[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
53-117 CC WASHINGTON : 1998
_______________________________________________________________________
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
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
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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
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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
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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\
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\1\ Michael E. Levine, ``Is Regulation Necessary? California Air
Transportation and National Regulatory Policy,'' Yale Law Journal, 74
(July 1965), pp. 1416-47.
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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.
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\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.
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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\
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\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\
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\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.
[GRAPHIC] [TIFF OMITTED] T12SMA05.001
[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
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Appendix L
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Appendix M
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Appendix N
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Appendix O
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Appendix P
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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
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
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\
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\1\ The first is America West. The second is Midwest Express.
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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\
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\2\ ``The Future or Regional Air Service--The challenge of the New
Realities.'' Published by The Boyd Group/ASRC, 1997.
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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.
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\3\ This was discovered at the NTSB hearings subsequent to the
ValuJet crash.
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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.
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\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\
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\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.
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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.
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\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).
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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.
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``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''.
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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\
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\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.
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\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.
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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\
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\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).
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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.
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\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\
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\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.
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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.
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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\
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\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\
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\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.
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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\
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\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\
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\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\
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\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\
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\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.
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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.
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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\
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\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)
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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).
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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\
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\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.]