you cannot see the margin sometimes?
    Dr. Kahn. Yes; that is right. But second, the antitrust 
laws and the policy of competition never has justified somebody 
saying, ``Well, we are not very profitable; therefore, permit 
us to cut the throats of some of our competitors.''
    If the industry is not capable of being viable under 
competition, then let it make its case to Congress that it 
should be reregulated and protected from competition, but not 
let it violate the antitrust laws and take it upon itself----
    Senator Shelby. Yes.
    Dr. Kahn [continuing]. To decide that its profits are not 
high enough and, therefore, it should be permitted to engage in 
destructive predatory competition.
    Senator Shelby. Dr. Kahn, we appreciate you coming down 
here. We wish we had had a plane to send after you----
    Dr. Kahn. I am----
    Senator Shelby [continuing]. From time to time. And we know 
that we will be calling on you again. And we appreciate it.
    Dr. Kahn. I am very grateful.
    Senator Shelby. We appreciate more than anything--I think 
the American people do, most of them--what you did to 
deregulate the airline industry and what you are trying to do 
to make sure that it works for everybody.

                           Prepared Statement

    Dr. Kahn. I am proud of it. And I thank you very much, 
Senator.
    Senator Shelby. Thank you, sir.
    Dr. Kahn. Fine.
    [The statement follows:]

                  Prepared Statement of Alfred E. Kahn

    I am grateful for this opportunity to testify before you. I do so 
with a sense of urgency because in my judgment events in the airline 
industry are moving with such rapidity as to raise what seems to me the 
greatest threat so far to what we worked so hard to accomplish 20 years 
ago.
    The events to which I refer are the sharp increases over the last 
year or so in unrestricted fares; incipient efforts to re-regulate, 
which can only intensify over time, unless the dominant carriers 
demonstrate greater restraint than they have recently in exploiting 
non-discretionary travelers; the many complaints of asserted predation 
that I understand have poured into the Transportation and Justice 
Departments from the many low-cost, low-fare carries that entered the 
market around 1994-96; the failures of many of them and the financial 
plight of those that remain.
    The Air Transport Association reports that average airline yields 
have increased from 8.0 cents per mile in 1976--just before the Civil 
Aeronautics Board began to permit large-scale discounting, in the 
initial stages of deregulation--to 13.72 cents in 1997. Since the 
Consumer Price Index increased during that same interval by 182 
percent, the increase in nominal yields of slightly less than 50 
percent translates into a decline, in inflation-adjusted terms, of 39.2 
percent.
    I do not have an authoritative figure for what average full fares 
were in 1976. Since, however, discount traffic constituted only a very 
small proportion of the total, I suspect it exaggerates the increase in 
full fares over the last 20 yeas only slightly to assume that the 8.0 
cent average yield in the initial year was not much lower than the 
average price per mile at which passengers could purchase tickets at 
the last moment and without having to stay over a weekend. Under that 
assumption, average full fares increased almost five fold during this 
period in nominal dollars--from 8.0 to its 1997 level of 39.07 cents 
per mile--and by some 73 percent, inflation adjusted.\1\
---------------------------------------------------------------------------
    \1\ This estimate is roughly confirmed by the ATA statistics for 
1978 to 1997, which show average yields per mile declining 33.8 percent 
during that slightly shorter period and full fares rising 62.1 percent, 
both in inflation-adjusted dollars.
---------------------------------------------------------------------------
    Even though it is of course inherent in averages that the combined 
weight of the full fares that increased more than 73 percent was 
exactly offset by the fares that increased less than that, and one of 
the economically efficient consequences of deregulation has been it has 
corrected the previous deliberate subsidization of short and thin 
routes by long-distance travel on dense routes, the legitimate public 
outrage over what has happened to unrestricted fares, on average, 
compounded by what has happened on the previously subsidized routes. I 
cannot refrain from pointing out, for example, that when, recently, the 
Transportation Department invited me, on short notice, to be present at 
the Secretary's announcement of their recent policy statement, I was 
told that the full fare, Ithaca to Washington and return, was $616--
over $1 a mile!
    In these circumstances, the mounting calls for reregulation are 
understandable. I do not see how one can object on principle to direct 
regulation or reregulation to protect consumers from monopolistic 
exploitation. The phenomenon of hubbing clearly has--along with such 
accompanying practices as frequent flier credits and override 
commissions to travel agents--produced situations of real monopoly 
power, which the carriers are ever more effectively exploiting, at the 
expense of non-discretionary travelers. But I don't begin to know how, 
practically, to reregulate one portion of a fare structure, paid by 
less than 10 percent of travelers. Or, if we tried to do so, how we 
would take into account all the non-price inducements with which 
airlines have been competing for traffic--automatic upgrades to first 
class, separate and shorter lines at the check-in counter, frequent 
flier credits and so on. Or the indisputably higher cost of offering 
those non-discretionary travelers the ability to book seats at the last 
minute.
    The theoretically correct basis for such charges to subgroups of 
customers, advocated by me and other economic witnesses and adopted by 
the ICC and Surface Transportation Board as the basis for seeing 
railroad freight charges to captive shippers under the Staggers Act, is 
stand-alone costs--the hypothetical cost of serving any partial 
grouping of customers alone. That is the ceiling that would prevail if 
there were perfectly free entry: in those circumstances rates higher 
than the current cost of efficiently serving any group or subgroup of 
customers would be undermined by new entrants. But measuring those 
costs in the railroad context has proved litigious and expensive, and I 
suspect it would be even more difficult in the case of the airlines, 
because of the need to take into account all the dimensions of service 
quality to which I have already referred.
    Clearly, the best way of ensuring that such a ceiling will prevail 
is free entry itself; and it was indeed on freedom of competitive entry 
that we relied for the protection of travelers when we deregulated the 
airlines. But what seems to have occurred time and again in recent 
years has been: unrestricted fares are jacked up and up; that induces 
entry of low-cost, more or less uniformly low-fare rivals, emulating 
Southwest, who can profitably serve those customers at much lower 
fares; the incumbents then cut their fares deeply and sharply increase 
the number of low-fare seats they offer on the routes--and only on the 
routes--on which they have been challenged; the new entrant departs; 
and fares immediately go right back up, with no further challenge. That 
is the kind of scenario that the Department of Transportation says it 
has seen played out many times in the last few years and that it sees 
as crying out for remedy.
    I agree with it. Confronted with that kind of objective sequence of 
events, I am prepared to characterize the response of the incumbents--
if the Department has accurately described them--as predatory: I see no 
reason to require any further demonstration. The most grievous 
governmental failure in recent years has in my opinion been the failure 
to prosecute a single case against what appear to have been just such 
cases of flagrantly predatory competition by incumbent major airlines 
against new competitors; and I applaud the apparent intention of the 
Department (to whose recent policy statement on the subject I made a 
modest contribution) now to undertake a vigorous enforcement effort.
    The history of the airline industry over the last 20 years clearly 
demonstrates the great importance of entry by low-cost, uniformly (or 
much more uniformly than in the case of the major carriers) low-fare 
carriers in keeping the industry competitive--so long as they survive. 
As I understand it, many if not most of the recent new entrants have 
either already been driven out of business or are in danger of being 
driven out, leaving the surviving major carriers with the power to 
raise prices once again after their departure. If that happens, I see 
no way in principle to oppose what I anticipate will be mounting 
pressure for reregulation.
    The antitrust laws prohibit, among other things, price 
discrimination whose effect ``may be substantially to lesson 
competition or tend to create a monopoly.'' The Department of 
Transportation evidently has information strongly suggesting that some 
carriers have engaged in just such a practice (which Corwin V. Edwards, 
an eminent antitrust economist, once characterized as ``discriminatory 
sharpshooting''), with precisely that intention and consequence, and 
that consumers are already paying the price.
    I do not suggest it is easy draw the line between healthy and 
predatory competition--between an acceptable, defensive response by 
incumbents to new completion and one that threatens to restore monopoly 
power; but I am convinced that drawing such a line is necessary if we 
are to continue to have an effectively competitive industry. The recent 
behavior of unrestricted fares suggests that the need is urgent.
    The acid test--whether framed as a test of predatory intent or of 
the likely objective anti-competitive consequences of such responses--
it seems to me, is or should be whether the incumbent airline is 
deliberately accepting financial losses, in the markets where it is 
subjected to competitive challenge by the entrants. Such a course of 
conduct would make no sense except if it regarded those losses as an 
investment in reestablish its previous position of dominance and, with 
it, the ability to recoup them in higher prices thereafter. Where the 
meeting of competition consists merely in offering a sufficient number 
of discounted fares to fill seats that would overwise be empty, the 
incremental costs are likely be so low that the traffic retained in 
this way might well be compensatory. But where, as I understand is 
often the case, the incumbent carrier responds by flooding the market 
with discount seats--partly by simply increasing the number of such 
seats it offers on its previously scheduled flights, but particularly 
if it also increases the number of its flights on the challenged 
routes--the incremental cost against which its revenues should be 
tested (to see if it is indeed deliberately taking losses) are not 
simply the very small cost of additional fuel, ticketing and baggage 
handling incurred in filling seats on flights that would otherwise go 
empty but would properly include the net revenues that those added 
flights were previously making or could make in other markets. In these 
circumstances, it seems to me the requisite predatory intent and threat 
to competition should be demonstrable.
    The Department of Transportation's policy statement would add to 
those opportunity costs the loss of revenue from sales of full-fare 
tickets consequent on the incumbent carrier's sharply increased offer 
of discounted seats. While I am not aware that the courts have 
heretofore recognized this possible component of the temporary losses 
of a putatively predatory policy, it seems to me correct. When, faced 
with a challenge to their previous rate structures, with their 
component of 40 cent per mile charges (the national average) for last-
minute, unrestricted fares, the carriers abandon their previous 
policies of sharply restricting the number of discount fares 
available--as well as stipulating restrictive conditions that travelers 
must meet to qualify for them--the consequent diversion of their own 
traffic from full-fare to discount-fare is one of the costs of their 
responses--costs that, experience seems clearly to demonstrate, they 
not only hope to recover after driving the interlopers out of the 
market but do.
    Unfortunately the courts have in recent years virtually defined 
predation out of the antitrust laws, on the theory--recently repeated 
in a vapid op-ed article in the Wall Street Journal by a Vice President 
of the Competitive Enterprise Institute, that ``in practice such 
predatory behavior rarely if ever works. To make the gambit worthwhile, 
the predator must not only make monopoly profits at the end, but make 
enough to compensate for its lost revenue--plus interest. That's hard 
to do, especially since another airline could always enter the market 
at a later date. In the history of anti-trust law, there have been few, 
if any, cases of successful predator pricing.'' \2\
---------------------------------------------------------------------------
    \2\ James L. Gattuso, ``Don't Outlaw Cheap Airfares,'' The Wall 
Street Journal, April 8, 1998.
---------------------------------------------------------------------------
    In effect, the Department of Transportation believes that such 
contentions represent a triumph of theory over fact. So did I: I take 
the liberty of attaching a copy of my letter to The Journal published 
just this Monday, accompanied, to my great satisfaction, by a similar 
letter from Representative Greg Ganske.
    Having severely criticized the succession of Administrations over 
the last 15 years or more for their failure to recognize the importance 
of antitrust and antitrust-like policies in vindicating the 
deregulation that was enacted with such broad scale bipartisan support 
in the late 1970's, I am delighted to have this opportunity to praise 
the Department of Transportation for its initiative.
    This is not a question of ideology; nor am I or the Department 
proposing ``reregulation'' of the industry, as the incumbent major 
airlines are quick to claim. On the contrary, deregulation makes sense 
and can continue only in the presence of effective competition as the 
protector of consumers. The scores of competitors that have entered the 
industry over the last 20 years attest to the widespread eagerness of 
enterprisers to take the risks of competing that is an essential 
ingredient of free markets. But the history of their entry and demise 
also demonstrates the essentiality of vigorous government intervention 
to keep open the opportunity for that entry, free of the threat--
apparently abundantly demonstrated by the actual practice--of predatory 
responses. The vapid assertion that such responses will not pay because 
re-entry is always possible in effect denies that the major airlines 
have done what the Department says it has strong reason to believe they 
have in fact done. It also denies the logic that my former student, 
Irwin Stelzer, graphically expounded when he said that a hunter, 
passing a field posted with a No Trespassing sign, may well ignore that 
warning; but if he sees the field just beyond the sign littered with 
the bodies of previous trespassers, he is likely to pay it greater 
respect.
    I urge you to give the Department of Transportation your 
sympathetic support--and legislative assistance, if necessary--in its 
effort to forestall or remedy discriminatory sharpshooting by incumbent 
airlines that restores their ability to charge captive customers fares 
of 40 cents a mile and more, while posting No Trespassing signs that 
they have given future would-be challengers excellent reason to 
respect.

                       Introduction of Witnesses

    Senator Shelby. Our second panel will be on the subject of 
airline yield management and ticket pricing practices. We have 
Prof. Darryl Jenkins, director of the Aviation Institute, 
George Washington University.
    We have Mr. Borden Burr, president, All Seasons Travel 
Agency in Birmingham, AL; Ms. Lauraday Kelley, vice president, 
Cruiselink, Hummelstown, PA; and Mr. Larry Darby, president of 
Darby Associates.
    If you folks would just take your seats at the table.
    [Pause.]
    Professor Jenkins--well, I will say it to all of you, your 
entire written statement will be made part of the record in its 
entirety. And I will ask you to come in and proceed as you 
wish.
    Professor Jenkins, you may proceed.
    Dr. Jenkins. Thank you very much.
    Senator Shelby. Pull it a little closer, because we have 
got a big audience today.
    Dr. Jenkins. Is this better?
    Senator Shelby. That is better.
STATEMENT OF PROFESSOR JENKINS, DIRECTOR OF THE 
            AVIATION INSTITUTE, GEORGE WASHINGTON 
            UNIVERSITY
    Dr. Jenkins. Good morning, amid the current fury and sound 
over airline pricing and competition, I welcome the opportunity 
to provide some facts and background that will help to inform 
rather than to inflame the debate.
    As the author of seven books on airline pricing and 
service, and as a consultant to just about every major airline, 
and at least five startup airlines, I bring some modest 
experience to the current discussion.
    I began this industry in 1974 as a travel agent. I am proud 
to be in it ever since.

                  Pricing and Yield Revenue Management

    Let me start first with airline pricing. It may be 
instructive to use the example that Prof. Alfred Kahn has 
already provided with this and in previous hearings.
    On very short notice, Professor Kahn booked a flight from 
Ithaca, NY, to Washington, DC, and paid over $616 round trip 
for the purchase. It goes without saying that Professor Kahn 
paid more than he would have liked. But if the fare had been 
one-half what he had paid, it is likely Professor Kahn would 
have never been on that flight.
    Given the robust economy and the unprecedented demand for 
air travel, the airline could have sold every seat on that 
flight weeks in advance for the restricted fare of less than 
$225.
    Instead, the airline sold some of its seats at deep 
discounts in advance and held some seats back for those wanting 
to travel at the last minute, like Professor Kahn.
    In effect, the airline used price as the means to allocate 
scarce resources, in this case, an airline seat. To decide 
exactly how many seats to offer and at what price, airlines use 
a system called revenue management. Revenue management allows 
an airline to decide how many seats to sell at which price on 
each flight at various fare levels; restricted discount fares, 
unrestricted discount fares, senior discount fares, and most 
importantly how many seats to hold back for business travelers 
who buy their tickets at the last minute and change plans 
frequently.
    Revenue management allows airlines to maximize their 
revenues by making sure that every seat on the airline is full. 
Revenue management is clearly good for the airline by helping 
to maximize revenue and most importantly to even out demand.
    Revenue management is also good for consumers. It provides 
a wider range of travel options, availability in fares that a 
broader group of consumers can afford.
    Professor Kahn talks about an increase in the average full 
fare since deregulation. This is true. Unrestricted airfares 
are higher. But the number of people who actually pay the full 
fare is small.
    Just to illustrate the point, I have attached a chart that 
shows the fare distribution on many flights.
    [Chart.]
    As you can see, less than 10 percent of consumers pay full 
fare. In fact, over one-half of the plane is flying on a 
discount of at least 70 percent. And almost 70 percent of 
passengers on the plane are flying at one-half off.
    Certainly, there will always be a group of consumers who 
are willing to pay a significant premium for added convenience 
or last-minute service.
    Professor Kahn, for example, could have mailed his 
testimony to this committee for 32 cents if he had finished it 
4 or 5 days ago; or he could have paid $10, 31 times as much 
mailing it today using Federal Express, wildly different prices 
for a very different service; so too, with airlines where every 
seat is really different, with different restrictions and 
different benefits.
    Discussions about high fares is important, but should not 
obscure what is happening at the low-fare side of the equation. 
While a relatively small number of people will actually fly at 
the highest fare, the vast majority of Americans are flying at 
cheap, very cheap fares.
    In fact, air travel has never been cheaper in real terms. 
Check out Sunday's Washington Post. You can fly round-trip from 
Washington to Atlanta on Delta for $124; Los Angeles for $305 
on American and United; or Chicago for $104 on Air-Tran.
    Cheap fares are also available on the so-called low fare 
and new entrant markets. In fact, the market share of these 
low-fare carriers has reached an historic high, somewhere 
around 18 percent according to Steve Morrison.
    This is good because it provides consumers with low-fare 
choices and big airlines with competition. What is not good, 
however, is DOT's recent guidelines on predatory pricing.
    These guidelines attempt to protect the new entrants from 
alleged predatory practices at the hands of the big airlines. 
But DOT and professor's basic premise about why new entrants 
fail is fundamentally flawed.

                    Reasons for New Entrant Failure

    New entrants, in fact, need no help failing. They do it 
perfectly good on their own. They have been doing it for years 
on their own.
    I have examined every bankruptcy filing of every airline 
that has gone out of business since 1978. And they all have one 
fact in common, not one of them mentions--not one mentions 
predation as a causation of their demise, not one.
    If we--I want to put this in a bigger context now. If we 
look at all of the routes in the domestic system where 
predation is alleged, it is not even \1/100\ of a percent of 
the total domestic capacity.
    This is the problem that we are arguing about today, when 
out at Leesburg Tracon, they have 30-year-old computers. That 
is a significant problem. That is a capacity constraint.
    Over one-quarter of new restaurants make it through their 
first 2 years. They fail because of bad service, management 
miscues, flawed pricing, and inadequate financing, among other 
reasons.
    And airlines fail at about the same rate. As a matter of 
fact, the rate of failure among new entrants is at its all-time 
low. During the eighties, between 1983 and 1988, new entrants 
actually had a shorter lifespan than they do now.
    Upstart airlines are notorious for underestimating their 
costs and miscalculating break-even load factors, consumer 
demand, and the competitive response.
    Vanguard, for example, is constantly changing its route 
structure. In just 2 years, it has entered and left over 25 
different city pairs. I recently called the vice president of 
marketing at Vanguard and asked him his previous pricing 
policy.
    He said, ``We had a bad product and we priced it 
accordingly.''
    Since 1995, Vanguard has lost in excess of $25 million.
    Successful low-fare airlines like Southwest, on the other 
hand, are extremely careful about the routes they serve. They 
do not serve Syracuse for a reason.
    In fact, in its 26-year history, Southwest has withdrawn 
from only a single market after it has launched service. One or 
two markets is all we could document.
    Big airlines do respond to competition by lowering their 
prices. That is how the marketplace works, ``We will not be 
undersold.'' It is a fundamental rule.
    If the new entrant airlines have legitimate complaints 
about predation, there are legitimate ways to handle this. I do 
not see lawsuits being used. If the evidence is clear, then let 
them bring forth an antitrust issue.
    It scares me, Senator, when you have Government regulators 
who do not have even 1 minute of practice in airline pricing 
telling those who do this on a day-to-day basis how they should 
do their job.
    Thank you.
    Senator Shelby. Mr. Borden Burr.
STATEMENT OF BORDEN BURR, PRESIDENT, ALL SEASONS TRAVEL 
            AGENCY
    Mr. Burr. Good morning, Mr. Chairman and members of the 
committee. I am delighted to be here this morning to discuss an 
issue of critical importance not only to my customers and the 
businesses of Birmingham and the entire State of Alabama, but 
to all travelers--airline ticketing and competition.
    First, Mr. Chairman, on behalf of all of us, we wish to 
express our gratitude to you for holding these hearings and for 
all you have done to focus attention on the needs of all 
travelers, business people, individuals wishing to travel to 
visit families and friends, and those seeking business 
opportunities.
    Not only have you held hearings that have shed light on the 
restrictive Wright amendment, but you have taken important 
action to address other factors that lessen competition that 
result in higher fares.
    I want to emphasize that my company exists today because of 
airline deregulation. My clients and I are believers in the 
marketplace. We do not want extensive Government regulation or 
control over the travel industry.
    But if we are going to have a deregulated system, it must 
be open for all who are willing to compete. Today, we have a 
system that does not allow all to come into the airline 
industry. As a result, consumers have fewer choices and in many 
markets, no choices.
    Mr. Chairman, this lack of competition hits small and 
medium-size communities the hardest. The impacts are enormous. 
When there are few flights into a city or a State, that State's 
economic development is jeopardized.
    We see less tourism and few companies expanding operations 
into our communities. Conventions go elsewhere and our 
residents drive hours to find more reasonable fares.
    Imagine having a loved one sick in a distant community and 
not being able to get a reasonable fare to visit that person or 
having to drive hours to catch a flight out of another airport. 
The purpose of deregulation was not only to create--not only 
create competition in certain communities.
    Mr. Chairman, we in Birmingham are fortunate to have some 
level of competition not enjoyed by other communities. As you 
know, we have service from a number of hub carriers including 
Delta and from Southwest. These carriers provide good service 
but unfortunately to many destinations, reasonable fares are 
not available.
    Moreover, when they are listed they are often not 
available. In addition, fares are more confusing than ever. In 
some cases, fare sales are misleading.

                           All Seasons Travel

    Let me tell you something about my company. We have eight 
offices in Alabama--Birmingham, Dothan, Montgomery, Selma, 
Tuscaloosa, and Vance, along with satellite ticketing printers 
in seven States.
    Although our primary clients are corporate accounts, we 
provide service to a number of others, including the University 
of Alabama and to individuals.
    All of our clients are sensitive to price. But as you can 
imagine, increased fares have a significant impact on the small 
companies and the educational institutions we serve.
    In order to best serve our clients, we have sophisticated 
computer systems that constantly, 24 hours a day, search for 
the lowest available fares. Even with that level of 
sophistication, we are often unable to find seats at fares 
advertised the previous day.
    We frequently get calls from customers who ask us to book a 
fare that was advertised in the morning newspaper and it is not 
available for service out of Birmingham, or there are so many 
conditions attached to it, that it cannot be used.
    Of course, the airlines would allow me to book a seat on 
the same airplane at three to four times the price. In fact, 
the airline likely has plenty of room on the airplane. However, 
they have so limited the lower fares that they are not 
available.
    In most cases, the customer books at the higher fare. Our 
regulators, State and Federal, would not tolerate this practice 
in other industries.
    Imagine if the local Sears store announced the sale of a 
certain model of shoe at a $50 price and the ad does not say 
that it only had three pairs that would be sold at that price. 
Would you accept it if you showed up that morning at Sears--at 
the Sears store and are told that the shoe is now $75?

