Commercial Aviation: Financial Condition and Industry Responses  
Affect Competition (02-OCT-02, GAO-03-171T).			 
                                                                 
This testimony discusses the economic state of the airline	 
industry. Many, but not all, major U.S. passenger airlines are	 
experiencing their second consecutive year of record financial	 
losses. In 2001, the U.S. commercial passenger airline industry  
reported losses in excess of $6 billion. For 2002, some Wall	 
Street analysts recently projected that U.S. airline industry	 
losses will approach $7 billion, and noted that the prospects for
recovery during 2003 are diminishing. Carriers have taken many	 
actions to lower their costs and restructure their operations.	 
Since September 2001, carriers have furloughed 100,000 staff,	 
renegotiated labor contracts, and streamlined their fleets by	 
retiring older, costlier aircraft. Carriers have reduced capacity
by operating fewer flights or smaller aircraft. In some cases,	 
carriers eliminated all service to communities. As the aviation  
industry continues its attempts to recover, Congress will be	 
confronted with a need for increased oversight of a number of	 
public policy issues. First, airlines' reactions to financial	 
pressures will affect the domestic industry's competitive	 
landscape. Second, airlines' reductions in service will likely	 
place additional pressure on federal programs supporting air	 
service to small communities, where travel options are already	 
limited. Finally, although domestic travel has been the focus of 
recent concern, there are numerous international		 
developments--especially regarding the	European Union (EU)--that
may affect established international "open skies" agreements	 
between the United States and EU member states. 		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-171T					        
    ACCNO:   A05224						        
  TITLE:     Commercial Aviation: Financial Condition and Industry    
Responses Affect Competition					 
     DATE:   10/02/2002 
  SUBJECT:   Airline industry					 
	     Losses						 
	     Terrorism						 
	     Transportation costs				 
	     Commercial aviation				 
	     Cost control					 
	     DOT Essential Air Service Subsidy			 
	     Program						 
                                                                 
	     DOT Small Community Air Service			 
	     Development Pilot Program				 
                                                                 

                                                                 
Commercial Aviation: Financial Condition and Industry Responses  
Affect Competition (02-OCT-02, GAO-03-171T).			 
                                                                 
This testimony discusses the economic state of the airline	 
industry. Many, but not all, major U.S. passenger airlines are	 
experiencing their second consecutive year of record financial	 
losses. In 2001, the U.S. commercial passenger airline industry  
reported losses in excess of $6 billion. For 2002, some Wall	 
Street analysts recently projected that U.S. airline industry	 
losses will approach $7 billion, and noted that the prospects for
recovery during 2003 are diminishing. Carriers have taken many	 
actions to lower their costs and restructure their operations.	 
Since September 2001, carriers have furloughed 100,000 staff,	 
renegotiated labor contracts, and streamlined their fleets by	 
retiring older, costlier aircraft. Carriers have reduced capacity
by operating fewer flights or smaller aircraft. In some cases,	 
carriers eliminated all service to communities. As the aviation  
industry continues its attempts to recover, Congress will be	 
confronted with a need for increased oversight of a number of	 
public policy issues. First, airlines' reactions to financial	 
pressures will affect the domestic industry's competitive	 
landscape. Second, airlines' reductions in service will likely	 
place additional pressure on federal programs supporting air	 
service to small communities, where travel options are already	 
limited. Finally, although domestic travel has been the focus of 
recent concern, there are numerous international		 
developments--especially regarding the	European Union (EU)--that
may affect established international ''open skies'' agreements	 
between the United States and EU member states. 		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-171T					        
    ACCNO:   A05224						        
  TITLE:     Commercial Aviation: Financial Condition and Industry    
Responses Affect Competition					 
     DATE:   10/02/2002 
  SUBJECT:   Airline industry					 
	     Losses						 
	     Terrorism						 
	     Transportation costs				 
	     Commercial aviation				 
	     Cost control					 
	     DOT Essential Air Service Subsidy			 
	     Program						 
                                                                 
	     DOT Small Community Air Service			 
	     Development Pilot Program				 
                                                                 

******************************************************************
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GAO-03-171T

Testimony Before the Committee on Commerce, Science, and Transportation U.
S. Senate

United States General Accounting Office

GAO For Release on Delivery Expected at 9: 30 a. m. EST Wednesday, October
2, 2002 COMMERCIAL AVIATION

Financial Condition and Industry Responses Affect Competition

Statement of JayEtta Hecker Director, Physical Infrastructure Issues

GAO- 03- 171T

Page 1 GAO- 03- 171T Airline Financial Condition

Mr. Chairman and Members of the Committee: Thank you for inviting us to
testify today on the economic state of the airline industry. Just over a
year ago, we testified before this Committee on guidelines for providing
financial assistance to the industry. 1 The Congress has long recognized
that the continuation of a strong, vibrant, and competitive commercial
airline industry is in the national interest. A financially strong air
transport system is critical not only for the basic movement of people and
goods, but also because of the broader effects this sector exerts
throughout the economy. In response to the industry*s financial crisis
generated by the events of last September, the Congress passed the Air
Transportation Safety and System Stabilization Act. 2 Thus, it is fitting
that we now return to this Committee to review the state of the industry*s
financial health and competitiveness.

