[Senate Hearing 106-1052]
[From the U.S. Government Publishing Office]
S. Hrg. 106-1052
AIRLINE COMPETITION: CLEAR SKIES OR TURBULENCE AHEAD?
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HEARING
before the
SUBCOMMITTEE ON ANTITRUST,
BUSINESS RIGHTS, AND COMPETITION
of the
COMMITTEE ON THE JUDICIARY
UNITED STATES SENATE
ONE HUNDRED SIXTH CONGRESS
SECOND SESSION
__________
MAY 2, 2000
__________
Serial No. J-106-80
__________
Printed for the use of the Committee on the Judiciary
__________
U.S. GOVERNMENT PRINTING OFFICE
73-032 WASHINGTON : 2001
COMMITTEE ON THE JUDICIARY
ORRIN G. HATCH, Utah, Chairman
STROM THURMOND, South Carolina PATRICK J. LEAHY, Vermont
CHARLES E. GRASSLEY, Iowa EDWARD M. KENNEDY, Massachusetts
ARLEN SPECTER, Pennsylvania JOSEPH R. BIDEN, Jr., Delaware
JON KYL, Arizona HERBERT KOHL, Wisconsin
MIKE DeWINE, Ohio DIANNE FEINSTEIN, California
JOHN ASHCROFT, Missouri RUSSELL D. FEINGOLD, Wisconsin
SPENCER ABRAHAM, Michigan ROBERT G. TORRICELLI, New Jersey
JEFF SESSIONS, Alabama CHARLES E. SCHUMER, New York
BOB SMITH, New Hampshire
Manus Cooney, Chief Counsel and Staff Director
Bruce A. Cohen, Minority Chief Counsel
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Subcommittee on Antitrust, Business Rights, and Competition
MIKE DeWINE, Ohio, Chairman
ORRIN G. HATCH, Utah HERBERT KOHL, Wisconsin
ARLEN SPECTER, Pennsylvania ROBERT G. TORRICELLI, New Jersey
STROM THURMOND, South Carolina PATRICK J. LEAHY, Vermont
Pete Levitas, Chief Counsel and Staff Director
Jon Leibowitz, Minority Chief Counsel and Staff Director
C O N T E N T S
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STATEMENTS OF COMMITTEE MEMBERS
Page
DeWine, Hon. Mike, a U.S. Senator from the State of Ohio......... 1
Grassley, Hon. Charles E., a U.S. Senator from the State of Iowa. 59
Kohl, Hon. Herbert, a U.S. Senator from the State of Wisconsin... 2
CHRONOLOGICAL LIST OF WITNESSES
Panel consisting of Alfred E. Kahn, Professor Emeritus,
Department of Economics, Cornell University, Ithaca, NY and
Steven A. Morrison, Professor of Economics, Northeastern
University, Boston, MA......................................... 4
Panel consisting of Robert Ferguson, President, Midway Airlines,
Raleigh-Durham, NC; Donald J. Carty, Chairman and Chief
Executive Officer, American Airlines, Dallas, TX; and Bill La
Macchia, Jr., President and Chief Executive Officer, Sun
Country Airlines, Mendota Heights, MN.......................... 28
ALPHABETICAL LIST AND MATERIAL SUBMITTED
Carty, Donald J.................................................. 35
Prepared statement........................................... 38
Ferguson, Robert................................................. 28
Prepared statement........................................... 31
Kahn, Alfred E................................................... 4
Prepared statement........................................... 8
La Macchia, Bill, Jr............................................. 42
Prepared statement........................................... 46
Morrison, Steven A............................................... 11
Prepared statement........................................... 13
APPENDIX
Addition Material for the Record
Edward P. Faberman, Air Carrier Association of America, prepared
statement and attachments...................................... 61
Paul M. Ruden, American Society of Travel Agents, letter and
attachments.................................................... 72
T. Allan McArtor, President and CEO, Legend Airlines, prepared
statement...................................................... 85
AIRLINE COMPETITION: CLEAR SKIES OR TURBULENCE AHEAD?
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TUESDAY, MAY 2, 2000
U.S. Senate,
Subcommittee on Antitrust, Business Rights,
and Competition,
Committee on the Judiciary,
Washington, DC.
The subcommittee met, pursuant to notice, at 2:04 p.m., in
room SD-226, Dirksen Senate Office Building, Hon. Mike DeWine
(chairman of the subcommittee) presiding.
Also present: Senator Kohl.
OPENING STATEMENT OF HON. MIKE DeWINE, A U.S. SENATOR FROM THE
STATE OF OHIO
Senator DeWine. Good afternoon. Two years ago, this
subcommittee held hearings to examine the competitive structure
and activity of the aviation industry. We have been following
the industry closely in the 2 years since those hearings, and
aviation continues to be among the most difficult marketplaces
to evaluate.
It is clear that competition has succeeded in improving
service and prices. In fact, since Congress deregulated the
airline industry in the 1970's, passengers have flown far more,
to a greater number of destinations, and at a lower average
price than ever before. The hub and spoke system, from all
reports, is responsible for a great deal of that progress.
But despite the general improvements in service and price
deregulation, we continue to hear complaints from consumers,
complaints ranging from high prices for business travelers, to
poor customer service for leisure travelers, particularly in
hub cities. Possibly as a result of this dissatisfaction,
start-up airlines continue to enter the market. Despite their
effort to meet customer demand, however, most start-ups fail,
often while complaining about the anti-competitive tactics of
the incumbent airlines, especially those that are entrenched in
hub airports.
In response to the failures of start-up airlines, Federal
enforcement and regulatory agencies have increased the scrutiny
of the industry. Specifically, the Department of Justice has
investigated a number of major carriers and has filed a case
charging American Airlines with predatory pricing. Further, in
the last 2 years the Department of Transportation has issued
and withdrawn draft competition guidelines and is now
considering whether to issue new guidelines. We will examine
the implications of both of these Government actions in our
hearing today.
Now, with regard specifically to the Department of
Transportation and its guidelines, I would like to make a
couple of points. As most of you know, the draft guidelines
that the Department of Transportation issued 2 years ago met
with a great deal of criticism, and I shared the concern of
many of the critics, namely that the draft guidelines were both
too vague and too restrictive.
Now, I know that the Department of Transportation has
received a great number of comments on the guidelines, and I
hope that if the Department does reissue the guidelines that
they took those comments into account and produce a document
that moves the debate forward.
More generally, however, I am still concerned about the
notion of Department of Transportation guidelines being used as
a benchmark for enforcement policy. By their very nature,
guidelines are difficult to draft, and they run the risk of
either over-regulating behavior, which is the last thing we
should be doing in the aviation industry, or not providing
enough guidance to competitors.
Accordingly, at this point I continue to believe that the
vigorous, reasonable enforcement of the predatory pricing laws
are a better alternative. If correctly enforced, the predatory
pricing laws should enable the Government to punish illegal
activity without chilling the sort of tough competition that we
want to encourage.
As I noted earlier, the Department of Justice is currently
litigating its first predatory pricing case in years, and I
think it makes sense to await the outcome of that case before
we consider any different type of enforcement mechanism.
In the meantime, the industry continues to evolve. Perhaps
one of the most significant changes is the tremendous growth of
regional jet service to provide direct, non-stop service to
many new cities. These jets are smaller and cheaper to fly than
the traditional jet airliner, but are much more popular than
the turbo-prop planes that they are replacing.
I am interested in hearing from our witnesses today in
regard to what impact the regional jet will have on the hub and
spoke system. I would also like to discuss other aspects of the
aviation industry which impact on competition, such as
exclusive gate arrangements at many airports and the need to
modernize our air traffic control system.
Because of Government actions addressing competition and
the industry's reaction to marketplace changes, this is an
important and an exciting time in the aviation industry. We
have a very distinguished and experienced group of witnesses
with us today to help us analyze recent developments, and I
look forward to hearing from them as this subcommittee
continues its work to increase competition and to help
consumers.
Let me turn now to the ranking minority member of the
subcommittee, Senator Kohl.
STATEMENT OF HON. HERBERT KOHL, A U.S. SENATOR FROM THE STATE
OF WISCONSIN
Senator Kohl. Thank you, Senator DeWine.
To paraphrase Charles Dickens, in many respects airline
competition today is a ``tale of two cities.'' Consumers in
large markets such as New York, Los Angeles or Washington, DC,
traveling to other large cities often benefit from vigorous
price competition among several choices in air carriers.
Unfortunately, outside these large markets, the picture is much
bleaker. Travelers in smaller and medium-size markets continue
to have few alternatives to the large incumbent carriers on
many routes.
As a result, only some of the benefits promised during
airline deregulation have been realized. Fares continue to be
higher than they should be, and choice continues to be limited.
Moreover, start-up carriers face serious obstacles in
establishing service competing with the incumbent carriers. And
according to business writer James Glassman, the established
large airlines seem content to divide the country into separate
fiefdoms defended by fortress hubs, avoiding direct competition
with each other and thereby ensuring high fares and higher
profits. That is why he advised investing in their stock.
When a start-up does enter a new route dominated by a
single carrier, the results are dramatic. Indeed, after Sun
Country Airlines recently began competing against Northwest
from Milwaukee to Minneapolis, prices dropped substantially, by
as much as half, according to our research, from the levels of
just 2 years ago. The findings reflected in thecharts behind me
demonstrate this dramatic change.
But the difficulty is not so much getting these start-ups
into the market, it is keeping them in the market in the face
of relentless and possibly predatory competition. Mr. La
Macchia, the President of Sun Country, will testify to the
problems faced by new entrants challenging large carriers in
their fortress hubs; for example, difficulty in obtaining
airport gates, huge increases of capacity by the incumbent
carrier, and large bonuses paid to travel agents for directing
consumers to the dominant carrier. We invited the CEO of
Northwest to testify to give his side of the story, but he
declined.
To be sure, there are no simple solutions to these
problems, but one answer may lie somewhere other than in
antitrust enforcement. That is because the standards for
predatory pricing are uncertain, making the large airlines'
behavior in many cases lawful under prevailing antitrust laws.
And antitrust enforcement almost always leads to complicated,
protracted, and lengthy proceedings. However, it is clear that
abuses exist, abuses that need to be corrected, and that in
many places the competitive conditions in the airline industry
are far from ideal.
For this reason, today we are writing to the Secretary of
Transportation to urge him to utilize his enforcement powers in
an innovative and effective way. The Transportation Act
authorizes the Secretary to prevent ``unfair, deceptive,
predatory, or anti-competitive practices in air
transportation.'' We believe, and the weight of authority is
strongly on our side, that some conduct by airlines, although
legal under antitrust law, is nonetheless unfair, unscrupulous,
and anti-consumer, and clearly actionable under the DOT
statute.
Using this approach--that is, having the DOT bring an
action against an airline for unfairness rather than predatory
pricing--can avoid years and years of litigation about whether
or not the technical requirements of antitrust law have been
met. In other words, it will help consumers sooner rather than
later, and it is more fair to the airlines, who don't deserve
to be in legal limbo for years and years and years.
Mr. Chairman, some of us may have different views about how
to promote competition, but all of us here today want to ensure
that the traveling public has the greatest possible number of
choices, the lowest possible prices, and the highest possible
quality of service and standards in air travel. So we are eager
to hear what our panelists think of these ideas and the state
of airline competition today.
It is a terrific group of witnesses, and I especially want
to thank Professor Kahn, the father of airline deregulation,
who is appearing before this committee for the first time since
1987. We welcome you all.
I return to you, Mr. Chairman.
Senator DeWine. Senator Kohl, thank you very much.
Let me introduce our first panel. Alfred Kahn is Emeritus
Professor of Political Economy at Cornell University and a
special consultant to National Economic Research Associates. He
is the former Chairman of the Civil Aeronautics Board and is
well known throughout the industry as the father of airline
deregulation.
Steven A. Morrison is Professor and Chair of the Department
of Economics at Northeastern University. During 1998 and 1999,
he was a member of the congressionally-mandated Transportation
Research Board Committee for the Study of Competition in the
U.S. Airline Industry. Professor Morrison testified in front of
this subcommittee about aviation competition about 2 years ago
and we are happy to have him back with us today.
Professor Kahn, we will start with you and we will take
your opening statement. Thank you for appearing, both of you.
PANEL CONSISTING OF ALFRED E. KAHN, PROFESSOR EMERITUS,
DEPARTMENT OF ECONOMICS, CORNELL UNIVERSITY, ITHACA, NY, AND
STEVEN A. MORRISON, PROFESSOR OF ECONOMICS, NORTHEASTERN
UNIVERSITY, BOSTON, MA
STATEMENT OF ALFRED E. KAHN
Mr. Kahn. Thank you, Mr. Chairman. One prefatory sentence.
While identifying me as the father of airline deregulation is
an exaggeration of history, I do not demand a paternity test. I
am honored by your invitation and hope I can be of some use to
you.
Fortunately, I can leave to my colleague, Professor
Morrison, who is the coauthor of the really definitive studies
of the effect of airline deregulation, documentation of my firm
opinion that deregulation has been a great success, in
particular by unleashing the forces of competition and bringing
air travel within reach of people of limited means without
sacrifice of safety.
I had in my formal statement, which I will try quickly to
summarize, a recognition of the fact that this has been
accompanied with a great deal of discomfort and congestion. In
part, I want to point out that was precisely our purpose. When
we had planes flying half full and half empty, it was nice to
have an empty seat next to you.
Our purpose was to bring low-fare, lower-quality service,
and that inevitably meant letting the airlines compete to fill
those empty seats. So the congestion is part of a remedy; low-
price and greater congestion is part of what we were attempting
to accomplish. But in addition, there has been a major failure,
I think, of Government institutions to provide the necessary
infrastructure and to price it correctly, and we can go into
that, but it is not really your subject today.
I don't have to point out to this committee the truism that
deregulation means increased reliance on competition, and
increased reliance on competition means greatly increased
importance of vigilance on the part of the antitrust authority.
In these remarks, I want to concentrate on one aspect of
antitrust policy as applied to this industry that has inspired
the greatest amount of controversy in several years, namely the
determination of what constitutes or should constitute unfairly
exclusionary policies--``unfair, deceptive, predatory,'' in the
terms of the authority of the Department of Transportation.
Along with the reform of the arrangements for providing
infrastructure and pricing it, and continuing to try to get rid
of the barriers to competition at the international level, I
can think of no other aspect of Government policy with greater
significance for the preservation and expansion of the benefits
of deregulation.
I therefore strongly endorse the proposition that DOT both
has and should have joint responsibility. It is the precise
counterpart of the statutory responsibility of the Federal
Trade Commission to prevent unfair methods of competition in
industry generally, from which airlines were exempted because
historically they were subjected to direct regulation.
The basis for the increased concern about such assertedly
exclusionary tactics as predatory pricing, interference with
fair access to airport facilities, refusal to interline or
exchange luggage, or the offer of special override commissions
in the face of competitive entry, is by now entirely familiar.
And I just want to set it forth in a series as quickly as I can
of propositions.
Average yields per mile have declined some 40 percent,
adjusted for the Consumer Price Index, in real terms. But full
fares, paid by only about 6 percent of all traveled mileage,
have apparently increased on the order of 70 percent; that is,
adjusted for the CPI. If you don't adjust it for the CPI, they
have increased five-fold. So you have had this increased spread
of fares.
Now, I think in large measure, maybe in major measure, that
spread has been beneficial for travelers, both those who pay
the low fares and those who pay the high fares. It reflects
wide differences in costs, with length of route, with density
of route, with time of day. If you try to get discount fares
between New York and Washington at 8 a.m. on a Monday morning,
you are not going to get it. Obviously, you are paying more,
but that is because congestion costs are higher at that time,
and the cost of holding seats out for last-minute availability,
which is one of the things you pay a lot for.
In the case of the fare quoted to me, Ithaca to Washington,
300 miles or less, round trip fare was $732. You could divide
it by the mileage. I don't have any scientific basis for
telling you that I find that outrageous, but I do take comfort
from the fact that if I can stay over a weekend, I can get very
good fares, and most people do. So there is this increased
spread.
I should point out that in some measure that spread is
discriminatory. It clearly is charging travelers with a highly
inelastic demand what that traffic will bear. But even
discrimination, on balance, is beneficial. It is a way, for
example, of filling seats that would otherwise be empty,
charging very low fares to discretionary travelers. And as long
as they cover the incremental costs of serving them, they
contribute toward using bigger planes which are more efficient,
with an increased availability of routes to different places,
which is clearly a product of deregulation, and convenient
scheduling, all of which are particularly beneficial to
business travelers.
At the same time, it has clearly raised legitimate concerns
about whether it represents also monopoly exploitation of the
demand-inelastic travel, not just business travelers, but
people traveling on family business who can't get a certificate
from a crematorium that they deserve a lower fare. I know about
that; I have had that experience.
There are only two ways of preventing that exploitation, if
it exists. One is, of course, the resumption of regulation. I
don't know anybody--well, I know some who are in favor of it,
but nobody I respect. [Laughter.]
The only alternative is freedom of entry, and that, of
course, is exemplified by the increasing challenge to the sharp
increases in full fares by new entrants in the middle-1990's.
The Department of Transportation has documented it. It
estimates that they saved travelers some $6 billion in 1996.
That is how a deregulated, competitive industry is supposed to
protect not really consumers generally, but any subgroup of
consumers. If a small carrier says, I can serve these people at
lower cost and at a lower fare, free entry is the way in which
we rely for protection.
I won't recite the pattern that is described by the
Department of Transportation, the pattern that is exemplified
by this showing, but certainly it has been found in case after
case, a drastic reaction, very sharp price reductions, an
enormous increase in the offer of discount fares only on the
particular routes where the challenge occurs. When and if the
entrant is driven out, fares go back up to their previous
level. And, of course, other carriers thinking about entry,
seeing what happened to the one before, are going to be
hesitant about entering.
Now, I can't even tell you that that is the typical
scenario. It has certainly happened many, many times. I have
not been able to do a continuing study, and I regret that the
Department of Transportation doesn't seem to have done so, to
tell us whether that is the typical picture or not.
But, interestingly, I came across my desk yesterday a
monograph by Professors Fred Allvine, of the Georgia Institute
of Technology, about whose work I have known in the past, and
Ashutosh Dixit, of the University of Georgia, which appears to
document at length and in great detail exactly the kind of
scenario that is described there and purporting to show a
pattern of very great consistency. And I urge you and the
Department of Transportation to look at it very carefully.
There is no question, according to the studies by Drs.
Morrison and Winston, that entry by more or less low-fare
carriers, low-cost, has made a disproportionately great
contribution to the benefits of price competition in the
industry. And they have actually made estimates of that and
they show that the contribution to savings from reduced real
fares by Southwest and other new entrants has been more than
twice as great as the competition supplied by incumbent
carriers. It plays an extremely important role in disciplining
the industry.
Now, the industry is especially susceptible to predation
because you can move aircraft in and out, and that is an almost
unusual circumstance in this industry. The incumbents incur
virtually no additional sunk costs if they simply increase
capacity on challenged routes, and then they can readily take
the capacity out. And that also makes it easier for the people
who are there to depart because they don't have major sunk
costs. They can transfer their planes out or be induced to do
so.
Yield management techniques also increase the ability of
the industry to practice predation. Because of that, it is
extremely difficult to apply the test that has typically been
adopted by the courts in antitrust cases under the Sherman Act
and under the Clayton Act because the principal component of
the average variable costs that supply the principal test under
antitrust jurisprudence are notproduction costs, which are
very, very low. They are opportunity costs, the revenues that you
sacrifice by transferring capacity from one route to the challenged
route, and what the Department of Transportation pointed out, the
sacrifice of net revenues that you may be making if you had pursued a
less aggressive policy.
That immediately makes it clear how difficult that is to
interpret and to administer, and I am one of the first to
recognize it. But, in principle, I point out to you that the
report of the National Research Committee, of which I was a
member, that reported last summer clearly recognizes the
infirmity of simply using average variable production cost.
That reflects direct expenses, but it is an unsatisfactory
proxy--I am quoting them--for marginal costs because it doesn't
account for the more profitable opportunities that are
foregone.
Now, I should emphasize, in fairness, the overall
profitability of this industry is nothing to write home about.
It seems over the years clearly to fall somewhere below the
average, and perhaps markedly below the average, of industry
generally.
On the other hand, that doesn't mean that there is no room
for additional competition. If competitive entry were freer
than it is today of predatory responses, the intensified
competition could be associated with lower costs, both because
of the increased pressures that it would impose on the
incumbent carriers to reduce their costs and because a greater
proportion of the traffic would be carried by low-cost
carriers.
My last observation, and I will stop. There is always a
danger in proceeding more vigorously against what appear to be
predatory pricing responses of weakening competition itself.
That is a legitimate concern that a more vigorous attack on
these responses by labeling healthy consumer-benefitting
responses as predatory could outweigh the benefits.
On the other hand, some of the responses to the Department
of Transportation's initiative to move against them on the
ground that it would suppress more competition than it would
protect generally ignores the fact that the only circumstances
under which DOT would move under these would be when the
incumbents were not offering those low fares in such profusion
until they were challenged, and then only in the particular
routes on which they were challenged.
The initiative has in almost all cases, almost invariably,
come from the entrants. So when one sheds tears about limiting
the competitive response of the incumbents, it is important to
bear it in the context that they occur only when the initiative
has come from competitive entrants. And, of course, they are
promptly withdrawn when they succeed in driving competitors
out.
On the third hand--you remember President Truman said he
used to go to bed at night praying for a one-handed economist--
there is the difficulty in enforcement actions of predicting
which of these vigorous competitive responses will have an
ultimately anticompetitive effect and which will not, and in
which markets, therefore, competition is likely to persist, to
the lasting benefit of consumers.
I am sorry that I have left you with a three-handed
dilemma. I do want to present you, however, with the case for
saying this is a serious problem. There is serious basis for
anger on the part of the 6 percent of mileage, and that is all
it is, who pay the full fare, and all of them live in Ithaca.
[Laughter.]
Therefore, I think DOT's exercise of its independent
authority should be encouraged.
Thank you.
Senator DeWine. Professor, thank you very much.
[The prepared statement of Mr. Kahn follows:]
Prepared Statement of Alfred E. Kahn
I am honored by the invitation to appear before you today, and hope
I can be of some assistance to you in your consideration of the state
of competition in the deregulated airline industry and the application
of the antitrust laws to it.
Fortunately, I can leave to my colleague, Professor Steven
Morrison, co-author of the definitive studies of the effects of airline
deregulation, documentation of my firm opinion, and his, that
deregulation has been a great success--in particular, by unleashing the
forces of competition, bringing air travel within reach of people of
limited means, without sacrifice of safety.
There are, I think, two things to be said about the fact that it
has also been accompanied by a marked increase in discomfort and
congestion: first, that it was precisely the failure of regulation to
offer travelers a low-cost/lower-quality product that was its greatest
failure; and, second, that this deterioration in the quality of the air
travel experience is a consequence, in important measure, of the
failure of government to provide the optimal infrastructure--
specifically, air traffic control and airport capacity--and to price it
correctly.
I take it as a truism, which requires no explanation to this
Committee, that the withdrawal of direct regulation shifts the
responsibility for protecting consumers to competition and
responsibility for preserving that competition to increased vigilance
in enforcing the antitrust laws.
In these remarks, I propose to concentrate my attention on the
aspect of antitrust policy, as applied to this industry, that has
inspired the greatest amount of controversy in the last several years--
namely, the determination of what constitutes or should constitute
unfairly exclusionary practices, such as the Department of
Transportation is charged with preventing. While I have not been in a
position to make any direct assessment, on the basis of historical
experience, of the importance of such practices--and am not at all
clear how it might be conducted--I have at least the strong impression
that the intense controversies engendered by DOT's promulgation of
proposed rules in fulfillment of that responsibility, in April of 1998,
does properly reflect their importance. Along with the reform of the
arrangements for providing and pricing access to infrastructure and our
long-continuing efforts to lift the governmentally imposed barriers to
competition at the international level, I can think of no other aspect
of government policy with greater significance for the preservation and
expansion of the benefits of deregulation--perhaps I should add, of
greater importance, for good or ill.
