Airline Competition: Cargo Airline Has Enhanced Competition in Hawaii but
Faces an Uncertain Future (Letter Report, 06/18/98, GAO/RCED-98-156).

Pursuant to a congressional request, GAO reviewed the basis for the
Federal Aviation Administration's (FAA) revision of its interpretation
of turnaround service in Hawaii, focusing on determining how American
International Cargo's (AIC) November 1995 entry into the Hawaiian
inter-island air cargo market with relatively noisy Stage 2 aircraft has
affected--and how its potential future exit could affect--competition in
Hawaii's air cargo markets.

GAO noted that: (1) in May 1995, FAA determined that one segment of a
flight AIC had been operating in November 1990 with a single Stage 2
aircraft included a takeoff and a landing in Hawaii and that it
therefore qualified as inter-island turnaround service; (2)
consequently, FAA concluded that, under the Airport Noise and Capacity
Act, AIC could legally initiate scheduled inter-island service using its
single Stage 2 aircraft; (3) however, after a formal inquiry from Aloha
Airlines and a broader assessment of the legislation's intent, FAA
revised its interpretation of turnaround service; (4) this revised
decision held that the flight AIC was operating in November 1990 did not
constitute turnaround service because it included points outside Hawaii;
(5) GAO's review of relevant legislation and the legislative history
found FAA's revised interpretation to be legally sound; (6) in
particular, the flight that AIC conducted at the time the federal noise
legislation was passed does not qualify as turnaround service--defined
in a 1991 amendment as consisting of the operation of a flight between
two or more points, all of which are within the state of Hawaii--and
therefore does not render the airline exempt from statutory noise
requirements; (7) AIC's November 1995 entry into Hawaii's inter-island
markets has enhanced competition markedly by providing new services to a
variety of customers; (8) for instance, since that date, AIC has offered
scheduled daytime flights using large cargo containers--a service that
its competitors do not offer; (9) this service has facilitated the
delivery of time-sensitive express cargo and has helped to create new
mainland markets for some of Hawaii's agricultural producers, who
previously had to rely on ocean transportation; (10) in addition,
although the airlines and their customers could not provide GAO with
sufficient data to determine AIC's overall impact on rates, anecdotal
information indicates that the company has introduced some price
competition into inter-island markets; (11) consequently, while there
could be a discernable effect on the breadth of services provided if AIC
exits Hawaii's inter-island markets after September 30, 1998, the extent
to which rates might increase remains unclear; (12) AIC told GAO that it
wishes to continue serving Hawaii's inter-island markets after this
date; and (13) however, absent federal legislation extending AIC's right
to use Stage 2 aircraft, the airline will need to use Stage 3 aircraft
to remain in these markets.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  RCED-98-156
     TITLE:  Airline Competition: Cargo Airline Has Enhanced Competition 
             in Hawaii but Faces an Uncertain Future
      DATE:  06/18/98
   SUBJECT:  Airline industry
             Airline regulation
             Air transportation operations
             Aircraft engines
             Interstate commerce
             Competition
             Transportation costs
             Noise pollution control
IDENTIFIER:  Hawaii
             DC-8 Aircraft
             Boeing 737 Aircraft
             Boeing 727 Aircraft
             Honolulu International Airport (HI)
             Honolulu (HI)
             Hilo (HI)
             Maui (HI)
             Kaui (HI)
             Kona (HI)
             Oahu (HI)
             
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Cover
================================================================ COVER


Report to the Honorable
John McCain, U.S.  Senate

June 1998

AIRLINE COMPETITION - CARGO
AIRLINE HAS ENHANCED COMPETITION
IN HAWAII BUT FACES AN UNCERTAIN
FUTURE

GAO/RCED-98-156

Airline Competition

(348039)


Abbreviations
=============================================================== ABBREV

  AIC -
  AIA -
  USPS -
  FAA -
  DOT -

Letter
=============================================================== LETTER


B-277484

June 18, 1998

The Honorable John McCain
United States Senate

Dear Senator McCain: 

The transport of cargo throughout Hawaii is greatly affected by the
state's unique geography.  Because Hawaii comprises eight major
islands remote from the U.S.  mainland, many cargo customers must
rely on air service as the only way to transport their goods in a
timely fashion.  Historically, two airlines--Aloha Airlines and
Hawaiian Airlines--have provided service to meet this need.  Under an
exemption from provisions of the Airport Noise and Capacity Act,
these two airlines are permitted to operate an interisland
"turnaround" service (i.e., flights within Hawaii) with relatively
noisy "Stage 2" aircraft, which are being phased out on the
mainland.\1 Specifically, airlines that were providing turnaround
service with Stage 2 aircraft when the act was passed in November
1990 are allowed to continue to do so. 