                         Need for Price Reform

    Let me give you an example of pricing. Julian Banton, 
chairman and CEO, Southtrust Bank, America's 26th largest bank, 
had to go from Birmingham to Greenville, SC. The fare was $615. 
He could have gone to London for about the same price; and for 
a little more, he could have gone on to Amsterdam.
    He was shocked. He had to take the trip, because it meant 
business for his bank and for the State of Alabama.
    Many business people could not afford that fare. Moreover, 
he could have paid much more for that seat. We were able to 
find him the $615 fare by having the computer search the fare 
records.
    Many people would have paid more. Of course, the airlines 
now have their own websites. We have gotten calls from 
customers who claim that a fare was shown on the website, but 
they were unable to get it. We were also unable to find those 
fares.
    Mr. Chairman, is the Government looking at how carriers use 
the websites?
    I frequently get calls from customers who want to visit a 
relative in another part of the State--of the country, who is 
sick or want to visit friends. If they can plan trips weeks 
ahead of time, they can usually get reasonable fares.
    Unfortunately, sometimes you do not have several weeks 
advance notice of illness or the need to help a friend or a 
family member. What do these people do? In most cases, they 
drive hours to catch a flight at airports with more affordable 
service or they do not go.
    Fortunately, Mr. Chairman, your actions in regard to the 
Wright amendment has made travel to Texas and other parts of 
the Southwest on Southwest Airline more accessible and 
affordable.
    The conditions placed by carriers on fares are complicated. 
Some fares may only be available in the morning, others in the 
afternoon, others only late at night. Some require weekend 
stays. Others require companion travel.
    In some cases, a two-for-one sale may be more expensive 
than purchasing two separate round trips. That confusion 
multiplies if you have a trip involving multiple stops.
    I can think of no other business where you have little 
choice of suppliers, and the only way an individual may learn 
the price is to call and ask. In some cases, a fare quoted by 
the airline is not the lowest.
    Mr. Chairman, my concern is that no one is watching over 
these ticketing issues. As the industry gets more consolidated 
and as fares become more complex, it is essential that 
Government officials oversee this pricing deception.
    That is not happening. There should be some standards on 
advertising, on seats available, and on what is told the 
public.
    I am not asking for price regulation, but I am asking that 
airline tickets, which are a big price item, be held to the 
same truths in advertising standards as shoes and other 
consumer goods.
    Mr. Chairman, as we sit here discussing problems associated 
with the air transportation in this country, I am dismayed at 
the prospect that we may end up with only three air carriers.
    The alliance proposals recently announced would bring the 
U.S. airline industry to a level of concentration that should 
concern all in Washington.

                           Prepared Statement

    Thank you very much, Mr. Chairman. I did not see the red 
light. I will stop.
    Senator Shelby. We appreciate your testimony.
    [The statement follows:]

                   Prepared Statement of Borden Burr

    Good morning Mr. Chairman and members of the committee. I am 
delighted to be here this morning to discuss an issue of critical 
importance to not only my customers and the businesses of Birmingham 
and the entire State of Alabama but to all travelers--airline ticketing 
and competition.
    First, Mr. Chairman, on behalf of all of us, we wish to express our 
gratitude to you for holding these hearings and for all you have done 
to focus attention on the needs of all travelers--business people, 
individuals wishing to travel to visit family and friends, and those 
seeking business opportunities. Not only have you held hearings that 
have shed light on the restrictive Wright Amendment, but you've taken 
important action to address other factors that lessen competition and 
result in higher fares.
    I want to emphasize that my company exists today because of airline 
deregulation. My clients and I are believers in the marketplace. We do 
not want extensive Government regulation or control over the travel 
industry. But if we are going to have a deregulated system, it must be 
open for all who are willing to compete. Today, we have a system that 
does not allow all to come into the airline industry. As a result, 
consumers have fewer choices and, in many markets, no choices. Mr. 
Chairman, this lack of competition hits small- and medium-size 
communities the hardest.
    The impacts are enormous. When there are few flights into a city or 
State, that State's economic development is jeopardized. We see less 
tourism and fewer companies expanding operations into our communities, 
conventions go elsewhere, and our residents drive hours to find more 
reasonable fares. Imagine, having a loved one sick in a distant 
community and not being able to get a reasonable fare to visit that 
person or having to drive hours to catch a flight out of another 
airport.
    The importance of airline service to small communities has been the 
subject of a number of forums including the national air service 
roundtable in Jackson, Mississippi in February, 1998 and in 
Chattanooga, Tennessee in February, 1997, where State, local, and 
Federal officials discussed market-based solutions to local air service 
problems. The genesis for the meeting was the need to provide focus and 
clarity to the national understanding about local air service problems 
and to finish ``the unfinished business of the Airline Deregulation Act 
of 1978 by bringing a competitive mix of service to all communities,'' 
particularly those that lack adequate airline competition or service 
quality. The conference recognized the direct linkage between air 
transportation and job creation, economic growth and quality of life. 
The significance of airline service to the economic growth of small 
communities was best summarized by the following conference statement:
    ``The evolving aviation marketplace in mid-size communities was 
revealed to have tremendous implications for major employers at the 
roundtable. For example, testimony delivered by an official from 
Eastman Chemical, Tennessee's largest employer and exporter, identified 
substandard local service as an obstacle to: organizing sales meetings; 
recruiting a talented work force; deploying sales personnel to field 
locations; and maintaining personal contact with valued clients.''
    Service to small and medium markets has also been the focus of a 
number of congressional hearings. An Eastman Company representative--
Fielding Rolston, Vice President, Customer Service and Materials 
Management, elaborated on how critical air service is to business 
growth when he testified on June 25, 1997 before the House Subcommittee 
on Aviation that:
    ``I told you at the beginning that I'm here representing the 
business community. I say that again because I want to underscore the 
fact that, as a company in a very competitive and regulated field, we 
do understand marketplace realities. We do understand how supply and 
demand works and we do understand the limitations of legislation and 
regulations in solving societal problems.
    ``But we also understand that this is a bigger question than 
whether the airlines need more competition. It's a question of whether 
this country wants an airline industry that ignores 20 percent of the 
communities and airports in this Nation. In short, it's a question of 
whether we're willing to let the small and medium-sized communities--
and all of the companies that call those communities home--fall by the 
wayside as they find it more and more difficult to attract and keep 
businesses.
    ``Deregulation has worked for 80 percent of the country. And we're 
certainly not asking for re-regulation. But we are asking that 
deregulation be taken one step further. By providing greater access to 
gates and slots, you can let the market take over and give competition 
a true chance to flourish. And in doing so you can ensure that small 
and medium-sized communities again have a seat at the table and a gate 
at the terminal.''
    The purpose of deregulation was not to only create competition in 
certain communities.
    The airline deregulation act provides:
  --Placing maximum reliance on competitive market forces and on actual 
        and potential competition.
  --Avoiding unreasonable industry concentration excessive market 
        domination, monopoly powers, and other conditions that would 
        tend to allow at least one air carrier or foreign air carrier 
        to unreasonably increase prices, reduce services, or exclude 
        competition in air transportation.
  --Encouraging, developing, and maintaining an air transportation 
        system relying on actual and potential competition.
    Mr. Chairman, we in Birmingham are fortunate to have some level of 
competition not enjoyed by other communities. As you know, we have 
service from a number of hub carriers including Delta and from 
Southwest. Those carriers provide good service but unfortunately, to 
many destinations, reasonable fares are not available. Moreover, when 
they are listed, they are often not available. In addition, fares are 
more confusing than ever. In some cases, fare sales are misleading.
    Let me tell you something about my company. We have 8 offices in 
Alabama--in Birmingham, Dothan, Montgomery, Selma, Tuscaloosa and 
Vance, along with satellite ticket printers in 7 States. Although our 
primary clients are corporate accounts, we provide service to a number 
of others, including the University of Alabama and to individuals. All 
of our clients are sensitive to price, but as you can imagine, 
increased fares have a significant impact on the small companies and 
the educational institutions we serve.
    In order to best serve our clients, we have sophisticated computer 
systems that constantly--24 hours a day--search for the lowest 
available fares. Even with that level of sophistication, we are often 
unable to find seats at fares advertised the previous day. We 
frequently get calls from customers who ask us to book a fare that was 
advertised in the morning newspaper and it is not available for service 
out of Birmingham or there are so many conditions attached to it that 
it cannot be used. Of course, the airline would allow me to book a seat 
on that same plane at 3-4 times the price. In fact, the airline likely 
has plenty of room on the plane, however, they have so limited the 
lower fares that they are not available. In most cases, the customer 
books the higher fare. Our regulators--State and Federal--would not 
tolerate this practice in other industries. Imagine if the local Sears 
store announced a sale of a certain model of shoe at a $50 price, and 
the ad doesn't say that only 3 pairs will be sold at that price. Would 
you accept it if you showed up that morning at the store and are told 
that the shoe is now $75?
    There is no industry that sells its products in a more deceptive 
way. Hundreds of fares for the same commodity--a seat on a plane 
between Birmingham and a hub airport.
    Not only does price depend upon when you bought the ticket but also 
on where you are flying. Sitting next to each other on a plane may be 
three people--one going from Birmingham to a hub, one going to the hub 
and then to London, and one going to another city from that hub. It 
should not surprise you to learn that the cheapest of these three fares 
could be the one to London. Why--because there may be some competition 
in that market.
    Let me give you an example of pricing. Julian Banton, Chairman and 
CEO, Southtrust Bank, had to go from Birmingham to Greenville, SC. His 
fare was $615. He could have gone to London for about the same price 
and for just a little more, he could go on to Amsterdam! He was 
shocked. He had to take the trip because it meant business for his bank 
and for the State of Alabama. Many business people could not afford 
that fare. Moreover, he could have paid much more for that seat--we 
were able to find him the $615 fare by having the computer search the 
fare records. Many people would have paid more. Of course, the airlines 
now have their own websites. We have gotten calls from customers who 
claim that a fare was shown on the website but they were unable to get 
it. We were also unable to find those fares. Mr. Chairman, is the 
Government looking at how carriers use websites?
    I frequently get calls from customers who want to visit a relative 
in another part of the country who is sick, or want to visit friends. 
If they can plan trips weeks ahead of time, they can usually get 
reasonable fares. Unfortunately, sometimes you don't have several weeks 
advance notice of illnesses or the need to help a friend or family 
member. What do those people do? In many cases they drive hours to 
catch a flight at airports with more affordable service or they don't 
go. Fortunately, Mr. Chairman, your action in regards to the Wright 
Amendment has made travel to Texas and other parts of the Southwest on 
Southwest airlines more accessible and affordable.
    The conditions placed by the carriers on fares are complicated. 
Some fares may only be available in the morning--others in the 
afternoon--others only late at night. Some require weekend stays--
others require companion travel. In some cases a ``2-for-1'' sale may 
be more expensive than purchasing two separate round trips. That 
confusion multiplies if you have a trip involving multiple stops. What 
if you get off the plane and do some business in the city and then fly 
to another destination before returning home. The fare quoted by the 
airline for that multiple stop journey may be higher than if you bought 
two separate tickets. Of course, the airline doesn't disclose those 
choices, and it certainly doesn't call the customer back if the fare 
drops.
    I can think of no other business where you have little choice of 
suppliers and the only way an individual may learn the price is to call 
and ask. In some cases, the fare quoted by the airline is not the 
lowest.
    Mr. Chairman, my concern is that no one is watching over these 
ticketing issues. As the industry gets more consolidated and as fares 
become more complex, it is essential that Government officials oversee 
this pricing deception. That is not happening. There should be some 
standards on advertising, on seats available and on what is told to the 
public. I am not asking for price regulation but I am asking that 
airline tickets--which are big price items--be held to the same truth 
in advertising standard as shoes and other consumer goods.
    Mr. Chairman, as we sit here discussing problems associated with 
air transportation in this country, I am dismayed at the prospect that 
we may end up with only three air carriers. The alliance proposals 
recently announced would bring the U.S. airline industry to a level of 
concentration that should concern all in Washington. For an industry 
that is already concentrated, this would further diminish opportunities 
for competition and affordable fares. I agree with Herb Kelleher, who 
has cautioned that these alliances could be devastating to small 
carriers. I urge you to ask the Department of Transportation to suspend 
consideration of these alliances until they have fully examined the 
implications on the entire country--particularly for those of us living 
and doing business in small and medium communities, have put in place 
final guidelines to prevent anti-competitive behavior, and have 
addressed all those issues that limit new entry and competition. To 
that end, I have included a copy of a letter sent by Ivan Michael 
Schaeffer, of Woodside Travel Trust, to Secretary Slater on this issue.
    To allow competition, I urge you to continue your review of 
barriers to entry that prevent competition in many business markets, 
and particularly hit smaller markets and states the hardest. 
Furthermore, you should also continue to review predatory behavior that 
prevents new entrants from coming to and staying in smaller cities such 
as Birmingham, Montgomery and Mobile. Mr. Chairman, it is also 
essential that steps be taken to improve airline competition. As new 
carriers enter markets, more discipline is introduced into the market 
place. A carrier that dominates a market has little incentive to be 
reasonable.
    Thank you, and I am prepared to answer questions.
                                 ______
                                 

         Letter From Ivan Michael Schaeffer, President and CEO

                                     Woodside Travel Trust,
                                      Bethesda, MD, April 24, 1998.
Hon. Rodney B. Slater,
Secretary of Transportation,
Department of Transportation, Washington, DC.
    Dear Mr. Secretary: The news that the number of major airlines in 
the United States decreased by 50 percent overnight was hardly 
unanticipated. The pell-mell rush of the airlines to consolidate their 
operations globally has continued, unabated, up to and including 
yesterday's announcement. Without swift and decisive action by you, all 
semblance of airline competition will evaporate from the global 
marketplace.
    This further and dramatic consolidation of what Salomon Smith 
Barney, in their study of concentration at the 50 largest airports 
shows excessive (more than twice the level that the Department of 
Transportation considers ``highly concentrated''), causes significant 
problems for the business and economy of the United States. This 
oligopoly, and in some cases monopoly, if left unchecked, guarantees no 
low cost carriers will remain. Furthermore, the cost to all travelers 
will increase, fewer will fly, many more communities will become 
underserved, all impacting upon the economic well being of those 
communities as well as upon our economy as a whole.
    As we begin the third post-deregulation decade in the United 
States, it appears that the now well entrenched hub and spoke system 
will continue to grow stronger and proliferate internationally. 
However, the alarming and pervasive negative results of this concept 
(even before yesterday's news), namely, uneven pricing, depending on 
location and passenger type, and a sharp reduction in service levels 
for many smaller communities, must be addressed. I would submit that 
the antidote is for the U.S. Departments of Justice and Transportation, 
Congress and the European Union to recover and preserve the fundamental 
tenet of a deregulated environment: the opportunity for competitive 
entry.
    Notwithstanding mountains of pressure from communities, airports 
and business groups, our governmental entities have spent months and 
now years wrangling over a number of concerns regarding hub dominance: 
the competitive response of the ``hubbing'' airlines to new entry such 
as predatory pricing and capacity dumping; the failure to make airport 
facilities, including gates and slots available to new entrants; and 
issues such as frequent flyer program dominance.
    We welcome the guidelines your Department recently released for 
comment. In the introduction to those Guidelines you recognize not only 
the ``mandate'' of DOT to intercede where anticompetitive activity 
occurs, but also the ``obligation'' to do so. Mr. Secretary, I would 
submit to you that ``standing pat'' with respect to the alliance 
announcement of American-US Airways and Delta-United (even as the 
comment period for those guidelines run) would be tantamount to a 
``breach'' of the Department's recognized obligation.
    I believe that there are those of us who are so profoundly 
interested in obtaining a competitive, accessible and fairly priced 
global air transport system that we must carefully examine the airline 
industry as it continues to takes shape. The goal, we thought when we 
embarked upon this effort, was to maintain a strong airline industry 
that contributes to the growth of the emerging global economy on the 
one hand, and at the same time fairly and adequately serves the 
interest of the public operating within that environment.
    The domestic airline industry is much different than anyone 
involved in de-regulation ever anticipate--fewer carriers, steadily 
increasing fares, airports and areas of the country dominated by one 
carrier, new levels of concentration, significant barriers to entry and 
instances of anti-competitive behavior. We now see proposals would 
allow three air carriers (along with their alliance partners, code-
sharing partners, and commuter affiliates) to control U.S. domestic 
traffic--approximately 82 percent of domestic revenue passenger miles. 
Their actual and proposed international alliances and ownership with 
foreign carriers will also allow them to dominate the world.
    For years, Government believed carriers would be reluctant to raise 
fares. However, with the reduction in the number of carriers competing, 
the dominating carriers fear has gone away. For the founders of 
deregulation, this rationale served to satisfy the concern over the 
economies of scale that exist in the airline industry, and justified 
the excessive market dominance that deregulation might cause. But the 
DOT and other parties now seem to acknowledge that such competitive 
pressure does not exist in fortress hubs, and in many other major 
markets and as a consequence there is no stabilizing pressure on 
airfares.
    Prior to yesterday's announcement, and according to a Salomon Smith 
Barney report, measures of concentration at the 50 largest airports 
showed an unprecedented degree of concentration or market lack of 
competition than at any other time in the history of the airline 
industry. The ``weighted'' average of airline market shares at each of 
the 50 largest airports in the United States demonstrate that the 
concentration for the industry is at excessive levels.
    As a result, concentration in the U.S. airline industry is an all 
time high; there are fewer carriers operating than at any time since 
deregulation; and there are few applications on file at DOT for air 
carrier certificates. The alliances announced yesterday and previously 
by Northwest and Continental are but a prelude to mergers that will 
irrevocably change the scope of global airline competition.
    Because the major carriers have responded so strongly to protect 
their turf, and the rumblings of discontent from the public is getting 
louder, DOT has decided to give the public fair opportunity to comment. 
The airlines obviously favored that approach, as it gave them time to 
mount a concerted public relations and lobbying effort and, of far 
greater significance, the space to unabashedly take these dramatic new 
initiatives to drive the nail in the coffin of the anticipated fruits 
of deregulation.
    Although your proposed anti-competitive guidelines address one of 
the factors that has decreased competition, barriers to entry and 
marketing practices utilized by large carriers block the growth of new 
entry. As Herb Kelleher, in commenting on the Department's proposed 
guidelines recently stated, he: ``found it inconsistent for the 
government to set guidelines to protect new entrants while advocating 
airline alliances. More consolidation * * * makes it tougher for 
startups to compete with big carriers that can make enough in their 
monopoly markets to subsidize losses in competitive markets.''
    Mr. Secretary, these issues and their impact on all are so 
significant that we call upon you to suspend consideration of all 
alliances (including, but not limited to Northwest-Continental, 
American-US Airways and United-Delta)--domestically and 
internationally--until the impact of these alliances and existing 
alliances can be fully evaluated and definitive measures are put in 
place that will ensure future competition and choice for all Americans.
    It is high time for debate and reflection to end and for our 
Government to undertake its duty to protect the travelers of this 
country.
            Sincerely,
                                    Ivan Michael Schaeffer,
                                                 President and CEO.
STATEMENT OF LAURADAY KELLEY, VICE PRESIDENT, 
            CRUISELINK
    Senator Shelby. Ms. Lauraday Kelley, CruiseLink.
    Ms. Kelley. Good morning. Mr. Chairman, members of the 
subcommittee, I am Lauraday Kelley, vice president of 
CruiseLink, a travel agency consortium. In addition, my husband 
and I have been Pennsylvania travel agency owners for over 20 
years.
    I have summarized my testimony but ask that the full text 
be submitted for the record.
    Senator Shelby. It will be, without objection.
    Ms. Kelley. Thank you. I would like to thank you for 
holding this very important hearing on the issue of airline 
ticketing practices and antitrust enforcement.
    I am here today representing the Coalition of Travel 
Industry Parity [CTIP], a coalition comprised of 23 travel 
agency co-ops, consortia, and franchise organizations with 
approximately 17,000 travel agency members.
    I also represent views strongly shared by the American 
Society of Travel Agents [ASTA], the world's largest travel 
trade association with 27,000 members in 170 countries.
    CTIP and ASTA are closely allied in support of legislation, 
Senate bill 1977, the Consumer Access to Travel Information Act 
of 1998 just introduced by Senator D'Amato and Senator Reid 
that we believe is needed to address the decline of competition 
as well as other problems in our Nation's air transportation 
system.
    This morning, I would like to briefly talk about the spate 
of anticompetitive practices recently undertaken by the major 
airlines and the effect of these anticompetitive practices on 
both the air traveler and thousands of small businessowners 
that comprise the travel agency industry.
    For the past 3 years, major U.S. airlines have begun trying 
to neutralize or eliminate the travel agent ticket distribution 
system. They are doing this for a very simple reason, to force 
consumers to purchase tickets directly from the airlines.
    Individual airlines currently do not and will not provide 
information about competitors' services, even if they offer 
better value and meet the consumer's needs.
    By eliminating consumers' access to an unbiased source of 
fair information, we believe that the airlines intend to 
achieve the effect of additional fare increases. As a result, 
the consumer loses.
    As the committee is aware, the major airlines now control 
hubs, fares, schedules, routes, slots, and small city services. 
And with this latest round of joint marketing agreements, that 
stranglehold over the air transportation system may be 
tightened even further.
    The major airlines would have us believe that they need to 
reduce expenses so that they can pass savings on to the 
consumer.
    As you know, Mr. Chairman, airline ticket practices have 
steadily increased with no recognizable benefits or improved 
services for the consumer. Airlines are posting record profits, 
while many consumers are paying some of the highest airfares in 
history.
    However, there is an additional threat to consumers. Mr. 
Chairman, the typical travel agency is a small business 
enterprise. Many times, we serve as the only ticket 
distribution system available to small, regional and new 
startup airlines.
    Without it, Mr. Chairman, the likelihood of a regional or 
startup airline surviving greatly diminishes.