Consistently with that opinion, I strongly endorse the proposition
that DOT both has and should have that responsibility: it is the
precise counterpart of the statutory responsibility of the Federal
Trade Commission to prevent unfair methods of competition--from which
airlines were exempted because of their historical subjection instead
to direct regulation.
The basis for the heightened concern in recent years about such
assertedly exclusionary tactics as predatory pricing, the interference
with new entrants obtaining fair access to airport facilities, refusals
to interline or exchange luggage, and the offer of special override
commissions to travel agents targeted at markets subjected to new
competitive entry is by now entirely familiar.\1\
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\1\ I testified on the subject before the Aviation Subcommittee of
the U.S. Senate Committee on Commerce, Science, and Transportation
approximately two years ago (April 22, 1998) and before the
Transportation Subcommittee of the same Committee on May 5, 1998, and
published a more formal statement, ``Comments on Exclusionary Airline
Pricing,'' which was published in the Journal of Air Transport
Management in 1999.
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1. While average yields, per mile, have declined on the order of 40
percent in real terms--i.e., adjusted for changes in the Consumer Price
Index--since deregulation, full fares, paid on only some 6 percent of
total mileage, have apparently increased on the order of 70 percent.
That sharply increased spread has surely been in large--indeed, I offer
the impression, major--measure beneficial to all travelers, for two
reasons. In part, it reflects wide differences in real costs as between
long and short, dense and thin routes and by hour of the day and day of
the week, as well as of holding seats open for last-minute
availability. Moreover, to the extent that the fare differentials are
discriminatory, they make it possible to use larger, more efficient
planes and offer more convenient scheduling on a greater number of
routes than would have been possible if all fares had to be uniform.
Within limits--of incremental costs at the bottom and stand-alone costs
at the top--the offer of heavily discounted tickets to discretionary
and/or leisure travelers, in order to fill seats that would otherwise
go empty, while charging higher fares to demand-inelastic travelers, is
beneficial to both of them.
2. At the same time, this increased discrimination has also raised
legitimate concerns about the likelihood that those full fares reflect
also monopoly exploitation of travelers who cannot make their
reservations weeks in advance or stay over a weekend--the most familiar
devices by which the airlines discriminate between demand-elastic or
discretionary travelers, on the one side, and demand-inelastic,
exploitable ones, on the other.
3. There are, effectively, only two ways of preventing exploitation
of the demand-inelastic travelers. One would be a resumption of
regulation; since no economist I know advocates this, it would be
superfluous to expatiate on our reasons for not recommending it.
4. The only alternative protection, and the one completely
consistent with deregulation, is competition. One important function of
free competitive entry is to ensure that no group of travelers is ever
charged more than the costs of serving it alone. This process was
apparently exemplified by the increasing challenge to the sharp
increases in full fares by new entrants in the middle '90s--documented
by the Department of Transportation, along with an estimate that they
saved travelers some $6 billion in 1996. This is precisely the way in
which a deregulated, competitive industry is supposed to protect not
merely consumers generally but any smaller subgroup of them.
As I put it in my testimony on April 22, 1998,
The theoretically correct basis for . . . charges to
subgroups of customers . . . 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: . . . .
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 should point out, at the same time, that the pattern I have just
described is by no means uniform and invariable. While the TRB
Committee, of which I was a member, that reported on Entry and
Competition in the U.S. Airlines Industry last summer,\2\ found some of
the responses of incumbents to competitive entry ``difficult to
reconcile with fair and efficient competition'' (p. 6), it could find
no uniform pattern in the instances of possibly exclusionary conduct
presented to it by the Department of Transportation: while incumbent
airlines typically reduced their fares sharply in response to such
entry, sometimes increasing capacity, sometimes not, there is no clear
and consistent relationship between those responses and either the
disappearance of the challengers or the restoration of fares to their
previous level. On the other hand, there has just come across my desk a
monograph by Professors Fred Allvine, of the Georgia Institute of
Technology, and Ashutosh Dixit, of the University of Georgia, which
appears to document, at length and in great detail, the kind of
scenario that I have just described, showing a pattern of great
consistency; it clearly deserves your careful attention and that of the
Department of Transportation.
---------------------------------------------------------------------------
\2\ Special Report 255, National Academy Press, Washington, DC,
1999.
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5. Market entry by low-cost, more or less uniformly low-fare-
charging carriers has made a grossly disproportionally great
contribution to the benefits of price competition in the industry,
according to the studies of Drs. Winston and Morrison.\3\
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\3\ In their magisterial studies of airline deregulation, Winston
and Morrison estimate that the contribution to the savings from reduced
real fares since deregulation by Southwest and other new entrants has
been more than twice as great as the ``competition supplied by
incumbent carriers,'' with Southwest accounting for some three-quarters
of the former. Winston, ``U.S. Industry Adjustment to Economic
Deregulation,'' Journal of Economic Perspectives, summer 1998, p. 101.
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6. The airline industry is especially susceptible to predation,
because of the mobility of aircraft and the consequent relatively small
proportion of sunk costs in undertaking to serve and responding to
competitive entry into individual markets: the incumbents need incur
virtually no additional sunk costs when they increase capacity on
challenged routes and entrants can be readily induced to depart,
because of their ability correspondingly to move their equipment out.
7. The sophistication of the major airlines in practicing yield
management, rationing the availability of deeply discounted tickets,
makes it easy for them sharply to increase the availability of such
fares on individual routes in response to competitive challenge and to
withdraw them when the challenge disappears.
8. This character of the industry and of its costs makes it
extremely difficult to apply the test of predation that has been most
widely adopted by the courts--namely, pricing by the incumbent below
their short-term marginal or average variable production costs. In the
circumstances that I have just described, the principal component of
those average variable costs are not production costs but opportunity
costs--the revenue foregone elsewhere by transferring capacity to the
contested route and/or the revenue from undiscounted or only modestly
discounted ticket sales sacrified by the suddenly increased
availability of deeply discounted ones. This is the essence of the
condition incorporated in all three indicators of ``unfair exclusionary
practices'' proposed by the Department of Transportation: that ``the
ensuing self-diversion of revenue results in lower local revenue than
would a reasonable alternative response.'' \4\ (in Transportation
Research Board, p. 166)
---------------------------------------------------------------------------
\4\ Despite the more or less even division of the members of the
TRB Committee for the Study of Competition in the U.S. Airline Industry
on the issue of whether DOT should be encouraged to proceed with its
independent enforcement actions or defer to the Department of Justice,
all members recognized the critical relevance of opportunity costs in
these circumstances (pp. 8, 86): ``to the extent that AVC [average
variable cost] mainly reflects the direct expenses incurred in
production, it is an unsatisfactory proxy for marginal cost--since it
does not account for more profitable opportunities foregone.'' By
emphasizing revenue ``self-diversion,'' DOT seemingly was trying to
incorporate opportunity costs into its method of detecting predation.
---------------------------------------------------------------------------
I must emphasize, in fairness, that the overall profitability of
the airline industry seems hardly reflective of what one would expect
from a monopolist: overall, it apparently has, on average over the
years, fallen well below the average of American industries
generally.\5\ This consideration does not, however, exclude the
possibility of purchasers of unrestricted tickets having a legitimate
complaint; and it by no means follows that if unrestricted fares were
to come down, discount fares would inevitably have to go up. The
industry is far from perfectly competitive, there is therefore a wide
range within which its rates of return can vary, not only from year to
year, but also in the long run, if only because its costs are not
exogenously fixed by perfectly competitive input markets but are
themselves instead responsive in important measure to the intensity of
competition in airline markets. If competitive entry were freer than it
is today of predatory responses, the intensified competition that it
could bring could clearly be associated with lower costs, the latter
because of both intensified downward pressures of competition on the
costs of incumbents and increase in the proportion of the traffic
carried by the low-cost carriers.
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\5\ I have had time only to look at the industry's ranking among
the Fortune 500 only over the last seven years: its median ranking was
21st out of 38 industries, reflecting rankings averaging around 32 out
of 35 in 1993-95 and a very satisfactory 12 out of some 38 in 1997-99;
but one need only dip back into the catastrophic losses the industry
suffered in the 1990-92 period to put the quite satisfactory showings
over the last years in proper context.
---------------------------------------------------------------------------
There is always a danger, in proceeding more vigorously against
what appear to be predatory pricing responses by incumbent airlines to
competitive entry of weakening competition itself. The concern is a
legitimate one--that a more vigorous attack on responses by incumbent
airlines to competitive entry may, by labeling healthy and consumer-
benefiting competitive responses by incumbents as predatory, outweigh
the benefits. On the other hand, some of the responses of the
Department of Transportation's initiative to move against such
responses, on the ground that it would suppress more competition than
it would protect, generally ignore the fact that the only possible
circumstances under which such a policy would discourage such price
reductions would be when the incumbents were not offering such low
fares in such profusion until they were challenged, offered them then
only in direct response to competitive entry and only on the particular
routes affected, and--in those instances in which the competitor had
been driven out--promptly withdrew them. On the third hand, however,
there is the difficulty, in enforcement actions, of predicting which of
the vigorous competitive responses will have that ultimately anti-
competitive effect, which will not, and in which markets, therefore,
competition is likely to persist, to the lasting benefit of consumers.
Senator DeWine. Professor Morrison.
STATEMENT OF STEVEN A. MORRISON
Mr. Morrison. Thank you. It is a pleasure to be back today.
My remarks will be brief. There is more detail in my testimony
and in the sources that are referenced in the testimony.
What I would like to do is go through some points to
provide my answer to the question that is the theme or the
title of these hearings: ``Airline Competition: Clear Skies or
Turbulence Ahead?'' My approach to this issue, as to all issues
of this type, is empirical. I look at the data.
What I am going to do in the next 5 minutes is, first,
present some aggregate figures that provide an overview of the
extent of competition in the airline industry, then present the
results of some statistical analyses that shed light on the
factors that underlie those aggregate results, and then
speculate on some possible policy responses that may improve
competition.
As for the overview, I would like to look at some key
measures of the extent of competition in the airline industry
and its effects. One of the most important measures of
competition is the number of carriers per route. And using that
measure, competition has been stable for the last 7 years, at a
level some 30 percent higher than it was before airlines were
deregulated.
As, or more important than that simple measure of number of
carriers per route, as Professor Kahn indicated, is the
presence of low-fare carriers. And by that measure, low-fare
carriers' share of passenger miles is now at an all-time high,
at 12 percent. But the influence of low-fare carriers goes
beyond their own share of passenger traffic because they
influence the fares of other carriers who compete against them,
as the chart illustrates.
If you look at the percentage of traffic that flies on
routes with low-fare competition, that measure, as well, is at
an all-time high of 42 percent.
Senator DeWine. Forty-two?
Mr. Morrison. Forty-two. I will add parenthetically that
two-thirds of both of those numbers is due to the premier low-
fare carrier, Southwest.
Using an even broader definition of the influence of low-
fare competition to include not just routes served but the
effect of potential competition, I have calculated the effect
of Southwest Airlines alone influences fares on 94 percent of
passenger miles in the country, just Southwest Airlines.
These figures on the extent of competition are of interest
because we know both theoretically and empirically that more
competition leads to lower fares. But as Professor Kahn said,
we can just look at fares to see what has happened. Fare per
mile adjusted for inflation is at a historical low of a little
bit less than 14 cents a mile. Indeed, there is a wide
variation in fares. We documented that in the report of the
Transportation Research Board panel.
So adding in the service benefits and fare changes,
travelers today are saving some $20 billion annually over what
they would have paid in the years of regulation. So, viewed in
the aggregate, airline markets are working. But aggregate
statistics can hide some details.
Although the average traveler is better off, our estimate
is that some 20 percent of travelers are paying higher fares,
the 6 percent that Professor Kahn indicated, but others as
well. And what I want to do in the second half of my testimony
is talk about what factors account for these winners and
losers.
To address that, Cliff Winston and I performed some
statistical analyses. The original source is documented in the
testimony. Some of the findings--perhaps most of them are not
surprising, but they provide a useful quantification of
conventional wisdom.
I have good news and bad news. The good news is competition
from Southwest Airlines saves travelers some $10 billion a
year. Competition from other low-fare carriers saves travelers
some $1.5 billion a year. The bad news is the long-term
exclusive use gates at airports and other lease policies that
make it difficult for airlines to acquire new gates, by our
estimates, cost travelers $3.8 billion annually.
Slot restrictions at the slot-controlled airports, the
high-density rule, costs travelers $.6 billion annually. Hub
dominance costs travelers $.4 billion annually, but this
appears to be because, with a few exceptions, Southwest
Airlines does not operate from dominated hub airports.
What we have found is that fares at hubs are no higher than
fares elsewhere that Southwest doesn't serve. Southwest has
such a huge impact on the outcomes in the marketplace that one
needs to in almost any analysis take their presence or absence
into account when making comparisons.
Finally, in the bad news category, we were provided by the
Department of Transportation a list of some 20-odd routes where
their unfair exclusionary practices criteria appeared to have
been violated. The routes on which those violations occurred
cost travelers $20 million a year. So that is a rather small
number compared to the billions that I have been referring to
before.
What can we do about it? Low-fare competition, especially
from Southwest, has a powerful effect on fares. To increase the
likelihood of the next Southwest coming on line, we could, and
I think we should, eliminate restrictions on foreigners owning
and operating U.S.-based airlines.
We need to do something, and I am not entirely sure what,
to increase gate availability. From what I have read, it
appears that existing policies of the DOT or existing
regulations of DOT and of airport operators provide them with
more leverage than they are using to open up gates, but that is
certainly an area that needs some attention. Remove slots and
replace them with congestion-based takeoff and landing fees. I
am not up to date on exactly what has happened, but I know some
legislation has been passed in that regard. Finally, I differ
with Professor Kahn about the importance, but more importantly
about the avenue to take with alleged predatory behavior. I
believe it should reside with the Department of Justice.
To summarize, to answer the question: airline competition:
clear skies or turbulence ahead, I would say clear skies with a
little light chop.
[The prepared statement of Mr. Morrison follows:]
Prepared Statement of Steven A. Morrison*
---------------------------------------------------------------------------
* Portions of this testimony rely on and are extracted from Steven
A. Morrison and Clifford Winston, ``The Remaining Role of Government
Policy in the Deregulated Airline Industry,'' in Sam Peltzman and
Clifford Winston, eds., ``Deregulation of Network Industries: What's
Next?,'' Washington, DC: The Brookings Institution, 2000 (forthcoming).
The paper is available in the research section of my web site.
---------------------------------------------------------------------------
INTRODUCTION
From time to time since airlines were deregulated over 20 years
ago, the question of the functioning of airline markets arises. For
example, seven years ago, after four years of staggering losses, a
national commission was formed to investigate whether the deregulated
airline industry was capable of achieving financial viability.\1\ The
industry's fortunes improved without any regulatory intervention and
for the last several years it has been recording record profitability.
Recently, concern has shifted from the plight of airlines to a concern
for their passengers. This testimony summarizes recent empirical
analyses I have undertaken to address the state of competition in the
airline industry.
---------------------------------------------------------------------------
\1\ The National Commission to Ensure a Strong Competitive Airline
Industry, Change, Challenge and Competition: A Report to the President
and the Congress, August 1993.
---------------------------------------------------------------------------
THE BIG PICTURE
Figure 1 shows the trend in the number of ``effective competitors''
\2\ at the route level from 1977, the year before formal deregulation,
through 1999. 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-1980s and bankruptcies in the early 1990s, the number of effective
competitors per route has been fairly constant since 1993 at 2.2, an
increase of more than 30 percent since 1977.
---------------------------------------------------------------------------
\2\ Because a simple count of carriers on a route would treat a
carrier with a large market share of equal importance as one with a
small market share, a measure of competition that takes market share
into account is appropriate. In particular, I use the inverse of the
widely used Herfindahl-Hirshman index (HHI), 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 HHI would be 0.50 \2\+.050 \2\=0.50.
Inverting gives two equal-sized competitors. The same result would
occur with three carriers with market shares of two-thirds, one-sixth,
and one-sixth.
---------------------------------------------------------------------------
In addition, however, to the number of carriers on a route, the
identity and business models of those carriers are also important,
especially if one's ultimate interest is the effect of competition on
fares. Figure 2 shows two measures of the influence of low-fare
carriers. The first measure is the percentage of domestic passenger
miles flown by low-fare carriers. This measure increased steadily from
1978 until 1985, declined in 1986 with the bankruptcy/merger of People
Express and has grown steadily since 1987. In 1999 low-fare carriers
accounted for 12 percent of domestic passenger miles, the highest
percentage ever.\3\ The second measure, however, gives a more accurate
picture of the effect that low-fare carriers have on airline
competition and fares. This measure takes into account that the
influence of low-fare carriers is greater than their share of traffic
because they influence fares of other carriers flying the same routes
(in this case, the same city pair). In particular, it measures the
percentage of domestic passenger miles flown (by all carriers) in city-
pair markets that are served by low-fare carriers. This measure follows
the same pattern as the previous one: increasing until 1985, declining
until 1987 and increasing since then. In 1999, low-fare carriers
influenced fares on routes accounting for 42 percent of domestic
passenger miles, an all time high.\4\ In addition, using a broader
measure of the effect of low-fare carriers that incorporates the effect
of actual route competition, competition on nearby routes, and the
effect of potential competition, I have found that Southwest Airlines
alone affects airfares on routes that account for 94 percent of U.S.
domestic passenger miles.\5\
---------------------------------------------------------------------------
\3\ About two-thirds of the passenger miles flown by low-fare
carriers are accounted for by Southwest Airlines. Although the
passenger miles of other low-fare carriers were at an all-time high in
1999, their share of passenger miles (4.0%) was slightly less than in
1997 (4.1%) when it reached an all-time high.
\4\ Again, about two-thirds of this is due to Southwest Airlines.
\5\ See Steven A. Morrison, ``Actual, Adjacent, and Potential
Competition: Estimating the Full Effect of Southwest Airlines,''
unpublished manuscript (available in the research section of my
website).
---------------------------------------------------------------------------
Interest in the extent of competition in the industry stems from
the observation that more competition--especially from low-fare
carriers--leads to lower fares. This is addressed directly in Figure 3,
which shows domestic airline yield (average fare per mile) from 1970 to
1999. Fares, adjusted for inflation, have fluctuated, but followed a
declining path since 1971. Compared with 1976, before the regulatory
reform that preceded deregulation in 1978, fares have fallen 40
percent. In 1999, real yield was a bit less then 14 cents, its lowest
level ever. However, as shown in the figure, fares were falling even
before deregulation. How much of the decline in fares is due to
deregulation and how much would have happened anyway (due to factor
prices and technological change, for example)? This is addressed in
Figure 4, which shows a conservative estimate of how much lower fares
are due to deregulation.\6\ For the last six years fares have been
about 27 percent lower than they would have been if they were
regulated. (Thus, about two-thirds (27/40) of the fare decline since
1976 can be attributed to deregulation). Further investigation shows
that 80 percent of passengers, accounting for 85 percent of passenger
miles, pay lower fares than the estimate of regulated fares.
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\6\ The estimate compares actual deregulated fares with an estimate
of what fares would be if they continued to be regulated. 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.
---------------------------------------------------------------------------
Deregulation has also affected service. Previous research has found
that travelers have gained substantially from the increase in flight
frequency facilitated by the acceleration ofhub-and-spoke
operations.\7\ Because deregulation freed airlines to serve all
markets, travelers have also gained from having to make fewer
connections that require changing airlines. These gains have been
partially offset by more crowded flights, travel restrictions that are
inconvenient for business travelers (especially the required Saturday
night stay), a few more connections, and slightly longer flight times
because of congestion. Accounting for fare and service quality changes,
the annual net benefits to travelers from airline deregulation
currently exceed $20 billion.
---------------------------------------------------------------------------
\7\ Steven A. Morrison and Clifford Winston, ``The Evolution of the
Airline Industry'' provides a detailed discussion of the findings
reported in this paragraph. The benefits from increased frequency are
nearly as important as the benefits from reduced fares, amounting to
more than 80 percent of the benefits from lower fares.
---------------------------------------------------------------------------
THE DETAILS
The results presented in the previous section indicate that, on
average, travelers have benefited from airline deregulation but that a
small minority has not. In this section I take a more disaggregate view
to try to identify those factors that distinguish the winners from the
losers and to identify any trouble spots and possible policy remedies.
To address this question, my colleague Cliff Winston and I used
regression analysis to examine the factors that influenced fare changes
between 1978:4 and 1998:4 on the 1,000 most heavily traveled routes in
1998.\8\ We found that increased competition, especially from Southwest
Airlines and other low-fare carriers leads to lower fares. In
particular, we found that competition from Southwest Airlines accounted
for $9.7 billion of the fare savings since 1978:4. Competition from
other low-fare carriers accounted for $1.5 billion, while additional
competition from pre-deregulation carriers accounted for $0.4 billion.
---------------------------------------------------------------------------
\8\ Steven A. Morrison and Clifford Winston, ``The Remaining Role
of Government Policy in the Deregulated Airline industry,'' in Sam
Pelzman and Clifford Winston, eds. ``The Deregulation of Network
Industries: What's Next?,'' Washington, DC: The Brookings Institution,
2000 (forthcoming) (available in the research section of my web site).
---------------------------------------------------------------------------
In another regression we examined the factors that influence the
level of fares (rather than the change in fares) on the same set of
routes used above. We found that the most important factor that
increases airfares to travelers was (lack of) gate availability. In
particular, we found that, other things equal, airports with a higher
fraction of gates available for use by other airlines (i.e., generally
common use gates) had lower fares. Quantitatively, if all airports had
common use gates, or other arrangements that precluded exclusive use of
gates by incumbent airlines, travelers would save $3.8 billion
annually.
Slots (at O'Hare and LaGuardia) raise fares by $0.6 billion
annually.
Domination of hub airports raises fares by $0.4 billion annually,
other things equal. Figure 5 sheds additional light on the hub premium
issue. The figure shows the percentage by which fares at 12
concentrated airports differ from fares at two sets of control groups.
Although the results differ from airport to airport, on average, fares
at concentrated hub airports are 23 percent higher than at all other
airports. But, as indicated above, the effect of Southwest Airlines on
fares is so important, that when the comparison group excludes airports
that Southwest serves, the average concentrated airport has fares 6
percent lower than the comparison group.\9\ Thus, it appears that what
looks like a hub premium is actually a ``premium'' that airlines charge
anywhere they can when they do not compete against Southwest.
---------------------------------------------------------------------------
\9\ This comparison is potentially misleading because three of the
concentrated airports are served by Southwest (Salt Lake City, St.
Louis, and Detroit). However, if these three airports are eliminated
from the analysis, fares at the nine remaining concentrated airports
are 29 percent higher than at all other airports and 1 percent lower
than the comparison group that excludes airports served by Southwest.
---------------------------------------------------------------------------
On routes where carriers appear to have violated the Department of
Transportation's Unfair Exclusionary Practices criteria, fares are
lower during the periods when the alleged transgressions are occurring
and return to their previous levels after the episodes are over. We
found that fares on these routes, before and after the alleged
predatory activity, are $20 million higher than on otherwise comparable
routes.