In May 1995, the Federal Aviation Administration (FAA) determined
that American International Cargo (AIC)\2 also qualified on the basis
of its November 1990 operations, in which it provided what FAA deemed
turnaround service in Hawaii--and "onward" service to the U.S. 
mainland--with a McDonnell-Douglas DC-8 Stage 2 aircraft.  In
November 1995, this airline began to conduct scheduled interisland
cargo service consistent with FAA's decision.  Shortly thereafter, in
a reinterpretation of its 1995 decision, FAA concluded that AIC did
not qualify to continue providing such service.  FAA's revised
interpretation required AIC either to begin operating quieter, Stage
3, aircraft on interisland routes or to exit these markets entirely. 
Converting an aircraft for Stage 3 operations typically costs an
airline $1.5 million per engine.  Legislation enacted in October 1996
allowed AIC to continue serving Hawaii's interisland markets with one
Stage 2 aircraft through September 30, 1998.  To help prepare the
Congress to reexamine the issue as the deadline approaches, you asked
us to determine on what basis FAA revised its interpretation of
turnaround service.  You also asked us to determine how AIC's
November 1995 entry has affected--and how its potential future exit
could affect--competition in Hawaii's air cargo markets. 


--------------------
\1 Under 49 U.S.C.  44715, the Federal Aviation Administration has
issued regulations defining three classes of aircraft in terms of
their noise levels.  Aircraft certified before 1969 that do not meet
the noise standards issued in that year are classified as Stage 1
aircraft (e.g., early model Boeing 707s and McDonnell-Douglas DC-8s). 
Aircraft meeting the 1969 standards (e.g., most Boeing 727s and
DC-9s) are known as Stage 2 aircraft.  Aircraft complying with more
stringent standards issued in 1977 (e.g., Boeing 757s and MD-80s) are
classified as Stage 3 aircraft. 

\2 AIC is a subsidiary of American International Airways (AIA), based
in Ypsilanti, Michigan.  In August 1997, Kitty Hawk, Inc., of Dallas,
Texas, purchased AIA and its subsidiaries, including AIC. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

In May 1995, FAA determined that one segment of a flight American
International Cargo had been operating in November 1990 with a single
Stage 2 aircraft included a takeoff and a landing in Hawaii and that
it therefore qualified as interisland turnaround service. 
Consequently, FAA concluded that, under the Airport Noise and
Capacity Act, American International Cargo could legally initiate
scheduled interisland service using its single Stage 2 aircraft. 
However, after a formal inquiry from Aloha Airlines and a broader
assessment of the legislation's intent, FAA revised its
interpretation of turnaround service.  This revised decision held
that the flight American International Cargo was operating in
November 1990 did not constitute turnaround service because it
included points outside Hawaii.  Our review of relevant legislation
and the legislative history found FAA's revised interpretation to be
legally sound.  In particular, the flight that American International
Cargo conducted at the time the federal noise legislation was passed
does not qualify as turnaround service--defined in a 1991 amendment
as consisting of the operation of a flight between "two or more
points, all of which are within the state of Hawaii"--and therefore
does not render the airline exempt from statutory noise requirements. 

American International Cargo's November 1995 entry into Hawaii's
interisland markets has enhanced competition markedly by providing
new services to a variety of customers.  For instance, since that
date, American International Cargo has offered scheduled daytime
flights using large cargo containers--a service that its competitors
do not offer.  This service has facilitated the delivery of
time-sensitive "express" cargo and has helped to create new mainland
markets for some of Hawaii's agricultural producers, who previously
had to rely on ocean transportation.  In addition, although the
airlines and their customers could not provide us with sufficient
data to determine American International Cargo's overall impact on
rates, anecdotal information indicates that the company has
introduced some price competition into interisland markets. 
Consequently, while there could be a discernible effect on the
breadth of services provided if American International Cargo exits
Hawaii's interisland markets after September 30, 1998, the extent to
which rates might increase remains unclear.  American International
Cargo told us that it wishes to continue serving Hawaii's interisland
markets after this date.  However, absent federal legislation
extending American International Cargo's right to use Stage 2
aircraft, the airline will need to use Stage 3 aircraft to remain in
these markets. 