                   Airlines' Threats to Travel Agents

    Mr. Chairman, I would like to describe some examples of how 
airlines are squeezing travel agents and thus hurting the 
consumer. One recent example of this absurd practice has to do 
with consumers who purchase round-trip tickets for one-way 
travel.
    In the strange world of airline fares, round-trip fares are 
sometimes less than one-way fares. So savvy consumers who 
purchase a round-trip ticket, simply throw away the return 
portion of the ticket and can thereby save hundreds of dollars.
    In response to this practice, one airline now states that 
it will at its own discretion collect the difference between 
the round-trip fare and the one-way fare from any travel agent 
involved in a transaction where the consumer does not use the 
return portion of their planned trip.
    Other examples of anticonsumer practices include: One, 
offering fares through the Internet that are not available for 
sale elsewhere, while advertising that the airline itself can 
give the consumer the lowest fare, thus penalizing the consumer 
who does not have access to the Internet; two, penalizing 
travel agents for granting refunds on so-called nonrefundable 
tickets while the airlines routinely make such refunds when 
contacted directly by the consumer; and three, punishing travel 
agents for issuing back-to-back and ``hidden city'' tickets, 
even though they may represent the lowest airfare for the 
consumer.
    One of the most stunning developments, Mr. Chairman, is 
that the major airlines have a computer--computerized system of 
obtaining a travel agent's proprietary consumer and sales data. 
In other words, one carrier may be able to look at the 
keystrokes of one particular agent to see if they are bringing 
up the schedule of a competing carrier over their own schedule.
    Senator Shelby. How do they do that?
    Ms. Kelley. They do that through a report that they receive 
through the data base of all the other airlines.
    Senator Shelby. OK.
    Ms. Kelley. I cannot think of another business where the 
supplier is allowed to do, actually, an unauthorized audit of 
the books of their distributor.
    Mr. Chairman, let me emphasize that the travel agent's 
livelihood depends on the U.S. consumer. We are in business to 
offer the U.S. travel consumer the most complete travel 
information in the travel industry, as well as to assist them 
in securing the very best airfares available.
    This is not just a case of one entity battling in the 
marketplace with another to provide the best service. This is 
about several large entities engaging in anticompetitive 
practices, with the intent of limiting information and 
competition for their own benefit.
    All we ask is that Congress preserves our ability to 
compete. If we are prevented from doing so, the American 
consumer will be the big loser.

                           Prepared Statement

    Mr. Chairman, on behalf of the 250,000 travel agents across 
the United States, thank you for providing me this opportunity 
to testify before you today.
    Senator Shelby. Thank you, Ms. Kelley.
    [The statement follows:]
                 Prepared Statement of Lauraday Kelley
    Mr. Chairman and Members of the Subcommittee: I am Lauraday Kelley, 
Vice President of CruiseLink, a travel agency consortium. My husband I 
have been Pennsylvania travel agency owners for 20 years. I appreciate 
the opportunity to appear before you today to explore the broader issue 
of competition in the aviation industry and in particular the anti-
competitive ticketing practices of US airlines.
    I am here today representing the Coalition for Travel Industry 
Parity (CTIP), a coalition comprised of 23 travel agency co-op, 
consortia, and franchise organizations, with approximately 17,000 
travel agency members. I also represent views strongly shared by the 
American Society of Travel Agents (ASTA), the world's largest travel 
trade association, with 27,000 members in 170 countries. CTIP and ASTA 
are closely allied in support of legislation that we believe is needed 
to address the decline of competition and growing array of problems 
within our nation's air transportation system.
    Since airline deregulation in 1978, it became apparent that the 
travelling public preferred to complete their flight arrangements with 
travel agents. The reason is simple: travel agents are the only source 
of complete, accurate and unbiased travel information and services 
available in the marketplace. Individual airlines currently do not, and 
will not provide information about competitor's services, even if they 
offer better value and meet the consumer's needs. Today, between 70 and 
80 percent of US air travelers depend upon travel agents to provide an 
accurate and complete selection of schedules, fares, and ticketing 
services for all airlines, both domestic and foreign, large or small. 
Travel agency sales of air travel currently exceeds $70 billion 
annually and continues to grow, despite competition from the airlines' 
800 numbers and the Internet.
    For the past three years, major U.S. airlines have tried to 
neutralize or eliminate the travel agency ticket distribution network, 
in order to force customers to purchase tickets directly from the 
airlines. By eliminating access to an unbiased source of information, 
we believe the airlines expect to greatly improve their profitability 
through the fares consumers pay for air travel. Consider that if 
airlines increase the average fare paid by one-half of travel agents' 
clients by a mere five dollars, they would reap an additional $455 
million in revenue per year.
    In 1978, airline deregulation was enacted with the belief that an 
unregulated marketplace would foster competition in prices and services 
and that consumers would benefit from lower fares and improved 
services. Today however, we see that four major airlines, United, 
American, Delta and Northwest effectively control pricing and 
distribution policies of the US air transportation system. These 
airlines also have considerable influence in the international 
marketplace. And with this latest round of joint marketing agreements, 
their stranglehold over the air transportation system may be tightened 
even further.
    Simply, we believe that the major airlines intend to wrest complete 
control over consumer access to information, reservations and ticketing 
services, much in the same manner they now control hubs, fares 
schedules, routes, slots and small city services. These airlines do not 
want consumers to continue to have the same ready access to comparative 
schedule and fare information that they enjoy today through the travel 
agency distribution system.
    The airlines are using a variety of techniques to achieve their 
goals. Twice in the past three years, they have initiated reductions in 
travel agent commissions on the sales of air travel, effectively 
reducing the commission below the agent's costs. As a result, travel 
agencies have been forced to levy transaction fees to offset the 
reductions in commissions. Although many consumers have elected to pay 
the fees to travel agents, other consumers who are unwilling or unable 
to pay these fees have only one viable option: to contact airlines 
directly and forfeit the comparative price shopping travel agencies 
provide. This puts the consumer right where the airlines want them, 
bereft of an unbiased source of information to deal with a bewildering 
array of complex airfares and rules.
    The major airlines have generally misrepresented the reason for 
travel agency commission cuts. They would have us believe that they 
need to reduce expenses so that they can pass savings on to the 
consumer. As you know, Mr. Chairman, airline ticket prices have 
steadily increased, with no recognizable benefits or improved services 
for consumers. Airlines are posting record profits while many consumers 
are paying the highest airfares in history.
    There is an additional threat to consumers, Mr. Chairman. The 
typical travel agency is a small business enterprise. We are often the 
only ticket distribution system available to small, regional, or new 
start-up airlines. Internet sites posting air travel information and 
offering ticket-purchasing mechanisms are already tightly controlled by 
major airlines. Any individual who has attempted to book a flight on 
the Internet learns quickly that the process can be very difficult and 
tedious. Further, major airlines have severely impaired Internet 
competition orchestrated by travel agents by adopting discriminatory 
and non-compensatory commission policies for travel agent bookings that 
originated through the Internet.
    For many years, airlines have threatened and harassed travel agents 
by unilaterally imposing a wide variety of penalties for alleged 
ticketing practices that often benefit consumers. These ticketing 
procedures are sometimes suggested by travel agents, but often are at 
the request of customers.
    One recent example of this absurd practice of the airlines has to 
do with consumers who purchase round-trip tickets for one-way travel. 
In the strange world of airline fares, round-trip fares are usually 
less than one-way fares, therefore consumers who purchase a round-trip 
ticket simply throw away the return portion of the ticket and thereby 
save often hundreds of dollars. In response to this practice, one 
airline has now stipulated that it may, at its sole discretion, collect 
the difference between the round-trip fare and one-way fare from any 
agent involved in a transaction where a customer does not use the 
return portion of their planned trip.
    Other examples of anti-consumer practices include: (1) offering 
fares through the Internet that are not available for sale elsewhere, 
while representing that the airline itself can give the consumer the 
lowest fare; (2) penalizing travel agents for granting refunds of so-
called non-refundable tickets while making such refunds when contacted 
directly, and, (3) punishing travel agents for issuing back-to-back and 
``hidden city'' tickets, even though they may represent the lowest fare 
for the consumer.
    The agent, of course, has no control over the customer once the 
ticket is sold. Nonetheless, as absurd as it sounds, under the current 
system, a travel agent has neither the right of appeal, nor any legal 
recourse against an airline that levies a penalty, for any reason, 
justified or not, against any travel agent. The travel agent must pay 
the penalty or the airline may terminate the agent's right to sell 
tickets on behalf of that airline. Any agent who loses the right to 
write tickets on a dominant hub carrier, has just been awarded a one-
way ticket of his very own--to bankruptcy court.
    Other examples of pressure tactics by carriers include dominant hub 
carriers that withhold benefits from agents who do not support the 
dominant airline. Major airlines have a computerized system of 
obtaining proprietary travel agency customer and sales data and worse, 
we have recently learned that some dominant carriers are now able to 
analyze the computer reservations keystrokes of travel agents to 
determine the order in which a travel agent, sitting at his or her own 
desk, accesses airline schedules. In other words, one carrier may be 
able to look at the keystrokes of a particular agent to see if they are 
bringing up the schedule of a competing carrier, over their own 
schedule.
    Two weeks ago, Senator D'Amato and Senator Reid introduced S. 1997, 
the Consumer Access to Travel Information Act, which addresses some of 
the problems I have highlighted. Representative Mike Forbes has 
introduced identical legislation, H.R. 3704, in the House. CTIP, ASTA 
and 250,000 travel agents support this legislation, as well as most of 
the other legislation that has been introduced in Congress this year to 
restore competition in the air transportation industry.
    Mr. Chairman, let me emphasize that the travel agent's livelihood 
depends on the U. S. consumer. We are in business to offer the United 
States travel consumer the most complete travel information in the 
travel industry as well as to assist them in securing the very best 
airfares available. We are not afraid to compete with airlines; we have 
competed with them for 50 years. We are however, deeply troubled with 
actions taken by the major airlines in the last several years, which, 
if unchecked, will make it impossible for us to compete.
    This is not just a case of one entity battling in the marketplace 
with another to provide the best service. This is about several large 
entities engaging in anti-competitive practices, with the intent of 
limiting information and competition for their own benefit. We believe 
the marketplace should determine who is the best provider of 
information and other consumer services, and that the marketplace 
should not be influenced by sheer size and magnitude of several 
competitors who stand to benefit from these anti-competitive practices. 
All we ask is that Congress preserve our ability to compete. If we are 
prevented from doing so, the American consumer will be the big loser.
    Mr. Chairman, on behalf of the thousands of small business people 
across the United States who are travel agents or run travel agencies, 
I thank you for holding these important hearings.
    This completes my prepared statement. I will be pleased to respond 
to any questions you may have at this time, or submit for the record at 
a later date. Thank you.
STATEMENT OF LARRY DARBY, PRESIDENT, DARBY ASSOCIATES
    Senator Shelby. Mr. Larry Darby, president, Darby 
Associates.
    Mr. Darby, welcome to the committee.
    Mr. Darby. Thank you, Mr. Chairman. I am happy to have the 
opportunity to be here this morning and thank you for that 
bubbly-blast. It is not often I get a free lecture from the 
dean of regulatory economists, Professor Kahn.
    You have asked me to summarize commercial arrangements 
called resale----
    Senator Shelby. Right.
    Mr. Darby [continuing]. In the telecommunication sector and 
to reflect a little bit on what that might mean in the 
airline----
    Senator Shelby. Draw the analogy if you can.
    Mr. Darby [continuing]. In the airline business. Let me 
sort of give a cautionary note. I am probably more qualified on 
the first than on the second.
    My background for the past 20 years is in the 
telecommunication side and less on surface and air 
transportation, although we do some business from time to time.
    Senator Shelby. That was an area where there was little, if 
any, competition.
    Mr. Darby. And I hope to bring out that issue----
    Senator Shelby. Go ahead.
    Mr. Darby [continuing]. As a possible differentiating 
characteristic.
    Senator Shelby. Yes.
    Mr. Darby. I have submitted a longer statement for the 
record, and I appreciate your----
    Senator Shelby. Your written statement will be made part of 
the hearing record in its entirety.
    Mr. Darby. And I appreciate that. And I also, in response 
to counsel, submitted a much longer statement on communications 
resale that I wrote in 1995 and----
    Senator Shelby. That will also be made part of the record 
in its entirety. This is the analysis statement?
    Mr. Darby. Yes, sir; and I will refer to that from time to 
time.
    Senator Shelby. OK.
    [The information follows:]
        Analysis of AT&T Market Power in the Resale Marketplace
                           executive summary
    The purpose of this report is to characterize and evaluate elements 
of AT&T's tariffing strategy in a market where some of its largest 
customers, resellers, are also a source of growing competition to it 
and other facilities based carriers in the end user market.
    The paper reports the results of a review of (a) the economics 
literature on matters related to the incentives of vertically 
integrated firms in its dealings with specialized rivals, (b) contract 
tariffs entered by AT&T under the authority granted them by the FCC in 
Docket 90-132, and (c) practices related to their negotiation, 
implementation and AT&T business practices in general in relationship 
to resellers. The paper interprets key provisions of those contracts in 
the context of our current understanding of the economics of vertical 
relationships and strategic pricing practices under partial regulatory 
constraint.
    The overall objective of the study is to determine whether, how and 
to what extent the business relationships entered with different users 
by AT&T and other interexchange carriers are marked by identifiable and 
systematic differences among user classes. The more specific goal is to 
determine whether such differences are consistent with Commission 
competitive policies and its goals with respect to providing a market 
environment congenial to the effective operation of the resale sector.
    The study commences with a review of the regulatory underpinnings 
of the development of the reseller industry and the Commission's goals 
in protecting and promoting resale. It turns then to a review of the 
current market structure of the interexchange marketplace; the nature 
of AT&T's ratemaking incentives, pricing discretion and strategy in the 
interexchange marketplace. This analysis is followed by a discussion of 
some economic principles and concepts relevant to the current market 
structure, which principles are brought to bear in an analysis of the 
terms and conditions attached to services offered to resellers compared 
to the terms and conditions offered by AT&T to end users.
    The results of our analysis indicate that AT&T has the ability and 
incentive to structure its general commercial relationships and to 
differentiate the terms offered in different contract tariffs in ways 
that conflict with the Commission's basic policies respecting resale 
and the Commission's broader goals for promoting competition in the 
interexchange marketplace.
    The analysis shows that because of its vertical integration of 
production, wholesale and retail of network services and its power in 
each of those markets, AT&T defines its relationships with resellers in 
ways consistent with economic theories of anticompetitive behavior 
designed to suppress competition by raising competitors' costs and by 
other means.
    The principal conclusion of the analysis is that market forces 
alone, given the current structure and incentives in the marketplace, 
are not clearly sufficient to assure continued evolution of competition 
to facilities-based carriers from the resale sector in conformance with 
long established Commission policies.
                   commission policy toward resellers
    Resellers make important contributions to achievement of the goals 
of the Commission's competition policies. The Commission has attempted 
generally to foster regulatory conditions congenial to the development 
of a healthy telecommunications resale sector, to complement its other 
procompetitive, deregulatory policies in interstate telecommunications.
    The telecommunication reseller industry was borne in 1976 with the 
FCC's decision holding that longstanding AT&T tariff prohibitions on 
sharing and resale of private line services were unjust, unreasonable 
and unlawfully discriminatory.\1\ Until that time, with limited 
exception, AT&T tariffs prevented users from sharing the services or 
reselling tariffed services, whether or not they added value before 
reselling, and limited customers to using the services in the conduct 
of its own business.
---------------------------------------------------------------------------
    \1\ Regulatory Policies Concerning Resale and Shared Use of Common 
Carrier Service and Facilities, 60 F.C.C. 2d 261 (1976), (Resale and 
Shared Use Order) recon. 62 F.C.C. 2d 588 (1977), aff'd sub nom. 
American Telephone and Telegraph Co. v. F.C.C., 572 F. 2d 12 (2nd Cir. 
1978); see also Regulatory Policies Concerning Resale and Shared Use of 
Common Carrier Domestic Public Switched Network Services, (Switched 
Network Resale Order), 83 F.C.C. 2d 167 (1980), aff'd sub nom. Southern 
Pacific Communications Company v. F.C.C., 683 F. 2d 232 (D.C. Cir. 
1982).
---------------------------------------------------------------------------
    The Commission found that elimination of the provisions in AT&T 
tariffs preventing resale of private line services would bring about 
several public benefits of an economic nature and emphasized the role 
of resellers in rationalizing the rate structure; forcing it more 
closely into conformance with the overall cost structure; and providing 
for more efficient use of underlying network capacity.\2\
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    \2\ The Commission specifically noted four expected benefits: a. 
the provision of communications services at rates more closely related 
to costs; b. better management of communications networks, and the 
provision of management expertise by users and intermediaries to the 
carriers; c. the avoidance of waste of communications capacity; and, d. 
the creation of additional incentives for research and development of 
ancillary devices to be used with transmission lines.
    Significantly, the Commission held that tariff restrictions on 
resale and shared use were not justifiable on grounds that such 
restrictions protected carrier revenues or rate structures.
---------------------------------------------------------------------------
    In various orders since the original resale order, the Commission 
has consistently reiterated its belief that the public's interest is 
served by the existence of a healthy resale industry and has adopted 
measures expanding the scope of resale and opportunities for reseller 
growth. A key factor came five years later when the Commission 
permitted resale of AT&T's MTS and WATS services, thereby making it 
possible for resellers more easily to acquire the ability to offer 
universal connections. The equal access requirements of local exchange 
companies contained in the Modified Final Judgment extended to 
resellers and permitted them, along with other competitors, to offer 
one-plus dialing comparable to that offered by AT&T. The emergence of 
U.S. Sprint as a major facilities based competitor and its decision to 
use resellers to expand its market share contributed to growth of 
resellers and the emergence of Sprint as a viable facilities based 
competitor to AT&T.
    In a recent restatement of its views of the economic role of 
resellers in the interexchange marketplace, the Commission has 
emphasized again the importance of resellers in helping to bring about 
cost-based rates and efficient use of underlying carrier capacity.\3\
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    \3\ While both cost based rates and effective capacity utilization 
contribute to economic welfare, the contribution of resellers to 
expanding the size of the market and hence capacity utilization for 
underlying facilities carriers is especially important. Given the 
considerable excess capacity of the industry and the substantial 
elasticity in end-user demand, a healthy resale industry is especially 
valuable in expanding capacity utilization by lowering the average 
level of rates through what is essentially an arbitraging function. The 
Commission's initial resale decision, combined with subsequent ones 
expanding the bounds of permissible resale, is the foundation of the 
development of competition in the interexchange marketplace. The 
ability to resell capacity obtained from AT&T has been instrumental in 
the survival and growth of MCI, Sprint and other facilities based 
carriers who used resale to win market share and to generate cash flow 
to underwrite facilities expansion.
---------------------------------------------------------------------------
    ``The Commission has a long-standing requirement that all common 
carriers must permit unlimited resale of their services. The Commission 
has found that unlimited resale promotes the public interest by 
creating competitive pressures on carriers to provide service at rates 
near the cost of service and by stimulating demand for such service.'' 
\4\
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    \4\ In the Matter of AT&T Communications: Apparent Liability for 
Forfeiture and Order to Show Cause. Adopted: December 30, 1994; 
Released: January 4, 1995 (mimeo) at p.2. (Hereafter, ``Apparent 
Liability''). While both cost based rates and effective capacity 
utilization contribute to economic welfare, the contribution of 
resellers to expanding the size of the market and hence capacity 
utilization for underlying facilities carriers is especially important. 
Given the considerable excess capacity of the industry and the 
substantial elasticity in end-user demand (as documented in the 
Interexchange Order), a healthy resale industry is especially important 
in contributing to efficient utilization of fixed network facilities 
from which services are available at very low costs at the margin.
    See also, In the matter of Competition in the Interstate 
Interexchange Marketplace, Report and Order, CC Docket No. 90-132, 69 
RR 2d 1135 at 1160 (1991). Hereafter, ``Interexchange Order''.
---------------------------------------------------------------------------
    Commission policy has been to eliminate tariff prohibitions on 
resale. ``Because of these benefits from resale of communications 
services, the Commission has rejected the restrictions on resale . . 
.'' \5\ Thus, outright prohibition is an unreasonable restriction on 
resale. And, the language of several orders indicates that it is also 
Commission policy to disallow tariff restrictions on resale, inasmuch 
as previous Commission holdings declare unlawful ``de facto'' tariff 
restrictions which fall short of outright prohibition of resale.\6\
---------------------------------------------------------------------------
    \5\ Ibid. ``Apparent Liability'', p.2. See also, MCI 
Telecommunications Corporation, 81 F.C.C. 2d 568, 572-73 (1980); 
American Telephone & Telegraph Co., 84 F.C.C. 2d 158, 1867-87 (1980).
    \6\ See, Public Services Enterprises of Pennsylvania, Inc. v. AT&T 
Corp., File No. E-93-09, FCC 95-169 (released May 5, 1995) and 
accompanying references.
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            contributions of resellers to commission's goals
    The reseller industry is an important contributor to achievement of 
the Commission's competitive goals in the interexchange marketplace. It 
has done so in several ways. Resellers have contributed toward 
conforming the structure of costs more closely with the underlying 
structure of costs, thereby advancing one of the Commission's principal 
underlying competitive policy objectives. Resellers have lowered the 
average rate for small and medium sized users to an extent that would 
not otherwise have been possible.
    Resellers provide a variety of services to end users. The industry 
can be separated into three main categories, which differ according to 
asset ownership and principal business function. Resellers may or may 
not own either switches or transmission lines, and they may or may not 
provide billing or other ancillary customer services.\7\ The principal 
sources of value added are: sales and marketing to end users, customer 
management, billing and collecting, and, more generally, provision of a 
full array of customer services.
---------------------------------------------------------------------------
    \7\ The simplest form of resale business entity is an 
``aggregator''. An aggregator, as the name suggests, simply gathers 
different customers together, aggregates their traffic for purposes of 
getting lower rates reflecting quantity discounts from the underlying 
carrier and order services from the relevant tariff. End users are 
billed the tariff charges by the facilities based carrier and they pay 
the aggregator a commission. Aggregation and marketing are the simplest 
forms of reseller value-added. Aggregators have declined in number and 
volume in favor of more complex forms of resale. The next level 
reseller has no facilities but does provide billing services. These 
``rebillers'' (or switchless resellers) may provide other customer 
services in addition to billing. They are compensated by billing end 
users amounts that reflect a markup over the rate they receive from the 
underlying carrier. The most sophisticated resellers own facilities--
switches and/or transmission lines. These companies provide a wide 
array of services, including billing, and set their own usage rates. 
They may sell to end users or to other smaller resellers. They have 
their own Primary Interchange Carrier (PIC) codes and pay access fees 
to interconnecting local exchange carriers.
---------------------------------------------------------------------------
    Resellers have contributed to capital formation in the 
interexchange marketplace. By providing an outlet for capacity from 
facilities based carriers--new entrants in particular--resellers have 
helped capitalize the development of fibre networks by competitive, 
underlying facilities based carriers.
    A consortium of regional long distance resellers, the National 
Telecommunication Network (NTN), was initiated as a means of providing 
a nationwide interconnected network of individual resellers of 
intercity communications capacity. The NTN is a product of agreements 
among resellers to interconnect networks; to share traffic; and, to 
terminate traffic for each other.
    A number of resellers have recently been innovators in providing 
detailed, analytical billing statements which users have found helpful 
in planning communications requirements and for monitoring and assuring 
efficient use of limited facilities.
    Resellers provide a cost effective distribution channel for 
carriers and frequently are able to offer customized services with 
value added features to end users whose particularized needs might 
otherwise be ignored by the underlying carrier. Resellers can reduce 
costly (to the underlying carrier) customer churn, by assuring them 
access to the best available value.
    Resellers are advancing the Commission's competitive agenda by 
their adaptation to user requirements and rate/service innovation in 
the interexchange market environment. In addition to bringing about 
greater rate competition, the reseller sector is diversifying its 
service offerings and entering new markets. New products include E-mail 
services, data services, new features on calling cards, prepaid cards 
(for residential callers, travelers, affinity groups and people without 
phones) and international callback services for U.S. based companies 
and foreign businesses. These represent significant additions to the 
traditional 1+ outbound and 800 services traditionally marketed to 
small and medium-sized businesses.\8\
---------------------------------------------------------------------------
    \8\ For a detailed accounting of the evolution of reseller services 
and plans for the future, as indicated in responses to a questionnaire, 
see ATLANTIC--ACM; 1994 Competitive Telecommunications Reseller Report; 
June, 1994 (section 2).
---------------------------------------------------------------------------
    economic framework for analyzing at&t behavior toward resellers
    The economic structure of the markets within which 
telecommunications services resale takes place is rather complex. For 
present purposes, the key characteristic of the market is the dual 
nature of AT&T's relationship with resellers who are both customers and 
competitors. This duality of resellers--as customers, whom it is very 
much in AT&T's interest to please, and as competitors, whom it is very 
much in its interest to thwart--creates contradictory incentives for 
AT&T's managers. These contradictory incentives create tensions between 
alternative patterns of market behavior--a pushing and pulling between 
cooperative and rivalrous behavior.
    These tensions in turn lead to questions about the extent to which 
pursuit of shareholder interests in dealing with resellers is 
consistent with the Commission's statement of the public interest in 
promoting resale.
    The purpose of this section is to clarify the nature of these 
tensions, their implications for AT&T's market conduct and the extent 
to which market forces will satisfy the public's interest in fostering 
a market climate conducive to resale and consistent with the 
Commission's purposes and policies.
    The structure of markets within which telecommunications network 
services are made available for resale to end users is characterized by 
three distinct vertical stages: network ownership and services 
production, sale of bulk capacity on a wholesale basis, and retail 
sales to end users. Some companies are fully integrated across all 
three phases, while others are only partially integrated or completely 
specialized in one phase. There are differential degrees of 
competition, market power and regulation within these segments and with 
respect to different services. The factual circumstances are not 
closely replicated, so far as we can tell, anywhere else in the 
domestic economy.\9\ The structure of the market and the relationships 
among various participants are illustrated in the graphic in Appendix 
1, which maps various market participants with the stage(s) of the 
market in which they participate.
---------------------------------------------------------------------------
    \9\ The market here has many of the characteristics of what has 
been studied under the broad rubric of the ``theory of the sale of 
intermediate goods'', which examines the contractual relationship 
between parties at successive vertical stages in the chain of value 
added. The similarities may be appreciated by considering the 
description of such markets written in a recent review and 
consolidation of the literature on vertical contractual relations: 
``There are several important respects in which intermediate goods 
markets differ from final good markets and thus merit independent 
study. First, intermediate goods markets often involve large 
transactions made by sophisticated buyers. Second, the products being 
sold may possess very complex bundles of attributes, making problems of 
moral hazard more severe, or at least more complicated. Third, the 
buyers' demands for an intermediate good are interdependent when the 
buyers are product-market competitors with one another. Fourth, the 
buyers of an intermediate good typically are involved in a game in the 
downstream product market, and the sales contract for the upstream 
product may affect the equilibrium of this downstream game. Lastly, 
buyers of intermediate goods often can credibly threaten to integrate 
backward into supply of the intermediate good.''
    Michael L. Katz, ``Vertical Contractual Relationships'', Handbook 
of Industrial Organization, vol. 1 (edited by Richard Schmalansee and 
Robert D. Willig), North Holland: Elsevier Science Publishers B.V., 
1989, p. 656.
---------------------------------------------------------------------------
    Stage 1--Facilities Ownership and Provision of Communications 
Capacity. AT&T is one of several suppliers at this level--carriers who 
provide services (on retail and/or wholesale basis) from facilities 
they own. While AT&T is the dominant provider of underlying network 
capacity and network services, it is joined at this primary level of 
production by several other facilities-based carriers, including, 
principally MCI and Sprint, but several other smaller ones as well. 
Even the largest facilities based carriers (other than AT&T) have at 
one time or another supplemented their offerings by reselling capacity 
obtained from other facilities based carriers. Most facilities based 
carriers continue to do so.
    AT&T is the dominant supplier of services to both end users and for 
resale. The other major facilities-based interexchange carriers--MCI, 
Sprint, and WilTel--provide services to both resellers and end users. 
Most smaller facilities-based, interexchange carriers fill out their 
networks with services obtained from the major carriers for resale. 
Some resellers have limited investment in switches, which provide 
linkages among circuits obtained from facilities based carriers. The 
line between small interexchange carriers and facilities-based resale 
carriers is not in principle a bright one, inasmuch as both segments 
are substantially dependent on the facilities of others.
    Stage 2--Provision of Service on a Wholesale (for Resale) Basis. 
AT&T and the large facilities based carriers provide capacity on a 
wholesale basis to intermediaries who in turn resell to end users. Some 
of the larger resellers also sell capacity to other smaller resellers 
thus assuming the role of both wholesaler and retailer. And, in fact, 
some of the larger users who obtain service either under contract or 
Tariff 12 may provide wholesale capacity to other smaller resellers or 
to end users in the retail market.
    Stage 3--Provision of Service on a Retail Basis to End Users. 
Facilities based carriers and resellers compete in the retail market by 
providing service to end users. They are joined in that competition by 
a handful of large users who buy under one or several volume discounted 
tariffs, then sell some of that capacity to smaller end users.
    Resellers are set apart from facilities based carriers by the fact 
that most, and in many cases all, of their revenue comes from the sale 
of minutes provided from the physical network of another carrier. 
Resellers may or may not own switches, and they may or may not bill 
their customers. These distinctions provide the basis for the three 
types of resellers identified in the table. The capital intensity of 
resellers varies from those that have significant investment in both 
switching and transmission facilities, to those that invest in switches 
only, to those that have no plant investment (pure resellers). Pure 
resellers may be further divided into aggregators and rebillers. 
Aggregators merely sign up users and arrange with the facilities based 
carrier(s) to provide and bill for service. Like aggregators, rebillers 
sign up multiple users and order service from the facilities-based 
carriers. In addition, however, the rebiller also bills the end user.
    The key points to emerge from this classification of various types 
of entities in the interexchange market are (a) AT&T is the dominant 
facilities provider and source of most capacity obtained by resellers, 
(b) AT&T and other major facilities based carriers are fully integrated 
through the entire vertical value chain from facilities provision, 
through wholesaling, to the end user retail market and (c) resellers 
are both competitors of the major facilities providers in the retail 
market and customers in the wholesale market.
    The analysis below will be concerned mainly with the implications 
of these differential degrees of vertical integration, market rivalry 
and market power.
                 at&t has incentives to suppress resale
    The structure of these markets belies simple characterization of 
the incentives and likely market behavior of firms generally and AT&T 
in particular. The foregoing sketch of the firms and markets involved 
in different phases of the value chain is complicated further by the 
details of different firms' day-to-day operations. The markets are 
characterized by incomplete and asymmetric regulation, different 
degrees of rivalry and market power, and widely varying degrees of 
vertical integration and market staying power. Thus, even a reasonably 
complete characterization of the incentives of firms in the sector 
would require consideration of several strands of contemporary economic 
analysis--behavior of the firm under different regulatory constraints; 
the economics of vertical integration and price discrimination; 
oligopoly pricing models under different assumptions about information, 
and others.
    While a full analysis is beyond our scope here, examination of the 
incentives and market opportunities of the fully integrated suppliers 
creates doubt whether the ``invisible hand'' is at work, bringing into 
conformance the private interests of the carriers and the broader 
public interest which the Commission undertakes to promote and protect. 
Because of the vertical structure of the market and the fact that sales 
to different buyers make different contributions to the company's 
bottomline and to the success of its overall market strategy, AT&T has 
a clear incentive to favor some classes of customer over others.
    AT&T is a publicly held and traded corporation. As such, its 
managers must be responsive to, and their decisions systematically 
reflect, the need to create value for AT&T shareholders. Thus, there is 
no reason to doubt that AT&T attempts to structure its tariffs and to 
price its various services, including those made available under 
contract, in ways that will create maximum value for its shareholders. 
It will have the incentive to do so even when such market behavior 
comes up against the constraints imposed by policies and rules of the 
Federal Communications Commission.
    AT&T has revealed its preferences about the resale market structure 
on several occasions in the past. It has almost without exception 
opposed the expansion of the types of services that may be resold, 
while resisting relaxation of the conditions governing resale.\10\ 
While several different reasons have been cited in AT&T arguments, the 
principal and recurring ones relate to economic harms (of a public 
nature) alleged to follow from initiation or expansion of resale.\11\
---------------------------------------------------------------------------
    \10\ Prior to the Commission's Order in Docket 20097, AT&T tariffs 
quite consistently and uniformly forbade resale and shared use. In the 
Docket 20097 proceeding, and again in the WATS resale proceeding, AT&T 
argued against relaxation on resale restrictions on various ``economic 
harm'' grounds. Thus, the company has generally signalled that it 
regards resale as counter to its own economic interests.
    \11\ Frequently the argument has taken the following form: Resale 
will reduce the revenue contribution of certain customers to overhead, 
thereby shifting the responsibility for recovering such overhead to 
other customers, whose rates will have to be increased.
---------------------------------------------------------------------------
    We can best identify and characterize the conflicts between the 
public interest as identified by the Commission and AT&T's corporate 
self-interests by considering the value of AT&T minutes or capacity 
sold to different customers or customer classes. For simplicity, 
consider minutes sold as a surrogate measure of shareholder value. 
Other things equal, AT&T prefers larger margins and contributions to 
earnings to smaller ones. In this context some minutes are more 
valuable than others, as measured by the differences in margins 
expected to be generated by different services. Different types of 
minutes also contribute differentially to the success of AT&T's overall 
market strategy.
    Recall that AT&T competes in two of the vertical markets in the 
value chain. First, it provides capacity to resellers on a wholesale 
basis, in competition with MCI, Sprint and other facilities-based 
carriers. Second, AT&T also competes with these resale carriers and 
with other facilities based carriers for the business of end users in 
the retail market. Thus, an interstate, interexchange minute of use by 
an end-user can be categorized from AT&T's point of view according to 
(a) which underlying carrier provides the capacity and (b) which 
carrier interfaces with the customer. This situation is characterized 
in the accompanying two by two characteristics matrix which divides 
interstate minutes into four discrete categories. Differences in value 
created for AT&T by different types of minutes--as measured by expected 
earnings--provides the basis for very strong preferences among them.
    The best case from AT&T's point of view is to sell minutes of use 
of its network directly to end-users. In this case AT&T garners 
whatever average cost reductions or other advantages of scale and scope 
that may be associated with producing and distributing those minutes; 
it earns on, or contributes to the overhead cost of, the resources used 
in both the production and distribution of minutes; and, it denies its 
competitors both those advantages in cost economies and earnings or 
overhead contributions.
    Selling directly to end users also maintains customer contact and 
control. As AT&T continues its evolution into a more diversified, 
multiservice market environment, maintaining direct contact with end 
users--``customer control''--becomes more and more valuable.
    Thus, dealing directly with the end user is preferred by AT&T from 
an earnings point of view, from the point of view of improving its cost 
competitiveness and market share in the sale of capacity, and as a 
means of maintaining contact with end users.
    AT&T has clearly revealed the strength and value of this preference 
in its persistent opposition to the Commission's resale 
initiatives.\12\
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    \12\ In subsequent sections we will explore the extent to which 
this aversion to resale and preference for bypassing resellers to get 
to end users is reflected in its market behavior toward resellers.
---------------------------------------------------------------------------
    The second best case for AT&T is to sell minutes of use of its 
network to a reseller, who in turn sells to end users who would 
otherwise buy minutes, directly or indirectly, from another facilities 
provider. In this case, AT&T earns on its provision of capacity, but 
not on its retailing organization. It reaps the cost advantage 
associated with selling minutes of use of capacity, but loses 
contribution to the cost of its marketing organization. It also loses 
contact with the customers.\13\
---------------------------------------------------------------------------
    \13\ This preference is clearly expressed by AT&T in the contracts 
it negotiates with resellers. Minutes sold by resellers to customers of 
AT&T's rivals are cheaper than rates for reseller services sold to 
AT&T's own customers. AT&T's desire to get these customers back on its 
own network is clearly expressed in the favorable pricing differential 
applied to ``Winback'' minutes in contracts negotiated with resellers.