Over the past several years, we have issued a number of reports that focus
on changes within the airline industry. They include analyses of the
potential impacts on consumers of airline mergers and alliances, carriers*
use of regional jets, and changes in service to the nation*s smaller
communities. 3 Our statement today builds on that body of work and
provides a current overview of (1) the financial condition of major U. S.
commercial passenger airlines; (2) steps taken by airlines to improve
their financial condition; and (3) some public policy issues related to
current conditions and changes in the aviation industry*s competitive
landscape.

In summary:  Many, but not all, major U. S. passenger airlines are
experiencing their

second consecutive year of record financial losses. In 2001, the U. S.
commercial passenger airline industry reported losses in excess of $6
billion. For 2002, some Wall Street analysts recently projected that U. S.
airline industry losses will approach $7 billion, and noted that the
prospects for recovery during 2003 are diminishing. Such projections could
worsen dramatically in the event of additional armed conflict, if travel
demand drops and fuel prices rise. Several carriers have entered

1 Commercial Aviation: A Framework for Considering Federal Financial
Assistance

(GAO- 01- 1163T), September 20, 2001. 2 P. L. 107- 42.

3 See list of related GAO products attached to this statement.

Page 2 GAO- 03- 171T Airline Financial Condition

Chapter 11 bankruptcy proceedings. Yet Southwest Airlines, JetBlue, and
AirTran continue to generate positive net income. These low- fare carriers
have fundamentally different business structures than most major U. S.
airlines, including different route structures and lower operating costs.
However, federal security requirements have altered the cost of doing
business for all carriers.

 Carriers have taken many actions to lower their costs and restructure
their operations. Since September 2001, carriers have furloughed an
estimated 100,000 staff, renegotiated labor contracts, and streamlined
their fleets by retiring older, costlier aircraft. Carriers have reduced
capacity by operating fewer flights or smaller aircraft, such as
substituting *regional jets* for large *mainline* jet aircraft. In some
cases, carriers eliminated all service to communities. For example, since
September 2001, carriers have notified the Department of Transportation
(DOT) that they intend to discontinue service to 30 small communities. At
least two carriers are modifying their hub operations to use resources
more efficiently by spreading flights out more evenly throughout the day.
Finally, to increase revenues, some carriers have proposed creating
marketing alliances under which the carriers would operate as code-
sharing partners. 4 United Airlines and US Airways announced plans to form
such an alliance on July 24, 2002, as did Continental Airlines, Delta Air
Lines, and Northwest Airlines one month later.

 As the aviation industry continues its attempts to recover, the Congress
will be confronted with a need for increased oversight of a number of
public policy issues. First, airlines* reactions to financial pressures
will affect the domestic industry*s competitive landscape. Some changes,
such as extending airline networks to new markets through code sharing
alliances, may increase competition and benefit consumers. Others, such as
carriers* discontinuing service to smaller communities, may decrease
competition and reduce consumers* options, particularly over the long
term. Second, airlines* reductions in service will likely place additional
pressure on federal programs supporting air service to small communities,
where travel options are already limited. Finally, while domestic travel
has been the focus of our concern today, there are numerous international
developments* especially regarding the European Union (EU)* that may
affect established international *open skies* agreements between the

4 In general, *code sharing* refers to the practice of airlines applying
their names* and selling tickets via reservation systems* to flights
operated by other carriers.

Page 3 GAO- 03- 171T Airline Financial Condition

United States and EU member states. Various studies have illustrated the
benefits to both consumers and carriers that flow from liberalizing
aviation trade through such agreements. As international alliances are key
components of major domestic airlines* networks, international aviation
issues will affect the overall condition of the industry.

The Airline Deregulation Act of 1978 has led to lower fares and better
service for most air travelers, largely because of increased competition.
The experiences of millions of Americans underscore the benefits that have
flowed to most consumers from the deregulation of the airline industry,
benefits that include dramatic reductions in fares and expansion of
service. These benefits are largely attributable to increased competition,
which has been spurred by the entry of new airlines into the industry and
established airlines into new markets. At the same time, however, airline
deregulation has not benefited everyone; some communities have suffered
from relatively high airfares and a loss of service.