CONCLUSION AND POLICY RECOMMENDATIONS
By and large, airline markets are working and competition is
healthy. There are a few trouble spots, however. By far the most
important is access to gates at airports. Slot restrictions are a
distant second, followed by hub dominance. The quantitative importance
of alleged predatory activity is quite small.
Although competition is robust, more competition would be better.
The effect of Southwest Airlines on competition and fares shows that
just one airline can have a large impact on competition and fares if it
is well financed and well managed. The likelihood of another Southwest
entering the industry would be increased if federal limits on
foreigners owning and operating U.S.-based airlines were eliminated.
The FAA/OST Task Force \10\ has recommended several policies to
improve gate availability at airports as has the TRB Committee for
Study of Competition in the U.S. Airline Industry.\11\ These range from
using the AIP and PFC programs to improve gate availability to airport
authorities buying back gates from dominant incumbents. Although I do
not have a particular policy in mind, any policy that improves gate
access should have a large impact on competition.
---------------------------------------------------------------------------
\10\ FAA/OST Task Force, ``Airport Business Practices and Their
Impact on Airline Competition,'' October 1999.
\11\ Transportation Research Board, National Research Council,
``Entry and Competition in the U.S. Airline Industry,'' Special Report
255, Washington, DC: National Academy Press, 1999.
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As for slots, I believe they should be eliminated and replaced with
congestion-based takeoff and landing fees.
Although I have found that the likely effect of alleged predatory
behavior is small, it should not be ignored. In cases of alleged
predatory behavior by airlines, I believe the Department of Justice
should investigate and take appropriate action, rather than the
Department of Transportation.
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Senator DeWine. Good, very interesting.
Mr. Morrison, do you want to summarize for me in descending
order the items that are causing the problems as far as lack of
competition? Give me that again.
Mr. Morrison. Gates.
Senator DeWine. Gates, number one.
Mr. Morrison. Number two is slots. Number three is hubs.
Senator DeWine. Gates, slots, hubs.
Mr. Morrison. Number four is alleged predatory behavior.
Senator DeWine. OK, and that is the order?
Mr. Morrison. Yes.
Senator DeWine. Professor Kahn, you mention in your
testimony that having the Department of Transportation take
action to prevent unfair exclusionary practices may actually
weaken competition, and I agree that that is a concern. How
would you protect against that sort of unwanted result?
Mr. Kahn. I am not sure that I have an easy answer. We have
the experience of the Federal Trade Commission in dealing with
the entire economy. It has almost precisely the same authority
under Section 5 of the Federal Trade Commission Act. I have
seen many criticisms of the FTC, but I have never heard it
seriously maintained that, on balance, they have weakened
competition.
One of my main reasons for wanting DOT to retain that
concurrent authority is that the Supreme Court has virtually
written predation out of the antitrust laws. They have
expressed the opinion time and again that predation is rarely
tried and even more rarely succeeds.
And by an interesting coincidence, the Supreme Court--I
suppose it is not surprising, given the fact that they are
lawyers--is a victim of a perceptual lag. They are all trained
by the University of Chicago and the economics profession has
moved about 15 years past the University of Chicago on the
question of whether predation is or is not a real problem. And
since I have referred to myself as a premature post-Chicagoan,
I take enormous satisfaction from that fact. And I would urge
you to look at the Allvine-Dixit memorandum.
So it is a question of what your opinion is about the
sufficiency of the Sherman and Clayton Act prohibitions as they
have been interpreted by the Supreme Court. I think there is an
enormous lag there, and I think that we should give DOT a
chance. I think their sensitivity to the danger of interfering
with good competition is very clear.
But the way I weigh the dangers, I weigh the danger much
more on the other side because, as I pointed out, they would
never move in a situation in which competition before the entry
of the entrant was effective. They would move only in those
particular situations in which somebody took the initiative to
come in, cut fares sharply. Then, of course, they are all in
favor of competition, but only as long as it is responsive and
it is not initiating.
The only other point I would make and then I promise to
stop is that I have had correspondence with Professors Winston
and Morrison on this point. Their measure which demonstrates
that predation has cost consumers virtually nothing is a
measure of the extent to which, after assertedly predatory
conduct, fares move up beyond the entry at which they were
before the competitor came in.
In other words, if you have entry and fares go down 50
percent, and then you have assertedly predatory tactics and
fares just go back up to the pre-entry level, their measure
would say zero cost to consumers. I think most of us would
define predation as being successful to the extent it restores
fares to the previous level. I recognize that that might be an
extreme the other way.
They have also introduced a second measure, which is, well,
if it restores fares to the previous level and those fares were
unusually high, that is compared with fares elsewhere, then to
the extent that they were unusually high, we will count that as
a cost to consumers.
My concern is with the pattern of pricing in the industry
all through the industry that has these very high unrestricted
fares. So, again, these measures which they identify, I think,
minimize the costs of what many of us would feel were the costs
of predation.
Mr. Morrison. May I follow up?
Senator DeWine. Absolutely.
Mr. Kahn. As he has in writing.
Mr. Morrison. Indeed, what we found was that, of course,
while these alleged predatory activities are going on, fares
are lower, and that when they are finished, fares go up to the
level that they were before, not higher, but that those fares
before and after were some $20 million, the number I mentioned
before, on the aggregate higher than on otherwise comparable
routes.
As far as the notion that predation in one market spreads
to others, I suspect that is true, but there is no way that I
can figure out to measure it, so the extent of it is
speculative.
Mr. Kahn. Yes. That was the other point I made in my letter
to them that one of the main bases for the post-Chicago view of
predation is that engaging in this kind of tactic protects the
price level all over your network because it deters future
entry. And, of course, Professors Winston and Morrison are
absolutely right. There is no way of measuring it, but, of
course, the fact that something can't be measured doesn't mean
it doesn't exist.
Senator DeWine. Senator Kohl?
Senator Kohl. Thank you, Mr. Chairman.
Professor Kahn, we have heard from several start-up
airlines that they find it very difficult to compete with the
established airlines at their hubs where the incumbents
dominate the market. Northwest in Minneapolis, US Air in
Pittsburgh, and Delta in Atlanta are just a few examples,
although there are many others.
When a new airline comes into a market, the established
airline can and oftentimes does drastically cut its fares to
undersell the entrant and can add vastly more capacity. Some
airline critics and consumer advocates call these tactics
predatory and say that they ought to be illegal under antitrust
law.
Do you have a view on that, Mr. Kahn?
Mr. Kahn. Well, my view is that some of those are almost
certainly predatory, sufficient even to deter a Southwest
Airlines from challenging the incumbent hub-dominating
carriers.
Now, there are two reasons why Southwest stays out. Partly,
when the hubs are congested, they can't engage in their really
efficient, rapid turnaround operations. But the other reason, I
know, is that if they were to try to come into Minneapolis to
remedy the situation that you described, they would run into a
buzz saw.
Now, it is generally understood in the industry that you
don't really take on Southwest. They have a very great
longevity. But it is also understood that Southwest doesn't go
into Boston, A, for the perfectly good reason that I have
mentioned, but, B, because it is already dominated and it would
start this kind of major price war. So, of course, they locate
at Providence and Manchester, which is great, and at Baltimore,
which is again great.
I mean, they are public benefactors, there is no question
about it. But I think that even they are deterred from
challenging directly--and I have heard this example--
specifically in Minneapolis because of what they know the
response is likely to be.
Senator Kohl. Professor Morrison, are you concerned that
these types of tactics practiced by some of the airlines will
harm consumers by driving competition out of the market or
preventing them from getting into the market in the first
place? Doesn't it bother you?
Mr. Morrison. Yes. My problem is what to do about it.
Senator Kohl. Well, what about this DOT authority to
commence an action?
Mr. Morrison. Well, the DOT authority, in my view, is
fairly vague, these best alternative responses, and depending
on where these data would come from, it might be 6 months after
an action that you knew whether it was legal or illegal.
As was mentioned by Senator DeWine and as everybody knows,
there is currently a Department of Justice case against
American Airlines. I know that American Airlines and its allies
say that the Justice Department wants to create new law. And I
gather what they mean by that is a different definition of
cost, and time will tell.
Senator Kohl. Well, in the case of Minneapolis, for
example, if they called in Northwest and said, you know, we are
watching this very carefully, and detailed what they are
observing and how important it was, in their opinion, to keep a
competitor fairly in business or not to drive them out of
business unfairly, and that, you know, while they are not going
to commence an antitrust action, they have the authority to
take a careful look at this and bring to bear some very serious
consequences, don't you think that that provides them with the
ability to do what you are concerned about?
Mr. Morrison. Yes. As I recall, they did that without these
new guidelines under Secretary Pena when Reno Air entered into
their markets. And they responded very aggressively, as I
recall, with a phone call, or maybe it was more than that, from
the Secretary. They moderated their response.
Senator Kohl. Professor Kahn, I believe that all American
consumers owe you a debt of gratitude for the ground-breaking
work you have done to promote airline deregulation. Sitting
here today in 2000, I wonder how you would assess the state of
airline competition today. More specifically, has deregulation
brought about lower fares and increased consumer choice, as you
imagined, and what are the biggest competitive problems that we
are looking at 20 years after deregulation?
Mr. Kahn. I have no disagreement at all with the general
conclusions of Drs. Winston and Morrison. The benefits to
travelers, the $20 billion that they estimate--you understand
these estimates are very difficult because you have to know
what fares would have been in the last 20 years and what
regulatory policies would have been adopted and changed if we
hadn't deregulated.
But I don't even have to look at their estimates. I can
look around me and I see that last year 94 percent of all
mileage was at discount fares, and that the average discount
from the, I say, perhaps outrageous full fare is 69 percent.
And I see the behavior of carriers. There couldn't have been
more than 15 percent of all mileage at discount fares when it
was regulated, and once we gave them freedom, they clearly
competitively were pricing down. I would say that deregulation
has exceeded my timid expectations by far.
Senator Kohl. Are there some major problems that you think
need to be addressed?
Mr. Kahn. Well, I think that, number one, clearly the
infrastructure. I mean, the system that we have for providing
air traffic control and airports could only have been designed
by a sadist. The pricing of access to airports, particularly at
times of congestion, and to air traffic controls systems is
insane.
When we had all those delays last summer and the airlines
responded, well, we schedule our flights when the travelers
want to travel--and they are absolutely right, but if you
charged for paintings the way you charge for landings at
airports, so much per pound, regardless of the day of the week,
regardless of the amount of congestion, regardless of the week
of the year, you would have riots where Van Gogh paintings were
for sale.
I mean, a market system would permit those rates at those
airports and access to air traffic control to be much higher,
and then use those surplus revenues to subsidize use of the air
traffic control system and access to those airports off-peak or
at feeder airports, and we might get some redistribution of the
traffic.
And that is what we did when I was chairman of the New York
Commission. When I came, rates on Long Island were 5 cents a
kilowatt hour, morning, afternoon, evening, summer, winter,
spring and autumn. By the time I left, rates to big users, for
whom alone you could have the necessary meters, were 3\1/2\
cents, 3 cents, 2\1/2\ cents, and in the summer, when the
temperature got above 84 degrees, 30 cents. That is sensible
pricing.
So the Government is simply not following elementary
economic advice, A, in the way it finances investment in air
traffic control, the fact that it is subject to the budgetary
process. There has got to be some sort of separate
corporatization where it can raise its own capital and then can
price intelligently. That is one.
The second is the international, including the one that
Steven mentioned, the prohibition of foreign ownership. I want
Richard Branson to come in here with Virgin Airlines. And the
third, I think, is this threat to independent entry of the kind
of violent competitive response that many of them can tell you
they encountered, temporary violent response, when they dare to
come in and bring in competition.
Senator Kohl. Just to finish my questioning with that line,
in this specific case, Minneapolis-Milwaukee, Sun Country
Airlines, is clearly beneficial to consumers. Mr. La Macchia
testifies that they are going to put them out of business. He
doesn't have much longer to go.
If he would suggest that that is what is happening,what can
we do, what should we do, either one of you?
Mr. Kahn. I have been in communication with the Department
of Transportation trying to see if we could devise a test that
would not be, I think, as impossible to administer, for the
reasons that Professor Morrison has mentioned. Was there a more
profitable course that they have abandoned, and in abandoning
it, they have taken losses; that is, they are pursuing a less
profitable course than otherwise. That is an acid test of
predation, and I find it extraordinarily difficult to do so.
I find myself attracted, as other economists have been, to
the notion that if an incumbent carrier responds in this way,
with sharp reductions in rates and increasing in the offer of
discount seats and capacity, and the entrant is driven out,
then the incumbent should be required to stay there to retain
those offerings for something like 2 years. That would be a
real test of whether they really thought that they were taking
the most profitable course or whether they were designedly
taking losses which could be explained only in the expectation
of succeeding in predation.
Senator Kohl. Ok. Mr. Morrison.
Mr. Morrison. I agree with Professor Kahn that it is
difficult. As to the 2-year idea, it is an intriguing idea. I
don't know how easy even that would be to enforce, what with
the fare structures the way they are with quite variable fares.
I really don't have an answer. It is a difficult question
because of the structure of airline costs, and it will be
interesting to see what the outcome of this American Airlines
case is.
Mr. Kahn. I think it is partly like pornography. I can't
define it, but I know it when I see it. I am quoting a very
distinguished predecessor.
Senator Kohl. I will just end with this observation. In a
sense, with great respect and deference to what you are saying,
it is pretty basic to this hearing. What do you do in those
situations where you do have clearly, or apparently, some
predatory situation that is going to drive out a competitor we
don't want to drive out. I don't have an easy answer either,
but that is why we are here today.
And I am somewhat troubled by your suggesting that you
don't have any remedy that you would----
Mr. Morrison. Well, my remedy is the Department of Justice.
Senator Kohl. Antitrust?
Mr. Morrison. Yes.
Senator Kohl. Long, drawn-out?
Mr. Morrison. It is better than the alternative.
Senator Kohl. By that time, somebody like Sun Country might
be long gone.
Mr. Morrison. Might be.
Senator DeWine. Let me ask both of you this question. One
of the advantages of the hub and spoke system is that it allows
the airline to serve a number of markets that would not
economically be feasible using the point-to-point system.
With the increasing use of regional jets which are cheaper
and smaller than conventional domestic jets, some of those
markets may now be able to support point-to-point service. Will
regional jet service, in your opinion, decrease the economic
value of hubs? How will that impact all that?
Mr. Kahn. My crystal ball on this is going to be much
poorer than Mr. Carty, who will follow me and who kind of
instructed me many years ago on the benefits of hub and spoke
in very lucid testimony that he gave.
Certainly, the availability of regional jets is a very
hopeful development. There are, I understand, major
difficulties in getting the unions to accept them, and I hope
that those can be worked out because there are point-to-point
markets that it appears could economically be served. That
would tend to encourage the possibility of entry and avoiding
the congestion at hubs, which is another very important
consideration.
I seriously doubt that it will diminish in a major way the
importance of hub and spoke. I mean, the market has told us
what we had great difficulty in predicting when we were trying
to regulate, that hub and spoke is an extraordinarily efficient
way of providing improved service. And whether or not there is
a hub premium, if you leave out Southwest from the control
group or you do not, it is a wonderful place to live in terms
of convenience of service.
Senator DeWine. Professor.
Mr. Morrison. I agree with Professor Kahn. I think that
there are obviously markets where the regional jet can and does
and will operate, but to expect it to have a significant effect
to dismantle hubs, I don't think is going to happen.
Senator DeWine. Let me ask another question. Both of you
have talked about and stressed improved access to airports as
an important way to increase competition. Do you want to share
with us any specific suggestions as to how to improve this
access?
Mr. Morrison. As I said, I am not an expert on this, but
various things I have read recently indicate that the Secretary
of Transportation, FAA, and airport operators have authority
unused at this time that can be used to free up even gates that
are under exclusive-use, long-term leases.
The passenger facility charge, PFC program, appears to be
or has the potential to be a way to increase the number of
gates. An aspect of that program is that gates constructed
under it cannot be exclusive-use, long-term gates. So that is
something that the evidence isn't in yet. One can be hopeful
about.
But as I said, I think there is enough on the books already
if it were utilized, taken seriously, and used aggressively to
free up airports at these hubs that are where the gates are
scarce.
Senator DeWine. Professor.
Mr. Kahn. I am sorry. I don't have anything more to add to
that. We have a very large number of assertions to that effect,
and the staff of the national research committee looked at that
and felt that there was substance to it. Clearly, it is a
carryover of the method by which airport construction was
financed in the past, and that carryover has simply got to be
eliminated.
Senator DeWine. We want to thank both of you very much. It
has been very helpful. Thank you for coming.
Let me invite our second panel to come up, and as you are
coming up, I will introduce you.
Donald J. Carty became Chairman, President, and Chief
Executive Officer of American Airlines in 1998, after having
served as President of AMR Airline Group and American Airlines
since 1995. He also serves as Chairman and interim Chief
Executive of Sabre.
Robert Ferguson III has served as Chairman of the Board,
President, and Chief Executive Officer of Midway Airlines since
February 1997. Mr. Ferguson also sits on the board of directors
of Capital Cargo International Airlines, an air freight
company, and in the past has served as CEO of Continental
Airlines.
Bill La Macchia has been President and Chief Executive
Officer of Sun Country Airlines since 1998, and has been an
instrumental part of Sun Country's success and growth into a
$250 million company.
Mr. Ferguson, we will start with you. Thank you all for
coming.
PANEL CONSISTING OF ROBERT FERGUSON, PRESIDENT, MIDWAY
AIRLINES, RALEIGH-DURHAM, NC; DONALD J. CARTY, CHAIRMAN AND
CHIEF EXECUTIVE OFFICER, AMERICAN AIRLINES, DALLAS, TX; AND
BILL La MACCHIA, JR., PRESIDENT AND CHIEF EXECUTIVE OFFICER,
SUN COUNTRY AIRLINES, MENDOTA HEIGHTS, MN
STATEMENT OF ROBERT FERGUSON
Mr. Ferguson. Thank you very much. Mr. Chairman, Senator
Kohl, committee members, thank you for the opportunity to speak
with you today. I am the President of Midway Airlines. It is
the only airline in America named for an airport it doesn't
serve. We are presently based in Raleigh-Durham, NC.
I have been involved in the aviation business now for some
20 years, and I think it is fair to say I have seen a number of
boom-and-bust cycles through the course of that period. In
1993, when I was the President of Continental Airlines, I had
the opportunity to testify before a commission established by
President Clinton, and one fact struck me as rather remarkable.
Since 1978, at the inception of deregulation, some 119
airlines have been started, and 117 of them had failed. That
didn't seem like a very auspicious beginning. They failed for
bankruptcies, they failed for mergers, they failed because of
bad business plans. The chances of success in this business, in
fairness, if you are a little guy, are very small.
I would like to tell you, however, that I do think it can
be done. There are ingredients, and I guess I would like to
tell you a little bit about Midway Airlines. In our case, we
believe that you can succeed in this business by beginning with
a business plan that is not premised on skimming the cream of
the major air carriers and their established routes.
Rather, an airline needs to find a growing market, an
economically vibrant city, perhaps one that is not an existing
hub, and it is located in our case in Raleigh-Durham.
Challenging a major carrier directly by initiating service into
their hubs on the first day of business is not a recipe for
success.
Two, the carrier must be well financed. He must have
patient investors. We have had both. We appreciate it.
Three, the product being sold, airline seats, must
absolutely be priced for profitability, not market share. Many
of the new entrant carriers over the years have priced for
market share and not profitability.
Four, you must place an emphasis on safety, dependability,
low fares, and hopefully, if you are lucky, financial
stability. We need a loyal workforce and, in fact, ultimately
we need some support from the Government. We need access to
airports, we need access to slots and gates. We need a fair
hearing before Federal regulatory agencies.
And, in fairness, it would be good if we had an air traffic
control system that we could fly around with. In our little
case, in the month of April, 58 percent of the delays we
experienced were attributable to the air traffic control
system.
Of the six elements that I have mentioned, we have tried to
apply all of them at Midway, and we have applied one additional
one. We have applied regional jets, 50-seat aircraft, allowing
us to size the capacity of our equipment for the size of the
markets in which we participate.
Raleigh-Durham was not the most auspicious place for a hub.
I will point out that American Airlines had a little experience
in Raleigh-Durham. In our opinion, part of the reason they were
not successful was that the average aircraft size was too large
for the market. Raleigh-Durham is, after all, the 50th largest
market in the United States. I don't believe there is another
hub that is in a city that is less than the 30th largest.
Midway's story, like so many other start-ups, began trying
to carve a niche in Chicago. We were unsuccessful. We were
unable to compete with the dominant carriers, even though we
carried the name of the city. Unlike Chicago, Raleigh-Durham
presented us with a great opportunity, and opportunity, in
fact, carved for us by American Airlines. They built the gates,
they built the infrastructure, they built the maintenance
facilities.
We seek to serve our customers. We have created a unique
product. We serve our customers with only technologically
advanced equipment. It is environmentally-friendly, it meets
all existing noise standards. We have some 32 aircraft with an
average age of 2.3 years. Of those aircraft, 22 are regional
jets. We have 17 new 737's on order, 2 of which have been
delivered.
In fact, over the course of the last 3 years, we have the
highest on-time performance in the industry, although I speak
in that respect only in regard to the 10 carriers who publish
their statistics because I can't know about the others. Our
baggage statistics routinely beat the major carriers, although,
as I mentioned, we are once again too small.
We have more leg room than our typical competitors,
although I have to say Mr. Carty is about to one-up us in that
respect. We have leather seats. We think we have friendly and
professional service and, of course, we focus on safety.
Finally, we do offer fares that are lower than those of our
major competitors. We are, however, not a low-fare carrier. We
are a lower-fare carrier and much higher quality. After an
initial period of unprofitability, we have been profitable now
for 13 consecutive quarters, and we take some pride in that and
the fact that we have built a business plan that actually
works.
The most important factor for us, however, is we are in the
midst of a growing city. Raleigh-Durham grew 24 percent last
year. It is growing at 35 percent presently. There is robust
competition in Raleigh-Durham. We have Southwest Airlines and
we had MetroJet. We have American Airlines and, in fact, we
have every other major air carrier.
We have been successful and we intend to continue being
successful. We have done that partly by avoiding picking fights
with the major air carriers. We avoid picking major fights with
them because it is simply a fact of life in the airline
industry and any industry in which there is very little margin
that if you try and skim another guy's passengers, he is going
to react strongly and aggressively.
We are beginning to feel that we are part of a hub. We are
finally achieving that status. We have grown from 47 flights 4
years ago to 236 flights a day. We would react aggressively and
affirmatively. At some point in the future, we are going to
have to fly into somebody else's hub, however. We tried it
once. We flew into another carrier's hub in a market that
hadn't been served in atleast the prior 10 years, and
immediately we were matched with overlaying services.
The Government can play a role; they can be a help. Little
guys do have a difficult time. Next time we go into a hub, we
will go with a much more aggressive posture. We will serve it
as completely as we can and we will be prepared to take the
losses necessary to sustain those services.
The other item I would like to mention here briefly is--and
I know my time is up and I apologize for that. Air 21, when you
pass that bill, is going to be extremely helpful to small
carriers like ourselves. In the case of LaGuardia, one of the
major carriers withdrew two slots from us, coincidentally at
about the time we started service into one of their hubs.
In any event, we are going to operate into and out of
LaGuardia now under the security of having slots available to
us, and we thank you for that. We are also thanking you for the
help you are going to give us in DCA. At least we are going to
get a chance to compete for some slots on the same basis as the
other carriers achieved them.
I believe, in the end, the Government can play a role. The
role, however, is not the one that I heard mention of a moment
ago. I do not believe the Justice Department is the right place
for this to reside. I got a $12 million education earlier in
the 1990's. I do not believe that the competition we see in the
airline business is against the law. I do think, however, it is
fair to say it is probably predatory.