                          FIGURE 1.--COMBINATIONS OF FACILITIES AND SERVICES PROVISION
----------------------------------------------------------------------------------------------------------------
                                          Facility provider sells to end         Facility provider sells to
                                                   user (retail)                   intermediary (resale)
----------------------------------------------------------------------------------------------------------------
AT&T Provides Facilities...............  Best Case--QT...................  Second Best Case--QTR
Others Provide Facilities..............  Worst Case--QF..................  Third Best Case--QFR
----------------------------------------------------------------------------------------------------------------

    The worst cases from AT&T's point of view involve end users buying 
minutes of use made available on a wholesale basis from the networks of 
its competitors, either directly from a competitive facilities provider 
or indirectly via an intermediate reseller. Assuming that direct 
contact with the end user has some value to facilities providers, AT&T 
probably has a mild preference that minutes of capacity sales lost to 
competitors be provided to end users by an intermediary reseller rather 
than directly by the facilities provider. These possibilities are 
illustrated in the accompanying graphic, Figure 1 above.\14\
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    \14\ The discussion in this section can be summarized succinctly. 
The total volume of minutes sold in the interstate, interexchange 
market can be expressed as the sum of these various combinations of 
minutes. The following expresses this relationship. Total minutes sold 
(Q) equals the sum of those sold directly by AT&T (QT), plus 
those produced by AT&T but sold by resellers (QTR), plus 
those produced by other facilities providers, either directly 
(QF) or indirectly (QFR).
                                    
Q=QT+QTR+QFR+ QF
    The contribution to fixed costs and earnings are different. Minutes 
sold directly to end users are more valuable than minutes sold through 
resellers. And, minutes sold by other facilities-based carriers have no 
value to AT&T, but some of these are probably less ``harmful'' than 
others, inasmuch as minutes sold directly by AT&T's facilities based 
competitors make them a stronger competitor than minutes sold 
indirectly through resellers. These considerations are summed up in the 
rankings below:
                                        