The airline industry is a complex one that has experienced years of
sizable profits and great losses. The industry*s difficulties since
September 11, 2001, do not represent the first time that airlines have
faced a significant financial downturn. In the early 1990s, a combination
of factors (e. g., high jet fuel prices due to Iraq*s invasion of Kuwait
and the global recession) placed the industry in turmoil. Between 1990 and
1992, U. S. airlines reported losses of about $10 billion. All major U. S.
airlines 5 except Southwest reported losses during those years. In
addition, several airlines* most notably Braniff, Eastern, and Pan Am*
went out of business, and Trans World Airlines, Northwest Airlines, and
Continental Airlines entered bankruptcy proceedings. By the start of 1993,
the industry had turned the corner and entered a period during which
nearly all major U. S. airlines were profitable. The industry rebounded
without massive federal financial assistance.

The events of September 11th accelerated and aggravated negative financial
trends that had begun earlier in 2001. Congress responded quickly to
address potential instability in the airline industry by enacting the Air
Transportation Safety and System Stabilization Act. Among other

5 For the purpose of this report, major airlines include Alaska Airlines,
America West Airlines, American Airlines, American Trans Air, Continental
Airlines, Delta Air Lines, Northwest Airlines, Southwest Airlines, United
Airlines, and US Airways. Background

Page 4 GAO- 03- 171T Airline Financial Condition

things, that act authorized payments of $5 billion in direct compensation
(grants) to reimburse air carriers for losses sustained as a direct result
of government actions beginning on September 11, 2001, and for incremental
losses incurred between September 11 and December 31, 2001 as a direct
result of the terrorist attacks. The act provided $10 billion in loan
guarantees to provide airlines with emergency access to capital and
established the Air Transportation Stabilization Board (the Board) to
administer the loan program. 6 The Board is tasked not only with providing
financial assistance to airlines but also with protecting the interests of
the federal government and American taxpayer. The act requires the Board
to ensure that airlines are compensating the government for the financial
risk in assuming guarantees. This requirement defines the loan guarantee
as a mechanism for supporting airlines with reasonable assurances of
financial recovery. In addition to the grants and loan guarantees, the
federal government has also established other ways to ease the airlines*
financial condition. 7

Many major U. S. passenger airlines are experiencing their second
consecutive year of record financial losses. In 2001, the industry
reported a net loss of over $6 billion, even after having received $4.6
billion from

6 The Air Transportation Stabilization Board is composed of the Chairman
of the Federal Reserve, the Secretary of Transportation, the Secretary of
Treasury, and the Comptroller General. The Comptroller General is a non-
voting member.

7 The Air Transportation Safety and System Stabilization Act (Title III)
authorized the Secretary of the Treasury to change the due date for any
tax payment due between September 10 and November 15 to some time after
November 15 (with January 15, 2002 as the maximum extension). The act
specifies taxes that may be postponed to include excise and payroll taxes.
Under Title II, (Aviation Insurance), the act also authorized DOT to
reimburse qualifying air carriers for insurance increases experienced
after the events of September 11th for up to 180 days. Funding constraints
effectively limited the program to reimbursing carriers their excess war
risk insurance premiums for only 30 days. Many Carriers Face

Deep Financial Losses

Page 5 GAO- 03- 171T Airline Financial Condition

the federal government in response to September 11th. 8 For 2002, some
Wall Street analysts have projected that U. S. airline industry losses
will total about $7 billion, but this projection may worsen in the event
of additional armed conflict, particularly if this results in decreasing
travel demand and rising fuel prices. According to industry data,
airlines* revenues have declined 24 percent since 2000, while costs have
remained relatively constant. US Airways and Vanguard Airlines filed for
Chapter 11 bankruptcy during this summer. United Airlines officials stated
that they are preparing for a potential Chapter 11 bankruptcy filing this
fall. Furthermore, some Wall Street analysts predict that it will likely
take until 2005 for the industry to return to profitability. Attachment I
summarizes the financial condition of major network and low- fare
carriers. 9

Major airline carriers* revenues have fallen because of a combination of a
decline in passenger enplanements 10 and a significant decrease in average
fares. As figure 1 shows, major carriers* enplanements increased for every
quarter of 2000 compared to the same quarter of the previous year, but
flattened in the first quarter of 2001 and then dropped, with the steepest
drop occurring in the quarter following September 11, 2001.