And I was very disappointed that one of your prior
witnesses took away my final line. I don't know whether, ``I
know it when I see it'' is basically the bottom line on
predation. There are clear examples in our business of people
going out of their way to ensure that other guys don't succeed.
I do not in any respect believe those are against the law. I
simply do not believe the laws in this country have been set up
to address our business, and that is a public policy question.
It is one for you to answer.
If we are going to have a standard of predation, it is not
one that applies to the bread makers or the steel mills or the
oil businesses of the 1920's and 1930's. We are in a very
different world and we need to have a lot of debate before we
decide.
I will make one suggestion. The Department of
Transportation, with one phone call, or perhaps a bit more,
managed to get my two slots back from the very same guy who
took them away, and in that respect I am very thankful and very
appreciative of the efforts made on our behalf.
Senator DeWine. Mr. Ferguson, thank you very much.
[The prepared statement of Mr. Ferguson follows:]
Prepared Statement of Robert Ferguson
Mr. Chairman, Senator Kohl and Committee Members, I would like to
thank you for the opportunity to testify today. I am the President of
Midway Airlines based in Raleigh Durham, North Carolina. I have spent
over 20 years in the aviation industry and have enjoyed the
considerable challenges it has presented. During this time, I have seen
many cycles of boom and bust.
In 1993, as President of Continental Airlines, I testified before a
Commission appointed by President Clinton and charged with examining
the Aviation industry. I was stuck by one stark fact. Following airline
deregulation 119 airlines had been started and 117 had failed. Since
1993, there have been additional bankruptcies and failures. The chances
of success in this business are small, but still some airlines do
succeed and many others will continue to try. I would like to tell you
what I think are the critical ingredients to success, describe how
Midway has applied those lessons, and finally address briefly the
question of the intense competition that exists in this industry and
what others might call predation.
It is my belief that in order to start--and perhaps more important,
to survive--in this industry, an airline must:
One, build a business plan that is not premised upon cream skimming
the routes of the major carriers. Rather, the airline needs to find a
growing, economically vibrant city that is not an existing hub and is
located in an area of unserved and underserved cities. Challenging a
major carrier directly by initiating service into one of their hubs on
the first day of business is a recipe for failure.
Two, the carrier must be well financed by patient investors who
understand that they are likely to sustain significant losses before
reaching profitability.
Three, the product being sold--airline seats--must be priced for
profitability not market share.
Four, the carrier must place an emphasis upon the basics: safety,
dependability, low fares, and financial stability.
Five, build a loyal workforce that enjoys the airline business,
conveying confidence and placing the customer first.
Six, obtain government support for equal access to airports, slots,
gates and a fair hearing before federal regulatory agencies.
These six elements constitute a yard stick that has been
successfully applied at Midway,but can also be used by other new
entrant airlines. They are borne out in part by recent market research
conducted by Harris Interactive Inc. and reported in the Wall Street
Journal last Thursday April 27th. Mr. Chairman with your permission, I
would like to submit the article for the permanent record and a copy
has been provided to you as the last page of my statement.
Midway's story, like so many other new start ups, began with an
effort to carve out a niche in a major market, Chicago. In part due to
restraints on access to gates and to intensified competition from other
airlines at Chicago's Midway airport, the airline moved its hub and
headquarters to Raleigh Durham in early 1995.
Unlike Chicago, Raleigh Durham presented Midway with an ideal
platform to relaunch itself. American Airlines had decided to withdraw
from Raleigh-Durham, leaving no dominant competitor in place. Indeed,
American left an excellent infrastructure of gates, baggage handling
facilities and maintenance equipment essential to our making a solid
beginning. Raleigh Durham, as many of you know, is one of the fastest
growing communities on the East Coast. Our target was to focus on the
business customer traveling to and from this high growth area.
To serve our customers, Midway created a product that is unique for
new entrant carriers. We use only new, technologically advanced and
environmentally friendly aircraft that exceed all existing noise
standards. We are an all jet airline with 32 aircraft having an average
age of 2.3 years. Midway has on order 17 new Boeing 737-700's, two of
which have already been delivered. We have the best on time performance
of any airline in the U.S. over the past three years. Baggage handling,
which is frequently a source of endless complaints, is also among the
best in the U.S. Midway is too small, however, to be reported with the
large incumbent airlines and is, thus not in Department of
Transportation's (DOT) rankings. Further, we offer leather seating with
extended leg room to all of our passengers on our larger aircraft and
professional and friendly service coupled with an attention to safety.
Finally, we offer fares that are generally lower than our competitors.
We are not, however, a low fare airline; rather, we are a high quality,
lower fare carrier.
After an initial start up period of unprofitability following our
move to Raleigh, we have been profitable for the last 13 quarters. This
is a significant accomplishment as many other new airlines remain
unprofitable. The single most important factor in this success has been
the fact that we are based in a growing city where we have been able to
build our hub without the need to challenge from the first day of
business any large incumbent carrier. Rather, we have taken the
infrastructure left by American Airlines and built a hub that has grown
from 42 daily flights to 7 states in 1995 to 236 daily flights to 25
destinations in 14 states. We now have a solid base of loyal customers
who know our airline and appreciate our attention to detail.
There is robust competition in Raleigh Durham, however, from both
Southwest Airlines and USAIR. Other major carriers, including American
Airlines, are also providing service to Raleigh Durham. Indeed, we were
able to survive Southwest's entry into Raleigh Durham market, an event
that has precipitated the exit of many other large and small carriers
in other markets, because we have been able to quietly build a strong
hub that serves a somewhat different passenger than Southwest.
We have consciously avoided picking fights with the major airlines
by flying directly into their hubs. This strategy has avoided the
bruising battles that your Committee has heard about repeatedly from
new airlines, which some call predation. I would call it the ``facts of
life'' in the airline industry. It is a simple fact that no airline,
whether it is American, United, or anyone else, can be expected to
allow a new carrier to begin operating out of their hub without
mounting a robust and vigorous response. Midway would do the same.
Margins in this business are very small and a few passengers each day
siphoned off by another carrier mean the difference between
profitability and a loss.
At some point in the future, Midway will have to fly into some of
the major carriers' hubs. In one instance, we tried it and had to
withdraw in the face of an intense competitive response. We learned
valuable lessons from this experience. What I am seeking is to build
Midway into a strong, profitable competitor. When we make our next
foray into a major carrier's hub, I will do it on the basis that I have
the financial resources and passenger base necessary to stay.
The Government does have an important role to play in this next
competitive phase. First, to succeed, Midway and other new entrants
need access to slots, gates and other airport infrastructure on the
same terms as the incumbents. In the case of landing slots (an issue
Mr. Chairman that you know about in depth from your experience with the
Cleveland/London route), the recently passed Wendell Ford Aviation Act,
known as ``Air 21'', will give Midway 9 slots at LaGuardia airport,
which we currently lease from a major carrier for $1.88 million per
year. We are also now able to apply for ``in perimeter'' slots at
National Airport. The avoidance of these lease costs will be one of the
most important things I can do to increase our profitability. In the
future, as airports are expanded with the new airport construction
funds made available by Air 21, the government needs to ensure that
some gates are reserve for small carriers.
The Government also can play an important role in tempering the
most outrageous behavior by competitors. Every airline needs help from
DoT. It is critical that DoT use its oversight role to keep the
competition within bounds. I do not believe that it requires antitrust
action by the Justice Department. Indeed, from my own experience at
Continental, it is very hard, if not impossible, to prove an antitrust
case. What I expect is for the Department of Transportation to simply
call the incumbent carrier and make it clear that their behavior is
unacceptable. In the case of Midway, I know that DoT's own actions had
such a positive result with one of our competitors. This does not mean
re-regulation of the industry, rather I view it as the carrot and stick
approach. If you want our help, then stop engaging in unfair
competition against the other smaller guy. What is the standard to be
applied? I think it is imprudent to try and put it on paper. This only
creates controversy, like when DoT issued its competition guidelines.
To paraphrase the Supreme Court, addressing another issue, we know
unfair competition when we see it.
Mr. Chairman, I want to thank you for this opportunity and I would
be happy to answer your questions.
[GRAPHIC] [TIFF OMITTED] T3032A.006
Senator DeWine. Mr. Carty.
STATEMENT OF DONALD J. CARTY
Mr. Carty. Mr. Chairman, Senator Kohl, before I begin, I
have to confess that some of the folks on my legal staff were
very nervous about my agreement to testify today. So I resolved
it by asking them for a list of the pros and cons of
testifying. They came up with 100 for and 87 against. Now, I am
confused; 100 to 87 was the score of last night's Bucks' win
over the Pacers. Did I mention that I was rooting for the
Bucks? [Laughter.]
Actually, I confess I told my staff if the Bucks win, I am
testifying for sure. If they lose, I suddenly have a bad throat
coming on.
Despite years of study by economists and volumes of
published reports, competition in the airline industry is still
widely misunderstood by the general public, and obviously by
the popular media. In the next couple of minutes, I am going to
address two of the most enduring myths in airline competition:
first, that hub and spoke systems are anticompetitive, and,
second, that airfares are too high because of a lack of
competition. In addition, I would like to talk briefly about
the subject of predation in the airline industry.
Now, the hub and spoke system really is, as Dr. Kahn
pointed out, very efficient. It allows a carrier to offer far
more frequent service to a lot more places than could be
achieved with the very same assets flying only point to point
by simply combining the traffic from various points onto each
hub route.
That exhibit that I have got up there explains the concept.
The top diagram shows the linear or point-to-point service with
five aircraft flying between five points in the West and five
in the East. Now, with point-to-point service, as you can see,
the carrier can only serve five routes.
In the bottom diagram, you have got an airline that is open
to hub between the eastern and the western cities. Now, using
virtually the same five airplanes, the carrier can link each
western city with every eastern city and, of course, vice
versa. In addition to that, he creates service between the hub
itself and each of the other 10 cities. As a result now, the
carrier offers service in essentially 35 markets, which is a
seven-fold increase in the destinations using virtually the
same number of aircraft.
So I guess the question is, does the tremendous deficiency
of hubs lead to dominant airlines that are harmful to
consumers. Well, obviously, for consumers living in a spoke
city, the answer is clearly no. Because of competition between
the networks of different carriers, a spoke passenger, or at
least most spoke passengers, enjoy frequent, one-stop service
through a hub to nearly anywhere in the world. And in most
spoke cities, passengers get to choose from several different
airlines, each serving that particular spoke to a different hub
and then on to many of the same destinations.
Now, that brings you to the question of passengers living
in the hub cities. The hub and spoke system provides non-stop
service to scores of destinations; in fact, far more service
than the local population of the hub city could support without
the feed traffic from all those other cities. So for all the
talk of the alleged evils of hubs, what has happened is nearly
every city in America wants to be one.
Now, despite the rhetoric, most hubs, and certainly
American hubs, are very competitive. There is a constant
competitive pressure, and that pressure can come from four
different sources. The first is direct competition from another
airline. Passengers that at least live in our two major
domestic hubs, Dallas/Ft. Worth and Chicago, have not one, but
two established hub carriers battling for their business.
At O'Hare, United Airlines is significantly larger than
American, and Delta Airlines operates a large hub at Dallas/Ft.
Worth. So this creates substantial direct competition on many
routes. And beyond the routes where there actually is
competition, when there is a second hub carrier, you have the
threat of potential entry on the routes where that carrier
doesn't yet operate.
Second, in addition to the direct competition that you can
have from major carriers, established low-fare carriers like
Southwest offer tremendous competitive pressure using
alternative airports; in the case of Dallas/Ft. Worth, Love
Field, and in the case of Chicago, Midway. And those airports
and that particular carrier in this instance competes for the
same hub-originating passengers that DFW and O'Hare do.
Third, the longest established low-fare carriers are not
alone. New entrants continue to begin new service on Dallas/Ft.
Worth routes, and some have operated successfully there for a
number of years now.
And, last, because most hubs are also spokes from every
other hub, large or small, the most heavily traveled routes
across the United States really have become the battle ground
on which the competitive skills of one hub carrier are pitted
against another.
Now, these sources of competition combine to challenge at
least our carrier's every move, and this intense competitive
pressure has had the desired effect. At the same time, American
tries to remain price-competitive in our hubs and across our
system. But we also spend a lot of other money on competition.
We will invest over $2 billion in ground facilities in the next
several years. We have on firm order about $6.7 billion worth
of new aircraft, and in 1999 spent more than $800 million on
on-board catering, more per passenger than any other major
carrier in the United States. And we have begun a $400 million
program to refurbish the interiors of our existing fleet,
including the program that Bob Ferguson mentioned to create
more room throughout all our coach cabins.
Now, these aren't the steps that you would expect of a
dominant hub monopolist. These are investments that we need to
make in product and service because we are engaged in very
vigorous competition.
Now, let me turn to the topic of air fares, perhaps the
most complicated and misunderstood aspect of airline
competition. The various public reports of trends in air fares
seem always to conflict with one another. The industry reports
declining prices and yields, and has year after year after
year. In the meantime, the media reports trumpet periodic fare
increases and high business fares.
Well, who is right? Well, it turns out, as Dr. Kahn said,
both are. When adjusted for inflation, average fares have
fallen almost 39 percent since deregulation. And while it is
true that full, unrestricted fares have gone up over the last
10 years, even those fares have increased onlyslightly more
than the rate of inflation.
Now, what is happening is the fare structures, the
difference between the lowest fare and the highest, are being
stretched. The highest fares are a little higher, but the
lowest fares are much lower. And in the end, a large majority
of our customers are paying less and traveling more, just what
you would expect in a healthy, competitive industry.
I will turn now to a few comments about predation in the
airline industry, and I have to point out that this subject is
somewhat sensitive because, as Senator DeWine observed, we are
currently engaged in litigation with the Government, and I
might add a host of private claimants as a result of that
Government claim, over allegations of predatory conduct at our
DFW hub. Accordingly, my comments are going to be limited to a
very few general observations.
Most importantly, American Airlines is an outstanding
airline, and quite frankly I cannot imagine why anyone would
ever want to fly on any other airline if you can get there on
American. Nevertheless, there are some people who still seem to
want to fly on a variety of other airlines, and competition is
very brisk.
In that context, I would like to address some assertions of
predation at DFW which I find particularly difficult to fathom
because DFW may represent the single most competitive hub in
America. It has two major carriers, American and Delta, both
operating hubs there, and we battle it out everyday. The
Nation's most profitable airline, Southwest, is in its backyard
at Love Field, along with Continental, and I might add start-up
carrier Legend Airlines. And DFW has no slots, no limits on
gates, no other facility constraints that would be a barrier to
new entry.
Not surprisingly, Dallas/Ft. Worth has attracted start-up
carriers over the years. Some who entered this competitive
environment tried to serve DFW with various combinations of
point-to-point, single low-fare strategies, infrequent service,
few on-board amenities, no frequent flyer programs, and/or
small networks that were unable to sustain profitable service.
Other start-ups, as in the case of carriers like Bob Ferguson
referred to, have found better business strategies and have
successfully operated DFW routes for years. And Dallas/Ft.
Worth continues to attract new entry even today.
I think it would turn the antitrust laws completely on
their head to interpret them to limit the kind of price and
service competition that we have got in a market like DFW.
Virtually all airlines match low prices that are launched by
their competitors. We didn't undercut competitive prices at
DFW, nor did we ever pursue a strategy to operate a route at
prices below our variable costs, which, as several people have
testified, is the well accepted measure of predatory pricing
under the law of the United States.
In some cases, we did add seats to a route if we thought
additional capacity was needed because of the increased demand
that was stimulated by lower fares. That just makes good
business sense. We are a formidable competitor. We strive to
provide our customers the service they want at a reasonable
price, and we invest tremendous resources to improve our
ability to serve our customers today and win more customers
tomorrow. That, in our view, is what competition really is all
about.
Senator DeWine. Mr. Carty, thank you very much.
[The prepared statement of Mr. Carty follows:]
Prepared Statement of Donald J. Carty
I would like to thank Chairman DeWine, Ranking Member Kohl and the
other members of the Committee for inviting me here today. Despite
years of study by economists and volumes of published reports,
competition in the airline industry is still widely misunderstood by
the general public and the popular media. This level of
misunderstanding is one of the primary reasons I greatly appreciate the
opportunity to speak with you today.
In the next few minutes, I will address two of the most enduring
myths in airline competition: First, that hub and spoke systems are
anticompetitive, and second that airfares are too high because of a
lack of competition. In addition, I will talk briefly about the subject
of predation in the airline industry.
One of the most dramatic results of deregulation has been the
formation of hub and spoke route networks. Started in the United
States, the hub and spoke system is now the most common model for
successful aviation operations world-wide--and with good reason. A hub
and spoke system is very efficient. It enables a carrier to serve many
routes with frequent flights by combining traffic from various points
onto each hub route.
The exhibit I have brought today explains the concept. The top
diagram shows linear or point-to-point service with five aircraft
flying between five points in the west and five in the east. With
point-to-point service, the carrier can serve only five routes. In the
bottom diagram, the airline has opened a hub between the eastern and
western cities. Now, using the same five aircraft, the carrier can link
each western city with every eastern city and vice versa, plus create
service between the hub itself and each city. As a result, the carrier
can now offer a total of 35 routes--25 between the easternand western
cities and 10 more between each city and the hub. This result--35
routes as opposed to 5--is a seven-fold increase in destinations using
the same number of airplanes.
In addition to their efficiency, hubs also permit service to much
smaller communities than linear service could ever support. Suppose in
our example that Western City Number 1 had only 10 passengers for each
departing flight bound for Eastern City Number 1. That would never be
enough to support daily nonstop service. But when combined with other
passengers originating in Western City Number 1, bound for each of the
other eastern cities, plus the hub, the route becomes commercially
viable.
This ability to concentrate traffic at a hub that is bound for
different destinations allows a hub and spoke carrier to serve each
spoke city with greater frequency than could be achieved without the
combination of passengers from the other spoke points.
Thus, a hub and spoke system affords tremendous efficiency. It
allows more frequent service to more places than could be achieved with
the same assets flying only point-to-point. But does it lead to
dominant airlines that are harmful to consumers?
To consumers living in a spoke city, the answer is clearly no.
Because of competition between the networks of different carriers,
spoke passengers enjoy frequent, one-stop service through a hub to
nearly anywhere in the world. In most spoke cities, passengers can
choose from several different airlines each serving the spoke to a
different, competing hub and then on to many of the same destinations.
For example, a passenger in Columbus, Ohio flying to Los Angeles can
travel with a single connection on Southwest through Nashville, on
America West through Phoenix, on Northwest through Memphis, on TWA
through St. Louis, on United through Chicago or Denver, or on American
through Chicago or Dallas/Ft. Worth. The Official Airline Guide shows
dozens of daily flights via several hubs for this route.
For passengers living in hub cities, the hub and spoke system
provides frequent service, numerous nonstop destinations and vigorous
competition. For all the talk about the alleged evils of hubs, nearly
every city in America would love to be one. Hub-originating passengers
enjoy non-stop service to scores of destinations--far more service in
terms of both frequency and destinations than the local population
could support without the ``feed'' traffic from other cities.
Despite the rhetoric, most hubs, and certainly American's hubs, are
very competitive. There is constant competitive pressure from four
sources. The first is direct competition from another major airline.
Passengers living in American's two largest hubs, Dallas/Ft. Worth and
Chicago, have not one, but two established hub carriers battling for
their business. At O'Hare, United Air Lines is significantly larger in
scope and scale than American--a fact we are working very hard to
change. Delta Air Lines operates a hub at Dallas/Ft. Worth--a hub where
Delta enplanes more passengers than Northwest at its Memphis hub,
Continental at its Cleveland hub or Southwest at its hub in Phoenix.
And Delta has promised to expand its presence at DFW in its recently
announced growth plan. This creates substantial direct competition on
many routes and the threat of potential entry on the rest.
In addition to direct competition from other major carriers, well-
established low fare carriers like Southwest offer tremendous
competitive pressure using alternative airports like Love Field and
Midway to compete for hub originating passengers at DFW and O'Hare.
The long-established low fare carriers are not alone. New entrants
continue to begin new service on Dallas/Ft. Worth routes, and some have
operated successfully for several years.
Last, because most hubs are served as spokes from every other hub,
large or small, the most heavily traveled routes across the U.S. are
the battlegrounds on which the competitive skills of one hub carrier
are pitted against another.
These sources of competition combine to challenge American
Airlines' every move and this intense competitive pressure has had the
desired effect. At the same time American tries to remain price
competitive in our hubs and across our system, we will also invest over
$2 billion in ground facilities improvements in the next several
years--including more than $500 million in the near term at DFW alone.
We have on firm order about $6.7 billion worth of new aircraft, in 1999
spent more than $800 million for onboard catering--more per passenger
than any other major carrier, and have begun a $400 million program to
refurbish the interiors of our existing fleet, including our program to
remove two rows of seats from every aircraft to create more room
throughout our coach cabins. These are not the steps one would expect
of a dominant hub monopolist. These are investments in product and
service made by a company engaged in vigorous competition.
Let me now turn to the topic of airfares--perhaps the most
complicated and misunderstood aspect of airline competition. For years,
the fact that on any given route, most carriers charge the same fares
has been misunderstood as evidence ofcollusion. Nothing could be more
wrong. The reason fares are often the same is that passengers have
taught us that they shop for air transportation based on price. That
fact, coupled with computer systems that allow the whole world to see
every available fare, means that we can and must match most fares to
ensure that we do not lose passengers. The fares are the same for the
same reason you often see identical gasoline prices between gas
stations on the same corner. Our passengers will rarely pay more for
American than for United, Delta, Continental or any other airline. So
if we want to keep our customers flying on us, we have to meet the
market price.
What about the reports of ever increasing airfares? The various
public reports of trends in airfares seem always to conflict with one
another. The industry reports declining prices and yields, while media
reports trumpet periodic fare increases and high business fares. Who is
right? Well, it turns out both are. When adjusted for inflation,
average fares have fallen almost 39 percent since deregulation
according to Air Transport Association statistics. However, while it is
true that full, unrestricted fares have gone up in recent years, over
the last ten years even those fares have increased only slightly faster
than inflation. What is happening is that the fare structures--the
difference between the lowest fare available on a route, and the
highest--are being stretched. The highest fares are a little higher,
but the lowest fares are much lower. Most importantly, the number of
people enjoying deeply discounted fares has soared while the number of
those buying the full fares has decreased to less than 7 percent of all
tickets sold. In the end, a large majority of our customers are paying
less and traveling more--just what you would expect in a healthy,
competitive industry.
As the fare structure gets stretched, the art and science of
revenue management becomes more important. Offering the right number of
seats at various price points in this range of fares is one of the most
complex challenges to successful commercial operations. The key is to
achieve an optimum ``mix'' of high fare passengers and low fare,
typically leisure passengers. Often in this industry, start up airline
managers are tempted to try to sell every seat at one low fare for
simplicity. Because of the low variable costs in the airline industry,
they cover short-term costs and appear to be making money. However, the
revenue generated from those fares must not only cover short run
variable costs, but must eventually, over the long term, cover the much
higher long-run fixed costs of operations as well--a business reality
that is often miscalculated by start up carriers.
A single fixed price would not be good news for travelers or
airlines. If airlines sold all of their seats at a single price and
that price was high enough to cover variable and long term fixed costs,
that average price would be higher than many deep discount fares
available today. So instead, airlines use a wide variety of prices,
associated with various fare restrictions to achieve a balance that
offers enough flexible fares at a higher price for business travelers,
combined with many deeply discounted seats available for leisure
travelers. And all of our fares are constantly re-evaluated based on
competition and market pressures.