QT>QTR>QFR>QF
    The task faced by a vertically integrated facilities provider in 
its transactions downstream is to maximize the contribution of total 
minutes, recognizing that some minutes are more valuable than others. 
The contracts negotiated by AT&T and the nature of their other 
commercial relationships very clearly confirm this ranking.
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    Given the different value to AT&T of these different types of 
minutes, we can reasonably expect that these preferences will be 
expressed in its commercial relationships. AT&T wants to sell as many 
minutes as possible, but it would prefer to sell them directly. And, in 
cases where it cannot sell them directly, it prefers having its own 
network resold to a situation in which its competitors networks are 
resold.
    The foregoing should help clarify the existence and nature of the 
ambiguity in AT&T's attitude toward resellers. On the one hand, the 
Commission's policy and rules direct AT&T to treat resellers as any 
other customer. This policy is re-enforced by market incentives when 
resellers are diverting minutes from AT&T's facilities based rivals. In 
this case, resellers are viewed by AT&T as good customers. On the other 
hand, AT&T is not so favorably disposed to resellers when they are 
diverting minutes from customers being served directly by AT&T. In this 
case, resellers are viewed not as customers but as rivals and AT&T's 
market incentives are inconsistent with the regulatory imperative to 
treat them as customers. The structure of the market, where some firms 
are fully integrated and some are not, dictates this tension between 
the cooperative (with downstream customers) and competitive (downstream 
rivals) forces operating on the firm in control of facilities.\15\
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    \15\ Professor Robert E. Hall makes this point differently but 
forcefully in another context comments on the consumer welfare 
implications of eliminating line of business restrictions in the 
Modified Final Judgment and thereby permitting the Regional Bell 
Operating Companies to enter the interexchange business and thereby 
integrate it with their local exchange businesses. Declaration of 
Robert E. Hall; Attachment H, AT&T Ex Parte Presentation (CC Docket No. 
79-252), April 24, 1995. Professor Hall states: ``Absent vertical 
integration, upstream firms cooperate with their downstream customer. 
On the other hand, horizontal rivals in the same market do not usually 
cooperate with each other. Cooperation is the antithesis of 
competition. Once an upstream supplier integrates vertically into the 
downstream market, it becomes the rival of its downstream customers. 
Accordingly, it is unrealistic to expect the upstream firm to cooperate 
with its rivals in the downstream market.'' (p. 2)
    In addressing the economic effect of permitting the RBOC's to 
integrate into the long distance market, Professor Hall's arguments are 
applicable here. He concludes: ``The strain between cooperation and 
rivalry is greater the larger the role of the vertically integrated 
firm in the upstream market''. (p. 2) Further on, he concludes: ``Two 
general principles emerge from this analysis: First, vertical 
integration into a downstream market merits scrutiny whenever the 
upstream seller has a significant role in the upstream market. Second, 
the social costs of the degradation of cooperation with the downstream 
rivals that will inevitably accompany vertical integration needs to be 
reckoned against any efficiencies that may result from the vertical 
integration.'' (p. 3)
    Professor Hall considers three policy options: allow the dominant 
upstream firm to dominate the downstream market; prohibit vertical 
integration of upstream and downstream activities; and, finally, force 
cooperation through regulation or litigation, thereby forcing firms to 
``act contrary to their shareholders' interests by providing downstream 
rivals with information and products.'' (pp. 4-5) The latter is of 
course the current Commission approach that is being reconsidered.
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    AT&T's ability to differentiate its rate and service offerings, and 
if it should so desire, to discriminate among different users and user 
classes, is conditioned in part by its ability to suppress resale of 
its services. While it is foreclosed by regulatory admonition from 
preventing resale in its tariffs, it may nevertheless find advantage in 
discouraging resale by pushing the limits of the Commission's 
regulations. Thus, to the extent that AT&T is attempting to 
differentiate rates and services from one customer to the next, its 
ability to do so is thwarted by a healthy resale sector. Resale is a 
check on AT&T's ability to discriminate.\16\
---------------------------------------------------------------------------
    \16\ Conditions necessary for discrimination are well known. Hal 
Varian, ``Price Discrimination'', Handbook of Industrial Organization, 
p. 599 states them as follows:
    a. the firm must have some market power;
    b. the firm must have the ability to sort customers into classes 
with different demand elasticities; and,
    c. the firm must have the ability to prevent resale.
    However, in the present context, the (re)phrasing of the third 
condition by Bonbright, et al. is of considerable relevance: ``The 
resale by those buyers who pay a low price to those who would be 
charged a higher price must be deterred.'' (Emphasis added). Thus, the 
weaker condition of ``deterring'', as opposed to ``preventing'' resale 
is sufficient to permit some price discrimination. See James C. 
Bonbright, Albert L. Danielsen, and David R. Kamerschen, ``Principles 
of Public Utility Rates,'' 2nd ea., Arlington: Public Utilities 
Reports, Inc. (1988) p. 520. Thus, inasmuch as AT&T has an incentive to 
practice ``de facto'' discrimination among different users as a means 
of increasing revenues, it has an incentive to ``deter'' or suppress 
resale. It is clear that AT&T's ability to discriminate by putting in 
place ``Ramsey Prices''--a strategy advocated by some--by establishing 
rates proportional to the inverse of demand elasticities would be 
advanced by market conduct designed to ``deter'', if not ``prevent'' 
resale. Indeed, Ramsey pricing and related strategies requiring demand-
based rate variations are not sustainable in an environment open to 
resale and shared use.
---------------------------------------------------------------------------
        at&t has the ability to suppress resellers' competition
    The Commission has on numerous occasions in recent years declined 
to deregulate AT&T's interstate operations, finding on each occasion 
that AT&T has market power and exercises dominance in portions of the 
interstate, interexchange marketplace. Thus, notwithstanding the 
Commission's open entry policies, the expansion in the number of 
competitors and the decline in AT&T's market share, the Commission has 
repeatedly found that AT&T has the ability to suppress competition in 
this market and declined completely to deregulate fully its interstate 
offerings.\17\
---------------------------------------------------------------------------
    \17\ See, ``Policy and Rules for Dominant Carriers,'' CC Docket No. 
87-313, 4 F.C.C. Rcd. 2873 (1989); see, also the Interexchange Order.
---------------------------------------------------------------------------
    There is no question that AT&T has considerable market power, even 
after more than twenty five years of competition, substantial increases 
in rivals' capacity and dramatic reductions in its own market share in 
recent years. Whether its market power has diminished to the point 
where it is insufficient to warrant pervasive regulation of the type 
traditionally practiced for dominant telephone common carriers is a 
separate question--and the Commission should keep it separate--from 
questions about AT&T's ability to suppress competition from resellers.
    While AT&T's market power may have declined sufficiently to warrant 
modification, relaxation, or elimination of many of the Commission's 
traditional regulatory programs and rules, it is less certain that 
increased in rivalry in the interexchange marketplace has been 
sufficient to eliminate AT&T's ability to suppress resale competition 
through exercise of its considerable remaining strength in the 
marketplace.
    There is compelling historical evidence that the services of other 
facilities based carriers have been imperfect substitutes for those of 
AT&T, even though they may be similarly configured and priced. Thus, it 
appears that AT&T has garnered over the years a substantial amount of 
brand loyalty from both large and small users. These facts imply that 
most buyers are willing to pay a premium price for AT&T services above 
comparable bundles offered by competitors.\18\
---------------------------------------------------------------------------
    \18\ Much of the evidence to our knowledge is now somewhat dated, 
but not necessarily without evidentiary value. The best and most recent 
survey on user preferences was submitted over five years ago. See 
Steven C. Salop, Steven R. Brenner and Gary L. Roberts, ``Market Power 
in the Supply of Long-Distance Services'', Appended to Comments of 
Competitive Telecommunications Association (CC Docket # 90-132). While 
we are not aware of any more recent evidence of customer preferences 
for AT&T services, and hence of more recent measures of ``brand 
loyalties'', neither are we aware of any rebuttal to that evidence; 
nor, of more recent evidence of any kind on point. Given the large 
proportion of customers in all classes who preferred AT&T services and 
the strength of intensity of those preferences, there is a strong 
intuitive basis for concluding that substantial preferences for AT&T 
among relatively large numbers of users still exist in the marketplace. 
(See Tables 1-15 in ``Market Power'', Salop, et al.)
---------------------------------------------------------------------------
    AT&T's ability to suppress competition from resellers through 
exclusionary or discriminatory conduct is attested to by two recent 
decisions by the Commission and judicial findings.
 abuse of market power--commercial practices that suppress competition
    In the previous two sections we have examined the nature of AT&T's 
incentives with respect to resellers. The facts presented support a 
conclusion that AT&T has both the incentive and ability to treat 
resellers differently from its other similarly situated customers; and, 
to do so in ways that will limit the scope and intensity of competition 
from the resale sector.
    Given the ability and incentive to do so, it is reasonable to 
expect AT&T will adopt marketplace strategies designed to buttress its 
market position and limit the growth of its rivals--including 
resellers. AT&T's shareholders expect it to do so. Given the incentive, 
the ability, and the opportunity to do so, the question is not whether 
they have been exercising that power in pursuit of long term market 
objectives, but whether the tactics adopted are within the gambit of 
acceptable competitive market behavior, or fall instead into the realm 
of so-called ``predatory'' conduct, or unacceptable anticompetitive 
behavior more generally.
    Let us be very forthcoming at the outset. From a public policy 
perspective, it is sometimes difficult to distinguish between 
acceptable and unacceptable competitive behavior; to separate healthy 
competitive activity from efforts to foreclose rivals; and, to 
differentiate aggressive rivalry from predatory behavior. Particular 
aspects of market conduct may be any of these, depending on the market 
context. The realm of generally accepted business practice changes from 
time to time and from market circumstance to market circumstance. The 
Commission's own rules reflect the fact that market conduct acceptable 
for one class of carrier (nondominantones) is not acceptable from 
others.
    Furthermore, the incentive of carriers with market power--including 
AT&T--is to abstain from blatantly discriminatory, patently 
unacceptable and clearly unlawful behavior, in favor of more subtle 
forms of market misconduct that arguably are in the realm of acceptable 
business rivalry. And, the more clever regulatory gamesman will tend to 
practice forms of anticompetitive conduct that can be cloaked in 
colorably legitimate business practices.\19\
---------------------------------------------------------------------------
    \19\ Professors Willig and Bernheim address the problem of 
identifying anticompetitive conduct and separating it from the type of 
market conduct encouraged in a market economy in their discussion of 
the behavior of the Regional Bell Operating Companies (RBOC's). The 
analysts are so widely and deservedly respected and their analysis so 
clear and on point here, that it is worthwhile to quote them at length.
    ``Since it is extremely difficult to assess an RBOC's true costs 
and technical capabilities, regulators are not always able to 
distinguish discriminatory acts from legitimate business practices, 
especially in the absence of extensive hearings and review of the 
evidentiary record. This implies that aggrieved parties must often seek 
the help of regulators and the courts through protracted and costly 
litigation, the outcome of which is usually highly uncertain. (p. 74)
    ``Even in cases where discriminatory practices are eventually 
disallowed, the RBOC's can rely on their colorably legitimate business 
explanations to argue that, since they acted in good faith within the 
grey areas of the law, legal or regulatory responses should be confined 
to prospective relief. Thus, the RBOC's can impose enormous costs on 
competitors even if regulators eventually detect and restrain 
discriminatory activities . . . The clear lesson is that the mere 
threat of discrimination can chill competition even in the presence of 
active regulatory oversight. B. Douglas Bernheim and Robert D. Willig, 
``An Analysis of the MFJ Line of Business Restrictions''; December 2, 
1994. (p. 75)
    ``As we have discussed at length above, we believe that the RBOC's 
will manipulate the terms and technical conditions of network access so 
as to create noticeable price and/or quality advantages for their own 
products, while cloaking this manipulation in the guise of colorably 
legitimate business practices. When competitors and/or regulators 
complain about observable differences in market offerings, the RBOC's 
will claim that apparent self-preference arises from unavoidable 
technical problems, considerations of cost, or competitive necessity. 
And, they will provide testimony . . . that unintegrated firms simply 
cannot achieve the same efficiencies, or provide the same innovative 
offerings, as integrated firms. Bernheim and Willig.'' (p. 80)
---------------------------------------------------------------------------
    Until fairly recently, much of the discussion of abuse of market 
power has focussed on strategic and pricing practices adopted by 
dominant firms (those with market power) as predatory means for 
eliminating competitors or for discouraging new entry through limit 
pricing.\20\ A firm's market power may be exercised not only over the 
price it charges, but in some circumstances it may also be exercised by 
taking measures that will diminish the attractiveness to consumers of 
its rivals offerings by either raising rivals' cost and/or reducing 
rivals' service quality.\21\ A variety of cost increasing/demand 
impairing activities have been explored in the literature.\22\ These 
evolving views of aggressive, anticompetitive pricing conduct indicate 
less likelihood of naked predatory pricing, but greater reliance on 
more moderate, and more difficult to detect, pricing methods designed 
gently, but unambiguously, to discourage competitors or entrants and to 
persuade them ``. . . that their resources would be better spent 
elsewhere.'' \23\
---------------------------------------------------------------------------
    \20\ Economic theory of predatory pricing behavior has been 
characterized as falling into three general categories: those dealing 
with asymmetric financial constraints and ``deep pockets'' of dominant 
incumbents; those involving the development of a reputation as a 
``tough'' competitor willing to offset and disarm any competitive 
incursions; and, those associated incumbent's use of price to 
``signal'' predatory intent and ability. These models are reviewed in 
Ordover and Saloner, pp. 546-62. See also, J. Roberts, ``Battles for 
Market Share: Incomplete Information, Aggressive Strategic Pricing, and 
Competitive Dynamics'', Working Paper, Graduate School of Business, 
Stanford University, (1985) and J. Roberts, ``A Signaling Model of 
Predatory Pricing'', Oxford Economic Papers, (Supplement), New Series, 
38:75-93 (1986).
    \21\ The academic literature addressing these kinds of questions 
begins formally with the work of Salop and Scheffman. See, S.C. Salop 
and D.T Scheffman, ``Raising Rivals Costs'', American Economic Review, 
73:267-271 (1983). See also Salop and Scheffman, ``Cost-Raising 
Strategies'', working paper no. 146, Federal Trade Commission, Bureau 
of Economics, Washington, D.C., Journal of Industrial Economics, 36:19-
34, (1987). This literature is summarized and fully referenced by 
Ordover and Saloner in ``Predation, Monopolization, and Antitrust'', 
Handbook of Industrial Organization, vol. 1, pp. 565-70.
    \22\ See Ordover and Saloner, pp. 568-9. They note that the 
development of the theory lags potential applications of the theory. 
Also, they report that most of the work has been done on cost 
increasing activities and less done on demand impairing activities, at 
370.
    \23\ Ordover and Saloner, p. 566.
---------------------------------------------------------------------------
    Just as the focus on predatory pricing has shifted to more subtle 
forms of pricing misbehavior that undermine competition without driving 
competitors out of business, there has been a companion shift of 
attention to other nonprice forms of strategic market activities that 
are less draconian than destroying competitors or foreclosing their 
entry, but which nevertheless may be regarded as anticompetitive 
behavior by firms with market power.\24\
---------------------------------------------------------------------------
    \24\ Ordover and Saloner call the most aggressive of these 
practices, ``nonprice conduct aimed at eliminating competitors'' (p. 
562), while reserving the less opprobrious ``putting rivals at a 
disadvantage'' and ``muscling out rivals'' (p. 565) for the less 
aggressive and less obvious anticompetitive practices.
---------------------------------------------------------------------------
    Firms use a variety of techniques to place rivals at a relative 
disadvantage in the marketplace. Some of the most prevalent forms and 
instances of such market behavior of dominant firms are the very 
essence of market competition and, as such, they are encouraged by 
regulatory policies--reducing rates as a result of improved efficiency, 
improving various dimensions of product quality, introducing new 
products and the like. These accepted forms of market rivalry share a 
common characteristic inasmuch as they represent efforts by the 
initiating firm to improve the price/performance characteristics of its 
own market offerings. But these forms of market rivalry are quite 
different from market strategies and activities by a firm with market 
power that acts in the first instance on the price/performance 
characteristics of its rivals' market offerings and, thereby, handicaps 
them in ways that benefit the initiating firm, but do not lead to 
greater economic welfare.
    The goal of these market strategies by dominant firms is to 
suppress rivals' expected growth and to dampen their earnings 
prospects. The result of the successful exercise of such strategies by 
incumbents with market power is suppression of capital formation and 
capacity to serve by competitors either from elimination of rivals, 
reduction of the growth of smaller incumbents, or suppression of the 
rate of new entry.\25\ Each of these results can be shown to increase 
the expected earnings and shareholder value for incumbents.\26\
---------------------------------------------------------------------------
    \25\ As indicated above, much of this behavior and results are 
resemble market conduct associated with healthy competitive processes 
and conceding the difficulty of determining clear dividing lines 
between the two. Thus, for example, elimination of a competitive firm 
and absorption of its output and customer base may have positive or 
negative welfare implications, depending on the circumstances. Note 
however that the preponderance of the literature indicates ``guarded 
support'' for the proposition that constraints on dominant firm 
behavior will frequently increase economic welfare. See Ordover and 
Soloner at pp. 538-9. In their words: ``In the context of strategic 
interactions, it is difficult to distinguish between those actions 
which are intended to harm actual (and potential) rivals that stifle 
competition, and thereby reduce economic welfare, and those actions 
which harm present rivals and discourage future entry but which, 
nevertheless, promote economic welfare. . . . Thus, it may be difficult 
to assess strategic behavior for purposes of determining impacts on 
economic welfare or conformance with broad public interest 
considerations.''
    \26\ Katz (``Vertical Restraints'') notes that sales, market share, 
profits and related measures of corporate objectives are positively 
related in the general case with the level of a rivals costs. (p. 706)
---------------------------------------------------------------------------
    Rivals' profits and earnings potentials may be suppressed in a 
variety of ways. Earnings are the difference between revenues and costs 
and will be influenced by market tactics that impact either. The 
principle nonprice market tactics that suppress competition are those 
that reduce a rival's earnings or profit prospects by reducing expected 
revenue and or increasing expected or realized costs. Let's consider 
these in turn.
    Reducing Resellers' Revenue.--Rivals' revenues depend on the prices 
paid and quantities purchased from them. Market tactics by dominant 
firms may influence them in a variety of ``revenue suppressing'' ways. 
These tactics are particularly apt when, as is the case with resellers, 
the dominant firm is also the supplier of an important input 
(telecommunications capacity) to its competitors in the downstream 
market (retail telecommunications sales).
    First, a vertically integrated, dominant firm may force its rivals 
to charge higher prices or it may otherwise reduce the differential 
between the prices of its competitors prices and the dominant firm's 
own price. The dominant firm may do this by selling to end-users at 
rates below those it offers comparably situated resellers. While much 
of the literature on this point discusses the incentive of a dominant 
firm to increase its dominance by integrating into downstream markets, 
the firm that is already integrated has the same set of incentives, 
vis-a-vis its downstream rivals, and may reasonably be expected to 
manifest similar types of market conduct.\27\ This type of conduct has 
been written about expansively and described generally as implementing 
``price squeezes''.\28\
---------------------------------------------------------------------------
    \27\ For a good exposition of the incentives and types of firm 
conduct predicted by standard economic models, see J.A. Ordover, A.D. 
Sykes and R.D. Willig, Non-Price Competitive Behavior by Dominant Firms 
toward the Producers of Complementary Products, in ``Antitrust and 
Regulation: Essays in Memory of John McGowan,'' Cambridge, Mass.: 
M.l.T. Press, pp. 315-330.
    \28\ For a good summary, see Martin K. Perry, ``Vertical 
Integration: Determinants and Effects'', Handbook of Industrial 
Organization, vol. 1, pp. 192-96 and references cited there. See, in 
particular, D.L. McNicol, ``The Two Price System in the Copper 
Industry'', Bell Jouma/of Economics, 6:50-73 (1975) for an analysis of 
the circumstances under which an integrated supplier can increase its 
profit by ``rationing'' quantity to its downstream rivals. He calls 
this ``quantity'' discrimination, which like price discrimination 
results in a ``supply squeeze'' that handicaps downstream rivals.
---------------------------------------------------------------------------
    Second, the dominant, vertically integrated firm can lower the 
quantity its rivals may sell at a given price by suppressing the 
quality of the inputs or intermediate products/services it provides to 
its downstream rivals, thereby reducing rivals' service quality. For 
this to happen, the inputs provided by the upstream supplier must be an 
important component of the downstream rivals production process or 
service--a condition that clearly holds in the relationship between 
integrated facilities providers and the resale industry.\29\
---------------------------------------------------------------------------
    \29\ It should be noted that providing downstream or potential 
competitors inferior services has frequently been alleged in the 
telecommunications industry. In the context of local exchange 
communications there is the problem of access to bottleneck facilities. 
In principle there is no difference between that kind of discriminatory 
access and the kind under review here, in which the dominant supplier 
uses its market power to diminish the quality of its competitors 
offerings by degrading the intermediate services it provides. Also, we 
note that offering inferior services to competitors might be regarded 
as an effort to raise competitors costs, inasmuch as there is, at least 
in principle, some quality enhancing, but costly, activities the 
downstream firm might make to compensate for the inferior service. The 
activities of dominant, vertically integrated firms designed to 
increase rivals' costs are discussed more fully below.
---------------------------------------------------------------------------
    Finally, the dominant, vertically integrated firm can lower 
expected and actual sales of its downstream rivals by ``locking in'' 
customers through long term contracts and by otherwise increasing 
customer ``switching'' costs.\30\ End-users of telecommunications 
services, business users in particular, may have to incur direct costs 
as a result of switching from one supplier to another. Long term 
contracts often have a variety of conditional requirements and 
associated forfeiture clauses that have the practical effect of 
increasing costs to the purchaser in the event that certain conditions 
are not met. While costs of switching are clearest in the case of 
``requirements contracts'' they are also important where different 
complementary goods or services are required to be used with the 
products or services or different vendors. But, even where specialized, 
complementary inputs are not required, end users generally experience 
switching costs of various types and magnitudes.\31\
---------------------------------------------------------------------------
    \30\ For a brief overview of the importance of switching costs, see 
Robert J. Reynolds, ``Aspects of Dominant Firm Behavior'', Appendix G 
of Sprint Comments in (Interstate Interexchange) Docket No. 90-132, p. 
11. See also, P. Klemperer ``Entry Deterrence in Markets with Consumer 
Switching Costs'', Economic Journal, 97 (Supp.) 99-117 (1987). While 
Klemperer focuses on end users and entry deterrence, many of the points 
made there can find ready interpretation in the context of the behavior 
of a vertically integrated firm that sells to a specialized retailing 
firm with which it competes in downstream markets. See also, P. Aghion 
and P. Bolton, ``Contracts as a Barrier to Entry, American Economic 
Review, 1987, 338-40.
    \31\ See Richard J. Gilbert, ``Mobility Barriers and the Value of 
Incumbency'', Handbook of Industrial Organization, pp. 506-508 (section 
on switching costs); see also, R. Schmalansee, ``Brand Loyalty and 
Barriers to Entry'', Souem Economic Joumal, 40:579-91 (1974) and R. 
Schmaiansee ``Product Differentiation Advantages of Pioneering 
Brands'', American Economic Review, 72:349-365 (1981).
---------------------------------------------------------------------------
    Raising Resellers' Costs.--A very direct way of reducing the threat 
of rivals in the marketplace is to take measures to raise their costs. 
As suggested above, there is an important and growing strain of the 
``predatory behavior'' literature that explores the ability and 
incentive of dominant firms to engage in market behavior that raises 
rivals' costs.
    Perhaps the most severe cost raising tactics involves denying 
competitors access to indispensable inputs through exclusive dealing 
arrangements or by otherwise gaining control of such inputs. However, a 
variety of less exclusionary practices fall short of outright 
prevention of access to resources, but merely makes them more 
expensive. Such practices can increase rivals costs in different ways 
and by amounts of differing relative importance.
    The structure of the communications resale market, with the largest 
firms integrating facilities provision with wholesale/retail 
distribution and selling to their (resale) competitors, gives rise to 
several different opportunities for integrated suppliers to increase 
the costs (and sustainable rate levels) of their specialized rivals who 
merely resell to end users.
    Raising Reseller Costs by Inflating Input Prices.--Resellers are 
critically dependent on the rates charged them for underlying capacity 
by integrated, upstream facilities providers like AT&T.\32\ The 
discussion in previous sections indicates that integrated, dominant 
carriers have a strong economic incentives to attempt to control the 
spread between the rates they charge end users and those they charge to 
intermediate resellers who will compete with them in the end user 
market.
---------------------------------------------------------------------------
    \32\ The proportion of total reseller costs made up of the cost of 
obtaining capacity from an integrated facilities provider will vary 
from one reseller to another. For those merely reselling, or rebilling 
in the limiting case, the proportion may exceed ninety percent. For 
other resellers who have facilities of their own--switches and/or 
transmission--and add value in other ways, the share of the total of 
outlays for capacity will be less. In all cases, however, the 
substantial dependence of resellers on underlying capacity providers is 
manifest in high proportions of reseller costs accruing to providers of 
the underlying facilities.
---------------------------------------------------------------------------
    Nonprice Means of Raising Costs.--In addition to raising 
competitors costs directly by charging excessive rates, there are 
several nonprice means for an integrated supplier to gain competitive 
advantage in downstream markets by imposing handicaps on their 
customers/competitors that will have the effect of raising their costs. 
A variety of these means have been reported and their theoretical 
implications explored.\33\
---------------------------------------------------------------------------
    \33\ The cases in the economics literature involve exercises of 
market power in both horizontal and vertical market contexts. Even 
though our interest here is principally in the vertical market context, 
it has been instructive to review summaries of the relevant literature 
from three different perspectives. See Katz, p. 706; Ordover and 
Saloner, pp. 565-70; and, R.J. Gilbert, especially pp. 499-503 
(Handbook of Industrial Organization) for three different 
perspectives--predatory behavior, vertical restraints, and barriers to 
entry--on strategies to raise rivals costs.
---------------------------------------------------------------------------
            at&t conduct toward resellers--contract tariffs
    The previous section summarized relevant parts of the economics 
literature as it may apply to the behavior of AT&T vis-a-vis the resale 
sector of the industry. That literature basically holds that firms 
situated like AT&T--vertically integrated and dominant in both upstream 
and downstream markets--have an incentive and the ability to behave in 
the marketplace in ways that may be anticompetitive. The analysis 
identified a variety of potential anticompetitive practices that might 
be present in the long distance marketplace. We turn now to a 
discussion of some of the terms of contracts entered by AT&T and their 
competitive implications, preceded by a brief analysis of the status of 
the Commission's evaluation of the impact of contract tariffs on 
resellers.
    Background.--AT&T and other interexchange carriers have only fairly 
recently been authorized to offer services pursuant to the terms of 
individually negotiated contracts. In 1990, the Commission undertook an 
examination of the state of competition in the interstate, 
interexchange business in Docket 90-132. On completion of its 
investigation, the Commission concluded that most AT&T business 
services were subject to substantial competition and, on that basis, it 
further streamlined regulation of most AT&T business services. In 
addition, the Commission found competition sufficiently robust to 
warrant permitting AT&T and other interexchange carriers to offer 
certain business services pursuant to terms individually negotiated 
with particular customers. As a condition of offering service under 
individual contract, the Commission required AT&T and other IXC's to 
make those contract terms generally available to other similarly 
situated customers.\34\
---------------------------------------------------------------------------
    \34\ The Commission cited language from Sea-Land Service, Inc. v. 
ICC, 738 F.2d. 1311 (D.C. Cir. 1984) to the effect that, ``. . . 
[a]lthough one normally regards contract relationships as highly 
individualized, contract rates can still be accommodated to the 
principle of nondiscrimination by requiring a carrier offering such 
rates to make them available to any shipper willing and able to meet 
the contract's terms.''
---------------------------------------------------------------------------
    Impact on Resellers.--The Commission has not fully reviewed the 
impact of contract tariffs on resellers. In the Interexchange Order, 
the Commission undertook very briefly to analyze the effects of 
contract carriage on resellers. It concluded: ``Nor do we believe that 
contract carriage will have an adverse effect on resellers.'' \35\
---------------------------------------------------------------------------
    \35\ Interexchange Order, p. 1160.
---------------------------------------------------------------------------
    The Commission's analytical support for this comforting conclusion 
is quite limited and in substantial proportion simply incorrect:
    ``. . . The fact that AT&T's competitors have been making contract 
offerings and still provide service to resellers indicates that 
contract rates would not adversely affect this segment of the market.'' 
\36\
---------------------------------------------------------------------------
    \36\ Ibid.
---------------------------------------------------------------------------
    This is a non sequitur. It does not follow, first of all, that AT&T 
will emulate the behavior of its competitors. Nor, is it true that 
simultaneous provision of service under contract and to resellers 
equates to no adverse effect on resellers. At best this observation 
suggests that the opportunity to offer service under contract will not 
lead to cessation of service, but it has no probative value at all on 
the question of lesser impacts on resellers.
    ``Moreover, resellers, like other users, are valued customers--in 
fact, they are large customers. It is not reasonable to assume that 
AT&T will refuse to present them with viable service options at 
reasonable rates.'' \37\
---------------------------------------------------------------------------
    \37\ Ibid.
---------------------------------------------------------------------------
    Indeed, there is no rationale for assuming any AT&T tariffing 
behavior simply on the basis that resellers are large customers. There 
is a substantial basis for supposing that AT&T's tariff practices are 
designed to impose costs on competitors, and that the incentive to 
impose such costs is greater for larger customers than for smaller 
ones.
    The Commission concludes its analysis of the effect of contract 
carriage on resellers by restating its resale policy and the general 
terms of its contract tariff decision.
    ``In any event, as noted above, the terms of AT&T's contracts must 
be filed with the Commission and made available to all similarly 
situated customers, including resellers. Moreover, our longstanding 
policy barring restrictions on resale applies with full force to 
contract carriage.'' \38\
---------------------------------------------------------------------------
    \38\ Interstate Interexchange Order, p. 1160; Emphasis added.
---------------------------------------------------------------------------
    This is the context in which the contract tariffs filed by AT&T 
should be considered and the standard against which the principle 
provisions in reseller contracts, and the differences between those 
comparable provisions in corporate contract tariffs, ought to be 
evaluated.
    We have reviewed the principal provisions of the majority of the 
more than 2,000 contract tariffs entered by AT&T since it was granted 
the necessary authority by the Commission. It goes without saying that 
these are complex agreements that spell out sometimes in excruciating 
detail, but sometimes with exasperating vagueness, a wide and rich 
range of privileges conferred and obligations imposed on buyers.
    A typical contract tariff contains restrictions and conditions that 
appear to vary with the likely cost of providing the service and with 
the likely ``value of the service''. Some provisions are inexplicable 
on either grounds. Restrictions are placed on the number of sites; 
services are tied together, so that rates depend on the total volume of 
all services; rates are bundled; minimum commitments are required and 
rewarded with lower rates, but penalized if not achieved; rates vary 
with the proportion of traffic (a) that is switched, (b) that is ``won 
back'' from another facilities-based carrier, (c) that is dedicated 
usage, (d) that is switched, etc., etc., etc. Users are ``locked in'', 
but they are compensated with lower rates for agreeing to such 
arrangements. These are the most apparent conditions; the fine print is 
even more vexing.
    The conditions found in the contract tariffs are in many cases 
clearly designed to separate resellers from corporate users--to 
discourage resellers from taking service under ``corporate'' contracts 
and, reciprocally, to discourage corporate users from taking advantage 
of benefits designed for resellers. As such they conform to one of the 
necessary conditions for practicing effective price discrimination--
separation of different classes of buyers and those with differing 
demand elasticities.
    We have identified conditions that appear to us to be on the margin 
of economic discrimination between resellers and corporate users, but 
which, to be quite candid, probably cannot be proved one way or the 
other without a sharper definition and sense of the strength of the 
public policy commitment to nurturing a market environment conducive to 
resale. As indicated above, what is good business practice in one 
context will be impermissible in another public policy context.
    We cited above the Commission's view of the sustainability of 
resale in a contract tariff environment. We are less confident that 
resale will thrive, as envisioned by the Commission, in an environment 
in which AT&T contracts are not subject to review under a broad public 
interest standard. Indeed, without such a regulatory constraint, the 
strength of AT&T's incentives and the latitude of its opportunity would 
most certainly lead to a less robust resale sector.
          at&t conduct toward resellers--commercial practices
    The tensions in AT&T's incentives toward resellers, and its 
understandable preference to deal directly with end users without 
intervening agents, are reflected frequently in AT&T's market conduct, 
which conforms generally to theoretical constructs that predict the 
behavior toward downstream rivals of vertically integrated firms with 
market power. Several of these practices are consistent with market 
strategies designed to suppress competition by raising rivals' costs; 
by reducing or rendering uncertain their revenues; by undermining 
various dimensions of rivals' service quality; and, otherwise 
handicapping its downstream, less diversified, resale rivals.
    Some examples of this type of behavior will be instructive. 
Consider first the longstanding and systematic use by AT&T of one of 
the most valuable assets a reseller possesses, information about its 
customer base. Customer proprietary network information (CPNI) 
routinely includes data about location, calling patterns, rates, 
payment histories, services preferences and other valuable marketing 
information. As the underlying facilities provider, AT&T has access to 
this information. And, if the information becomes available to AT&T 
marketing personnel, it provides a valuable marketing tool permitting 
selected, high-margin, or otherwise preferred customers of resellers to 
be targeted.
    Successfully employed, abuse of CPNI by AT&T clearly increases 
reseller marketing costs, reduces the value to resellers of their 
proprietary information, reduces their expected revenue and 
significantly increases their market risk--all of which make resellers 
less effective competitors to AT&T and less able to fulfill the role 
foreseen for them in consistent restatements of Commission competition 
and resale policies.
    Resellers are of course critically dependent on the reliability, 
timeliness, regularity and general quality of service provisioning by 
AT&T and to a much lesser extent the other underlying facilities-based 
carriers. It is difficult for a reseller to compensate for delays, 
uncertainties, missed schedules and commitments, mistakes and 
oversights committed the underlying carriers. Provisioning problems 
originating with AT&T can for the most part only be passed through to 
end users by resellers, who must take final responsibility for the 
degraded service. Any degradation of AT&T provisioning to resellers 
will suppress the quality and vigor of reseller competition by raising 
reseller cost, reducing their revenue and frequently both.
    There is no good purpose served here by repeating the full litany 
of abuses alleged by the resellers and other large buyers against AT&T. 
Those are a matter of record, and they are gradually being resolved 
through regulatory and judicial processes. The purpose here is to 
provide a basis for interpreting the anticompetitive nature of actions 
taken toward resellers. It is important to have a framework for 
understanding the impact of AT&T market conduct on reseller 
competitiveness through its impact on reseller costs, revenues, risk, 
growth expectations and other parameters of performance important to 
the survival and growth of the sector as competent competitors to 
facilities-based carriers.
                               conclusion
    The results of our analysis indicate that AT&T has the ability and 
incentive to structure its general commercial relationships and to 
differentiate the terms offered in different contract tariffs in ways 
that conflict with the Commission's basic policies respecting resale 
and the Commission's broader goals for promoting competition in the 
interexchange marketplace.
    The analysis shows that because of its vertical integration of 
production, wholesale and retail of network services and its power in 
each of those markets, AT&T defines its relationships with resellers in 
ways consistent with economic theories of anticompetitive behavior 
designed to suppress competition by raising competitors' costs and by 
other means.
    The principal conclusion of the analysis is that market forces 
alone, given the current structure and incentives in the marketplace, 
are not clearly sufficient to assure continued evolution of competition 
to facilities-based carriers from the resale sector in conformance with 
long established Commission policies.