8 The federal government has provided significant amounts of financial
assistance under the Stabilization Act. First, according to data from DOT,
as of September 18, 2002, 396 passenger and cargo carriers had received
payments totaling $4.6 billion. Second, 16 carriers submitted applications
for loan guarantees. The Board approved a loan of $429 million to America
West Airlines, and conditionally approved the applications of US Airways,
Inc. for a federal guarantee of $900 million and American Trans Air for a
federal guarantee of $148. 5 million. The Board has denied the
applications of four airlines. Third, various airlines have taken
advantage of the tax deferment. For example, Southwest stated that it
deferred approximately $186 million in tax payments until January 2002.
Finally, the Federal Aviation Administration provided reimbursements to
air carriers for up to 30 days of increased war risk insurance expense. To
date, 188 air carriers have received $56. 9 million in reimbursements. We
are completing reviews of the $5 billion financial assistance program and
the War Risk Insurance Reimbursement program to ensure that payments made
were in compliance with the act.

9 Network carries are defined as carriers using a hub and spoke system.
Under this system, airlines bring passengers from a large number of
*spoke* cities to one central location (the hub) and redistribute these
passengers to connecting flights headed to passengers* final destinations.
We adopted DOT*s definition of low- fare carriers, which includes AirTran,
American Trans Air, Frontier, JetBlue, Southwest, Spirit, and Vanguard.

10 *Enplanements* represents the total number of passengers boarding an
aircraft. Thus, for example, a passenger that must make a single
connection between his or her origin and destination counts as two
enplaned passengers because he or she boarded two separate flights.

Page 6 GAO- 03- 171T Airline Financial Condition

Figure 1: Major Airlines* Passenger Enplanements (quarterly) - Percentage
Change from Prior Year

Source: GAO analysis of data from the Air Transport Association.

Over the same period, major airlines have also received lower average
fares. Data from the Air Transport Association indicate that the average
fare for a 1,000- mile trip dropped from $145 in June 2000 to $118 in June
2002, a decrease of about 19 percent (see fig. 2). Average fares started
dropping noticeably in mid- 2001 and have not risen significantly since.
Industry data suggest that the decline is due to the changing mix of
business and leisure passenger traffic, and particularly to the drop in
highfare business passengers.

Page 7 GAO- 03- 171T Airline Financial Condition

Figure 2: Average Domestic Airfares for Major Network Carriers, January
2000 Through June 2002

Note: Data are in nominal dollars for 1,000- mile trips on U. S. major
airlines (excluding Southwest). Source: GAO presentation of data from the
Air Transport Association.

Through June 2002, all major network carriers generated negative net
income, while low- fare carriers Southwest Airlines, JetBlue, and AirTran
returned positive net income. Like the major carriers, these low- fare
carriers* passenger enplanements dropped in the months immediately
following September 2001. Attachment II summarizes passenger enplanements
for individual major and low- fare carriers for 2000, 2001, and the first
5 months of 2002.

Why have some low- fare carriers been able to earn positive net income in
current market conditions, while network carriers have not? The answer
seems to rest at least in part with their fundamentally different business
models. Low- fare carriers and major network carriers generally have
different route and cost structures. In general, low- fare carriers fly
*pointto- point* to and from airports in or near major metropolitan areas,
such as Los Angeles, Chicago, and Baltimore- Washington. In comparison,
major network carriers use the *hub and spoke* model, which allows them to
serve a large number of destinations, including not just large cities, but
small communities and international destinations as well. American
Airlines, for example, can carry a passenger from Dubuque, Iowa, through
Chicago, to Paris, France.

Low- fare carriers have also been able to keep costs lower than those of
major airline carriers. For example, 2002 data reported by the carriers to

Page 8 GAO- 03- 171T Airline Financial Condition

DOT indicate that Southwest*s costs per available seat mile (a common
measure of industry unit costs) for one type of Boeing 737 is 3.79 cents.
For the same aircraft type, United Airlines reported a cost of 8.39 cents*
more than twice the cost at Southwest.

All airlines are now entering an environment in which some of the costs of
doing business have increased. The federal Transportation Security
Administration has taken over responsibility for many security functions
for which airlines previously had been responsible. The Air Transport
Association (ATA) estimated that the airline industry spent about $1
billion for security in 2000. 11 Despite the shift in functional
responsibilities, airlines have stated that they continue to bear the
costs of other new federal security requirements. In August 2002, Delta
Air Lines estimated the cost of new federal security requirements that it
must bear to be about $205 million for 2002. This includes the cost of
reinforcing cockpit doors, lost revenues from postal and cargo
restrictions, and lost revenues from carrying federal air marshals.