The discussion of single-price efforts by start up carriers leads
naturally into a discussion of predation in the airline industry. I
must point out that this subject is very sensitive because we are
currently engaged in litigation with the government and a host of
private claimants over allegations of predatory conduct at our DFW hub.
Accordingly, my comments are going to be limited to a few general
observations.
First and most importantly, American Airlines is an outstanding
airline that offers its customers one of the best route networks in the
world, the best frequent flyer program, terrific customer service
agents at our gates, ticket counters and reservation offices,
proficient, well-trained pilots, mechanics and flight attendants and
now even the most comfortable, spacious interiors in our aircraft. In
short, I cannot imagine why anyone would ever want to fly on any other
airline if we can get you there.
Nevertheless, there are some people who still seem to want to fly
on a variety of other airlines, which leads me to my second point about
predation. Assertions of predation at DFW are particularly difficult to
fathom, because DFW may represent the single most competitive hub in
America. It has two major carriers operating hubs there and battling it
out every day. It has the nation's most profitable airline, Southwest,
in its backyard at Love Field, along with continental and start up
carrier Legend Airlines. DFW has no slots, gates or other facility
constraints that would be a barrier to new entry. Not surprisingly,
Dallas/Fort Worth has attracted start up carriers over the years. Some
who entered this competitive environment tried to serve Dallas/Fort
Worth with various combinations of point-to-point, single low-fare
strategies, infrequent service, few on-board amenities, no frequent
flyer programs and/or small networks and were unable to sustain
profitable service. Other start ups have found better business
strategies and have successfully operated DFW routes for years. Dallas/
Fort Worth continues to attract new entry even today.
It would turn the antitrust laws completely on their head to
interpret them to limit the kind of price and service competition I
have just described at DFW, rather than to promote it. Virtually all
airlines match low prices launched by their competitors. American did
not undercut the competitive prices at DFW, nor did we ever pursue a
strategy to operate a route at prices below our variable costs--the
well-accepted measure of predatory pricing. In some cases we added
seats to a route if we thought additional capacity was needed because
of increased demand stimulated by lower fares. If, at the same price,
more people want to fly on American Airlines than onanother airline,
its because every single day our employees get up in the morning and go
to work to make exactly that happen. We are a formidable competitor
because we strive to provide our customers the services they want at a
reasonable price. We work hard and invest tremendous resources to
improve our ability to serve our customers today and to win over more
customers tomorrow. That, in our view, is what competition is all
about.
I would like to conclude with an observation on an emerging
competitive issue--global competition. Aviation is a network business.
The U.S. Government, through its approval and endorsement of immunized
alliances has created an environment in which U.S. carriers have formed
partnerships with other airlines throughout the world.
In a world of alliances, it is particularly important for the
government to foster an atmosphere of healthy competition. That means
no one alliance should be favored or disfavored by government policy.
Just as the networks of the hub and spoke carriers in the U.S. overlap
and compete with one another for domestic passengers, it is important
that the international networks of the global alliances overlap and
thus spur robust competition. Accordingly, we were very pleased when
Dr. Kahn agreed to support American's application in the China route
case. As Dr. Kahn pointed out to the Department of Transportation, it
is essential that a decision in that case take into consideration the
need to balance competitive opportunities among alliances. The
Department has an opportunity to achieve this balance by awarding the
available route rights to a U.S. passenger carrier in a global alliance
that will compete with the incumbent airline alliances that have held
historic rights to serve China for many years. We are hopeful that the
Department will act favorably on this opportunity.
[GRAPHIC] [TIFF OMITTED] T3032A.007
American Airlines,
Dallas/Fort Worth Airport, TX, June 15, 2000.
Hon. Michael DeWine,
Chairman, Senate Antitrust Subcommittee, U.S. Senate, Washington, DC.
Dear Chairman DeWine: On May 2, 2000, I testified at the
Subcommittee's hearing on competition in the airline industry. As part
of that testimony, I responded to your question concerning T2, the
website being developed jointly by several of the major airlines,
including American. I have since learned that my answer is being
misconstrued by competitors of T2 in an attempt to mislead
policymakers. T2's competitors would like policymakers to believe that
there is some kind of improper agreement among the equity owners of T2.
I am writing to you to ensure that my answer is properly understood. I
would very much appreciate it if this letter could become a part of the
official record of the hearing so that I may stop the improper use of
my earlier testimony.
At the hearing, you asked a question about exclusivity provisions
in the T2 agreement. There has been an extraordinary amount of false
and misleading information spread about T2 on this point, so it is
important for me to be very succinct. There are no agreements, tacit or
express, among the T2 equity holders or participants, to make any fares
available exclusively on T2. In fact, the written agreements state
precisely the opposite. Pursuant to the express terms of the equity and
charter associate agreements, any carrier may make available any fare
offered on T2 to any, or every, travel agency whether online or
traditional bricks and mortar.
What I said at the hearing was that there is an expectation that
some fares may appear on T2 and not on other sites. The point is that
carriers are likely to independently choose to make some deeply
discounted fares available on T2 and their own airline site, but not on
the other online travel agency sites. This is not because of any
illicit, exclusive agreement among the airlines, but because of simple
economics. Every airline has a strong incentive to sell its service
through the least costly distribution channel. For some very deeply
discounted fares, a low-cost distribution mechanism may be an essential
means of preserving a thin margin above variable costs.
The market-leading structure of T2 is expected to operate at lower
distribution costs for every airline that uses it to sell air
transportation services--lower than any other online travel agency site
such as Travelocity or Expedia. Accordingly, every airline will have an
economic incentive to make the deepest discounted tickets available
through T2 because it is the least expensive distribution channel,
other than a carrier's own website. The attractive economics of T2 are
even slightly better for the equity holders who have the added desire
to see their investment in T2 succeed.
T2 is an innovative response to the very serious problem of
distribution costs for the airline industry. For some time, the four
computerized reservation systems have operated largely free of price
competition for the services they provide to the airline industry.
Accordingly, the fee paid by every airline to a CRS for each booking
made by travel agencies or over the Internet has increased at a rate of
about 7 percent every year since 1994, despite declining computing and
telecommunications costs. T2's innovative pricing has made the first
small dent of competition in this area of airline costs. We are hopeful
that T2 will afford the technological foundation for much greater costs
savings in the future. Quite frankly, it is time for the CRS owners and
the largest online travel agencies to respond to the T2 challenge with
new innovation and price competition, not misinformation and aggressive
lobbying.
I would be happy to provide you or your staff with additional
information on this subject, if you wish. Thank you for the opportunity
to respond to the misuse of my earlier testimony.
Sincerely,
D.J. Carty,
Chairman, President, and CEO.
Senator DeWine. Mr. La Macchia.
STATEMENT OF BILL La MACCHIA, JR.
Mr. La Macchia. Thank you, Chairman DeWine, Senator Kohl.
Senator DeWine. As you can tell by the bell, we have a vote
that has just started, but we will proceed with your statement.
Mr. La Macchia. OK, thank you. I couldn't tell because I
didn't know what that was, but I am new to this. I am just a
small-town kid from Wisconsin, so bear with me.
Senator DeWine. We have heard that before. [Laughter.]
Mr. La Macchia. Thank you, Mr. Chairman, Senator Kohl, for
your attention to the issue of airline competition and the
antitrust concerns associated with market dominance from mega
airlines.
We are a different story. We started as a charter airline
in 1983. We continue to this day to operate on behalf of tour
operators, not only that we own, but others that have utilized
our service through the years. Let me emphasize we are not in
favor of re-regulation. We are in favor of being given the
opportunity to compete in a fair and open marketplace, and
provide choices for the traveling public.
The major airlines will argue that Government should not
play a role in promoting competition. Clearly, the major
airlines have a double standard. They want Government
assistance when it benefits them internationally, but cry foul
when new entrants and low-cost carriers ask for the same
consideration to promote domestic competition.
Today, I will argue that promoting domestic competition is
necessary. Predation does occur. Northwest Airlines, the fourth
largest airline, but arguably the most predatory and
anticompetitive of the majors, is employing a variety of
tactics that are questionable under the Sherman Antitrust Act
and threaten to drive us out of the market. We are based in
Minneapolis. We had options when we bought this airline to do
other things, but we felt we were committed to the community,
and we knew what we were getting into and we believe our
business plan is just.
According to third quarter 1999 DOT figures, as you will
see in this chart, Northwest Airlines and its affiliates
comprised 68.5 percent of the market share in the Twin Cities,
their partners being Continental, America West, and Mesaba.
That doesn't even take into account its charter subsidiary,
Champion Airlines, which is not required to report to the
Department of Transportation.
Competition is good, but it is the intent of the carrier's
aggressive action which must be called into question. We
believe it is Northwest's intent to drive us from the market
and achieve an even greater level of monopolization.
History shows that Northwest's strategy of predation has
worked before and, left unchecked, will probably work again. We
are all aware of what happened in 1993 when Reno Air entered
the Minneapolis market to provide 3 daily non-stop trips
between Reno and Minneapolis, with connecting service to West
Coast cities. Northwest then increased its service, actually
announced service, as they were not flying that market, and it
added service from Reno to Los Angeles, Seattle and San Diego.
Northwest, utilizing its tactics of perks such as frequent
flyer miles, had targeted the residents of Reno, and at the end
of the day had really called for Reno to make a business, which
was to withdraw from the market. Today, a 7-day advance fare
from Minneapolis to Reno is $1,026.
By driving Reno Air out of the Minneapolis market and
raising its fares, it is believed Northwest was able to recoup
the investment it made in below-cost pricing. Again, this
disproves conventional wisdom and contestability theories on
predation.
Now, flash forward 5 years to September 1998. The Northwest
pilots go on strike and the Minneapolis-St. Paul market is held
hostage without sufficient choices for air transportation. We
had made a decision based on our market strategies and the
manner of the business that we were anticipating losing by not
flying for one of Northwest's subsidiaries, MLT Vacations, and
we saw an opportunity in the marketplace that that market was
indeed deserving of an alternative.
Studies by the Department of Transportation and the
Minnesota Planning Commission showed that Minnesotans were
paying higher than average fares compared to other cities of
comparable distances, costing them an additional $500 million
per year.
This graph was created by Dr. Paul Stephen Dempsey, a
renowned expert on airline competition from the University of
Denver. As you can see the pink line--this goes back to the
first quarter of 1990, over 10 years, and the pink line with
the box represents Minneapolis-St. Paul. And you will see in
some cases where there are dramatic decreases on the other
markets where low-fare competition had come into play.
As with Reno, Northwest responded vigorously to Sun
Country's announcement when we began scheduled service on June
1, 1999. There is a chart which shows exactly the fare
decreases which complements that of Senator Kohl about the
Minneapolis-Milwaukee market, and we knew this going into it.
We knew that the prices would be matched. Our business strategy
and our marketing strategy was such that we felt we were going
to be able to create our niche in the marketplace. In addition
to the fare matches, there were also those of capacity
increases.
In the chart on the bottom which shows the history in
markets where we are currently flying, you will see by the
jagged red line at the top what happened when, in 1996, we had
entered the Minneapolis-St. Paul market on a scheduled charter
basis. Northwest completely matched fares and increased
capacity. We pulled that down and the rates went back up. Then
you will see how they operate with the thick dotted line as to
the non-Sun Country markets, non-low-cost competition.
What constitutes fair competition? Well, what a difference
a few years makes. In 1992, Northwest said the pricing behavior
we just described was unfair and even illegal, which points out
another glaring double standard by Northwest. After sustaining
enormous losses from an extended price war with American,
Northwest filed a predatory pricing lawsuit against American.
Northwest said that American was offering discounts for a
greater number of passengers and incurring substantial revenue
losses itself.
Northwest also alleged that American engaged in illegal
anticompetitive and monopolistic activities which were intended
to further eliminate competition. In fact, Northwest Chairman
Gary Wilson referred to American's then CEO, Bob Crandall. ``It
is not fair, it is time that the bully in the schoolyard got
punched.'' Well, aftertheir unsuccessful lawsuit, a new and
even more forceful bully came into the schoolyard, that being Northwest
Airlines.
In addition to its own fleet of 428 aircraft, Northwest is
utilizing its tour operator, MLT Vacations, which is 100-
percent owned by Northwest, and its charter affiliate airline,
Champion Airlines, which is owned 40 percent by Northwest. The
other individual that owns the airline is Carl Poulad, who is a
major stockholder in Mesaba Airlines. MLT's reservation center
has also recently introduced their air outlet center to
introduce drastically discounted fares on Sun Country routes,
not only to come after us, but another travel company in the
Twin Cities.
This combination of Northwest, MLT, and Champion is so
unique in the industry it does not even show up on the radar
screens of Federal regulators. Together, MLT and Champion have
been able to aggressively compete with Sun Country without
Department of Transportation, Department of Justice, or
congressional scrutiny. This relationship is an anomaly in the
industry, but a significant competitive advantage and one that
this committee should be very focused on for possible antitrust
implications.
No other major airline in the United States has Northwest's
ability to dominate a market for both scheduled and charter
flights. Northwest has used MLT to add low-fare capacity on our
common routes. They have also utilized MLT and its charter
airline, Champion, to add frequency on common routes.
The Minnesota Attorney General asked the DOT to investigate
their behavior and wrote, ``It is not difficult to conclude
that the use of this three-front attack by Northwest creates a
climate of expanded seating, reduced prices, and scheduling
conflicts designed to push an emerging competitor out of the
marketplace.''
Northwest has recently announced service on routes that
they had not flown, which is two flights a day to New York's
JFK and also two flights a day to San Antonio. These are the
only new domestic routes announced by Northwest this year in
their Minneapolis or Detroit hubs.
In cities where Sun Country has two flights a day,
Milwaukee and Detroit, Northwest has added two to three times
the number of discount seats. Clearly, it was not their
benevolence which provided----
Senator DeWine. Mr. La Macchia, I have to interrupt you. We
are now down to 5 minutes in the vote. We only have about 5
minutes to get there, so we will have to----
Mr. La Macchia. Very well. I will end at this moment.
Senator DeWine. We will be back in approximately 15
minutes. Thank you very much.
[The subcommittee stood in recess from 3:25 p.m. to 3:44
p.m.]
Senator DeWine. Mr. La Macchia, you wanted to finish?
Mr. La Macchia. I will just finish.
Senator DeWine. Yes, sir, proceed.
Mr. La Macchia. In a hearing before this committee on April
1, entitled ``Airline Hubs: Fair Competition or Predatory
Pricing,'' then Northwest Senior Vice President of Corporate
Affairs, Richard Hirst, had testified, ``We sublease gates at
Detroit and Minneapolis to numerous of our competitors,
including Southwest Airlines, America West, and new entrants
such as Vanguard and Frontier. In addition, we provide ground
handling services at Detroit, such as Spirit and Reno Air, as
well as maintenance services to our other competitors. Frankly,
it is in Northwest's best economic interests to do so.''
If sharing facilities and other services is in Northwest's
best economic interests and they utilize this as a statement as
to how anticompetitive behavior in the fortress hubs does not
exist, then why shortly after his testimony did Northwest
cancel our agreements for a ground handling office and ticket
counter space in Boston, preferring to leave the space vacant
rather than leasing to us? And 1 month later, we received
notice of the same in Los Angeles.
In June 1999, 6 days after we began scheduled service,
Northwest canceled our part sharing and purchase agreement. And
if it is in their best economic interests to provide
maintenance service to competitors, why is it that we are not
allowed to purchase unwanted and excess parts from their
surplus parts listing which is used by all other airlines,
which is industry standard in the best interests of this
industry to provide support for other airlines, if needed?
In order for competition to work, it must be fair. The
charts that I have here show that major airlines operate
differently when they are competing against another major
airline, versus Southwest Airlines, and a new entrant. The
strategy of a large, high-cost, mega carrier is clear. They
will sacrifice short-term profitability with opportunity costs
in order to reestablish monopoly power. In the end, the
consumer is going to lose and pay higher fares.
Again, as part of their suit against American, John
Dasburg, CEO of Northwest Airlines, said, ``In the long run,
predatory pricing will reduce the number of airlines,
ultimately cutting the number of flights and choices available,
particularly in smaller markets. This will leave the few
surviving airlines free to price just as high as they want to
for just as long as they want.'' We thank him for making our
point so well.
Over the last decade, major airlines have created a
reputation of predation that, left unchecked, will end the
emergence of low-fare carriers in large hub markets, and send a
message to the community that if Southwest Airlines isn't
there, you don't have competition in a low-fare category.
In conclusion, our mission today was to inform you of our
situation, as it is unique. What you choose to do with this
information is entirely up to you. We have chosen to compete
for the customer and will do so and continue to do so in a fair
and honorable manner.
Thank you.
[The prepared statement of Mr. La Macchia follows:]
Prepared Statement of Bill La Macchia, Jr.
Thank you, Chairman DeWine, ranking member Senator Kohl,
distinguished members of this subcommittee, for your attention to the
issue of airline competition and the anti-trust concerns associated
with the market dominance of mega airlines.
Let me begin by thanking Alfred Kahn, the father of deregulation,
for his testimony today. Now is the time to take his efforts to the
next level. To truly promote competition, more must be done to level
the playing field.
Let me emphasize: we are not in favor of re-regulation. We are in
favor of being given the opportunity to compete in a fair and open
marketplace and provide choices for the traveling public. We are
against predatory behavior designed to protect monopolies and cartels.
The major airlines will argue that the government should not play a
role in promoting competition and that, left alone, competition will
flourish. Why is it then that the majors continue to come before
Congress and the Department of Transportation (DOT) and beg for
government intervention for open skies agreements and access to
international airports? And further, why do they request antitrust
exemptions for their alliances?
Clearly, the major airlines want to promote a double standard. They
want government assistance when it benefits them internationally but
cry foul when new entrants and low cost carriers ask for the same
considerations to promote domestic competition.
For this hearing, let me also debunk conventional wisdom and
contestability theory that predation is ``implausible'' and therefore,
does not occur. The argument that companies rarely engage in predatory
conduct because of the prohibitive upfront costs and the notion that
the attempt by the predator to ``recoup'' the financial losses will not
be successful is proven incorrect in several instances in this
testimony.
Further, the argument that the predators would not engage in this
behavior because a stream of new entrants would come after the previous
one driven from the market is also incorrect, as airlines establish a
dominance in their hubs and a reputation for predation that deters new
entrants from coming in and competing.
For our testimony today, we will argue that promoting domestic
competition is necessary, predation does occur, and how Northwest
Airlines (the fourth largest airline, but arguable the most predatory
and anticompetitive of the majors) is employing a variety of tactics
that are questionable under the Sherman Antitrust Act and threaten to
drive us out of the market.
NORTHWEST'S STRATEGY FOR MARKET CONTROL AND DOMINATION
According to 3rd quarter 1999 DOT figures, Northwest alone control
62 percent of the market share in Minneapolis/St. Paul (MSP) compared
to Sun Country 8 percent. With it's alliance partners, Continental,
Mesaba America West, Northwest's combined market dominance exceeds 70
percent. That doesn't even take into account its charter subsidiary,
Champion, which is not required to report to the DOT.
With this level of domination, why is it that Northwest continues
to aggressively attack Sun Country via fare actions, capacity increases
and control of facilities?
Again, competition is good--but it is the ``intent'' of the
carrier's aggressive action which must be called into question. We
believe it is Northwest's intent to drive us from the market and
achieve an even greater level of monopolization.
History shows that Northwest's strategy of predation has worked
before, and left unchecked, will probably work again.
RENO AIR VS. NORTHWEST AIRLINES
Northwest's predatory conduct against Sun Country replicates
predatory conduct by Northwest that drove a low cost competitor, Reno
Air, from the MSP market in 1993.
In April 1991, Northwest canceled service between MSP and Reno,
Nevada, because that route was not sufficiently profitable.
In February 1993, seeing a niche that was not being served, Reno
Air announced that it would begin three daily non-stop trips between
Reno and MSP.
NWA's new Reno service
Northwest retaliated and announced it would also begin three daily
MSP/Reno non-stop flights. In addition, Northwest said it would begin
daily roundtrips from Reno to Reno Air's destination cities of Los
Angeles, Seattle and San Diego.
NWA adds flights, perks for Reno
To further squeeze the Reno market, Northwest then announced on May
1, 1993, it would begin a second daily flight from Reno to both Los
Angeles and Seattle. In addition, Northwest announced special ``World
Perks'' (i.e. frequent flyer) bonus miles for Reno residents in an
effort to control that market.
NWA slashes fare, adds capacity
to further secure their dominance, Northwest matched Reno Air's low
fares on the Reno/MSP route and also matched or undercut their fares on
their other common routes. In addition, Northwest offered more seats
than Reno Air and provided additional seats at these low prices.
This predatory combination of reducing price and adding capacity
forced Reno Air to abandon the market.
Predation returns NWA to profits
In June 1993, after Reno Air's withdrawal from the market,
Northwest's lowest fare increased from $86.36 to $135.46 to $149.09.
Its lowest refundable fare increased from $136.36 to $454.55. Today, a
seven-day advance fare from MSP to Reno is $1,026.
Reno Air did sue Northwest for its predatory practices in 1997.
That lawsuit was dropped when Reno Air was bought by American Airlines.
By driving Reno Air out of MSP and then raising its fares,
Northwest was able to recoup the investment it made in below-cost
pricing. Northwest's predation and intent to dominate the Reno routes
worked, disproving again conventional wisdom and contestability
theories on predation.
ENTER SUN COUNTRY
Flash forward now five years to September 1998, the Northwest
pilots go on strike and the MSP market is held hostage without
sufficient choices for air transportation.
Studies completed by the U.S. Department of Transportation and
State of Minnesota Planning Commission, showed that Minnesotans were
paying higher than average fares compared to other cities for
comparable distances--costing them an additional $500 million per year
due to a lack of competition.
This graph and the other airfare comparison charts I will be
showing you today were created by Dr. Paul Stephen Dempsey, a renowned
expert on airline competition and the Director of the Transportation
Law program at the University of Denver. As you can clearly see,
Minneapolis/St. Paul has historically the highest airfares compared to
other hub cities.
Sun Country saw an opportunity to provide an affordable choice for
air travel and announced it would begin scheduled service on June 1,
1999.
NWA'S PREDATION: SAME SONG, SECOND VERSE
As with Reno, Northwest responded vigorously to Sun Country's
announcement and promptly slashed fares. Compare the following, seven-
day advance purchase fares on flights from MSP in the summer of 1998,
before Sun Country began scheduled service to summer of 1999, when Sun
Country inaugurated scheduled service.
------------------------------------------------------------------------
1998 1999
------------------------------------------------------------------------
Northwest fares to:
Boston.................................... $814 $298
New York.................................. 750 $298
Washington, DC............................ 675 $298
Seattle................................... 628 318
Detroit................................... 634 218
Milwaukee................................. 427 128
------------------------------------------------------------------------
In addition to fare matches, Northwest has added capacity on routes
flown by Sun Country, including both additional flights and larger
aircraft. For example:
------------------------------------------------------------------------
August 1998
(per week) August 1999 (per week)
------------------------------------------------------------------------
Northwest flights to:
Anchorage................ 3 planes/570 5 planes/950 seats.
seats.
Phoenix.................. 5 planes/750 6 planes/940 seats.
seats.
------------------------------------------------------------------------
The public has benefited since Sun Country entered the market.
Consumers are expected to save an average of $120 million in the first
year of our scheduled service.
NWA'S DOUBLE STANDARD
Now, you may ask, what is fair competition? What a difference a few
years makes. In their 1992 lawsuit against American, Northwest
contended that this type of pricing behavior was unfair and even
illegal, which points out another glaring double standard by Northwest.
In 1992, after sustaining enormous losses from an extended price
war with American Airlines, Northwest filed a predatory pricing lawsuit
contending that American had dropped fares to drive them out of
business.