                     APPENDIX 1.--RESALE MARKET STRUCTURE, MARKET FUNCTIONS AND PARTICIPANTS
----------------------------------------------------------------------------------------------------------------
                                                                                         Resale carrier--
                                                             Large      Small   --------------------------------
                                                   AT&T      IXC's      IXC's      Type 1     Type 2     Type 3
                                                                                    \1\        \2\        \3\
----------------------------------------------------------------------------------------------------------------
Facilities provision..........................          X          X          X          X  .........  .........
    Switching.................................          X          X          X          X          X  .........
    Transmission..............................          X          X          X  .........  .........  .........
Wholesale.....................................          X          X  .........  .........  .........  .........
Retail........................................          X          X          X          X          X          X
----------------------------------------------------------------------------------------------------------------
\1\ Type 1 (facilities-based) resellers have investments in lines and/or switches.
\2\ Type 2 (switchless) resellers have no investment, but perform billing functions.
\3\ Type 3 resellers (aggregators) have no facilities and do not bill customers.

                  Deregulation and Telecommunications

    Mr. Darby. In the time you have given me, I want to talk 
about four questions quickly.
    One: How, why, and when did resale come about in the 
telecommunication sector?
    Two: How did it develop over time?
    Three: What have been its effects to date?
    And four, the last question: What might be expected if 
resale were extended to the airline section?
    Resale describes a common practice in many lines of 
commerce, normally called wholesaling. Somebody breaks bulk, 
buys from the underlying manufacturer, breaks the bulk, passes 
along part of the discount to retailers and to consumers.
    In surface transportation, it was called freight 
forwarding. And in telecommunications, it is called resale. But 
effectively, it interjects a new economic entity between the 
producer and the consumer.
    Senator Shelby. It is basically buying wholesale and then 
retailing it, is that the----
    Mr. Darby. Precisely. It combines two of those functions.
    Senator Shelby. Sure.
    Mr. Darby. And I take great pains in my earlier paper to 
walk through what those pieces are.
    Senator Shelby. OK.
    Mr. Darby. To understand why it was introduced, I urge you 
to recall, if you can, the days when AT&T was a monopoly.
    AT&T had a monopoly in both the production and the 
distribution of services, long-distance and local. Its tariffs 
forbid resale. They simply said, ``You buy, you use it. Do not 
share it. Case closed.''
    Second, the tariffs also had substantial bulk discounts for 
large users. And the net effect of two of those effects was to 
prevent arbitrage by a third party, by buying low and 
subsequently selling high.
    Senator Shelby. Explain that. Explain that, just so----
    Mr. Darby. The business as it has----
    Senator Shelby. We have a big audience here.
    Mr. Darby. Sure. The business as it has developed permits 
some users and some new business institutions to buy service 
from the underlying facilities carriers, to buy large volumes 
at low cents per minute--or low cents per circuit----
    Senator Shelby. Yes.
    Mr. Darby [continuing]. And then reenter into the market in 
competition with the facilities-based carriers at the retail 
level, by breaking bulk and reselling that.
    So I might buy dozens and dozens of private line circuits 
from AT&T and then break those down and offer switch telephone 
service, let us say from Dothan, AL, to Indianapolis, IN.
    The net effect of that is that I am both a customer of AT&T 
or the underlying facility carrier, and a competitor. And that 
dual role provided some ambiguity, which I will get into, if 
you would like.
    The purpose for the FCC's rationale, Federal Communications 
Commission rationale for implementing resale was that it was a 
quick and easy way to introduce fare competition or rate 
competition into an industry that was tightly held by a single 
monopolist.
    Recalling that communications is very capital intensive, it 
has taken MCI over 25 years to assume--to get its current size. 
Resale provided a means for the FCC quickly to introduce rate 
competition into the sector.
    Its purpose was to increase user choice, which it did; to 
intensify price and service competition, which it did; and to 
do so very quickly by increasing the number of competitors.
    The FCC, I should point out, rejected a variety of claims 
of economic harm and technical harm that were advanced by AT&T. 
Those were never proved and they have not subsequently 
materialized.
    How was resale developed quickly since 1976? It is grown. 
It now has roughly 800 practitioners, some of which are 
facilities based; some of which have no facilities whatsoever. 
Some have more facilities than others.
    It currently accounts for about 15 percent of the revenue 
of this approximately $80 billion intercity telecommunications 
business. Initially, it began as pure resellers of long-
distance service. The industry has subsequently migrated into 
other services. They now resell international services, local 
services, wireless services. Some provide one-stop shopping. 
They have also expanded from sort of pure resellers into value-
added carriers. They provide a number of additional services 
that were not otherwise available.
    I mentioned the ambivalence of the incumbents toward 
resellers. The ambivalence is reflected in the fact that 
resellers are both customers and competitors of the facilities-
based carrier.
    So the best of all possible worlds if I am a facilities-
based carrier and you are a reseller is that you buy my 
services and then steal away customers of MCI, so that I 
effectively serve those customers.
    The worst case is if you use my facilities to take away my 
customers, because that reduces my yield.
    Most economists' expectation of the resale sector have been 
realized. The sector has forced rate structure toward a 
structure of cost. It has identified and served niche 
customers. It has lowered the communications bills for millions 
of small- and medium-size businesses and residents as well.
    It has intensified the market discipline on the incumbents 
and required them to emulate the successful practices of 
resellers. And it has improved the rate of capacity utilization 
for underlying carriers.

                          Lessons for Airlines

    Introduction of resale into the airline environment would 
completely disrupt the current ticketing practices and airline 
yield management pricing by introducing resellers as new 
customers and competitors, with entirely different pricing 
opportunities and objectives.
    The direction of the first order effects are 
straightforward. Resale of the variety experienced in 
telecommunications in my view would: create a new class of 
competitors; require incumbent carriers to design entirely new 
fare-setting algorithms; reduce spreads between the lowest and 
highest rates; shift revenue from carriers to resellers and 
customers; reduce average fares and stimulate demand; put 
pressure on carriers to reduce operating expenses; and increase 
the risk and cost of capital to incumbents, and you should 
realize that.
    In sum, resale would tend to reduce incumbent carrier 
revenue; increasing revenue for resellers; change the structure 
of fares, higher for some, lower for others; and forcing 
carriers to adjust in a variety of ways to the changes in their 
cash flow.
    That requirement would bring into play considerations, it 
seems to me, of quality of service, wages and employment and, 
indeed, the full range of carrier operating practices.

                           Prepared Statement

    I will be happy to answer your questions and thank you 
again for asking me.
    Senator Shelby. Thank you.
    [The statement follows:]
                  Prepared Statement of Larry F. Darby
    Mr. Chairman, members of the Subcommittee, thank you for the 
opportunity to be here this morning. You have asked me to summarize key 
elements of commercial arrangements called resale in the 
telecommunications business and how that experience might inform your 
efforts to define the future role of government regulation in the 
airline industry.
    I am Larry Darby. I conduct a telecommunications economics 
consulting practice here in Washington, D.C. I have participated in a 
variety of ways in the development of Federal Communications Commission 
(FCC) policies toward telecommunications resellers, beginning with an 
analysis of the practice incorporated in an Office of 
Telecommunications Policy petition to the FCC in 1975.
    In addition to my statement this morning, I agreed to submit for 
the record a longer and more detailed paper on telecommunications 
resale I wrote for other purposes some time ago, but which, 
nevertheless, should help the Committee understand the role and impact 
of telecommunications resale in principle and in practice.
    I cannot in the time allotted this morning convey the full richness 
and detail of the history and performance of telecommunications 
resellers. I will, though, try to answer four questions:
    1. How, why and when did resale come about in the telecom industry?
    2. How did resale develop?
    3. What have been its effects?
    4. What might be expected, if resale of airline capacity were 
permitted?
    How, why and when did resale come about in the telecom industry? 
Resale, as the name suggests, describes the practice common in many 
lines of commerce of buying in large quantities at prices reflecting 
volume discounts, then breaking bulk, marking up the rate and reselling 
in smaller volumes. In the general trade the practice is called 
wholesaling. In surface transportation it was called freight 
forwarding. In telecommunications it is called resale, a practice that 
took a variety of forms which I will describe after providing some 
context.
    While AT&T enjoyed a monopoly in the provision of both long 
distance and local telephone services, its tariffs forbid resale and 
shared use of company facilities or services. The practical effect for 
users was straightforward. You buy a telecom service, you use it. Don't 
sell it; don't share it. Case closed.
    AT&T tariffs also provided volume discounts. While most users paid 
by the month, or according to call distance or call setup and holding 
time, large users, principally business or institutions, could lease 
private lines or otherwise obtain bulk capacity at lower unit costs to 
accommodate their high volume requirements.
    After decades of prohibition by AT&T and its regulators, resale was 
first permitted in the late sixties as a means of assisting new 
facilities-based entrants into the long distance telecommunications 
business. MCI and others complemented the facilities they constructed 
and owned with lines they leased from AT&T and then resold. The 
practice permitted entrants to offer services, and thereby compete with 
AT&T, in geographic areas where they had no, or insufficient, 
facilities. While MCI and Sprint and others today have nationwide 
facilities networks, each originally relied on AT&T facilities to 
``fill out'' their geographic service offerings and national coverage, 
pending build-out of their own networks.
    The FCC first licensed MCI in 1969, then generalized and expanded 
that pro-competitive decision on several occasions in the early 1970's. 
However, it was not until 1976 that the Commission completely set aside 
AT&T tariff restrictions and thereby permitted unlimited shared use and 
resale. It was five more years before the decision was extended to 
permit resale not only of private lines, but also of basic switched 
services like simple long distance connections (message toll services 
or MTS) and wide area telephone services (WATS).
    The rationale for the resale decisions was straightforward. Put 
simply, the FCC wanted to increase user choice among both carriers and 
services; to intensify price and service competition; and, to do so by 
quickly increasing the number and market strength of new competitive 
rivals. Each purpose was served by reducing the very substantial 
barrier to entry posed by the enormous threshold capital requirements 
of constructing new and duplicative common user telecommunications 
networks. Resale made it possible for new entrants to mushroom 
literally over night and to provide service of comparable scope and 
quality to that offered by incumbent facilities-based carriers.
    The FCC anticipated that elimination of AT&T tariff provisions 
prohibiting resale would bring about a variety of benefits to the using 
public. These included rationalizing the rate structure; forcing rates 
more closely into conformance with the overall structure of costs; 
stimulating demand; lowering rates and diversifying service for some 
users; and, providing for more complete and efficient use of existing 
network capacity.
    It is important to note that the FCC rejected a variety of AT&T 
claims of harm to the network and allegations of assorted economic 
harms to other users and to itself. It is equally notable that none of 
these harms actually materialized.
    The FCC recently reviewed and reaffirmed its resale policies and 
observed that: ``. . . unlimited resale promotes the public interest by 
creating competitive pressures on carriers to provide service at rates 
near the cost of service and by stimulating demand for such service.''
    How did resale develop? Since 1976 the resale industry has grown, 
matured and diversified. Today there are over 800 resellers serving 
pretty much the full spectrum of the business community, especially 
small and medium sized firms, as well as millions of households. 
Resellers have captured more than fifteen percent of the $80 billion 
domestic intercity telecommunications business. In addition to revenue 
growth, the two decade transition has been marked as well by expansion 
of the scope of services offered by resellers to include international 
services, local exchange services, wireless services, specialized 
billing services and a variety of ``bundled'' services customized to 
individual user needs.
    Reseller growth and diversification was gradual and episodic. 
Though the resale sector was first given life by a 1976 FCC decision 
declaring unlawful AT&T tariff prohibitions of resale, the decision had 
important antecedents in earlier ``procompetitive'' FCC decisions, not 
the least of which launched MCI, today's second largest long distance 
carrier. Subsequent FCC decisions have loosened restrictions and 
otherwise enlarged the domain for resale activity.
    Pure resale has been distinguished by the FCC from shared use of 
capacity by members of a common organization or institution and from 
value-added carriage, in which the reseller not only disaggregates and 
resells circuits, but also improves on their quality or value before 
repackaging them for resale. Early resellers were also value added 
carriers. Most today add value to the basic circuits and services they 
provide, in addition to offering lower rates.
    Resellers perform a variety of functions. They may own and operate 
their own facilities--particularly switches--and many do. Facilities-
based resellers link their own lines and switchers to transmission and 
distribution lines leased from larger, more diversified companies. 
Other resellers provide no facilities and merely buy, repackage, 
market, resell and bill for the facilities or capacity they obtain from 
others.
    Finally, some resellers do not provide billing, relying instead on 
an underlying facilities carrier to do the billing. These companies are 
called ``aggregators'', which describes their role of combining traffic 
from several users in order to obtain bulk discounts. Aggregators look 
quite like commission sales agents for the underlying facilities 
carriers whose capacity they market. (I have discussed these categories 
and their implications more fully in the accompanying paper.)
    I suspect that this form of resale--the ``aggregator'' mode--would 
be the one most likely to emerge in the airline industry.
    Facilities-based carriers are ambivalent toward resellers, and that 
ambivalence is reflected in their conduct toward resale generally and 
toward particular resellers. Depending on circumstances, a particular 
reseller can help, harm or have little impact on a given underlying 
facilities-based carrier. (These outcomes are also developed in greater 
detail in my paper.)
    The ambivalence to resellers of incumbents is traceable to the fact 
that a reseller is both a potential customer and a potential competitor 
to the vertically integrated, underlying facilities-based carriers that 
operate as both wholesalers and retailers. In the best of circumstances 
from, say, AT&T's point of view, a reseller would take capacity from 
it, then market the capacity to customers of one of its competitors--
say, MCI. The worst circumstances for AT&T are the obverse, wherein a 
reseller takes capacity from MCI, then markets to AT&T's customers. The 
middle case is one in which a reseller uses AT&T capacity to take away 
some of AT&T's retail customers. This ambivalence is most clearly 
manifest in the industry wide practice of giving greater discounts for 
capacity that is used to supply so-called ``win back'' customers--that 
is, those previously served by ones competitor(s).
    What have been its effects? It is probably fair to say that most of 
FCC's expectations of the resale sector have been subsequently realized 
in the marketplace. The theory of resale accurately anticipated the 
facts emerging from actual practice.
    In my previous detailed review of the resale sector, I found 
several important general contributions of resellers to the FCC's 
overall competitive policies. At that time I concluded that the market 
conduct of resellers had contributed to improved market performance in 
several ways, including:
  --Forcing the rate structure toward the structure of costs by 
        arbitraging the volume discount spreads;
  --Identifying and serving ``niche'' customers and needs that might 
        otherwise be overlooked by industry majors;
  --Contributing to lowering the average telecommunications bill for 
        millions of residential users and numerous small and medium-
        sized businesses and institutions;
  --Intensifying market discipline on incumbents and forcing them to 
        emulate successful rate and service innovations of resellers; 
        and
  --Stimulating demand and improving the rate of capacity utilization 
        of the underlying carriers, while also providing capital 
        support to migration by underlying carriers to fibre optic and 
        other high capacity facilities.
    Most resellers do more than simply arbitrage the volume discount 
structure of underlying carrier tariffs. While that is an important 
function, resellers may also add value for users in a variety of ways. 
In addition to passing along part of the bulk rate discounts they 
receive by virtue of their volume purchases, resellers today frequently 
provide an array of value-added services and customer support services, 
including customized billing, customer consultation and network 
planning assistance to users. Some bundle a variety of services for 
``one-stop'' shoppers.
    What effects might be expected, if resale of airline capacity were 
permitted? I understand that current yield management techniques have 
many characteristics of what economists call Ramsey pricing. That is, 
prices are set according to the elasticity of demand for individual 
passengers, a practice that in an earlier time was called charging what 
the traffic would bear. The pricing scheme is intended to maximize 
revenue per aircraft by systematically differentiating the fare in ways 
designed to fill the aircraft, while exacting the maximum from each 
passenger.
    The introduction of resale into this environment would completely 
disrupt the current system by introducing resellers as new customers 
and competitors with entirely different pricing opportunities and 
objectives. The current scheme is not sustainable in a resale 
environment.
    The direction of the first order effects of introducing resale are 
fairly straightforward. Resale in the current environment would in the 
first instance undermine the ability of carriers to differentiate rates 
according to current ticketing and revenue yield management practices. 
More particularly, permitting resale of the variety experienced in 
telecommunications would:
  --Create a new class of competitors;
  --Require incumbent carriers to design entirely new fare setting 
        algorithms;
  --Increase the intensity of rate competition;
  --Reduce spreads between the lowest and highest rates;
  --Shift revenue from carriers to resellers and passengers;
  --Reduce average fares and stimulate demand;
  --Put pressure on carriers to reduce operating expenses; and
  --Increase risk and the cost of capital to underlying carriers.
    The impact of these first order effects suggests some good news and 
some not so good news. Determining the balance will require far more 
analysis than I have undertaken for purposes of this hearing. 
Conceptually though, it is clear that the net effect will depend, 
first, on the relative magnitudes of these contradictory effects and, 
secondly, on the direction and magnitude of a variety of distant and 
collateral second order effects that I have not had the occasion 
systematically to analyze, nor even identify.
    In sum, resale would tend to reduce incumbent carrier revenue, 
increase revenue for ``resellers'', change the structure of fares--
lowering some, but raising others--and forcing carriers to adjust in a 
variety of ways to reduced cash flow. That requirement would bring into 
play considerations of quality of service, wages and employment and, 
indeed, the full range of carrier operating practices.