   BACKGROUND
------------------------------------------------------------ Letter :2

As a grouping of eight major islands located near the center of the
Pacific Ocean, Hawaii has a geography that bears significantly on the
manner in which goods and people can move throughout the state.  In
addition, Hawaii's relative lack of industry means that most finished
goods must be imported from the mainland.  Unlike much of the
mainland--where transport relies on air, sea, rail, and
highway--Hawaii must rely primarily on the first two means.  For
cargo customers, air shipment is the faster and more expensive
option, and sea transport is the slower but less expensive option. 
Most cargo for which the speed of delivery is not critical moves by
sea, both among the islands and between Hawaii and the mainland. 
However, other goods--particularly, perishable produce, mail, and
time-sensitive items--move by air. 

The bulk of interisland cargo shipments moves among four
islands--Oahu, Maui, Kauai, and the "Big Island" of Hawaii. 
Honolulu, Oahu's urban center, is the largest city in the islands and
the center of the state's economic activity.  Its airport, Honolulu
International, is by far the busiest in the state.  The island of
Hawaii, the state's second most populous, has two key airports, at
Kona and Hilo, which serve distinct economic regions.  The airport at
Kona supports an active tourism trade and offers direct flights to
the mainland.  By contrast, the airport at Hilo supports no direct
flights to the mainland but serves as a key distribution point for
tropical plants and flowers, the cultivation of which is becoming
increasingly important to Hawaii's economy.  The islands of Maui and
Kauai also support scheduled commercial jet service.  Figure 1 shows
the major Hawaiian islands, their key communities, and their
scheduled air cargo service; table 1 summarizes key operating
statistics for Hawaii's airports. 

   Figure 1:  Hawaii's Major
   Islands, Commercial Airports,
   and Scheduled Air Cargo Service

   (See figure in printed
   edition.)

   Source:  GAO's analysis of data
   from AIC, Aloha Airlines, and
   Hawaiian Airlines.

   (See figure in printed
   edition.)



                                Table 1
                
                     Aircraft Departures, Number of
                 Passengers, and Cargo Volume for Major
                         Hawaii Airports, 1997

                                                             Volume of
                                  Aircraft     Number of     cargo (in
Airport (Island)                departures    passengers       tons)\a
----------------------------  ------------  ------------  ------------
Honolulu (Oahu)                     82,438     8,938,773       219,840
Kahului (Maui)                      29,474     2,548,939        18,500
Kona (Hawaii)                       15,872     1,204,260        11,490
Hilo (Hawaii)                       11,847       779,302        18,634
Lihue (Kauai)                       16,250     1,186,391         4,774
----------------------------------------------------------------------
\a Volume includes cargo shipped among Hawaii's islands, as well as
to destinations outside the state. 

Source:  DOT. 

Prior to AIC's November 1995 entry into scheduled interisland
service,\3 Aloha Airlines and Hawaiian Airlines were the chief
providers of air cargo transport throughout the state.  Aloha began
its service to Hawaii's "outerisland" residential and commercial
centers in 1946.  In addition to over 180 daily jet flights among
Oahu, Maui, Kauai, and the Big Island of Hawaii, Aloha operates a
nighttime cargo service using some passenger aircraft with the seats
removed.  Aloha also operates an "Aloha Island Air" service using
small propeller-driven aircraft to reach remote rural areas. 
Hawaiian Airlines, for its part, has provided air service among the
islands since 1929.  Hawaiian's cargo service is conducted in
conjunction with its passenger service; all cargo is carried below
deck on more than 150 daily flights among the state's major
communities. 


--------------------
\3 From April 1990 until February 1991, AIC operated a cargo service
from Los Angeles through Honolulu and Hilo and back to Los Angeles. 
After a 6-month hiatus, AIC restarted its Los Angeles-Honolulu
roundtrip service in August 1991, with no onward segment to Hilo. 
Finally, in November 1995, AIC started serving Hilo from Honolulu on
a frequent, scheduled basis. 