Northwest said that American was ``offering discounts for a far
greater number of passengers and incurring substantial revenue losses
to itself.'' Northwest also alleged that American engaged in ``illegal,
anticompetitive and monopolistic activities'' which were ``intended to
further its goal of eliminating competition.''
Northwest Chairman Gary Wilson also implied that American Airlines
was trying to ground Northwest with below-cost pricing. Referring to
American's CEO Bob Crandall, Wilson said, ``It's not fair . . . It's
time the bully in the schoolyard got punched.''
After their unsuccessful lawsuit, a new and even more forceful
bully came into the schoolyard . . . Northwest Airlines.
ENFORCEMENT OF THE SHERMAN ANTITRUST ACT
While Northwest may have been unsuccessful in suing American, in
current there does exist remedy for this anticompetitive behavior.
The Sherman Act outlaws all contracts, combinations, and
conspiracies that unreasonably restrain interstate trade. This includes
agreements among competitors to fix prices, rig bids and allocate
customers. The Sherman Act also makes it a crime to monopolize any part
of interstate commerce.
Under the Sherman Act, an unlawful monopoly exists when only one
firm provides a product or service, and it has become the only supplier
not because its product or service is superior to others, but by
suppressing competition with anticompetitive conduct.
Joel Klein, Assistant Attorney General for the U.S. Department of
Justice's (DOJ) antitrust division appeared before the Senate Judiciary
Committee on March 22, 2000.
Klein said that, under the Sherman Act, DOJ had identified
predatory pricing and monopolization practices by American Airlines.
On March 22, 2000, Klein testified:
[First let me say a few words about our pending case against
American Airlines under section 2 of the Sherman Act for
monopolizing airline passenger service on routes emanating from
its hub at Dallas/Ft. Worth International Airport. As the
complaint we filed sets forth in detail, American repeatedly
sought to drive small, start-up airlines out of DFW by
saturating their routes with additional flights and cut-rate
fares. After it succeeded in driving out the new entrant,
American would re-establish high fares and reduce service.
Passenger traffic surged when the low-cost airline began
operations and more people could afford to fly, and then fell
back dramatically after American had driven out the upstart and
resumed monopoly pricing. American knew this strategy was a
money-loser in the short term, but expected to make that up by
preserving its ability to set fares at monopoly levels.
American, like anyone else in our capitalist economy, is free
to compete, and compete aggressively. But it crossed a
fundamental line into predation. This is the first predation
case brought against an airline by the Antitrust Division since
the industry was deregulated in 1979. I think it will be
tremendously important for our traveling public throughout the
country, who deserve the lower fares and expanded choices
available in a competitive airline marketplace.]
As with the recent government break-up of AT&T and the proposed
break-up of Microsoft, the federal government has the authority and
responsibility to break up other monopolies. The major airlines, each
monopoly in their fortress hubs but collectively a giant cartel, may be
the next target for such action.
Examine how Northwest uses a wholly-owned tour operator, charter
airline affiliate and discount ``Air Outlet Center'' to create a mini-
monopoly and control the Minneapolis/St. Paul market.
NWA MARKET DOMINANCE AND MONOPOLIZATION
MLT Vacations (100 percent NWA owned); Champion Airlines (40
percent NWA owned); and Air Outlet Center (a division of MLT's
Reservation Center).
In addition to its own fleet of 428 aircraft, Northwest is also
using its tour operator MLT Vacations (100 percent owned by Northwest)
and its charter-affiliate airline, Champion Airlines (40 percent owned
by Northwest) to go after Sun Country. MLT's reservation center has
also recently introduced their ``Air Outlet Center'' to drastically
discount fares on Sun Country routes.
Let me first explain: the combination of Northwest, MLT and
Champion is so unique in the industry that it does not even show up on
the radar screen of federal regulators. Together, MLT and Champion have
been able to aggressively compete with Sun Country, without DOT, DOJ or
Congressional scrutiny.
This relationship is an anomaly in the industry but a significant
competitive advantage and one that this committee should be most
interested in for possible Sherman antitrust implications.
No other major airline in the United States has Northwest's ability
to dominate a market for both scheduled and charter flights.
Northwest has used MLT to add low-fare capacity on Sun Country
common routes. Compare their service before and after we began
scheduled service.
------------------------------------------------------------------------
August 1998 August 1999
------------------------------------------------------------------------
Northwest/MLT to:
Las Vegas................ 680 seats....... 920 seats.
Los Angeles.............. 1,650 seats..... 2,170 seats.
Orlando.................. 560 seats....... 1,030 seats.
------------------------------------------------------------------------
Northwest has used MLT and it's charter airline Champion to add
frequency on common routes with Sun Country. Compare before and after
we announced scheduled service.
------------------------------------------------------------------------
Summer 1998 Summer 1999
------------------------------------------------------------------------
Northwest's MLT/Champion to:
MSP/Las Vegas............ 2x/week since Daily.
1985.
MSP/Orlando.............. 2x/week since Daily.
1985.
------------------------------------------------------------------------
What is surprising is that many of these increases are on routes
that Northwest was already experiencing its lowest operating profits.
MLT's own employees have questioned why Northwest is asking them to do
this.
History has shown, as with Reno Air, that Northwest is willing to
suffer slim margins and even losses in the short-term to drive a
competitor from the market and recoup profits later by restoring the
routes to higher fares.
Left unchecked, this predatory behavior will again drive
competition from the MSP market. You'll recall from an earlier chart
that the cost of air travel in MSP is among the highest for consumers.
Why? Because of the dominance and control of Northwest Airlines.
The Minnesota Attorney General has asked the DOT to investigate
Northwest's behavior and wrote, ``It is not difficult to conclude that
the use of a three-front attack by Northwest (through Champion, MLT and
its own carriers) creates a climate of expanded seating, reduced
prices, and scheduling conflicts designed to push an emerging
competitor out of this marketplace.''
new nwa routes vs. sun country
Northwest has recently employed a new, more aggressive strategy of
going after Sun Country on routes they were not serving and Sun Country
had a niche. In March, Northwest announced new twice daily nonstop
service to New York-JFK and new nonstop service to San Antonio.
We have to question why--after all the years of careful market
analysis--would Northwest suddenly decide to begin new service to those
routes. Again, it is important to question their ``intent.''
Did Northwest see a market opportunity because Sun Country had
expanded the market on these routes? Or, do they want to establish
control of the route, drive Sun Country away, and then raise fares when
competition no longer exists? As you'll recall, a similar thing
happened when Northwest went after Reno Air's other destination cities.
ADDED CAPACITY WHERE SUN COUNTRY HAS MORE FREQUENCY
Northwest has also acted very aggressively in key markets where Sun
Country has frequency.
In the markets where Sun Country has two flights per day, Milwaukee
and Detroit, Northwest has added 2.5 to 3 times the number of discount
seats that Sun Country has. Northwest has also added 2.5 to 3 times the
number of discount seats that Sun Country has to Boston, where it
previously had no other competition.
This aggressive, predatory behavior is of grave concern to us.
As every airline knows, the best assurance of profitability is to
add frequency to your routes and attract more frequent or business
travelers. If Northwest acts in this kind of predatory manner for every
route that Sun Country has more than one flight per day, Sun Country
may not be able to build a profitable hub.
sherman act: suppressing competition by anticompetitive conduct
Beyond pricing, the Sherman Act also says that an unlawful monopoly
exists when one supplier is able to suppress competition with
anticompetitive conduct. While the mega carriers will say they do not
engage in anticompetitive behavior in their fortress hubs, this is
another example of saying one thing and doing another.
In a hearing before this committee on April 1, 1998, entitled
``Airline Hubs: Fair Competition or Predatory Pricing?'' Northwest's
Senior Vice President of Corporate Affairs, Richard B. Hirst,
testified:
[On a related point, unfounded claims have been made that
major network carriers engage in anticompetitive practices to
preserve their dominant position at hub airports. These charges
are wholly without merit. Detroit, for instance, is a facility
constrained airport and all airlines are similarly constrained
in their growth, most significantly Northwest. Nonetheless, we
sublease gates at Detroit and Minneapolis to numerous of our
competitors, including Southwest Airlines and America West and
new entrants such as Vanguard and Frontier. (Northwest Deck,
page 62) In addition, we provide ground handling services to
competitors at Detroit such as Spirit Airlines and Reno Air, as
well as maintenance services to other competitors. (Northwest
Deck, page 62) Frankly, it is in Northwest's best economic
interest to do so.]
If sharing gates, facilities and other services is in Northwest's
best economic interest, why then, shortly after Mr. Hirst's testimony,
did Northwest do the following?
In October 1998, Northwest canceled our agreements for
groundhandling, office and ticket counter space in Boston, preferring
to leave the space vacant rather than lease to Sun Country. One month
later, they did the same in Los Angeles.
In June 1999, six days after we began scheduled service, Northwest
canceled our part sharing agreement and posted a large sign in Detroit
saying ``no parts to Sun Country.''
If it is Northwest's best economic interest to provide maintenance
services to competitors, why is it that Northwest even refuses to sell
Sun Country its unwanted and excess parts from their surplus parts
listing service, which is used by all other airlines?
With regard to gates, Sun Country has repeatedly asked Northwest to
sublease us gates at the Main passenger terminal. Repeatedly, they
ignored or refused our request.
VARYING DEGREES OF COMPETITION
Let us reiterate: competition is a good thing. But in order for
competition to work, it must be fair. Our concern, and the concern of
other new entrants and low-cost carriers is the severity of competing
methods employed by mega carriers against low cost carriers.
Compare the fare histories of the following charts and see the
differing degrees of how a major competes with a major; major competes
with Southwest; and a major competes with a new entrant.
FAIR AND EQUAL ACCESS TO COMPETITION
The strategy of the large high-cost mega carriers is clear. They
will sacrifice short-term profitability in order to re-establish
monopoly power in the market place. In the end, the consumer . . . your
constituents . . . lose and pay higher fares.
Again, as part of their suit against American, John Dasburg, CEO of
Northwest Airlines said, ``In the long run, predatory pricing will
reduce the number of airlines, ultimately cutting the number of flights
and choices available, particularly in smaller markets. This will leave
the few surviving airlines free to price just as high as they want for
just as long as they want.''
We thank him for making our point so well.
While the mega carriers can shift their vast resources to cover
routes where they are being extra-competitive and operating at or below
costs, the new entrant cannot. We need prompt action by the DOT and DOJ
to take action against the predatory behaviors I've outlined today.
Beyond that, if new entrants and low-cost carriers are to survive
we need:
Fair and Equal Access to Airport Facilities. The major carrier in
the market, who dominates that hub, should not be allowed to dictate
policy and bully the airport commissions and local governing bodies
into submission--thereby, squelching competition. New entrants, who are
able to bring value to the community should have access to gates and
facilities.
Fair and Equal Access to the Most Profitable Routes. Particularly,
we need open access to slot-controlled airports, where the major
airlines have a lock on the airports and refuse to allow new
competition in. This is an areas where Congress has provided some
relief through the FAA Reauthorization bill, but more must be done to
open up these markets.
We are not asking for special treatment, we are only asking you for
the same things that the major airlines ask you for in opening up
international skies and airports: for fair and open access. When you
are considering their requests, we only ask that you hold them to the
same standard to promote domestic competition.
Thank you.
Senator DeWine. Mr. La Macchia, thank you very much. Mr.
Ferguson has stated that he expects a competitor to react if
somebody invades his hub, and therefore will not enter a hub
unless he has the financial resources to handle that reaction.
That was at least a summary of what he had to say. Is that the
right way to approach a competitor's hub, in your opinion?
Mr. La Macchia. Well, we were already there. We have been
based in Minneapolis since our beginning, and it is just as
much, we feel, our hub and our operation as it is anyone
else's.
Senator DeWine. How about a general question, though? My
question was general.
Mr. La Macchia. We look at the opportunity and our balance
of our marketing approach is that there was an opportunity to
utilize our aircraft. And there were individuals who did not
have the ability to fly, and we recognized that and we feel we
are providing that benefit to customers and we are providing
individuals a choice and we are ensuring that there is
competition. Ultimately, at the end of the day it is up to the
customer to make that choice, but we have a very good product.
Senator DeWine. Mr. Carty, in your testimony you note that
despite the complaints about hub service, cities seem to want
to host airline hubs in their airports. However, based on some
press reports at least, a few mid-size cities such as Kansas
City, Jacksonville, and Indianapolis appear to think they are
better off maybe without hubs because of the broad range of
competition they have been able to attract to their airports.
Is this type of reaction common, and what do you think is
its significance?
Mr. Carty. Well, I think it is less than common. I have
been approached by at least two of those three cities in the
last 10 years urging exactly the opposite. So I guess my
instinct is to question the sincerity of it. The fact of the
matter is cities that are hubs get a lot more non-stop flights
to more destinations than any other city of comparable size.
Senator DeWine. There is, as you have already pointed out
in your testimony, quite a tradeoff, though. I mean, there is a
tradeoff. That is the good news.
Mr. Carty. Well, if you are a spoke, you get all the
advantages of being a spoke.
Senator DeWine. I understand.
Mr. Carty. But as I said in my testimony, every hub is also
a spoke, so every hub is the winner of deregulation. They get
to be a spoke to every other hub, so they have got that same
competition for one-stop service everywhere in the world. In
addition to that, they have the premium product of non-stop
service to almost everywhere in the world with high frequency.
So they are the true winners.
There are very few people and very few cities that I am
aware of that wouldn't prefer their cities to be hubs. The
reason the hub cities have done so well in terms of economic
development is they are a magnet for business and business
growth.
Senator DeWine. Mr. Carty, I do not question what you are
saying, but I can take you to some cities and show you a lot of
consumers who would vehemently disagree with what you are
saying. And I am not going to get into specifics today, but we
could cite some hubs and we could give you some examples on
pricing, and I think you know what I mean. So I don't think it
is quite as clear-cut as you have outlined.
I understand what you are saying, and I think most cities
by and large historically have said, sure, they would like to
be a hub. I also think that once you get beyond some of the
business leadership in the community, you will find other
consumers who will say, my Lord, why am I paying so much to fly
there? And when they look into it, they find out why they are
paying that much to fly there because there isn't any
competition.
Mr. Carty. Well, you know, again I would say to you that
the evidence is not at all clear to me. I know the average
consumer in Dallas/Ft. Worth has the availability of these same
highly discounted seats that Dr. Kahn referred to on more
flights to more places than any other community in the world.
He also has a full-fare ticket that is, as Dr. Kahn
represented, more fully priced. The very limited number of
people that are paying full-fare ticket--and I think Dr. Kahn
cited a number of 7 percent--are paying very much what they
paid prior to deregulation. But the average fare in all markets
across the United States is down literally almost 40 percent.
Now, would consumers like more service and even lower
fares? Of course, they would. That is true in almost every
product in the United States today. But the transparency of
pricing in our business for the last 20 years has been like no
other business in the world. The rest of the businesses in the
world are starting to see it with Internet, but we have
essentially had the transparency of fare information in our
business for 20 years that most other businesses are beginning
to see.
Senator DeWine. Mr. Carty, I don't question what you are
saying. My only point is a very simple point, and I think you
are candidly maybe overreacting to what I am saying. I want to
make sure you understand what I am saying. All I am saying is
that there are pros and cons to being a hub. That is all. There
is good and bad, and as you pointed out, most people think that
the good outweighs the bad. But we can take you to some
communities where the pricing structure is pretty rough if you
live in a hub city.
American has recently announced that it will be a part of a
joint venture with Continental, Northwest, United, and Delta to
create an Internet reservation site called T2. This joint
venture purportedly will include a large number of other
carriers, and has raised some concerns among competing
reservation services.
There are contradictory reports about how exactly this is
going to work, so I would like maybe if you could take a moment
to briefly explain what T2 will do. Specifically, will it be an
exclusive system that does not allow the participants to post
their fare information on other reservation services?
Mr. Carty. T2 is a business concept that involves, as you
say, providing an Internet access capability to as much of the
industry's fare and schedule information as we can possibly
attract to the site. It was originally started by the other
carriers. We were recently invited to become an equity holder
in that company and accepted that invitation. We had not been
invited before because we were a very large holder in a
competing reservation system, Travelocity, that is owned by
Sabre.
I think what you are seeing with the advent of theInternet
is airlines and other travel providers trying to put their product in
every conceivable Internet shelf that is developed, whether it is
Microsoft's Expedia, whether it is Travelocity, whether it is their own
airline sites, or whether it is this combined site or the hundreds of
others, the priceline.coms, and so on.
It is envisaged by this particular site that some offerings
will be made on this site that won't be made on other sites, at
least by the equity owners of the airlines. That is not
necessarily true of other airlines. It is sort of up to them,
just as it is also true today that we offer and other airlines
offer on their own sites some offerings that aren't offered on
the broader travel agency sites.
I think the reason for this development, Senator, is the
concern by the airlines and other travel providers that a very
small number of so-called electronic travel agents, Travelocity
and Microsoft's Expedia in particular, were in danger of
completely dominating this space, to the detriment of the
travel providers themselves. So I think this is one of the
strategies that the airlines have used in response to that.
Senator DeWine. Mr. Ferguson, in your testimony you seem
willing to rely upon the Department of Transportation to put
pressure on incumbent carriers to basically just behave
themselves. Some would argue that the Department does that now
without much success. Let me just ask you if you agree with
that, and if so, what else should the Department of
Transportation be doing?
Mr. Ferguson. The reason I find that the proper venue is
because I had a little education, to the tune of $12 million
and David Boyce's representation--and he has been representing
the Government recently--on sort of what the antitrust laws are
in the United States. And I don't believe the competition
offered by Mr. Carty, or frankly the other major airlines,
generally fits in the category of predatory. I do think there
are instances in which behavior appears predatory, and
certainly looks that way.
I do think from time to time the Department has stepped in.
I think there are some clear examples of that. I think they
have done that on our behalf. I think the efforts in rules that
were passed some years ago were an attempt. In all honesty, I
am not sure that we have a position as a public policy matter
about where we want to get to that lets the Department, whether
it be Justice or Transportation, take a real position.
I mean, it is not that fares in the industry are too high.
They are not. If they were too high, we would all make money,
and we don't; we make a little bit. I think the question that
needs to be answered is the disparity, the widening that Mr.
Carty has described. Is that unfair? And if it is, then we need
a policy that espouses some way to make that close.
But I don't think the rules that were authored in the
1930's, I guess it was, are going to address that problem in
our business. I just don't think that is the place to look, and
so I think you have to look to the Department. I think they
have tried to do a good job. I don't think they have always
been perfect, but they have tried.
Senator DeWine. Senator Kohl.
Senator Kohl. Mr. La Macchia, in that route, Minneapolis to
Milwaukee, what are the two or three most egregious things that
they have done to hurt you?
Mr. La Macchia. Well, one issue is because of the fact that
we are in the same area for gates. We have asked the airport to
step up and get involved because they were literally blocking
the area for our aircraft to come in. We had shared the bag
room and there were contentious relationships with their
baggage handlers and the group that we had utilized.
Clearly, they have opened the inventory and the bucket of
lower priced seats in that route that were never there before.
It used to cost $600, as it says there, in order to continue to
provide them with, well, you can get the same price by flying
on us.
And, lastly, I would say in that route our job is to take
care of the customers, and it is interesting to note that in
situations where the other airline may have canceled a flight
or were delayed or what have you, most airlines have agreements
for passenger protection. There have been days when they
would--in fact, they have never walked their customers down to
us and have said, here is an option. That is their choice, and
the customer's. But yet it goes to another standpoint when they
tell a customer, no, there are no other flights, Sun Country's
flight has already left, when, in fact, it hasn't. So it is
really up to the customer's issue.
Senator Kohl. These are the most egregious things they have
done?
Mr. La Macchia. Well, it is like the bully in a schoolyard.
I can go on and on. There are issues where when we have to move
a part on an aircraft, it mistakenly or seemingly gets lost.
Senator Kohl. Let me just stop there. What would you have
the Government do about these things?
Mr. La Macchia. Well, it is not just that route, but there
are issues in other routes; for example, the squeezing of
travel agents to apply pressure in order to ensure that they
are not losing market share and forcing the agents to operate
at a certain increased level of market share, which is a
distribution arm.
From our perspective, we have solutions. We are not coming
here saying we need you to protect us. We are saying we have
these facts of how difficult it is to compete in some of these
markets. Some of the solutions that we have put into place--I
agree with Alfred Kahn's issue of ensuring that the other
airline stays in the market with the prices and the inventory
levels for a few number of years.
I also believe that we should put the onus on the other
airlines to explain and prove that their actions did not remove
the new entrant from a marketplace. Everybody looks at us
saying prove it. Well, you know, no one has put the onus on the
other airlines and said, all right, be accountable for these
actions.
We talk about limiting the impact and the squeezing of the
travel agents. It is also the issue of other assets and
resources that are available, and I think it is important that
we review the relationships and partnerships of the airlines,
not only with the technology arm, but also now performing a
relationship with purchasing and buying of parts and sharing of
that. We will be applying to have entry into T2. We will see if
we are denied.
We also believe that a solution is to hold airports
accountable and make them show how they have spent money, and
does it benefit the community or does it benefit a certain
airport. And, lastly, maybe we need to come up witha better
term than ``predatory.'' I think that is a term that everybody is so
hung up on. We have talked about, well, you know it when you see it,
but from our perspective it is about the people.
My father and I entered into the Minneapolis market because
we had a belief in a strategy. Can we move our assets
elsewhere? Yes, we can, but we believe----
Senator Kohl. How long have you been in that market?
Mr. La Macchia. Milwaukee-Minneapolis we initiated a year
ago.
Senator Kohl. How many flights do you have a week?
Mr. La Macchia. Well, we have two flights a day. Last fall,
we initiated connecting service from Milwaukee to Minneapolis
which would then connect to Seattle, San Francisco, and Los
Angeles.
Senator Kohl. You have been doing it for how long, a year?
Mr. La Macchia. A year, and we are continuing to see our
loads----
Senator Kohl. But you are continuing those flights from
Milwaukee to Minneapolis?
Mr. La Macchia. Pardon me?
Senator Kohl. Those flights continue to operate twice a
day?
Mr. La Macchia. Yes, they do, and we recognize that that
route, Minneapolis to Milwaukee, would not be successful down
the road if we do not ensure that there is connecting traffic
to broaden that base of business. We do the same out of
Detroit.
My father and I continue to invest in the organization. We
are not profitable. We have a strategy in place that we think
we can be profitable. The scheduled service of our business is
not the only part of our business. We still operate on behalf
of the tour operators which allows that balance.
Senator Kohl. Mr. Carty, you have been listening to a
little guy talk about his business and some of the problems he
has competing with some of the big guys. What would you say to
Mr. La Macchia?
Mr. Carty. Well, Senator, listening to both Mr. La Macchia
and Mr. Ferguson, and the previous testimony, I guess the
question is where are the impediments to competition and how
can we remove them, on the one hand. I think the gate issue is
a very interesting issue.
I am not experienced in most of my route network in a
shortage of gates, but I have seen reports in markets that are
not as much interesting to me where there are gate shortages.
The one market where I am experiencing gate shortages is Los
Angeles. You can't get gates in Los Angeles. I think the
financing of gates which the expanded PFC's will allow us to do
should begin to alleviate that issue.
I might add that the FAA already has power to force a local
airport to take underutilized gates and allocate them to
carriers that want them, as opposed to those that aren't using
them properly. That power exists and that should happen. And,
in fact, if that process is taking too long--and it may take
too long; there are very few examples of it being tested--then
it needs to be accelerated.
I am a great believer in getting rid of those impediments.