                        Yield Management Benefit

    Senator Shelby. Professor Jenkins, I want to thank you for 
your summary of the yield management. At least I know, 
superficially, anyway, why everyone on the flight has a 
different fare when we fly. And people do wonder about this 
everywhere.
    Who are the winners, professor, and the losers in a yield 
management environment as opposed to the period before yield 
management became the standard pricing strategy of the network 
airlines?
    Dr. Jenkins. Well, the winners clearly are the majority or 
the--or clearly the overwhelming plurality of leisure 
travelers, those who have some flexibility in their travel 
plans. I do not know necessarily that there are----
    Senator Shelby. Lead time, in other words.
    Dr. Jenkins. Yes; lead time. Some flexibility. If Professor 
Kahn had had flexibility in coming here, his fare need not have 
been $616. It could have been $380, if he had had 1 day 
flexibility on it; or if he could have taken a different flight 
and at a different time. I checked out the fares to find some 
of these things out myself on his testimony. I hear anecdotes 
all the time.
    Senator Shelby. Yes.
    Dr. Jenkins. As a mathematician, they drive me a little 
crazy. When I started out in this business in 1974 as a travel 
agent--and I have been a travel agency owner ever since then 
and still am----
    Senator Shelby. Yes.
    Dr. Jenkins. We did not book leisure travel. The people 
like my parents could not fly. They could not afford it. People 
like myself, outside of the discounts that I got for being a 
travel agent, did not fly.

                   Business Travel Pricing Practices

    The only people who flew then were business travelers and 
very wealthy people. So I think overall the net has been 
positive for both leisure and business.
    Now, on the business side, the fares are at an all-time 
high. But some of these city pairs that you have been looking 
at, I have gone back and I have checked the records since 1978. 
Even those prices at their highest level have not yet still 
kept up with inflation rates.
    Senator Shelby. Let me ask you a question. Part of the high 
fare--and we have heard some testimony to this effect--of a 
business traveler's fare is last-minute booking, is that it? By 
the nature of business itself----
    Dr. Jenkins. Well, it is. Business travelers and all of us 
who have been travel agents know that these guys will book and 
rebook at least two or three times on average. All right?
    Senator Shelby. It depends----
    Dr. Jenkins. And then they may or may not show up.
    Senator Shelby. It depends on their business line.
    Dr. Jenkins. It depends on your business line. That is to 
be sure. And it depends on routes that you are going on, so----
    Senator Shelby. Have not a lot of businesses--I know a few 
myself, small, medium-size businesses--working with their 
travel agencies have reexamined their travel expenses and call 
Mr. Burr, Ms. Kelley, or others to say, ``Look, we have to save 
some money. How do we do this, you know. You are the 
professional. We have got so much traveling to do. We know 
this. How do we do it?''
    Is that a fair question, Mr. Burr or Ms. Kelley?
    Ms. Kelley. Absolutely.
    Dr. Jenkins. Do you want to comment?
    Ms. Kelley. I would like to comment on that. Several things 
have taken place. One is that the small and large companies 
have reduced the amount of travel. They are doing a lot more 
teleconferencing, because they cannot afford to send their 
businessmen out as often. They do not send two or three. They 
may just send one.
    But some of the practices that they are using, particularly 
in my own area, and using Harrisburg, PA, as the airport, for 
me to come to Washington, the airfare is $503, because I am 
only coming today, going home tomorrow.
    However, if I was to stay over Saturday night, which would 
encompass a couple more hotel nights, obviously the rate would 
be a lot cheaper. But what the business travel----
    Senator Shelby. Do the hotels subsidize the airlines on 
that? Is that----
    Ms. Kelley. Yes; I believe the hotels do subsidize the 
airline. [Laughter.]
    But what is happening with the business community is that 
the employer is giving incentives now for perhaps a Saturday 
night overstay. If a gentleman or a woman has to go on a trip 
on a Friday to some city they will offer an incentive for them 
to spend Saturday night away from the family, thus cutting into 
the quality family time that is limited as it is.
    The second thing that they are doing is offering to drive 
by car to alternate airports. Again, going back to my area, if 
I was to fly out of Harrisburg anywhere on a business trip, 
because all I have is four major airlines, my fares are 
outrageous.
    If I was to advise my consumer to drive to Baltimore or to 
Philadelphia, both of them about a 2-hour trip, then they can 
save over one-half most of the time of what their airfare is, 
because there is Southwest, Air-Tran, and some of the low-cost 
airlines in these areas.
    Senator Shelby. Professor Jenkins, I want to get back to 
you on a question. What other industries that you know about 
use pricing strategies similar to the yield management as 
evidenced in the airline industry?
    Dr. Jenkins. The stock market.
    Senator Shelby. The stock market.
    Dr. Jenkins. Yes.
    Senator Shelby. OK.
    Dr. Jenkins. Let me just answer your--your previous 
question also----
    Senator Shelby. OK.
    Dr. Jenkins. Three years ago, the airlines tried in the 
fall, tried to push through some very high fare increases on 
your unrestricted tickets.
    At that time, the consumers basically voted the fare 
increase down, and nobody booked for 3 days unrestricted 
tickets at all.
    The economy has been so robust in the last couple of years, 
growing at 4.5 percent that literally during rush hour, every 
seat on every plane is full.
    Now, when you have a scarce commodity, how do you allocate 
that scarce commodity? And this is no surprise to Professor 
Kahn. It should not be any surprise to him why unrestricted 
fares are so high.
    The commodity is scarce and the price is high. This will 
change when two things happen: When the economy goes into the--
goes south or when we have thousands of new airplanes, which we 
do not have right now. There is no new capacity in this system 
whatsoever.
    Senator Shelby. Are we going to get it?
    Dr. Jenkins. Well, 5, 10 years from now.
    Senator Shelby. OK. Lead time?
    Dr. Jenkins. Yes; lead time.
    Senator Shelby. Mr. Darby, what similarities, if any, do 
you see between the state of competition at the moment in the 
airline industry and the state of competition in the 
telecommunications industry before telecom deregulation----

             Airline competition versus Telecom Competition

    Mr. Darby. The similarities--let me just quickly spell out 
my view of the current market structure of each, and a little 
bit about market conduct.
    Before the introduction of competition, as I indicated 
before, there was AT&T and only AT&T.
    Senator Shelby. Yes; a total monopoly.
    Mr. Darby. A total monopoly, with the exception of a few 
small or retailers on the side, but effectively a monopoly.
    There is competition among airlines today, but that 
competition is becoming increasingly constrictive, it seems to 
me, as the industry becomes more concentrated. So----
    Senator Shelby. More consolidated?
    Mr. Darby. More consolidated. So there--I would 
characterize as an economist the market structure of 
telecommunications as a virtual monopoly in contrast to the 
market structure of airlines in what would be called a tightly 
held oligopoly and apparently becoming even more tightly held.
    And the pricing practices, as it becomes more tightly held, 
pricing practices of a tightly held oligopoly approach of those 
of a monopoly. So in that sense, the structure is similar.
    There was very little pricing coherence in 
telecommunications. AT&T's tariffs sort of grew up like topsy, 
willy-nilly.
    You know, you sort of try to figure out if there is any 
rhyme or reason to why some people pay more, some people pay 
less. It was mainly historical accident.
    And whether you like current airline rate structure or not, 
it is coherent. It is understandable. It is driven, you know, 
by an understandable motive which is to maximize the fare 
yield. So introducing resale into that environment would 
dramatically change the rate structure in ways that, you know, 
are not clear to me. It depends on the structure of resale.

                         Large Volume Discounts

    Senator Shelby. Professor Jenkins, one last question: Do 
airlines engage in ticket discounting for large volume 
purchasers? And if so, who would be a typical candidate that an 
airline would discount for?
    Dr. Jenkins. Well, we have corporate discounts.
    Senator Shelby. Yes.
    Dr. Jenkins. I do not know that even the airlines know the 
answer of how many of their flyers are flying on corporate 
discounts, or even who their corporate flyers are----
    Senator Shelby. OK.
    Dr. Jenkins But most likely, one-half of all business 
travelers fly on some type or other corporate discount. Clearly 
for a major corporation like Ford----
    Senator Shelby. Yes.
    Dr. Jenkins Ninety percent of the city pairs that they fly 
on a lot, those will have corporate discounts on. There will be 
some flights that they take that, you know, where they might 
only use once or twice a year. They will not have discounts on 
them, but on other major routes, they have discounts on those.
    Senator Shelby. OK.
    Dr. Jenkins. And they will vary. They might do them like a 
group fare, where you can book at any time during the middle of 
the week.
    Senator Shelby. All right.
    Mr. Burr, would you as a travel agent--and, I guess, Ms. 
Kelley, I can ask the same question in your--would you like to 
get the same price for tickets that the airlines give to their 
largest customers? And if so, how would that work?
    Ms. Kelley. You may answer that on my behalf. [Laughter.]
    Mr. Burr. Well, of course, yes. To dwell on that a little 
bit, I would say that the pricing structure is so complicated 
out there now----
    Senator Shelby. Very.
    Mr. Burr. That I do not know how to define that to you. As 
a professional in the business right here, I find it hard to 
explain the price of your ticket to you.
    Senator Shelby. Yes.
    Mr. Burr. And it changes daily.
    Senator Shelby. Yes; all the time.
    Mr. Burr. Minute by minute.
    Dr. Jenkins. Well, let me make a suggestion to Mr. Burr 
then. Since he does not understand the system and I am a 
professor, I will explain it to him at his leisure. It is 
certainly not complicated at all. It is just fundamental supply 
and demand. And I will be happy to teach him how to get better 
fares for his corporate accounts.
    Senator Shelby. Well, you all do that outside the room in a 
minute. [Laughter.]

                        Yield Revenue Management

    Professor Jenkins, is yield management used only by the 
network airline, or do some point-to-point airlines like 
Southwest use it as well?
    Dr. Jenkins. Southwest uses it as well, because they have 
walkup fares----
    Senator Shelby. OK.
    Dr. Jenkins. And they have advanced purchases. Those who 
have not used yield--revenue management is the correct term--
would include Eastern Airlines, Pan Am Airlines and just about 
every airline that is no longer with us.
    Senator Shelby. Do the point-to-point airlines use yield 
management to the same degree as the network airlines? And if 
not, why not?
    Dr. Jenkins. They use it. They do not have the same fare 
structure though.
    Senator Shelby. Why?
    Dr. Jenkins. Vanguard, for example, recently initiated a 
revenue management system. The people that they are attracting 
is way down on the demand curve, and so the consumer is very, 
very price elastic.
    Senator Shelby. Ms. Kelley, as a travel agent of, what, 20 
years experience?
    Ms. Kelley. Thirty-three.
    Senator Shelby. Thirty-three, excuse me. In your testimony, 
you indicate that the Internet air travel sites are severely 
impaired by the airlines adopting discriminatory and 
noncompensatory commission policies for travel agent bookings 
originating through the Internet.
    Ms. Kelley. Two things----
    Senator Shelby. Would you describe some examples of those 
discriminatory or noncompensatory policies for the committee 
today?
    Ms. Kelley. Two things that have happened on the Internet 
with the air carriers--we are willing to compete. We feel our 
services are superior to any services that an airline would 
offer.
    Senator Shelby. Yes.
    Ms. Kelley. However, we want to be able to compete with the 
same airfares that they are offering other people. And many of 
the airlines have recently posted fares that are available only 
to the consumer if the fare is purchased via the Internet. They 
have blatantly put disclaimers on that these fares are not 
available through travel agents.
    Senator Shelby. Yes.
    Ms. Kelley. And in many instances, if the consumer elects 
to purchase the airfare on the Internet, the travel--and then 
go into their travel agency to pick up the ticket, the travel 
agent is not compensated by commission or if they do receive 
commission, it is a reduced rate, less than what we have 
already been reduced to.
    And so that is some of the situation that is happening with 
the Internet and the discrimination that the airlines are 
putting on us.
    Senator Shelby. Professor Jenkins, I am not picking on you, 
but you----
    Dr. Jenkins. I enjoy it. [Laughter.]

              The Stock Market versus the Airline Industry

    Senator Shelby. How does the stock market use yield 
management? You alluded to that earlier.
    Dr. Jenkins. Well, if you go in----
    Senator Shelby. Is it----
    Dr. Jenkins. If you look at a price of a stock right now, 
its price is a function of its supply and demand.
    Senator Shelby. That is right.
    Dr. Jenkins. If you go in and look at it tomorrow, the 
price is different. Nobody complains. And it is the same basic 
commodity. You get a piece of paper that says you own a 
certificate of stock in that industry.
    Senator Shelby. Are you telling us that the airline 
industry is run like the stock market?
    Dr. Jenkins. Well, basically, yes. It is----
    Senator Shelby. How? How?
    Dr. Jenkins. Airline seats are, in fact, a commodity. And 
they are sold like a commodity in real time.
    That is why you have CRS's. That is why you have travel 
agents. That is why travel agents have exploded in numbers 
since deregulation because there are more fares and there are 
more options available.
    Senator Shelby. Mr. Darby, do you want to comment on that?
    Mr. Darby. I basically disagree that pricing of stocks and 
pricing of airline passenger seats are the same. I mean, they 
have some similar characteristics, but basically the stock 
market is an example of a circumstance in which you have a 
large number of buyers and a large number of sellers coming 
together to create what is an intensely competitive market, 
with free entry and exit, frictionless entry and exit, in sharp 
contrast, it seems to me, to the airline industry, which is 
highly concentrated, tightly concentrated with fares 
essentially administered by the major carriers.
    There is no analogue to administered fares at the New York 
Stock Exchange.
    Senator Shelby. I appreciate your coming today. We 
appreciate your comments here and also your written testimony 
for the record and your candor. Thank you very much.
    Ms. Kelley. Thank you.
    Mr. Darby. Thank you.
    Dr. Jenkins. Thank you.
    Mr. Burr. Thank you.
                      DEPARTMENT OF TRANSPORTATION

STATEMENT OF PATRICK V. MURPHY, DEPUTY ASSISTANT 
            SECRETARY, AVIATION AND INTERNATIONAL 
            AFFAIRS

                        Introduction of Witness

    Senator Shelby. Our third panel will be Mr. Patrick Murphy. 
He is the Deputy Assistant Secretary, Aviation and 
International Affairs, U.S. Department of Transportation.
    Of course, this will be dealing with the subject of the 
administration's enforcement policy here.
    Mr. Murphy, again, welcome to the Committee. We always 
appreciate you coming, your participating. And your written 
testimony will be made part of the record in its entirety. And 
you may proceed as you wish.
    Mr. Murphy. We, at the Department of Transportation, Mr. 
Chairman, take the view that deregulation of domestic air 
travel 20 years ago was one of Congress' best efforts to bring 
powerful economic forces to bear on behalf of travelers, 
shippers, and the airlines themselves.
    Deregulation in the United States has expanded the pie for 
everyone and has been for the benefit of everyone.
    Traffic is up. Fares are down. And profits are at record 
levels. However, deregulation can only work in the long run if 
the airlines compete fairly with each other.

                         A Competition Problem

    In the past few years, the Department of Transportation has 
received an increasing number of complaints by smaller airlines 
that the largest airlines are using unfair tactics to keep them 
from getting a foothold in many markets at hub airports. Others 
have echoed these complaints--Members of Congress, local 
communities, travel agencies, business and leisure travelers. 
These complaints, Mr. Chairman, are especially troublesome at a 
time when new entry has virtually stopped, low-fare airlines 
are struggling financially and the number of markets with 
competition have now declined for 6 straight years.
    Mr. Chairman, we have not moved precipitously in response 
to these complaints. The department undertook a detailed 
analysis of the complaints brought to us. Our experts spent 
countless hours studying extensive company records, identifying 
patterns of behavior and analyzing industry data. We conferred 
with expert staffs at the Department of Justice and the Federal 
Trade Commission.
    As a result of these efforts, we are concerned that unfair 
exclusionary practices by some major network airlines are 
preventing needed competition at hub airports, effectively 
denying more reasonable fares and affordable access to tens of 
millions of passengers across the country.
    Senator Shelby. And how much money, billions of dollars 
perhaps, costing----
    Mr. Murphy. I could not really quantify that. We know that 
40 percent of the country has the benefit of low fare 
competition.
    Senator Shelby. Yes.
    Mr. Murphy. We have 60 percent without that benefit at this 
time.
    Senator Shelby. But it would be a big dollar item, would it 
not?
    Mr. Murphy. We believe it would be a very large item, yes, 
sir.
    Senator Shelby. OK.
    Mr. Murphy. Under the statutory mandates, we have to 
preserve and foster competition in air travel, we concluded 
that we have an obligation to act. We considered enforcement 
action against the airlines, but in the end, we concluded the 
best approach was to set forth policy guidance on what the 
Department's views would constitute unfair exclusionary conduct 
warranting Federal action.
    We have shaped a policy that targets only the most 
egregious conduct. We will apply a final policy prospectively 
so that the airlines are fully aware and on notice in advance 
of what conduct will be found to be unfair exclusionary 
conduct.
    And the Secretary determined that we would put out for 
public comment a proposed policy so that we could engage in the 
very kind of dialog we are having today. I might add that we 
put that policy out 1 month ago.
    We have no intention of reregulating the airline industry 
as some have charged. Rather, we want to assure that effective 
competition, which is the linchpin of deregulation, is 
preserved.

                      Proposed Enforcement Policy

    Our proposed policy statement identifies the behavior that 
we will consider to be unfair exclusionary practice. If in 
response to new entry into one of its hub markets, a major 
carrier pursues a strategy of price cuts and capacity increases 
that either, one, results in substantial self-diversion of 
revenue or, two, results in substantial worse short-term 
operating results than would be a reasonable alternative 
competitive strategy, we propose to find this unlawful.
    We do not wish to stifle legitimate competitive responses 
to new entry. We are not proposing a policy to protect 
competitors, but to promote competition.

                          Statutory Authority

    Some have contended that the Department has exceeded its 
authority in issuing the proposed enforcement policy. It is our 
view that an enforcement policy of this kind is a proper use of 
our statutory authority to define and prohibit unfair methods 
of competition and a proper discharge of our statutory mandate.
    Section 41712 of our statute tasks the Secretary, when he 
or she considers it to be in the public interest, to ``decide 
whether an air carrier is engaged in an unfair or deceptive 
practice or an unfair method of competition'' and to take 
appropriate action to end any such abuse.
    Furthermore, Congress deemed our exercise of this authority 
to prevent unfair competition essential to the successes of 
deregulation.
    While Congress eliminated many of our regulatory provisions 
governing the airline industry as part of deregulation, 
Congress' review of the operation of deregulation 6 years after 
deregulation, caused it to conclude that the statute must 
maintain DOT's authority to prohibit unfair methods of 
competition.
    As Congress recognized and the courts have held, the 
Department's authority to prohibit unfair competition allows us 
to prohibit anticompetitive conduct that does not violate the 
antitrust laws.
    Our proposed enforcement policy falls within the language 
of our statute, is consistent with the court's interpretation 
of the scope of our statutory authority and carries out 
Congress' determination.

                               Alliances

    I would now like to comment for just a moment, if I may, 
Mr. Chairman, about alliances and the possible competitive 
implication of increased concentration in the airline industry.
    Let me first note that the recently announced alliances 
between the six largest U.S. airlines--Continental and 
Northwest, the fifth and fourth largest carriers; American and 
USAir, the second and sixth largest airline; as well as Delta 
and United, the third and largest airlines, represent the first 
combinations among domestic airlines in the past several years.
    I might add also that these three alliances would account 
for 80 percent of the U.S. airline industry.
    There was a wave of mergers in the airline industry 10 
years ago in the mideighties, but no major domestic airline 
transactions in recent years. These recent transactions 
represent a new form of alliance. In the past, alliances were 
between regional airlines and large carriers promoting feed 
traffic or U.S. and foreign airlines building cross-border 
networks. These newly proposed linkages present very different 
issues. They represent nothing less than a major transformation 
of the airline industry.
    We have heard concerns about these transactions. Now, let 
me assure you that we and the Justice Department have the tools 
and the willingness to investigate whether such transactions 
would lead to a significant loss of competition, and if 
necessary, to prevent such harm.
    The potential size and scope of these proposed alliances 
warrant our close scrutiny. Consequently, we have recently 
requested that the carriers provide us with full details of 
their alliances.
    We intend to examine carefully the potential effects of 
these large arrangements. In particular, we will consider 
whether they may reduce competition, either in specific markets 
or overall.
    We will consider the potential impact of these alliances on 
the competitive capability of other major airlines and of new 
entrants.
    In conclusion, Mr. Chairman, the Department of 
Transportation is working hard to preserve the benefits of 
competition and to protect the interests of consumers. The 
administration is committed to ensuring competition in domestic 
and international airline business. That is why we have worked 
hard in recent years to secure 30 Open Skies agreements.
    We have issued our proposed competition policy. We have 
recently granted 85 slot exemptions to provide valuable new air 
service and competition. And we are now beginning to review 
whether new airlines have been thwarted in various markets due 
to an inability to obtain adequate airport facilities on 
reasonable terms. We are also just beginning to review the big 
three proposed domestic alliances.
    Thank you, Mr. Chairman.