   UNDER FAA'S REINTERPRETATION OF
   TURNAROUND SERVICE, AIC MUST
   USE STAGE 3 AIRCRAFT OR
   DISCONTINUE INTERISLAND
   OPERATIONS
------------------------------------------------------------ Letter :3

In 1990, the federal government acted to reduce aviation noise. 
Specifically, the Congress passed the Airport Noise and Capacity Act,
requiring the gradual phaseout on the U.S.  mainland of Stage 2
aircraft weighing over 75,000 pounds by December 31, 1999.\4 The law
did not cover any aircraft operations in Hawaii.  In October 1991,
the act was amended in part to require that no airline operate a
greater number of Stage 2 aircraft in the state of Hawaii than it had
operated on November 5, 1990, when the act was first passed.\5
According to the amendment's legislative history, this amendment was
included to ensure that Hawaii does not become a "dumping ground" for
Stage 2 aircraft as these aircraft are phased out on the mainland.\6

Thus, in order to use Stage 2 aircraft within Hawaii, an airline must
have provided turnaround service on November 5, 1990.  As
long-standing incumbents, Aloha Airlines and Hawaiian Airlines meet
this qualification and currently serve all major communities in
Hawaii using Stage 2 aircraft.  On May 25, 1995, in response to a
formal request from AIC, FAA determined that AIC also had provided
qualifying turnaround service during November 1990.  As described, in
November 1990, AIC was operating an air cargo service routed from Los
Angeles to Honolulu to Hilo and then back to Los Angeles.  In a
subsequent letter to AIC, FAA explained that because the airline's
service involved at least one takeoff-and-landing cycle in Hawaii,
the airline qualified to provide scheduled interisland service with
Stage 2 aircraft between Honolulu and Hilo. 

However, in May 1996, FAA issued a revised interpretation of
turnaround service.  Earlier, in February 1996, FAA had received a
complaint from Aloha Airlines in which this airline challenged AIC's
legal right to operate scheduled interisland service with Stage 2
aircraft in Hawaii.  According to an FAA attorney, the agency
reexamined its position on turnaround service because of comments
submitted as part of a related rulemaking action begun on May 11,
1995.  In its reinterpretation, FAA quoted language from the 1991
amendment's legislative history, which described turnaround service
as "local flights between two Hawaii cities and/or counties which
also serve as the origin and destination.  .  .  ." FAA cited further
language from the legislative history, emphasizing that the 1991
amendment was designed to "ensure that Hawaii does not become a
dumping ground for Stage 2 aircraft.  .  .  ." On the basis of these
statements, FAA concluded that the Congress had intended to preclude
an airline from flying an aircraft from the mainland to Hawaii, and
then flying that same aircraft between two points in Hawaii in order
to qualify the latter segment as turnaround service. 

Although AIC argued to FAA that one takeoff and one landing
constituted a flight, under the 1991 amendment a flight qualifying as
turnaround service consists of operation among "two or more points,
all of which are within the state of Hawaii." Thus, the 1991
provision clearly contemplates that such a flight may consist of more
than one takeoff and one landing.  There is no indication either in
the statute or in the legislative history that turnaround service may
include points outside of Hawaii.  The use of the word "local" in the
Senate report also supports the assertion that only points within
Hawaii may be considered to constitute turnaround service. 

According to AIC, the procompetition mandates of the Federal Aviation
Act, as well as other public policy encouraging competition in air
transportation, should also bear on any legal interpretation of
turnaround service.  AIC has maintained that two sections of the
Airport Noise and Capacity Act direct the Secretary of Transportation
to consider various competitive impacts of the requirements to phase
out Stage 2 aircraft.\7 However, these sections are not relevant for
operations in Hawaii because the noise legislation's mandatory
phaseout of Stage 2 aircraft applies only in the contiguous 48 states
on the U.S.  mainland. 