I think we ought to get rid of those impediments. I think we
have made some real progress on the slots. We are obviously not
finished. We have still got slots left in the country, but we
have made some progress. I think the air traffic control issues
that Dr. Kahn referred to are critical. In fact, the removal of
slots is going to aggravate them and the air traffic control
problem in the short term. We need to fix that.
But in terms of the antitrust laws themselves, I think we
really do need to be very careful with them. I don't disagree
with the conclusion that laws that were written in the 1930's
for steel companies may or may not be appropriate to today's
marketplace, but I don't think that is a unique phenomenon to
the airline business.
When there is a price war on the corner of a street where
there are two gas stations, does the guy that matched, if the
other guy goes out of business, have to keep his gas price at
$.90 for 2 years afterwards? The answer is no. When MCI
undercuts AT&T in the long-distance market and AT&T matches
them, when AT&T finds that their lines are ringing busy because
they don't have enough capacity and adds capacity, isn't that
really very much a parallel to what we are talking about here
in the airline business?
So I think there is a valid question of whether it is time
we revisit as a country our antitrust laws. I think we ought to
be very careful of treating the airlines uniquely. This is a
business like every other business; in fact, as Bob Ferguson
pointed out, substantially less profitable than most other
business. Our price earning multiple in the airline business is
in sort of the single-digit range for most of us.
And this wonderful public beneficiary that we refer to as
Southwest Airlines is the only guy that has got a 20 multiple
and, in fact, is returning more to his shareholders than any of
us. So, you know, he is also a beneficiary of his shareholders.
I just think we need to be very careful as we massage these
antitrust laws that we don't invent solutions for airlines that
are sort of quick-fix answers without thinking through the
implications for our total economy.
Senator Kohl. OK.
Mr. Carty. But I would support revisitation of those
antitrust laws.
Senator Kohl. Mr. Ferguson, do you have something to say to
Mr. La Macchia?
Mr. Ferguson. I guess the only thing I would have to say to
him is I wish him extremely good luck, and if he is going to
make the service survive, he is going to have to do it premised
on connecting passengers. I don't believe you can win a point-
to-point war with a major air carrier in a straight-out fight.
I don't know how wealthy Mr. La Macchia and his family are,
but the carrier they are fighting is probably worth $5 billion,
$10 billion, I don't know. If they apply that capital, he
cannot win. So, you know, he is going to have to do it by
carrying people connecting through that network, but that is a
business recommendation. I am not sure I see sort of how else
you win that fight.
Senator Kohl. And neither one of you, Mr. Carty or Mr.
Ferguson, have any quarrel with one strategy that Northwest
employs, which is to price that flight between those two cities
really low? I mean, you don't have a quarrel with that in terms
of a business practice that is accepted in combatting
competitors in this country?
Mr. Carty. Again, I think that is the kind of
businesspractice you would expect to see in any business. When you have
got a product that is closer to a commodity than we would like it to
be, if you don't match price, particularly with the transparency of
pricing that I referred to a moment ago where everybody knows what
everybody charges, you are just not going to have any business.
So if you have got a lot of loyal passengers in a market--
and I know nothing about the Minneapolis-St. Paul to Milwaukee
market, to be perfectly honest with you--you are either going
to lose those passengers to price or you are going to match the
price. It is as simple as that. And if you match the price and
the price is significantly lower than the price that has been
in the market, you are going to genuinely generate new demand.
And if you want to accommodate that demand, if you want to
accommodate your loyal passenger, you have got to have enough
capacity so that when he phones up and says, I want to go to
Milwaukee, you have got a seat for him. So on that pure piece
of it, I think that is not unique to the airline business. You
know, the analogy with the communications companies is obvious.
The analogy to almost every business--whether you are a gas
station, a car manufacturer, a grocery store, or a
communications company, I think that strategy would be common.
Now, the courts have defined a standard of predation, one
that at least Dr. Kahn is uncomfortable with, and that is if
you price below your variable cost, maybe we are in the
situation where the person is clearly engaged in predation. But
when you start redefining average variable cost to include
things like opportunity cost, what you are saying to a company
is you must optimize profits in the short term. Don't worry
about your customers in the long term, don't worry about your
business plan in the long term, don't worry about what happens
in the long term. You have to deploy your assets and price them
more to maximize profit tomorrow. If you don't, you are
predator. That is not a standard that is going to hold up in
very many industries in the United States. And I don't mean to
suggest anybody here suggested it, but it is a very difficult
question. Very few companies manage for the short term.
Senator Kohl. But you would also concede, would you not,
that there is a public policy question here just in terms of
that route that if you don't have a competitor like Sun
Country, again, just business being what it is, and if they are
the only carrier, Northwest is likely to be charging consumers
a lot more than they would like to be charged?
Mr. Carty. That tends to be the nature of business. I would
agree.
Senator Kohl. So there are other considerations here----
Mr. Carty. I would agree.
Senator Kohl [continuing]. That we weigh when we consider
what you are saying and we consider his situation.
Mr. Carty. I would agree with that.
Senator Kohl. Thank you.
Senator DeWine. Senator Kohl, thank you very much.
I have a statement from Senator Grassley that I will make a
part of the record at this point.
[The prepared statement of Senator Grassley follows:]
Prepared Statement of Hon. Charles E. Grassley, a U.S. Senator From the
State of Iowa
Good afternoon, Mr. Chairman. I commend you for calling another in
your series of hearings on the important subject of airline
competition. You and Senator Kohl have shown leadership in bringing to
light many of the problems surrounding true airline competition. The
traveling public owes you a debt of thanks and a vote of confidence for
your efforts.
You have assembled two very distinguished panels this afternoon.
Everyone is familiar with Dr. Alfred Kahn and his pioneering work on
the deregulation of the airline industry. We all look forward to his
comments on where we are now, and if this is the actual point that he
expected the airline industry to be at this time. Similarly, we look
forward to the comments of his colleague, Dr. Morrison, from
Northeastern University.
I am also pleased to join you in welcoming Donald Carty, the
Chairman, President, and CEO of American Airlines and AMR Corporation.
Mr. Carty, I would like to personally thank you and your staff for the
help that you provided me during the debate on AIR-21. This is truly a
landmark piece of legislation that will hopefully benefit states like
Iowa which lack a major hub airport. I know that increasing competition
was our joint goal as we worked together to phase-out the antiquated
slot-control system at Chicago's O'Hare and New York's LaGuardia and
Kennedy airports. Your support of the phase-out, with its help for
turbo-prop and regional jet aircraft, is key to helping several smaller
communities in Iowa. You have been very sensitive toour needs.
Welcome also to Robert Ferguson, Chairman, President and CEO of
Midway Airlines, and to Bill La Macchia, President and CEO of Sun
Country Airlines. I am aware of your concerns about competition and
look forward to what you have to say.
We are currently blessed with the longest peace-time economic
expansion in the history of our great country. Access to economical,
reliable air service is key for communities to be able to participate
equally and fully in this economic boom. Trustworthy air service at
economical fares is essential if businesses are to enter the national
and international marketplace. If good service and fares are not
available at their current business location, some businesses move to
cities that can provide them. This is unfair to underserved
communities.
AIR-21 seeks to bring about more airline competition. As a
conferee, I successfully fought for a phase-out of the out-dated slot-
control system. Why? Because I fear that an abrupt end to the slot
system would only benefit large hub airports, to the exclusion of
medium, small and non-hub airports. This would in turn, further skew an
already skewed competition system. Looking at airline ads in the
newspaper, large airport to large airport traffic already enjoy many
favorable schedule and low airfare advantages. But just try to fly out
of Sioux City or other Iowa regional airports and see how much you have
to pay and how difficult it is to reach some locations.
The phase-out of the slot rule favors turbo-prop and regional jet
aircraft that will serve small and non-hub airports.
Air-21 also provides much-needed funds for necessary infrastructure
improvements at all levels of airports. These funds will help build new
runways, taxiways, aprons, ramps, additional gates and terminals. This
will help to ease congestion and allow airlines to either begin new
service or expand existing service to reach more places and increase
competition.
Also, there are new programs to directly assist small communities.
One of the most important is a pilot project that allows small
communities to apply for up to $500,000 in direct financial assistance
to attract or improve new commercial air service. There is also a
regional jet purchase loan program that will be closely followed.
Importantly, Section 155 of AIR-21 found that ``15 large hub
airports today are each dominated by one air carrier, with each such
carrier controlling more than 50 percent of the traffic at the hub.''
It further states, ``the General Accounting Office has found that such
levels of concentration lead to higher airfares.'' Section 155 requires
that these airports submit a written competition plan to the Secretary
of Transportation before they can increase their passenger facility
charge.
The competition plan is required to include the following
information: availability of airport gates and related facilities,
leasing and sub-leasing arrangements, gate-use requirements, patterns
of air service, gate-assignment policy, financial constraints, and
other pertinent data.
This is a very important provision that neither the airlines nor
the affected airports should take lightly.
I have not talked about AIR-21 to say that the Congress has done
its job with regard to airline competition and it is time to move on to
other issues. To the contrary, we still have a job to do. We have made
a good first step. That is why I comment you, Mr. Chairman, for holding
this hearing. We must continue to send a message to the airline
industry that there is still work to do to bring about increased
competition and that we are watching. The traveling public expects no
less. It will take time for some of the provisions of AIR-21 to fully
mature and have their effects felt and understood. But in the interim,
we must not relax our vigilance on airline competition. Oversight is
the name of the game.
Senator DeWine. Let me thank our witnesses from this panel
and the previous panel for their testimony today. I think this
hearing was very helpful in bringing us up to date on a wide
variety of competition issues affecting the aviation industry.
As I mentioned earlier, the aviation industry is a very
complex and difficult industry to analyze. It is very important
that we continue to hear from the experts, both those who study
aviation and the industry and those who work in the industry.
For our part, this subcommittee will continue to promote
competition for large and small airlines alike. We will closely
monitor developments in the next few months, with particular
focus on the Justice Department litigation against American
Airlines and any enforcement policy decisions made by the
Department of Transportation.
This is an important time for the industry, and it is
important that we take the right steps to promote competition.
Today's testimony will help us do that, and I look forward to
continuing to work with Senator Kohl, the other members of this
subcommittee, the enforcement agencies, representatives of the
industry, and the experts to ensure that consumers have the
full benefits of vigorous competition in this industry.
I want to thank again this panel and our previous panel, an
exceptional group of witnesses. Your testimony has been very
helpful. Thank you very much.
[Whereupon, at 4:11 p.m., the subcommittee was adjourned.]
A P P E N D I X
----------
Additional Submissions for the Record
----------
Prepared Statement of Edward P. Faberman, on Behalf of Air Carrier
Association of America
Dear Chairman DeWine and Senator Kohl: On behalf of travelers and
communities from throughout the country, we thank you for again holding
a hearing to review airline competition. As we move into the new
millennium, 20 years since deregulation, we face a system in which:
hub concentration is increasing (In some markets, the
largest hub carrier has 85 to 90 percent market share. This is unheard
of in any other industry.);
there are fewer air carriers than at any time since
deregulation;
consolidation continues;
larger carriers continue to expand their international
alliances and partnerships providing them with additional resources;
more new entrants have stopped operations or filed for
bankruptcy than have started service;
barriers to entry still exist; and
anti-competitive behavior continues.
We have just passed the second anniversary since the Department
issued draft anti-competitive guidelines. Although some carriers act as
if there are no limits on actions they can take to attack new entrant
competitors (they don't take similar actions in response to large
carriers or even Southwest), the guidelines have not yet been
finalized.
When Secretary Slater announced his intention to issue guidelines
he stated: ``Our responsibility at the Department of Transportation is
to ensure that every airline--large or small, new or established--has
the opportunity compete freely. That is what deregulation is supposed
to be all about--a fair chance to compete.''
When the Department issued the ``Proposed Guidelines on Unfair
Competitive Practices in the Airline Industry,'' the Secretary stated:
The purpose of deregulation was to make the airline industry
competitive and make air travel affordable. But competition
only works if it exists.
There is growing concern that major carriers are willing to
lose money--lots of it--in the short run to drive off
competition.
This policy is not intended to ensure the success of any
start-up carrier, but rather to ensure a level playing field.
Consumers deserve a pro-competitive standard that helps ensure
affordable airfares and accessible service. To provide a level
playing field, we must preserve vigorous competition and
prohibit unfair exclusionary practices meant solely to
eliminate that competition.
Our common goal is to expand the pie, to provide opportunity
for all, and prepare the aviation industry for the challenges
of the 21st century.
While some smaller carriers have been able to grow and compete,
pressures continue. Midway Airlines, one of the carriers represented at
your hearing, is an example of how one carrier has survived without
offering low-cost service or competing directly with large carriers.
After Midway went through bankruptcy and moved to Raleigh Durham where
it took over American's facilities, it signed a marketing agreement
with American. It apparently has decided that it will not compete on
American's routes. It does not operate to Miami or Dallas--markets
served by American. Even more surprisingly, it does not operate to
Chicago, where it started. American operates to Chicago, Miami and
Dallas from Raleigh Durham. Midway has been able to survive in part
because it has avoided serving some of the most congested hubs and was
able to serve the critical markets of LaGuardia and National because
American provided slots to them.\1\ Under deregulation, each carrier
should be able to serve the markets it elects to enter and at the fares
it wants to charge. Nevertheless those carriers that elect to take a
different approach than Midway and service a concentrated large hub
airport, competing directly with a major carrier, should be able to
take that approach and not face predatory behavior.
---------------------------------------------------------------------------
\1\ Another successful new carrier--Midwest Express--also has
obtained high density slots. Would Midwest Express still be in
existence if it didn't obtain access to National and LaGuardia?
---------------------------------------------------------------------------
As to the approach that large carriers take to combat competition
and their views of the competitive environment, I refer you to the
following comments.
Former American Airlines Chairman and Chief Executive Officer
Robert Crandall, speaking at a November 1997 National Press Club
luncheon, made comments that demonstrate the need for the very action
he denounced. He stated:
Unfortunately, the byproducts of our cost control efforts
have all too often been long and bitter labor disputes and
customers upset by things like smaller seats, fewer closets and
reduced food service.
Losing a small percentage of the people on each plane to a
startup will take away the profit of any airline. We want to
keep all those passengers. Any airline that sustains losses for
the purpose of damaging competitors is not going to stay around
very long. That is not to say an airline won't cut fares or
lose money for awhile to defend market share at an airport
where it cannot afford to lose. When somebody challenges us in
a market where we must prevail, we will compete. If that
competition costs us money, we are prepared to do it. [Airline
Financial News, November 17, 1997, p. 3.]
The following statement by Gordon Bethune, President and CEO of
Continental Airlines, best summarizes what large carriers will do to
force competitors out of markets:
Last year, because we [Continental] were able to offer better
discounts than United for Newark to San Francisco and Newark to
Los Angeles, and because we were able to offer those discounts
to the people in Boston, United put in a four jet operation,
four times a day from Boston to Newark. We said, ``Boston to
Newark?''
``What the heck's United coming in for--we ran USAir out of
there some years ago.'' So we put four flights between L.A. and
San Francisco. Get that? You do that stuff to us, we do that
stuff to you. Now they're [United] down to one flight and I
think we'll pull out.
When you have 20 percent of the market [Continental and
Northwest combined], United will say, ``You know what, between
those two guys they might put 100 flights into L.A. Screwing
with one might be the same as screwing with the other.'' Now,
as a joined-at-the-hip partner with Northwest, you better watch
out if we do get upset. We have a lot of different ways that we
can pay you back. [Business Travel News, February 23, 1998.]
The following article from the May 1998 issue of Air Transport
World describes the type of actions taken by large carriers:
In testimony before Congress last fall, Reno Air VP/General
Counsel Bob Rowen said that when Reno entered the Detroit-Reno
city-pair with nonstop service, Northwest, which did not offer
a nonstop in the market, inaugurated its own nonstops and
flooded the route with capacity. ``A market that Reno entered
with fewer than 4,000 seats per month soon had over 24,000
seats per month,'' said Rowen. Northwest also offered nonstop
fares that were lower than its previous one-stop fares, he
said. Rowen alleged that Northwest was guilty of predatory
pricing in another instance. When Detroit-based start-up Spirit
Airlines entered the Detroit-Boston market, a market heavily
served by NWA, ``Northwest dropped its fares by over 50%.''
Major airlines are unapologetic about these actions. ``The
imperative to defend . . . core markets means that when
challenged, we will compete aggressively with whoever
challenges us,'' says Crandall. [Bob Crandall, former CEO of
American Airlines.] Matching fares and boosting capacity in the
face of a challenge are ``only natural,'' since ``every
consumer's first concern is price,'' while adding service
``enhance[s] the quality of its product offering.''
It is clear that some large carrier continue to engage in actions
to discourage competition. The following statement from a Hoover
Institute essay, ``A Fair Fight'' explains the likely motive behind
this behavior:
In the late 1970's and early '80s, the dominant view among
economists was that so-called predatory pricing--pricing below
your firm's own costs with the purpose of driving your
competitors out of business--was not a profitable strategy. The
reason was simple: If you price below cost, you lose money. And
if you win market share from your competitors, you lose even
more money.
For predatory pricing to be worthwhile, the ``predator'' must
more than make up such losses by charging a higher price once
all its competitors drop out. But there's a problem: Once the
predator raises prices above what they were when competitors
were present, other firms will be tempted to enter the market.
Some resourceful competitor might even buy the assets of the
``victim'' at fire-sale prices.
American judges who are asked to rule on antitrust matters
have, by and large, agreed with this economic reasoning. But in
the past 10 years or so, some economists, particularly those
who employ game theory, have revived the idea of predatory
pricing. They argue that if the predator can convince his prey
(i.e., potential entrants) that he's serious--or
``committed''--he can deter entry after he raises his price.
Who, after all, wants to be the next sucker to lose his shirt?
[David R. Henderson, Viewpoints, Stanford University.]
To demonstrate the significant advantages held by the nation's
largest carriers, I have attached a number of charts that highlight
advantages held by those carriers and the status of a new entry. As new
entrants are driven out of markets and fares increase, the impacts are
enormous:
Business travelers have been forced in recent years to bear
the brunt of higher fares in markets where network carriers
aren't exposed to low-fare competition, and business fares
continue to rise. [Department of Transportation ``Competition
in the U.S. Domestic Airline Industry: The Need for a Policy to
Prevent Unfair Practices'', July, 1998.]
In describing the impact of predatory behavior, in its comments to
the Department's proposed Policy, the National Business Travel
Association stated:
Characteristically, corporations bear a disproportionate
financial burden for air travel by their employees when
contrasted to the amount that leisure travelers pay for their
airline tickets. Often business travel fares are four times as
much as leisure fares because of the price of the airline
ticket and the accompanying federal passenger taxes.
To a great extent, we have arrived at the current dilemma
because the Departments have not acted. They have allowed the
situation to drift, with no enforcement or clearly defined
rules of the game spelling out for airlines and consumers alike
what acceptable competitive behavior is under deregulation. The
Departments have not defined what constitutes predatory pricing
or unfair competitive practices and have not, until recently,
shown much inclination to act on those practices.
The need to move forward was emphasized by an editorial in Business
Week (Airlines Should Reform Themselves,'' February 16, 1998.):
Consider some recent trends: Price-gouging of business
customers. Virtual monopolies on certain routes. Neglect of
small markets. Now, Washington is on the case, with the
Transportation Department and Congress mulling some moves.
Of all the reforms being contemplated, Transportation's is
the most worthwhile. Defining predatory behavior and setting up
a mechanism by which airlines can be monitored and complaints
promptly adjudicated would go a long way toward countering the
most flagrant anticompetitive acts--like when Northwest
Airlines Inc. pulled out all the stops in 1993 to outsell Reno
Air Inc.'s new route between Reno and Detroit, going so far as
to establish a mini-hub in Reno, a city it had never before
served.
On some business routes, the big airlines have stopped
competing on price. At some airports, they have a lock on
slots. The upshot: New competitors can't even get to the gate,
and underserved markets remain so.
Total deregulation is fully supported by small carriers. For a
competitive air system to survive, we must have a level playing field
and open markets. It is essential for this Committee to urge the
Departments of Transportation and Justice to ensure the future of
airline competition. Without it, business will be impaired and
travelers will not be able to visit friends, relatives, take vacations
and important business trips. Deregulation should not only exist in
certain markets and for certain carriers.
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American Society of Travel Agents,
Alexandria, VA, May 2, 2000.
Hon. Mike DeWine,
Chair, Senate Subcommittee on Antitrust, Business Rights and
Competition, Dirksen Senate Office Building, Washington, DC.
Dear Senator DeWine: The American Society of Travel Agents (ASTA)
applauds your efforts to continue monitoring competition in the
aviation industry. As a proponent of airline deregulation and an
advocate of the traveling consumer, ASTA is deeply concerned with the
rising tide of consumer dissatisfaction with air transportation which
reflects a lack of effective industry competition.
Although there are many complex issues facing the airline industry
today, ASTA submits for the hearing record on Airline Competition the
attached filing with the Department of Justice (DOJ) on the proposed
operation of a joint airline web site. Our filing requests the DOJ to
investigate and undertake enforcement action with respect to the stated
plan of the major United States and foreign airlines to create a joint
Internet Web-site to monopolize the provision of retail travel services
on the Internet and, ultimately, in all markets. Most recently,
American Airlines joined the site as the fifth equity owner. No other
industry of which ASTA is aware has attempted such a frontal assault on
the competitive process.
ASTA encourages the Subcommittee to closely follow the developments
of this web site as it reviews all the current aspects of competition
in the aviation industry.
Sincerely,
Paul M. Ruden,
Senior Vice President, Legal & Industry Affairs.
Attachment.
American Society of Travel Agents,
Alexandria, VA, February 16, 2000.
Hon. Joel I. Klein,
Assistant Attorney General, Antitrust Division, Department of Justice,
Washington, DC.
Dear Mr. Klein: The American Society of Travel Agents, Inc.
(``ASTA'') respectfully requests the Department of Justice to
investigate and undertake enforcement action with respect to the stated
plan of the major United States and foreign airlines to create a joint
Internet Web-site to monopolize the provision of retail travel services
on the Internet and, ultimately, in all markets.
The agreements of which we complain, will, in the words of the
recently, published Draft Antitrust Guidelines for Collaborations Among
Competitors,\1\
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\1\ 64 Fed. Reg. 54483, 54489, October 6, 1999.
---------------------------------------------------------------------------
``involve agreements on price, output or other competitively
significant variables, or on the use of competitively
significant assets, such as an extensive distribution network,
that can result in anticompetitive harm. Such agreements can
create or increase market power or facilitate its exercise by
limiting independent decision making; by combining in the
collaboration, or in certain participants, control over
competitively significant assets or decisions about
competitively significant variables that otherwise would be
controlled independently; or by combining financial interests
in ways that undermine incentives to compete independently.''
Whatever limited efficiency-enhancing integration of activity may
be plausibly claimed for the joint Web-site cannot overcome the fact
that all such benefits can be achieved ``through practical,
significantly less restrictive means.'' Consequently, these agreements
are not ``reasonably necessary,'' as defined in the Guidelines, to
achieve any procompetitive benefits.\2\ For example, United Airlines,
the largest of the partners in this venture, has created a new company
to continue operating its own Web-site, www.ual.com, which already
offers booking services for over 500 airlines, 45 car rental firms, and
30,000 hotels worldwide.\3\ The joint Web-site will add nothing that
cannot be achieved through independent action by these giant
corporations.
---------------------------------------------------------------------------
\2\ Id. at 54487.
\3\ United also operates the Web-site for the nine-carrier Star
Alliance at www.star-alliance.com.