To address mounting financial losses and changing market conditions,
carriers have begun taking a multitude of actions to cut costs and boost
revenues. First, many carriers have trimmed costs through staff furloughs.
According to the Congressional Research Service, carriers have reduced
their workforces by at least 100,000 employees since last September.
Further, some carriers, including United Airlines and US Airways, have
taken steps to renegotiate contracts in order to decrease labor and other
costs. A US Airways official stated that its renegotiated labor agreements
would save an estimated $840 million annually.

Carriers have also grounded unneeded aircraft and accelerated the
retirement of older aircraft to streamline fleets and improve the
efficiency of maintenance, crew training, and scheduling. Carriers
accelerated the retirement of both turboprops and a variety of larger
aircraft, including

11 The amount that the industry paid for security in 2000 is in question.
ATA*s $1 billion estimate, made in August 2001, included $462 million
annually for direct costs, $50 million for security technology and
training costs, and $110 for acquisition of security equipment. Since
then, ATA certified that the industry incurred only about $300 million in
securityrelated costs. The amount is important, because the airlines are
required to remit an amount equal to the security costs incurred by the
airlines in calendar year 2000 to the U. S. government, which assumed
certain civil aviation security functions through the Transportation
Security Administration. DOT*s Inspector General is examining the
discrepancy between the $1 billion and the $300 million estimates.
Airlines Have Taken

Numerous Actions to Address Changing Market Conditions

Page 9 GAO- 03- 171T Airline Financial Condition

Boeing 737s and 727s. For example, United and US Airways retired the
Boeing 737s used by United*s Shuttle service and US Airways* MetroJet
system, and the carriers discontinued those divisions* operations.
Industry data indicate that the airlines have parked over 1, 400 aircraft
in storage, with more than 600 having been parked since September 2001.

Although carriers had begun reducing capacity earlier in 2001, those
reductions accelerated after the terrorist attacks. Between August 2001
and August 2002, major carriers reduced capacity by 10 percent. Carriers
can decrease capacity by reducing the number of flights or by using
smaller aircraft, such as replacing mainline service with regional jets,
which are often operated by the network carrier*s regional affiliate and
normally have lower operating costs. For example, American Airlines serves
the markets between Boston, New York (LaGuardia), and Washington, D. C.
(Reagan National) only with regional jet service provided by its
affiliate, American Eagle. Another way carriers have reduced capacity is
to discontinue service to some markets, primarily those less profitable,
often smaller communities. Our previous work showed that the number of
small communities that were served by only one airline increased from 83
in October 2000 to 95 by October 2001. Between September 2001 and August
2002, carriers had notified DOT 12 that they intend to discontinue service
to 30 additional communities, at least 15 of which were served by only one
carrier and are now receiving federallysubsidized service under the
Essential Air Service (EAS) program. 13

Some carriers are modifying their *hub and spoke* systems. American is
spreading flights out more evenly throughout the day instead operating
many flights during peak periods. American began this effort in Chicago
and has announced that it would expand its *de- peaking* efforts to its
largest hub at Dallas/ Fort Worth beginning November 2002. American
officials stated that these changes would increase the productivity of
labor and improve the efficiency of gate and aircraft use. Delta officials
said they are also taking steps to spread flights more evenly throughout
the day.

12 Under 49 USC 41734, carriers must file a notice with DOT of their
intent to suspend service, and DOT is compelled by statute to require
those carriers to continue serving those communities for a 90- day period.

13 The EAS program, established as part of the Airline Deregulation Act of
1978, guaranteed that communities served by air carriers before
deregulation would continue to receive a certain level of scheduled air
service, with special provisions for Alaskan communities. As of July 1,
2002, the EAS program provided subsidies to air carriers to serve 114
communities.

Page 10 GAO- 03- 171T Airline Financial Condition

Beyond the steps individual carriers are taking to restructure and cut
costs, some carriers are proposing to join forces through marketing and
codesharing alliances in order to increase revenues. Under these proposed
alliances, carriers would sell seats on each other*s flights, and
passengers would accrue frequent flyer miles. Company officials stated
that the carriers would remain independent competitors with separate
schedules, pricing, and sales functions. On July 24, 2002, United and US
Airways announced a proposed codesharing alliance to broaden the scope of
their networks and potentially stimulate demand for travel. United and US
Airways estimated that the alliance would provide more than $200 million
in annual revenue for each carrier. One month later, Northwest announced
that it had signed a similar agreement with Continental and Delta.
According to Northwest, this agreement builds on the alliance between
Northwest and Continental that had been in existence since January 1999.
These alliances would expand both their domestic and international
networks. The Department of Transportation is currently reviewing these
proposals. 14

Because a financially healthy and competitive aviation industry is in the
national interest, and because carriers* and the federal government*s
efforts to address the current situation may affect consumers both
positively and negatively, Congress will be confronted with several major
public policy issues. These policy issues underscore the difficulties this
industry will encounter as it adapts to a new market environment. We are
highlighting three of these issues: the effect of airlines* current
financial situation, including new business costs, on industry health and
competition; the impact of reductions in service on federal programs
designed to protect service to small communities, and international
developments that may further affect the domestic industry.