As a result, from our own review of the statutory provision set forth
in the act's 1991 amendment and the relevant Senate committee report,
we found that FAA's most recent interpretation of the law is correct. 
We believe that a route from Los Angeles to two points in Hawaii and
back to Los Angeles does not qualify as turnaround service within the
meaning of the 1991 amendment.  Because AIC did not provide
turnaround service at the time the Airport Noise and Capacity Act was
passed, under an October 1996 amendment it must either cease serving
Hawaii's interisland cargo markets after September 30, 1998, or
provide service with Stage 3 aircraft, as a company official has
indicated it may do.  Alternatively, the Congress could pass
legislation temporarily extending AIC's right to operate Stage 2
aircraft, which would allow the airline to continue interisland
service without modifying the single aircraft that provides it. 


--------------------
\4 49 U.S.C.  47528. 

\5 49 U.S.C.  47528(e). 

\6 Senate Report No.  102-148 at p.  57 (1991). 

\7 49 U.S.C.  47528(b)(2) and 47528(c). 


   AIC'S ENTRY INTO INTERISLAND
   MARKETS HAS ENHANCED
   COMPETITION
------------------------------------------------------------ Letter :4

AIC's November 1995 entry has enhanced competition in Hawaii's
interisland air cargo markets, most markedly by offering new service
options for some customers.  For example, executives with a
small-package delivery firm and a freight forwarding company told us
that they have benefited primarily because AIC provides them with a
daytime all-cargo service and convenient connections to the mainland. 
Additionally, many Big Island agricultural producers with whom we
spoke consider certain specialized features of AIC's service--such as
its ability to handle large shipping containers and its ability to
refrigerate cargo at Honolulu International Airport--as crucial to
their immediate and long-term needs. 

We also found that many customers consider each of the three
competing airlines' interisland cargo rates when making shipping
decisions but that they seldom select an airline on the basis of rate
considerations alone.  Three customers told us that they had observed
a price decrease during the past 2 years and that they attribute this
to AIC's presence in interisland markets.  We could not obtain
sufficient data to draw broad, marketwide conclusions about the
airline's effect on interisland rates.  Nevertheless, if AIC exits
from interisland markets, the breadth of services provided would
decrease discernibly unless one or more airlines were to initiate
similar service. 


      AIC HAS BECOME THE
      SECOND-LARGEST AIRLINE
      SERVING HAWAII'S AIR CARGO
      MARKETS
---------------------------------------------------------- Letter :4.1

Since November 1995, when AIC began providing scheduled interisland
cargo service, it has acquired nearly one-fifth of the total market. 
According to data from Hawaii's Department of Transportation, this
made AIC the second-largest cargo airline in the state during 1997,
in terms of the volume of cargo shipped.  AIC has achieved this rapid
growth primarily by using one cargo-dedicated Boeing 727 aircraft.\8
Although the B-727's fuselage has virtually the same circumference as
that of the Boeing 737s used by Aloha Airlines, the AIC aircraft's
interior space is larger because, as a cargo aircraft, it contains no
overhead luggage bins.  Consequently, AIC's aircraft can accommodate
the same basic type of cargo container used by Aloha and can also
carry taller containers.  At the time of our study, AIC provided
twice-daily service to Maui, Kona, and Hilo--once during the day and
once at night--with onward connections to the mainland. 

Some of AIC's growth represents the provision of entirely new air
transportation services.  For example, some customers who had
previously shipped by sea are now shipping by air with AIC.  Another
portion of AIC's growth has occurred at the expense of Aloha and
Hawaiian.  Figure 2 shows cargo being unloaded from AIC's B-727 at
Honolulu International Airport.  Figure 3 shows the three airlines'
volume of cargo shipped and their respective market shares. 

   Figure 2:  AIC's Cargo Is
   Unloaded From Its Boeing 727
   Aircraft

   (See figure in printed
   edition.)

   Figure 3:  Changes in Hawaii's
   Interisland Air Cargo Markets,
   1995-97

   (See figure in printed
   edition.)

   Notes:  Data on U.S.  passenger
   airlines' interisland
   operations were unavailable for
   1995-97.

   (See figure in printed
   edition.)

   Others include several small
   cargo airlines providing
   service among the islands using
   propeller-driven aircraft.

   (See figure in printed
   edition.)

   Figures sometimes do not add to
   the total because of rounding.

   (See figure in printed
   edition.)

   Source:  GAO's analysis of data
   from Hawaii's Department of
   Transportation.