---------------------------------------------------------------------------
We believe that the proposed arrangements must inevitably lead to
price fixing and on their face involve a concerted refusal to deal with
travel agencies, both per se violations of the antitrust laws. For
example, United owns 17 percent of Galileo, the Computer Reservation
System, and is funding $5 million in advertising and promotion for a
new Galileo Web-site that will undercut existing commission rates paid
to online travel agencies to induce listing of fares that also undercut
the prices that United provides to those agencies for resale to the
public. The new joint Web-site appears to contemplate similar
arrangements from which travel agents will be excluded. How can the
airlines make joint claims for what this Web-site will offer without
exchanging and committing to future price understandings and policies?
The desire to make this partnership, involving a huge segment of the
airline industry's assets, a success at its stated goals will undermine
incentives to compete vigorously and heighten the already pronounced
tendency of the airlines to copy each other in almost everything they
do.
In practical effect, the United States airline industry has begun
to operate as a single enterprise, of which the joint Web-site is just
the most recent manifestation. A graphic illustration of the
extraordinary network of commercial relationships that have developed
between the domestic carriers (and many of their foreign counterparts),
involving most of the major industry assets devoted to the production
and sale of domestic and foreign air transportation, is set out in
Attachment A to this letter. It is doubtful that any industry in this
country, or the world, exhibits such incestuous interconnectedness
among firms that are supposed to be full-fledged competitors.
While there are still some signs of competitive life left in the
industry, the opportunities for their long-term survival are quickly
diminishing. If the Department of Justice does not intervene
immediately to stop the unification of the competitive assets and the
destruction of the competitive spirit of this industry, it may be too
late to do so later when the damage caused by these amalgamations is
more obvious. We leave this introduction with this non-legal but
insightful commentary:
A century-old principle of antitrust is that when the same
company controls both content and the carriage of content,
anticompetitive abuses arise. The gate keeper (such as a
railroad) can overcharge users, keep out competitors, and
frustrate technological advance. This led the government to
insist that companies must choose between being common carriers
or providers of content. You could be railroad or shipper that
uses railroads, not both, and as railroad you had to treat
shippers equally. You could control the TV network, but not the
production companies. If you were the phone company, you had to
connect all calls.
The Internet has different technologies, but similar
economies principles. There is the same temptation to combine
and dominate, less to achieve economies of scale than to
achieve market power . . . Far from being scrapped, antitrust
policy needs to be brought into the Internet Age.\4\
---------------------------------------------------------------------------
\4\ ``Pirates, Snoops, Monopolists: Why the Net Needs Some Cops,''
Robert Kuttner, Business Week, February 21, 2000, at 24.
---------------------------------------------------------------------------
BACKGROUND
On November 9, 1999, four major airlines, United, Delta, Northwest
and Continental, together representing more than 45 percent of the
passengers carried in domestic air transportation (more than 11,482,
daily flights), announced a ``partnership'' to operate a ``multi-
airline travel portal'' that was self-proclaimed to ``offer the most
comprehensive selection of online airfares and other travel information
available anywhere on the World Wide Web,'' a site ``superior to all
travel sites,'' a site with ``the best of everything.'' \5\
---------------------------------------------------------------------------
\5\ Joint Press Release of United, Delta, Northwest and
Continental, November 9, 1999.
---------------------------------------------------------------------------
It is important to understand the significance in this claim of the
phrase ``online airfares.'' This does not refer merely to the
publication on the Internet of otherwise generally available airfares.
It refers instead to the publication of fares not available anywhere
but the Internet, and thus leads to the additional claim that ``for the
first time, online travel consumers will be able to compare and
purchase the Internet fares offered by several airlines . . . by
visiting just one site.'' \6\ ``It would support our business model if
they supplied special Internet-only capacity.'' \7\
---------------------------------------------------------------------------
\6\ Id.
\7\ Attributed to Ben Burnett, Vice President of Boston Consulting
Group, a firm retained to act as ``temporary launch manager.'' ``Nearly
Two Dozen Airlines Will Join Planned Web Site of Four Big Carriers,''
Susan Carey, Wall Street Journal, February, 2000.
---------------------------------------------------------------------------
This, then, is the real goal of this venture: to combine in one
retail location owned and controlled by the airlines the Internet-only
fares offered to consumers and not available for sale by the
independent travel agency community whose members are, in every other
respect, the full and unqualified agents for these airlines for the
retail sale of air transportation. The joint announcement makes clear,
moreover, that this new joint site is not in lieu of the individual
Web-sites provided by the participating carriers--those will continue
to operate and will continue to offer Internet-only fares also.\8\
---------------------------------------------------------------------------
\8\ Id.
---------------------------------------------------------------------------
The joint announcement refers also to ``unique travel packages''
that will be offered through ``combined product offerings of our [non-
airline] partners.''
Predictably, and in keeping with the airline industry's history of
advance announcements to their competitors of business intentions,
additional airlines have stated their plans to join the pack, yielding
a total, to date, of 27 airlines, including American and US Airways.
These new airlines are called ``Charter Associates,'' but the exact
nature of their relationship to the four ``founders'' has never been
made clear. The added participation of the new US airlines brings the
combined market share of the partners to more than 68 percent of
domestic passenger traffic. The other participants include some smaller
U.S. airlines plus Air Canada (the monopoly route carrier in Canada),
Alitalia, KLM Royal Dutch Airlines and other major foreign carriers.
Press reports indicate that other participants are expected.
The latest press report is that many of the participating European
carriers are now discussing a joint Web-site of their own, involving
virtually all of the principal U.S.-Europe foreign airlines (including
Air France, British Airways, Lufthansa, Iberia, Swissair, and Sabena.
Air France has stated that its marketing alliance will also have a
joint Web-site. Most of these carriers have marketing alliances and/or
code-share agreements with the partners in the US carrier Web-site. How
long will it be before these sites are merged? \9\
---------------------------------------------------------------------------
\9\ Those same airlines are parties to a proposal to assign common
identified numbers to corporate clients so that, among other things,
airline alliances can ``track corporate business across several
airlines.'' See Application for Approval of Agreements by the
International Air Transport Association, Docket OST-99-6694-1, filed
December 21, 1999.
---------------------------------------------------------------------------
Any hopes that anyone had that the Internet would remain a vigorous
and open competitive marketplace are about to be dashed on the rocks of
consolidated market power in the hands of a few industry giants. For
example only, research released on February 3 by Gomez Advisors states
that three ``dominant online travel firms . . . now take in over 40
percent of all online travel bookings.'' \10\ One of these firms,
Preview, is about to merge into one of the others, so there will two
firms with a 40 percent share.
---------------------------------------------------------------------------
\10\ See http://biz.yahoo.com/prnews/000203/
ma_gomez_o_l.html.
---------------------------------------------------------------------------
The Gomez report states that:
``the real leaders are solidifying their dominant positions .
. . the online travel giants are gobbling up as many niche
companies as possible in an effort to dwarf any smaller
competitors. This amount of consolidation taking place in the
market is making it nearly impossible for any but the top three
online travel sites to earn significant revenues.'' \11\
---------------------------------------------------------------------------
\11\ Id.
---------------------------------------------------------------------------
The airlines' collective attempt to cut off the online agencies at
the pass may or may not ultimately leave a survivor or two. Perhaps the
best outcome that can now be foreseen for retail travel completion on
the Web is one in which two or three consolidated sites compete for
almost all the business. All others will be shut out.
More likely, however, is the prospect that the airlines, by
combining assets and special fares not available to their competitors,
will succeed eventually (and in the Internet world ``eventually'' is
not far off) in destroying all their competition online as well as
offline.\12\ After all, once allowed to establish themselves
collectively on the Internet, what is there to stop the airlines from
completely terminating the compensation they pay to their online
competitors? This will leave the airlines in sole control of the supply
of information on which consumers must rely to make comparisons among
competing choices.
---------------------------------------------------------------------------
\12\ Traditional travel agencies are declining in number in the
face of the combined onslaught of reduced commissions (50% in four
years) and numerous other marketing practices calculated to raise
agency costs and impair their competitive flexibility. See ASTA's
Complaint in ``In the Matter of American Society of Travel Agents,
Inc.'', Docket OST-99-6410, U.S. Department of Transportation.
---------------------------------------------------------------------------
Such an outcome has no precedent. Since the earliest days of
commercial aviation, there has been an independent presence in the
market, offering consumers an alternative to dealing directly with the
airlines for information and transactions. It may be hard to conceive
that it could happen so swiftly, given the short life of the Internet,
but all signs now point to the complete domination of the Internet by a
handful of firms.
All of this is occurring just when traditional travel agencies are
extending their customer outreach to and through the Internet. One
example, previously brought to the department's attention, is Act
Travel at www.actdc.com which maintains a traditional brick-and-mortar
agency as well as a booking engine online. Today's travel agencies are
rapidly adapting to new means of commerce like the Internet and to
hybrid business models that encompass electronic communications and
booking services in a diverse array of service packages. All of these
agencies, newcomers and traditional agencies, that use or will use the
Internet for booking travel are considered ``online agencies'' for
purposes of this complaint.
Both the fully online agencies and the ``traditional'' agents who
have embraced this technology provide an efficient means to deliver the
one-stop, accurate, and unbiased comparative travel information and
advice that consumers value. This avenue has become increasingly
important to agents as airlines' reductions in compensation to non-
compensatory levels place them in a profit squeeze and threaten to
deprive the public of the access that travel agents uniquely provide to
comparative price information.
The airlines are not content to compete with these firms for
consumer patronage. They are intent now upon massing their forces so as
to dominate the medium and thereby control the message.
If the airlines can divert any meaningful amount of this business
to their individual Web sites while deterring travel agencies from
reaching consumers through the Web, the potential gain to them is
enormous, not merely in commissions avoided, but in the higher overall
prices that consumers will pay for air travel. Deprived of easy access
to independent sources of comparative price and service information,
consumers inevitably will end up paying more, on average, even if the
airlines never raise another fare.
Clearly, the airlines would like customers to make their
reservations directly on the carriers' own Web sites. Standing alone,
that objective does not necessarily offend competition policy. But the
airlines have gone well beyond merely luring consumers with ``better
deals.'' They have implemented commission policies and other
restrictions with respect to Internet-based bookings by travel agencies
that are designed to thwart travel agency use of the Internet to
communicate and book travel. The more successful they are in this
approach, the fewer practical options consumers will have for comparing
prices and purchasing travel, leading to less competition in travel
services and higher prices for consumers. We have attached to this
letter a copy of ASTA's complaint to the Department of Transportation
in Docket OST-99-6410, wherein we detail other competitive abuses
directed at the independent travel retailer by the major US airlines.
CONCLUSION
No other industry of which we are aware has attempted such a
frontal assault on the competitive process. Time is running out. The
expansion of the joint Web-site is well-advanced.
The Department should issue a Civil Investigative Demand upon all
the partners in the proposed Web-site to obtain inspection of the
underlying agreements and marketing plans. That is the only way anyone
can be satisfied that this scheme is not what we have alleged it is:
the finishing blow in a campaign calculated to destroy public access to
comparative information about air travel services and to end once and
for all the hope for a vigorous competitive industry that was the
promise of airline deregulation in 1978.
ASTA would be pleased to meet with representatives of the Antitrust
Division to discuss this matter further.
Respectfully submitted,
American Society of Travel Agents, Inc.
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Prepared Statement of T. Allan McArtor, President and CEO, on Behalf of
Legend Airlines
On behalf of Legend Airlines, I would like to thank you for holding
this hearing and addressing airline competition issues. We appreciate
the opportunity to provide the information on the status of competition
in the airline industry from a new entrant's perspective. Let me begin
by stating that I thought that my prior experiences as a combat pilot,
head of Federal Express Airline and Administrator of the FAA had
prepared me for my current assignment. Well, I can now assure you that
nothing prepares one for attempting to start a new entrant airline
carrier, particularly in a city dominated by one of the world's largest
air carriers. We never could have imagined that a carrier that fought
so hard against us and our right to fly under federal laws in multiple
forums would then turn around and duplicate our premium service at Love
Field and nowhere else. American continually switches its positions--
one day arguing that it and DFW Airport would be destroyed and that it
would be best if the Supreme Court blocked flights out of Love Field,
the next day arguing that they owe it to the people of Dallas to offer
service at Love Field. It would not be surprising if American changes
its story again tomorrow. The bottom line is, if a carrier is allowed
to go to such extremes to drive a new entrant out of business, the
future of competition indeed looks bleak.
Legend Airlines is a new entrant carrier operating out of Dallas
Love Field that started service on April 5 to Washington Dulles, Los
Angeles, and Las Vegas. We fly jet aircraft reconfigured to hold only
56 seats (consistent with federal law), offering premium service at
coach fares. Since Legend was founded in 1996, American Airlines and
its surrogates have been waging a multi-million dollar litigation and
media campaign to put us out of business. It is difficult enough to
start out in a market where the incumbent carrier has a 75 percent
market share, but Legend was willing to compete in accordance with
federal law and DOT orders. From the sheer magnitude of American's
response, you would have thought Legend was a 400 aircraft operation
with multiple alliances--certainly not what it is, a four aircraft
startup with jets limited to 56 passengers. (For comparison's sake,
American has 32 alliance partners, a 641 aircraft fleet and
approximately 1,000 slots at O'Hare Airport.)
When Legend and Continental Express first announced plans to fly
out of Love Field--consistent with federal law known as the Wright
Amendment, American's CEO Robert Crandall announced that ``if the
Wright Amendment is ever changed, we'll sue everybody in America to
close Love Field.'' The headline in the October 4, 1996 Dallas business
Journal stated, ``AMR chief promises to fight to the death on Love
Field.'' They were not exaggerating. Before Legend even filed for DOT
certification, American was intent on destroying it. In October 1997,
Congress passed the Shelby Amendment, which amended the Wright
Amendment expressly allowing jets reconfigured to carry no more than 56
passengers to any destination. Before the President had signed the
Shelby Amendment into law, American sued Legend, Continental Express
and the City of Dallas in Texas state court to prevent us and
Continental Express from operating out of Love Field.
While many cities throughout this country--including Houston, New
York, Washington, D.C., Los Angeles, Miami--have many multiple airports
that compete, as a part of American's campaign, it spread misleading
information throughout the Dallas area that American and its DFW hub
would be destroyed by any level of competition introduced at Love
Field.\1\ American opposed allowing nonstop flights to Mississippi,
Alabama and Kansas and use of 56-seat aircraft to any destination. Such
oppressive restrictions exist nowhere else in the country. Such
restrictions exist nowhere else in the world.
---------------------------------------------------------------------------
\1\ An example of American's misinformation campaign: ``Because
more than 90% of Dallasites and more than 50% of Metroplex residents
live closer to Love Field than DFW, airlines will add service at Love
and reduce it at DFW. With fewer local customers, in the long term DFW
will not compete with hubs like O'Hare, Atlanta, and Denver. DFW will
become a second-tier hub.'' [Dear Colleague Letter from American
Chairman, Don Carty, July 6, 1998.]
---------------------------------------------------------------------------
To demonstrate that it is not just a one-carrier predator, American
also challenged Continental Express' right to fly 50-seat regional jets
from Love Field to Cleveland. It announced that it would use 12 LGA
commuter slots to serve LaGuardia-Cleveland--one of Continental's hubs,
a market where Continental already operated six daily roundtrips.\2\
---------------------------------------------------------------------------
\2\ The following news reports describe a series of actions taken
by American to drive Continental Express out of Love Field:
American said Monday that it is starting service from Austin to
Houston's Hobby Airport on September 9, the same day American also
plans to launch three daily flights from Hobby to New York's LaGuardia
Airport.
The new service comes as Continental presses its own plans to fly
from Dallas Love Field to Continental's hub in Cleveland. A state
district judge in Fort Worth has blocked that service at the request of
Fort Worth and Dallas/Fort Worth International Airport board.
Analysts said American's new Houston Service appears to be simply
retaliation against Continental's Love field plans.
``It's spite,'' said Joseph Berman, senior aviation analyst at
Avmark Inc. ``They're saying, `If you're going to go into our market
and do that, we're going to go into your market and do this.' ''
[Dallas Morning News, Tuesday, July 21, 1998.]
In commenting on American's action to stop Continental Express'
proposed flights at Love Field, David Siegel, President of Continental
Express, Inc., stated in Commuter/Regional Airlines News (July 20,
1998): ``It is refreshing to see new leadership at DFW's flagship
airline. Many hoped that with the easing of the dress code at American
Airlines would be more than symbolic. But whether dressed up or dressed
down, the same old anticompetitive, protectionist actions continue to
thrive and deny consumers their rights to choice convenience and
reasonable fares.''
Analysis of American's Houston-LaGuardia service is similarly
enlightening: ``. . . but Carty is `no pushover by a long shot,' the
[American] official said, describing him as tough and aggressive,
particularly when it comes to competitive response. `Don [Carty]
doesn't like to sit there and take it,' he said, `He wants to
retaliate' . . . its unusual for us to fly nonhub-to-nonhub routes,' an
official said. `It's a signal to anyone who comes messing around with
our market.' '' [``American Builds on Crandall's Legacy,'' Aviation
Week & Space Technology, August 24, 1998.]
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Because these were federal issues and impacted the national
aviation system and interstate commerce, DOT tried to resolve the
conflict by instituting an Interpretive Proceeding wherein it
considered whether federal law permits Legend's proposed operations. On
December 23, 1998, DOT issued a Declaratory Order finding that Legend's
proposed service is authorized under federal law. American and its
partners appealed that decision to the Fifth Circuit Court of Appeals.
On February 1, 2000, the Fifth Circuit rendered a decision affirming
DOT's Orders and upholding Legend's authority under federal law to
operate at Love Field. (Fort Worth has petitioned to bring this case
before the Supreme Court. It is expected that American will file as
well.
Within two hours of the Fifth Circuit decision, American announced
plans to reconfigure Fokker 100 jets and MD-80 jets (normally seating
135 passengers) to combat Legend. As reported by the February 2 Dallas
Morning Star, ``American's plan is to create a special fleet of jets
that will be used at Love Field only.'' Therefore, in its effort to
copy Legend, American is spending millions of dollars to reconfigure
each of the aircraft it will utilize at Love Field (this is in addition
to the expenses it will incur at Love Field to build and upgrade
facilities,\3\ add personnel, build catering facilities, and create a
specialized marketing program) in Legend's markets with the sole intent
of driving Legend out of Love Field.
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\3\ American spent close to $100 million to block the use of
certain passenger facilities at Love Field, claiming that they would
use the facilities for office space. In 1997, American entered a 25-
year lease for ``office space'' in a former Love Field terminal at an
annual lease price of $3.5 million. The facility needs approximately
$8.5 million in asbestos work and several million dollars worth of
general renovations.
---------------------------------------------------------------------------
American has admitted that it will not use these aircraft in other
markets. If American were to utilize these aircraft elsewhere in this
system or halt this service, they would again reconfigure these
aircraft to restore the original interiors. Although this would add
millions of additional dollars to its costs, American is prepared to do
so.
American has made it very clear that it would prefer that all
service from Love Field to destinations beyond the four border states
be prevented, regardless of the million they are spending.
American's spokesman explained its actions in the Dallas Morning
News:
``If Legend is allowed to fly out of Love Field, we will also
fly out of Love Field, and we will fly in competitive markets
and at competitive fares,'' said American spokesman Tim Doke,
adding that American can offer more flights than Legend to the
same destinations.
``We are confident that a court will step in and enjoin
Legend from selling tickets,'' Mr. Doke said.
Fort Worth has appealed a lower court ruling that allows
long-haul service from Love. If the Supreme Court takes the
case and rules in Fort Worth's favor, it means that American
would have to ``undo all that we've done--all the planes we've
reconfigured and so forth,'' Carty said.
But, even so, ``For a whole variety of reasons, we continue
to believe that from American's perspective, that's better for
us, even though it would cost us some money,'' Carty told
reporters after a speech yesterday at the SMU Management
Briefing Series at the Fairmount Hotel.
Carty said earlier that it would be better for the region if
the Supreme Court were to overturn the 5th U.S. Circuit Court
of Appeals' Feb. 1 ruling. (Forth Worth Star Telegram, April
20, 2000.)
American has never utilized aircraft with one level of service and
never shifted operations to Love Field to combat Southwest. Nor has
American added flights to Cleveland to challenge the operations of
Continental Express out of Love Field. Moreover, when Midwest Express
(another carrier with an upscale interior and special flight amenities)
entered the DFW market American did not reconfigure aircraft to match
Midwest Express' cabin configuration.\4\
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\4\ American now codeshares with Midwest Express.
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The markets selected by American for its Love Field service further
demonstrate that it is focusing on Legend. Although American serves the
DFW-LAX market with 18 roundtrips per day, after hearing that Legend
would operate to LAX, American immediately announced LAX as the first
market it would serve from Love Field, offering four roundtrips. As a
result of American's DFW-LAX schedules, American has a total of 20
flights in the same time period. For example, Legend has a 5:10 p.m.
departure at Love Field which is surrounded by American flights at
3:50, 4:00, 4:30 (Love Field), 5:15, and 6:00. This is a prime example
of an already dominant carrier adding to its market presence to leave
little room for a new entrant. To dissuade Legend from entering the
Chicago market after Legend announced its intent to serve Chicago,
American will increase its roundtrips to 33.\5\ In addition, American
is matching fares, offering discounts and turning the heat up on travel
agencies and corporations.
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\5\ American has over 1,000 slots at O'Hare; therefore, it can
adjust schedules at will. Since O'Hare is a high density airport,
Legend was blocked from entering that market. Now American has 33
scheduled roundtrips from Dallas to Chicago, Therefore, American will
make it difficult for Legend to enter that market.
As to why American is increasing its O'Hare frequencies: ``If a
simple price match is insufficient to deprive an entrant of enough
local traffic to survive, the hub carrier can shift enough capacity to
the local markets to accomplish that goal. Moreover, where service in a
market is constrained by slot availability, a hub carrier with access
to a large pool of slots has even greater ability to respond to entry
in this way because the entrant will be unable to add capacity on its
own. American's president has referred to such strategic responses as
predatory scheduling. The net result of predatory scheduling is to
discourage a new entry in the first place, or render it unprofitable
where it occurs. [Department of Justice Comments on Joint Application
of American Airlines and British Airways' Application for Antitrust
Immunity and Alliance Agreement (OST-97-2058), May 21, 1998.]
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While Legend's officers and stockholder fully understand the
competitiveness of the air carrier industry and the enormous advantages
that American already holds in the Dallas-Fort Worth marketplace,
American's overall actions amount to much more than competition. If
this is not a classic case of predation, then it is hard to imagine
what would cross the line. As the Department of Justice in United
States of America v. AMR Corporation, Civil Action N. 99-1180-JTM, May
13, 1999 accurately surmised:
American is under investigation for a series of actions taken
against new entrants. American dominates DFW and charges
monopoly fares on many DFR routes. When small airlines try to
compete against American on these routes, American typically
responds by increasing its capacity and reducing its fares well
beyond what makes business sense, except as a means of driving
the new entrant out of the market. Once the new entrant is
forced out, American promptly raises its fares and usually
reduces its service. Through its predatory and monopolistic
conduct, American deprives consumers of the benefits of
competition in violation of the antitrust laws.
As American, its affiliates and alliance partners control 75
percent of the Dallas/Fort Worth market, it makes it very difficult for
a new entrant to compete. In addition to its other advantages, if a
carrier with that much control over the marketplace can add any number
of flights in a new entrant's market and add a type of service it has
never before operated, then new entrants may be a thing of the past.
For these reasons, it is essential the DOT and DOJ actively pursue
carriers who engage in anticompetitive behavior and threaten to destroy
the benefits of deregulation. I urge this Committee to remind both DOT
and DOJ that it must move aggressively to ensure that deregulation is
not just a distant memory.