 How will the carriers* reactions to current financial pressures affect
the industry*s competitive landscape? There is a new aviation business
reality that has increased the airlines* financial pressures and which
ultimately will be felt by U. S. consumers. Increased federal security
requirements, which are part of this new reality, are adding to the cost
of

14 DOT is authorized under 49 U. S. C. 41712 to block the airlines from
implementing their agreements, if it determines that the agreements*
implementation would be an unfair or deceptive practice or unfair method
of competition. Such a determination is analogous to the review of major
mergers and acquisitions conducted by the Justice Department and the
Federal Trade Commission under the Hart- Scott- Rodino Act, 15 U. S. C.
18a. Critical Public Policy

Issues Are Associated With the Industry*s Changing Competitive Landscape

Page 11 GAO- 03- 171T Airline Financial Condition

competing in the industry. The cost of these policies will most likely be
borne both by industry, through higher operational costs, and the
consumer, through higher fares. In the current pricing environment,
carriers may not be able to pass on these costs to consumers, and thus may
be bearing their full impact during the short run. On the other hand,
these same security requirements may be helping the airlines maintain some
of its passenger revenue; some portion of the airlines* current passengers
may be flying only as a result of knowing that these heightened security
requirements are in place. Thus, the question arises about the net impact
of the new market environment and new security requirements on the
carriers and their passengers while the industry restructures. While
understandable from the perspective of an individual airline*s bottom
line, the restructuring activities of individual carriers will
significantly change the competitive landscape. When carriers decrease
available capacity in a market by reducing the number of flights,
decreasing the size of aircraft used to meet reduced demand, or dropping
markets altogether, the net result is that consumers have fewer options.
In doing so, airlines reduce the amount of competition in those markets.
As has been shown repeatedly, less competition generally leads to higher
fares in the long run.

A related issue concerns the industry*s consolidation, whether through
marketing alliances among or mergers between carriers. Because of the
potential that consolidation presents for competition, federal oversight
has been critical. As we have noted before, while alliances may offer
potential consumer benefits associated with expanded route networks, more
frequency options, improved connections, and frequent flyer benefits,
consolidation within the industry raises a number of critical public
policy issues. 15 These include increasing potential barriers to market
entry, the loss of competition in key markets, and a greater risk of
travel disruptions as a result of labor disputes. 16 Since these alliances
and mergers have a direct impact on the level of competition within the
airline industry and would therefore influence the affordability of air
travel to many consumers, these issues are still relevant.

15 Airline Competition: Issues Raised by Consolidation Proposals (GAO- 01-
402T), February 7, 2001. 16 GAO has recently initiated an analysis of
issues relating to airline industry labormanagement relations conducted
under the Railway Labor Act.

Page 12 GAO- 03- 171T Airline Financial Condition

 How will the federal government*s support of small community air service
be affected? The Congress has long recognized that many small communities
have difficulty attracting and maintaining scheduled air service. Now, as
airlines continue to reduce capacity, small communities will potentially
see even further reductions in service. This will increase the pressure on
the federal government to preserve and enhance air service to these
communities. There are two main programs that provide federal assistance
to small communities: the Essential Air Service (EAS) program, which
provides subsidies to commercial air carriers to serve the nation*s
smallest communities, and the Small Community Air Service Development
Pilot Program, which provides grants to small communities to enhance their
air service. 17

As we reported in August, the number of communities that qualify for EAS-
subsidized service has grown over the last year, and there are clear
indications that that number will continue to grow. Federal awards under
the program have increased from just over $40 million in 1999 to an
estimated $97 million in fiscal year 2002. 18 As carriers continue to drop
service in some markets, more communities will become eligible for
subsidized EAS service.