   (See figure in printed
   edition.)

Between 1995 and 1997, Aloha Airlines was the dominant cargo airline
in Hawaii's interisland markets.  As shown in figure 3, in 1997 Aloha
was estimated to have carried over 3.5 times the cargo volume that
AIC carried.  None of the B-737 aircraft that Aloha uses to carry
interisland cargo is permanently dedicated to cargo service; instead,
Aloha reconfigures five aircraft nightly by removing the passenger
seats.  This activity, which takes about 15 minutes per aircraft, is
reversed each morning.  However, Aloha cannot remove the overhead
luggage bins, thus somewhat limiting the height of cargo containers
that its aircraft will hold.  Aloha uses its "quick-change" aircraft
extensively throughout the night, operating multiple flights into and
out of Kona, Hilo, Maui, and Kauai.  For example, Aloha makes five
nightly roundtrips between Honolulu and Maui and four nightly
roundtrips between Honolulu and Kona.  Figure 4 shows Aloha employees
moving cargo into one of its five quick-change B-737s. 

   Figure 4:  Aloha Airlines
   Carries Cargo Using Boeing 737s
   Converted From Passenger
   Service to Cargo Service

   (See figure in printed
   edition.)


Hawaiian Airlines, which in 1995 was the state's second-largest cargo
airline, has carried a decreasing total cargo volume since then, as
have several smaller airlines.\9 Hawaiian provides no service
dedicated solely to cargo.  Rather, Hawaiian offers cargo customers
the opportunity to ship their items in the belly of its daytime DC-9
passenger flights.  The relatively small space available in the belly
of these aircraft limits the size and weight of cargo that can be
shipped, and passengers' luggage and the U.S.  mail must take
priority over other types of belly cargo.  Hawaiian also operates to
4 destinations on the mainland, and another 13 destinations via
marketing agreements with other airlines.  Finally, several major
U.S.  airlines--including American Airlines, Delta Air Lines, United
Airlines, and United Parcel Service (UPS)--also carried interisland
cargo during part or all of the 1995-97 period, but did not report
data to the state of Hawaii.  Figure 5 shows cargo being loaded into
the belly of one of Hawaiian's aircraft. 

   Figure 5:  Hawaiian Airlines
   Carries Cargo in the Belly of
   Its DC-9s

   (See figure in printed
   edition.)

   Source:  Hawaiian Airlines.

   (See figure in printed
   edition.)


--------------------
\8 Although the law allows AIC to maintain an aircraft in reserve for
interisland service, AIC officials told us that after Kitty Hawk,
Inc., bought AIC in 1997, the parent company moved that aircraft out
of Hawaii. 

\9 In general, these other airlines--such as Corporate Air, Genavco,
and Trans Air--have operated smaller commuter aircraft that serve
outerisland airports, which cannot accommodate larger jet aircraft. 
Most of these companies' small aircraft are equipped with engines
that do not produce significant amounts of noise. 


      AIC HAS EXPANDED SHIPPING
      OPTIONS AND HAS OPENED NEW
      MARKETS FOR AGRICULTURAL
      PRODUCERS, BUT MANY
      CUSTOMERS STILL PREFER
      COMPETITORS' SERVICES
---------------------------------------------------------- Letter :4.2

Small-package delivery companies and freight forwarders have
benefited from AIC's presence in interisland markets because the
airline provides new services that have increased the customers'
shipping options.  A senior official with FedEx, which alone accounts
for half of AIC's customer base, told us that it contracts with AIC
primarily because the airline provides convenient daytime departures
to key outerisland destinations.  According to the official, this
daytime service is crucial to satisfying FedEx's overriding need,
which is to guarantee on-time delivery for its customers at certain
key points during a business day.  Additionally, several freight
forwarders that transport cargo among the islands confirmed that
AIC's daytime service and convenient mainland connections are key to
meeting their own needs.  For example, a senior official with a
forwarder that arranges for cargo transport from the mainland,
through Honolulu, to key outerisland destinations explained that
AIC's presence provides the company with greater choice than would
otherwise be the case.  An additional forwarder mentioned that AIC's
focus on cargo service encourages more careful handling of cargo than
is the case with competing airlines.  Finally, several customers
expressed satisfaction that, because AIC operates an all-cargo
service, none of their freight will get "bumped" in favor of
passengers' needs. 