                           Prepared Statement

    Senator Shelby. We appreciate your remarks and also your 
continuing to appear before this committee and many others. We 
will insert your complete statement in the record.
    [The statement follows:]
                Prepared Statement of Patrick V. Murphy
    Mr. Chairman and Members of the Committee: I welcome the 
opportunity to be here today and applaud you for bringing together 
individuals to undertake an open and serious discussion about a matter 
important to all of us--competition in aviation across the United 
States.
    When Secretary Slater recently called for a dialogue on airline 
competition, he knew that Congress would be an essential voice. I am 
pleased to be a participant in your discussion today.
    We have seen over the years that we accomplish far more in aviation 
by engaging in constructive give-and-take and by working together. 
Witness the birth of airline deregulation itself. That landmark event 
in the history of domestic air travel in the United States would not 
have come about without the concerted efforts of many--inside 
government and out.
    More recently, Government, airline management, and labor worked 
together successfully to overcome the recession that gripped the 
industry at the time President Clinton took office.
                        success of deregulation
    This same cooperative spirit can pay equal or greater dividends as 
we grapple with today's issue--forging appropriate measures to preserve 
and foster a competitive climate in the air transportation industry. 
Let no one mistake our view--deregulation of domestic air travel in 
1978 was one of Congress' best efforts to bring powerful economic 
forces to bear on behalf of the traveler, the shipper, and the airline 
industry itself. This view is widely shared, and is confirmed by all of 
our studies at the Department.
    Deregulation in the United States has expanded the pie for everyone 
and for the benefit of everyone. U.S. airlines carry about 270 million 
more passengers a year than under regulation. On average, domestic 
consumers pay a third less (in constant dollars) than they did twenty 
years ago. And, airline operating profits are also at record levels--
totaling $20 billion in the last three years.
    Airline deregulation works when the airlines compete fairly with 
each other. Consumers benefit when the airlines compete because, to win 
business, they have to offer more attractive service and fares. In 
fact, one airline--Southwest--has established itself as one of the 
nation's larger and stronger airlines by offering consumers both low 
fares and good service.
    In response to deregulation, the major airlines developed hub-and-
spoke networks and have created twenty hub airports around the country. 
Hubbing creates advantages for many travelers, since it gives travelers 
at the hub cities many more flights and enables airlines to offer more 
service in markets without enough traffic to sustain non-stop service. 
On the other hand, hubbing has the disadvantage of making effective 
competition in the hub's local markets very difficult, thereby allowing 
the hub airline to charge higher fares in such markets. A hub airline 
has competitive advantages in those markets because it operates the 
most flights and can offer travelers a more attractive frequent flyer 
program and travel agencies more attractive incentive commission 
programs. As a result, most hub markets have little competition, and 
the passengers in those markets pay relatively high fares. New service 
by a low-fare airline is likely to be the only way that many hub 
markets will ever benefit from competitive airline service.
    A low-cost airline's entry into a hub market can produce enormous 
consumer benefits. For example, the Department's April 1996 study of 
low-cost airlines examined the effects of the low-fare service offered 
by Morris Air and Southwest, which acquired Morris, in a number of Salt 
Lake City markets. Average fares in those markets dropped by about 
fifty percent, and traffic in those markets tripled when fares in other 
Salt Lake City markets were increasing somewhat. As a result, by late 
1995 the average fares in the markets served by Morris and Southwest 
were only one-third the level of fares in other Salt Lake City markets.
                         a competition problem
    In the last few years, however, the Department has received an 
increasing number of complaints by smaller airlines that the largest 
airlines are using unfair tactics to keep them from getting a foothold 
in many markets at hub airports. Others have echoed these complaints--
Members of Congress, local communities, travel agencies, and business 
travelers. These complaints are especially serious at a time when the 
number of markets with competition have declined for six straight 
years, new entry has virtually stopped and low-fare airlines are 
struggling financially.
    Let me give you one example of what we have heard and what we have 
found.
    When a new entrant started operation in one major city-pair market, 
the dominant hub carrier initially did not slash its fares and increase 
capacity in response to the new service. However, after a few months 
the hub carrier matched the newly offered $49 one-way fare and added 
more seats. Before this move, thirty percent of the hub carrier 
traffic--about 13,000 passengers--paid fares of $325 to $350, while 
fewer than 1,500 passengers paid fares of $75 or less, during a three-
month period. After the hub carrier dropped its fares and increased 
capacity, it carried almost 50,000 passengers who paid no more than $75 
and less than 1,000 passengers who paid fares of $325 to $350. In a 
three-month period after the new entrant left the market, the hub 
carrier sold fewer than 1,000 seats at fares under $75, carried only 
about 3,000 passengers paying fares of $325 to $350, but carried over 
12,000 passengers paying fares of $350 to $375.
    Mr. Chairman, we have not moved precipitously in response to this 
type of complaint. The Department undertook a detailed analysis of the 
complaints brought to us. Our airline experts spent countless hours 
studying extensive airline company records, identifying patterns of 
behavior, and analyzing industry data. In developing our proposed 
policy, we conferred with expert staffs at the Department of Justice 
and the Federal Trade Commission. As a result of these efforts, we are 
concerned that unfair exclusionary practices by some major network 
airlines are preventing needed competition at hub airports, effectively 
denying more reasonable fares and affordable access to tens of millions 
of potential passengers across the country.
    Under the statutory mandates Congress has enacted to preserve and 
foster competition in air travel, we concluded that we are obligated to 
act. We considered enforcement action. But in the end, we concluded (in 
fact at the suggestion of some of the airlines) that the best approach 
was to set forth policy guidance on what, in the Department's view, 
constitutes unfair exclusionary conduct warranting Departmental action.
    Reviewing the continuum of carrier behavior over several years, we 
have shaped a policy that targets only the most egregious conduct--when 
a combination of factors occur in carrier behavior that cannot be 
adequately explained as good economics. We will apply a final policy 
prospectively, so that carriers are fully aware in advance of what 
conduct will be found to be unfair exclusionary conduct. And the 
Secretary determined that we would put out for public comment a 
proposed policy so that we could engage in the kind of dialogue we are 
having here today. We have no intention of reregulating the airline 
industry, as some have charged. Rather, we want to assure that 
effective competition--which is the linchpin to the success of 
deregulation and the benefits it brings to consumers--is preserved.
                      proposed enforcement policy
    Our proposed policy statement identifies the behavior that we will 
consider to be an unfair exclusionary practice. If, in response to new 
entry into one of its hub markets, a major carrier pursues a strategy 
of price cuts and capacity increases that either (1) sacrifices more 
revenue than all of the new entrant's capacity could have diverted from 
it or (2) results in substantially worse short-term operating results 
than would a reasonable alternative strategy for competing with the new 
entrant, we propose to find this unlawful. Any strategy this costly in 
the short term is economically rational for the major carrier only if 
it forces the new entrant from the market, after which it can readily 
recoup the revenues sacrificed to achieve this end.
    It's one thing for an established airline to match the prices of a 
competitor's new service. That is legitimate competition. It's another 
thing entirely for an airline to not only match that price, but to also 
sell ten times as many seats as the new entrant at the low fare, 
thereby ensuring that both the new entrant and the established airline 
will lose money or forego profits . . . but only until the new entrant 
is driven from the market. Then, the established carrier slashes the 
amount of service, raises fares, and recoups its losses or lost 
profits--all at the cost of much higher prices to the consumer. This, 
under our policy, is unfair competition.
    To provide guidance we have set forth three types of obviously 
suspect responses to new entry that will normally trigger an 
enforcement proceeding to determine whether a violation has occurred:
    (1) when the major carrier adds capacity and sells such a large 
number of seats at very low fares that the resulting self-diversion of 
revenue results in lower local revenue than would a reasonable 
alternative response;
    (2) when the major carrier carries more local passengers at the new 
entrant's low fares than the total number of seats that the new entrant 
offers, resulting, through self-diversion, in lower local revenue than 
would a reasonable alternative response; and
    (3) when the major carrier carries more local passengers at the new 
entrant's low fares than the new entrant does, again resulting, through 
self-diversion, in lower local revenue than would a reasonable 
alternative response.
    To summarize, before we undertake any formal investigation, at a 
minimum we will ask these three questions: first, did the major carrier 
cut its fares to effectively match those of the new entrant; second, 
did the major carrier also significantly increase the capacity it 
offered at low fares; and third, did the decrease in fares coupled with 
the increase in low-fare capacity result in considerably lower local 
revenue than the major carrier would have realized under a reasonable 
alternative strategy.
    We do not wish to stifle legitimate competitive responses to new 
entry, which provide the lasting benefits to consumers that 
deregulation should bring. We recognize that this can involve a 
delicate balance, and that is one of the reasons we are eager to get 
the views of all interested parties. We are not proposing in this 
policy to protect competitors, but to promote competition. We are 
carrying out our statutory responsibilities to ensure that if a low-
fare airline's entry into a major carrier's hub markets fails, it fails 
on the merits, not due to unfair methods of competition.
                          statutory authority
    Some have contended that the Department has exceeded its authority 
in issuing the proposed enforcement policy. It is our view that an 
enforcement policy of this kind is a proper use of our statutory 
authority to define and prohibit unfair methods of competition and a 
proper discharge of our statutory mandate to promote competition.
    Section 41712 of our organic statute (formerly section 411) tasks 
the Secretary, when he or she considers it to be in the public 
interest, to ``decide whether an air carrier . . . is engaged in an 
unfair or deceptive practice or an unfair method of competition'' and 
to take appropriate action to end any abuse. Nothing in the terms of 
that section excludes any type of unfair competitive conduct from its 
reach.
    In addition, other provisions of the statute make it clear that 
Congress expected us to take action when major airlines engage in 
conduct that unreasonably threatens competition in airline markets. The 
statute's policy section specifically directs the Secretary, in 
carrying out his responsibilities, to consider that the public interest 
requires ``preventing unfair, deceptive, predatory, or anticompetitive 
practices.'' The statute also directs him or her to consider in the 
public interest ``avoiding unreasonable industry concentration, 
excessive market domination, monopoly powers, and other conditions that 
would tend to allow [a carrier] unreasonably to increase prices, reduce 
services, or exclude competition. . . .'' 49 U.S.C. 40101(a)(9) and 
(13).
    Furthermore, Congress deemed our exercise of this authority to 
prevent unfair methods of competition essential for the success of 
deregulation. While Congress eliminated many of the other regulatory 
provisions governing the airline industry as part of deregulation, 
Congress' review of the operation of deregulation in 1984 caused it to 
conclude that the statute must maintain our authority to prohibit 
unfair methods of competition. And it did not carve out any area of 
airline operations from the scope of that authority. As the House 
committee stated, H.R. Rep. No. 98-793, 98th Cong., 2d Sess. (1984) at 
4-5:

          There is also a strong need to preserve the Board's authority 
        under Section 411 to ensure fair competition in air 
        transportation . . . Although the airline industry has been 
        deregulated, this does not mean that there are no limits to 
        competitive practices. As is the case with all industries, 
        carriers must not engage in practices which would destroy the 
        framework under which fair competition operates. Air carriers 
        are prohibited, as are firms in other industries, from 
        practices which are inconsistent with the antitrust laws or the 
        somewhat broader prohibitions of Section 411 of the Federal 
        Aviation Act (corresponding to Section 5 of the Federal Trade 
        Commission Act) against unfair competitive practices.

    As the House recognized then, and as the courts have held, the 
Department's authority to prohibit unfair methods of competition allows 
us to prohibit both conduct that violates the antitrust laws and 
anticompetitive conduct that does not violate the antitrust laws. 
Congress gave us that authority (and the FTC comparable authority over 
other industries) because Congress believed that businesses could 
engage in practices that unreasonably and unfairly threatened 
competition without violating the antitrust laws and that the 
Department should have the power to prohibit such conduct.
    The unfair exclusionary behavior we address in our proposed policy 
is analogous to, and may in some cases amount to, predation within the 
meaning of the federal antitrust laws. A major airline's use of large 
fare cuts and capacity increases and sacrifice of revenues in the short 
run in order to eliminate competition in hub markets, after which it 
can cut capacity and raise fares to at least their original levels and 
recoup losses or lost profits, closely resembles conduct prohibited by 
the Sherman Act. In any event, the authority given us to prohibit 
unfair methods of competition is not confined to practices that violate 
the antitrust laws.
    In sum, our proposed enforcement policy comes within the language 
of our statute, is consistent with the courts' interpretation of the 
scope of our statutory authority and, most importantly, carries out 
Congress' determination that the success of deregulation requires us to 
preserve competition and stop anticompetitive behavior.
    As Secretary Slater has said: ``Our responsibility at the 
Department of Transportation is to ensure that every airline--large or 
small, new or established--has the opportunity to compete freely. That 
is what deregulation is supposed to be all about--a fair chance to 
compete.''
                               alliances
    I would also like to address another issue affecting competition in 
the aviation industry--the possible competitive implications of 
increased concentration in the airline industry.
    Let me first note that the recently-announced alliances between the 
six largest U.S. airlines, Continental and Northwest (the fifth and 
fourth largest U.S. carriers), American and USAir (the second and sixth 
largest airlines) as well as Delta and United, (the third and first 
largest) represent the first combinations among domestic airlines in 
the past several years. There was a wave of mergers in the airline 
industry in the 1980's, but no major domestic airline transactions in 
recent years. These recent transactions represent a new form of 
alliance. In the past, alliances were between regional airlines and 
large carriers to promote feed traffic, or U.S. and foreign carriers to 
build cross-border networks. These newly proposed linkages present very 
different issues. They represent nothing less than a major 
transformation of the industry.
    We have heard concerns that the three recently announced 
transactions will reduce competition in the domestic airline industry. 
Let me assure you that we and the Justice Department have the tools and 
the willingness to investigate whether such transactions would lead to 
a significant loss of competition, and if necessary, to prevent such 
harm.
    The potential size and scope of these proposed alliances warrant 
our close scrutiny. Consequently, we have requested that the carriers 
provide us details about their alliances. We intend to examine 
carefully the potential effects of these large arrangements. In 
particular, we will carefully consider whether they may reduce 
competition, either in specific markets, or overall. We will consider 
the potential impact of these alliances on the competitive capabilities 
of other major airlines and of new entrants.
    Our focus on the impact on other major airlines will be on whether 
competition will decrease or be eliminated.
    The proposed alliances also raise concerns about the continued 
ability of new airlines to enter underserved or overpriced markets.
                               conclusion
    Mr. Chairman and members of the Committee, the Department of 
Transportation is working hard to preserve the benefits of competition 
and to protect the interests of consumers. This Administration is 
committed to ensuring competition in the domestic--and international--
airline business. That is why we have worked so hard to secure 30 Open 
Skies agreements; we have issued our proposed competition policy; we 
have recently granted 85 slot exemptions to provide valuable new air 
service and competition. And we are now beginning a review into whether 
new airlines have been thwarted in various markets due to an inability 
to obtain adequate airport facilities on reasonable terms. We are also 
just beginning to review the big three proposed domestic alliances. We 
look forward to working with Congress to ensure that the aviation 
system continues to grow and that consumers continue to benefit.
    Thank you Mr. Chairman. This completes my prepared statement, and I 
would be pleased to respond to your questions and those of the 
Committee.

                           Enforcement Policy

    Senator Shelby. Mr. Murphy, the Department of 
Transportation has recently issued guidelines, which you've 
alluded to, as to what constitutes unfair exclusionary 
practices.
    In the statement of enforcement policy to the request for 
comments on these new guidelines, a carrier is placed on notice 
that it will be considered to be in violation of the guidelines 
if it pursues a strategy of price cuts, capacity increase, or 
both, that: one, either causes it to forgo more revenue than 
all of the new entrants' capacities could have diverted from it 
or, two, results in substantially lower operating profits or 
substantially greater operating losses in the short run than 
would a reasonable alternative strategy for competing with a 
new entrant.
    To enforce these guidelines would seem to require a great 
deal of analysis or second guessing business strategy to carry 
out either of those tests, especially when determining whether 
a reasonable alternative strategy for competing with a new 
entrant would result in higher operating profits or lower 
operating losses.
    The guidelines seem to me to be subject to a great deal of 
interpretation by the Department in the course of enforcement. 
Would you disagree with that assessment? And if so, does the 
Department have the authority and the staff ability to make 
such assessment?
    Mr. Murphy. I would first respond that we believe we have 
the authority.
    Senator Shelby. OK.
    Mr. Murphy. As far as the difficulty in the enforcement, I 
would say this is a complex area. Everybody who has looked at 
it agrees that defining precisely what is unfair exclusionary 
behavior is difficult.
    Senator Shelby. But just because something is complex, just 
because it is difficult, just because it is hard to do is no 
reason to ignore it, is that right?
    Mr. Murphy. That is our view, Senator, and that is why we 
worked so long with the Justice Department Antitrust Division, 
the Federal Trade Commission, people like Professor Kahn to 
develop these standards. I might add, we also developed in our 
document for comments the tests or the triggers that we would 
use before we would open an investigation.
    Senator Shelby. Yes.
    Mr. Murphy. And we put those out there in an attempt to 
alert the carriers, even more precisely what it is we would 
look for before we would open an enforcement case.
    And those are an increase in capacity, a substantial 
increase in capacity, a substantial lowering of price and that 
this would not be a reasonable alternative response. We put 
those additional measures out there.
    Our guidelines are now out for comment. They have been out 
for a month. The comments we have received to date have been 
very supportive. We have another month of comment and then a 
month of responses. Then we will move to finalize our 
guidelines.

                     Determining Predatory Activity

    Senator Shelby. Mr. Murphy, there are no really bright 
lines in the guidelines that we can point to and say ``If an 
airline is doing that then it is clearly engaging in predatory 
activity,'' are there? And finding those bright lines seems to 
be very, you know, much of a challenge, as you have said.
    Would you comment on why that is the case? In other words 
why it is so tough----
    Mr. Murphy. I think one of----
    Senator Shelby But not impossible?
    Mr. Murphy. I think one of the reasons it is tough is that 
we do not want to get into the business of drawing very firm 
lines. We want the airlines to compete. We want them to have 
the ability to respond in an appropriate way----
    Senator Shelby. Yes.
    Mr. Murphy And compete very vigorously with these new 
entrants. We are not trying to shelter anyone from vigorous 
competition. We are only trying to eliminate the most egregious 
behavior.
    Senator Shelby. Yes.
    Mr. Murphy. And based on our investigations, this was not 
really, I might add, Mr. Chairman, an academic exercise. We 
went out and investigated and looked into the books of the 
large airlines and saw how they were moving against these small 
companies.
    We are trying to eliminate some of the behavior that we 
think we could have started an enforcement case right then and 
there. But rather, we felt it was more productive to set out 
guidelines so people prospectively would know that we were 
watching this behavior.

                          Level of Competition

    Senator Shelby. Mr. Murphy, Dr. Kahn has spoken about how 
quickly the industry is changing, and some of the other 
witnesses have described how technology has and will have an 
impact on the industry. Given the pace of change in the 
industry, do we risk doing more damage to, rather than improve, 
competition with the uncertainty inherent in vague guidelines? 
In other words, guidelines, I think, ought to be specific. They 
should not be vague, indefinite, and uncertain in any way. And 
if you have guidelines to promote competition, that is great. 
But if it will not do anything to promote competition, it is a 
problem, is it not?
    Mr. Murphy. One response I would give, Senator, is that the 
level of competition in the airline industry is already 
declining.
    Senator Shelby. Sure.
    Mr. Murphy. It has been declining for 6 to 8 years. New 
entry has come to a virtual stop.
    Senator Shelby. Yes.
    Mr. Murphy. The smaller carriers are in difficulty 
financially. They are the companies that bring the low-fare 
pressure on the airlines. We want to make sure we continue to 
have a stream of good low-fare competitors out there to keep 
the big airlines and perhaps these big alliances competitive.
    Senator Shelby. Basically, in America, don't we want 
competition to work? And for it to work, you cannot have 
regional monopolies or other monopolies, is that correct?
    Mr. Murphy. And clearly that is our concern----
    Senator Shelby. Yes.
    Mr. Murphy Especially at these dominated hub airports.
    Senator Shelby. OK. Senator Kohl.
    Senator Kohl. Thank you, Senator Shelby.

                        Midwest Express Airlines

    Mr. Murphy, I am from Wisconsin. And Midwest Express 
Airlines is an outstanding airline operating out of Milwaukee.
    Mr. Murphy. Sure.
    Senator Kohl. And I am concerned about your having placed 
them into the so-called major category. By comparison to the 
other companies in the major category, they are not only the 
smallest, but by comparison, they cannot be considered to be 
comparable.
    Mr. Murphy. OK.
    Senator Kohl. Their sales are about $350 million a year, 
whereas the others are in the billions of dollars. They 
basically operate out of one city, Milwaukee, with a minor hub 
in Omaha.
    And they are not in a position to compete with the majors. 
They do not try to. They operate, as you know, a different kind 
of a business.
    If a major wanted to come into Milwaukee and compete with 
them and put them out of business, it would not be difficult. 
And I am concerned about the categorization, because that 
categorization, as you know, has inferences and has direct 
consequences.
    And I would like to hear from you why you have decided at 
this point to put them in that category.
    Mr. Murphy. Yes, sir; I would be happy to comment on that. 
First of all, I agree with your characterization of Midwest 
Express as an outstanding newer airline that does a fine job.
    When we put this definition in our proposed--and I will 
underline proposed guidelines--we were really responding to 
what we had observed with regard to the very large airlines 
going after the very small low-fare airlines, the newest low-
fare airlines.
    That is how we came up with this definition. I must say 
that the definition has probably received as much comment as 
any other part of our proposal.
    And with just your suggestion that we were too rigid in how 
we characterized carriers, we are going to take another look at 
that. This is a proposal. We have heard comments from other 
carriers who feel they were left out.
    And I can assure you we will be looking at that definition 
again, Senator.
    Senator Kohl. Yes; well, you say major carriers versus low-
fare. They are not low fare either.
    Mr. Murphy. I know that, Senator.
    Senator Kohl. So they are neither major, nor are they low 
fare.
    Mr. Murphy. Yes.
    Senator Kohl. Maybe there is another category you are 
looking for entirely that describes Midwest Express, you know, 
because they are fairly unique. Their percentage of the 
domestic market is 0.3.
    Mr. Murphy. Yes.
    Senator Kohl. I do not know how much smaller you can get.
    Mr. Murphy. Well, I appreciate----
    Senator Kohl. They only have 26 airplanes. So again, I do 
appreciate what I think I hear you saying, which is that you 
will be looking at that categorization and attempting to be as 
fair as you can.
    Mr. Murphy. Yes, sir.
    Senator Kohl. And I do appreciate that. That is very good 
to hear. I thank you.
    Senator Shelby. I want to thank you, Senator Kohl.
    I want to thank each one of the participants here today. We 
have had a lively hearing and several different points of view. 
But I want to thank everyone for participating here.
    These aviation competition hearings we have been having, I 
believe, have played an important role in helping us on the 
committee and in the Senate understand what can and what should 
be done, Mr. Murphy, to help foster competition and improve air 
service for all Americans.
    I am convinced that this is an area, which deserves 
continued congressional scrutiny and also scrutiny by the 
administration----
    Mr. Murphy. Yes, sir.
    Senator Shelby Particularly in the light of the newly 
announced code-sharing allowances and the new DOT guidelines.
    This subcommittee will do whatever it takes to ensure a 
level playing field in the aviation industry and ensure that 
the American people have affordable, timely access to air 
service.

                         Conclusion of Hearings

    This hearing now will be recessed subject to the call of 
the Chair. Thank you. That concludes these aviation competition 
hearings.
    [Whereupon, at 10:50 a.m., Tuesday, May 5, the hearings 
were concluded, and the subcommittee was recessed, to reconvene 
subject to the call of the Chair.]

                                  
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