In 2002, nearly 180 communities requested over $142.5 million in grants
under the Small Community Air Service Development Pilot Program. DOT
awarded the total $20 million available to 40 communities in 38 states to
assist them in developing or enhancing their air service. The grants will
be used for a variety of programs, including financial incentives to
carriers to encourage either new or expanded air service, marketing
campaigns to educate travelers about local air service, and support of
alternative transportation. We are currently studying efforts to enhance
air service in small communities, and expect to report on these programs
early next year.

 How will future international developments affect established agreements
between the US and EU member states? There are a

17 Congress created the Small Community Air Service Development Pilot
Program under the Wendell H. Ford Aviation Investment and Reform Act for
the 21st Century (P. L. 106- 181). That act authorized $75 million over 3
years. DOT made no awards under the act in fiscal year 2001, because the
Congress did not appropriate any funds for the first year of the program
but $20 million was appropriated for fiscal year 2002.

18 Figures in constant 2002 dollars.

Page 13 GAO- 03- 171T Airline Financial Condition

number of international issues that will influence the domestic aviation
industry*s attempts to recover from financial losses. The European Court
of Justice is expected to reach a decision in the near future on the
authority of individual European Union nations to negotiate bilateral
agreements. This could raise uncertainties over the status of *open skies*
agreements 19 that the United States has signed with individual European
Union nations. This is especially critical with regard to negotiating an
open skies agreement with the United Kingdom, our largest aviation trading
partner overseas. Because almost all of the major US carriers partner with
European airlines in worldwide alliances, this decision could potentially
impact the status of antitrust immunity for these alliances, which could
in turn affect alliances established with airlines serving the Pacific Rim
or Latin America. These alliances are key components of several major
airlines* networks and as such significantly affect their overall
financial status. Various studies have illustrated the benefits to both
consumers and carriers that flow from liberalizing aviation trade through
*open skies* agreements between the United States and other countries.

This concludes my statement. I would be pleased to answer any questions
you or other members of the Committee might have.

For further information on this testimony, please contract JayEtta Hecker
at (202) 512- 2834. Individuals making key contributions to this testimony
included Triana Bash, Carmen Donohue, Janet Frisch, Patty Hsieh, Steve
Martin, Tim Schindler, Sharon Silas, Pamela Vines, and Alwynne Wilbur.

19 *Open skies* agreements are bilateral air service agreements that
remove the vast majority of restrictions on how the airlines of the two
countries signing the agreement may operate between, behind, and beyond
gateways in their respective territories. DOT has successfully negotiated
open skies agreements with 56 governments, including many in Europe.
Contact and

Acknowledgement

Page 14 GAO- 03- 171T Airline Financial Condition

Network carriers Net income (loss) 2000 Net income (loss) 2001 Net income
(loss) 2002: 2Q

Alaska ($ 70,300,000) ($ 39,500,000) ($ 4,500,000) a America West
$7,679,000 ($ 147,871,000) ($ 366,759,000) b American $813,000,000 ($
1,762,000,000) ($ 1,070,000,000) c Continental $342,000,000 ($ 95,000,000)
($ 305,000,000) Delta $897,000,000 ($ 1,027,000,000) ($ 583,000,000)
Northwest $256,000,000 ($ 423,000,000) ($ 264,000,000) United $50,000,000
($ 2,145,000,000) ($ 850,000,000) d US Airways ($ 269,000,000) ($
2,117,000,000) ($ 517,000,000) e

Total $2,026,379,000 ($ 7,756,371,000) ($ 3,960,259,000) Low- fare
carriers Net income (loss) 2000 Net income (loss) 2001 Net income (loss)
2002: 2Q

AirTran $47,436,000 ($ 2,757,000) $2,027,000 f American Trans Air ($
15,699,000) ($ 81,885,000) ($ 53,518,000) g Frontier( 8) $54,868,000
$16,550,000 ($ 2,935,572) JetBlue - - $27,590,000 h Southwest $603,093,000
$511,147,000 $123,683,000 Vanguard ($ 26,031,626) ($ 30,914,459) ($
7,963,262) i

Total $663,666,374 $412,140,541 $88,883,166

Source: Airline annual reports and SEC filings. Notes: Unless otherwise
stated, 2002: Q2 data is for six (6) months ended 6/ 30/ 02. Spirit
Airline*s data is unavailable as it is a privately held concern. a Three
(3) months ended 6/ 30/ 02. Alaska Air Group, Inc.

b America West Holdings Corp. c AMR Corporation. d UAL Corporation. e US
Airways Group. f AirTran Holdings, Inc. g ATA Holdings, Inc. and
subsidiaries. Formerly Amtran, Inc. h Data reflects Frontier FY 2001 ended
3/ 31/ 01; FY 2002 ended 3/ 31/ 02; FY 2003: 1Q three (3) months ended 6/
30/ 02. i JetBlue Airways Corporation went public on 4/ 11/ 2002.

j Three (3) months ended 3/ 31/ 02. Filed Chapter 11 on 7/ 30/ 02.

Appendix I: Summary of Network and Lowfare Airlines* Financial Condition,
2000 * June 2002

Page 15 GAO- 03- 171T Airline Financial Condition

Network carriers 2000 2001 Percentage

change (2000- 2001)

2002 (Jan to May)

2001 (Jan to May)

Percentage change (Jan to May

2001- 2002)

Alaska 12,841,367 13,241,705 3.1% 5,067,518 5, 570,751 -9.0% America West
19,989,290 19,432,305 -2.8% 7, 506,559 8, 484,761 -11.5% American
69,431,436 62,661,131 -9.8% 31,772,755 27,156,822 17.0% Continental
37,118,040 35,085,749 -5.5% 13,445,688 15,311,743 -12.2% Delta 100,389,816
88,928,779 -11.4% 34,372,033 38,791,329 -11.4% Northwest 49,464,897
45,570,838 -7.9% 17,328,913 19,515,133 -11.2% United 73,757,167 65,259,307
-11.5% 22,852,094 28,424,896 -19.6% US Airways 58,035,050 53,806,153 -7.3%
19,428,304 24,287,301 -20.0%

Low- fare carriers 2000 2001 Percentage

change (2000- 2001)

2002 (Jan to May)

2001 (Jan to May)

Percentage change (Jan to May

2001- 2002)

AirTran 8, 014,274 8, 306,772 3. 6% 3, 868,744 3, 661,883 5. 6% American
Trans Air 6, 183,661 6, 856,076 10.9% 3,056,609 2, 938,045 4. 0% Frontier
3, 065,564 2, 907,611 -5.2% 1,468,583 1, 329,633 10.5% JetBlue 1, 147,761
3, 118,096 171.7% 2,055,962 1, 131,841 81.6% Southwest 82,170,284
82,234,829 0. 1% 32,570,332 34,679,716 -6.1% Spirit 2,817,734 3, 290,277
16.8% 1,443,537 1, 537,719 -6.1% Vanguard 1, 880,257 1, 421,062 -24.4%
664,479 587,492 13.1%

Source: GAO analysis of data from BACK Aviation Solutions.

Appendix II: Summary of Network and Lowfare Carrier Enplanements, 2000-
2002 (January to May)

Page 16 GAO- 03- 171T Airline Financial Condition

Options to Enhance the Long- term Viability of the Essential Air Service
Program. GAO- 02- 997R. Washington, D. C.: August 30, 2002.

Commercial Aviation: Air Service Trends At Small Communities Since October
2000. GAO- 02- 432. Washington, D. C.: March 29, 2002.

Proposed Alliance Between American Airlines and British Airways Raises
Competition Concerns and Public Interest Issues. GAO- 02- 293R.
Washington, D. C.: December 21, 2001

*State of the U. S. Commercial Airlines Industry and Possible Issues for
Congressional Consideration*, Speech by Comptroller General of the United
States David Walker. The International Aviation Club of Washington:
November 28, 2001.

Financial Management: Assessment of the Airline Industry*s Estimated
Losses Arising From the Events of September 11. GAO- 02- 133R. Washington,
D. C.: October 5, 2001.

Commercial Aviation: A Framework for Considering Federal Financial
Assistance. GAO- 01- 1163T. Washington, D. C.: September 20, 2001.

Aviation Competition: Restricting Airline Ticketing Rules Unlikely to Help
Consumers. GAO- 01- 831. Washington, D. C.: July 31, 2001.

Aviation Competition: Challenges in Enhancing Competition in Dominated
Markets. GAO- 01- 518T. Washington, D. C.: March 13, 2001.

Aviation Competition: Regional Jet Service Yet to Reach Many Small
Communities. GAO- 01- 344. Washington, D. C.: February 14, 2001.

Airline Competition: Issues Raised by Consolidation Proposals. GAO- 01-
402T. Washington, D. C.: February 7, 2001.

Aviation Competition: Issues Related to the Proposed United Airlines- US
Airways Merger. GAO- 01- 212. Washington, D. C.: December 15, 2000.

Essential Air Service: Changes in Subsidy Levels, Air Carrier Costs, and
Passenger Traffic. RCED- 00- 34. Washington, D. C.: April 14, 2000.

Aviation Competition: Effects on Consumers from Domestic Airline Alliances
Vary RCED- 99- 37. Washington, D. C.: January 15, 1999. Related GAO
Products

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