AIC's all-cargo service is also expanding the number of mainland
markets in which Big Island agricultural producers can offer their
large tropical plants for sale.  AIC's service has accomplished this
by decreasing the transport time from 10 days to less than 1 day,
allowing plants to arrive fresh at their destinations.  Alternative
air transportation is not a viable option because no competing
airline accommodates the size of container necessary to ship these
plants properly.  Prior to AIC's entry, cultivators of tropical
plants relied on ships for the trans-Pacific voyage to California. 
After the 10-day voyage, the plants had to be "refreshed" at a
greenhouse, at substantial additional cost.  Typically, even with
this care, the plants could not be fully restored to their original
condition and therefore could not sustain additional transport to
markets on the East Coast or elsewhere on the mainland.  By contrast,
a 12-hour voyage by air eliminates the need for such greenhousing. 
Sealed at Hilo for shipment to the mainland, the plants arrive at Los
Angeles International Airport in nearly original condition.  This
allows the farmers to sell them at any mainland location at a price
commensurate with their original quality.  Big Island farmers also
cultivate a wide variety of tropical flowers for sale to mainland
florists.  In this case as well, AIC's Hilo to Los Angeles service
allows the flowers to arrive fresh and to be shipped onward from Los
Angeles to any U.S.  destination in a timely manner.  The president
of the Hawaii Florists' & Shippers' Association told us that members
of his organization prefer AIC's unique services, which include
refrigerated storage in Honolulu and ï¿½seamlessï¿½ connections to the
mainland, offered jointly with FedEx. 

Nevertheless, other air cargo customers, including national
small-package delivery companies, local freight forwarders, and at
least one bakery need not make use of the larger container used
exclusively by AIC.  In their cases, a variety of alternative
considerations is more important.  Several company executives whom we
interviewed cited successful sustained business relationships with
Aloha and Hawaiian but also explained that these two incumbents offer
both a frequency and quality of service that AIC has not yet
demonstrated.  According to the president of a local bakery, Aloha's
frequent nighttime flights and its effective backup strategies in the
event of an aircraft's mechanical breakdown are persuasive reasons to
continue signing long-term contracts with this airline.  The bakery
president stated that his company's credibility with consumers
depends entirely on the distribution of his baked goods every
morning.  Only Aloha, he said, currently maintains an ability to
deliver his appreciable amount of cargo on time daily, with few
delays.  In addition, according to two freight forwarders with whom
we spoke, Aloha's consistency in following up on damage claims is a
similarly compelling reason to select the airline's interisland
service. 

Finally, for some customers, the business relationships that they
have maintained with Aloha and Hawaiian during more than five decades
of interisland service are more important than the new services that
AIC has begun to offer.  According to one senior state official, the
uniqueness of Hawaii's remote island geography creates a situation in
which customers throughout a variety of local industries place high
value on long-term market presence.  For these customers, this
consideration may take precedence over an immediate economic benefit,
such as a lower interisland cargo rate or a new service feature. 
These customers know that, in Hawaii, air service is essential to
their business, and they are therefore inclined to contract with
long-serving incumbents that have a proven ability to provide
frequent, consistent service.  Having recently witnessed the entry,
and subsequent exit, of several passenger airlines that also carry
cargo--including MidPacific Airlines, Discovery Airlines, and Mahalo
Air--these customers prefer the long-term stability of the two
largest incumbents. 


      CUSTOMERS' SERVICE NEEDS
      WEIGH HEAVILY IN THEIR
      CONSIDERATION OF RATES
---------------------------------------------------------- Letter :4.3

AIC's, Aloha's, and Hawaiian's primary types of
customers--small-package delivery firms, freight forwarders, and
agricultural producers--have distinct shipping needs.  The three
airlines have responded to these distinctions by pricing their cargo
services in a variety of ways.  For example, with small-package
delivery firms such as FedEx, UPS, and Airborne Express, the airlines
typically prenegotiate a standard set of interisland rates for an
established period of time.  By contrast, the airlines often
negotiate with freight forwarders to meet the forwarders' need to
move individual cargo shipments.  A forwarder often seeks the best
option available for a shipment of heavy cargo on the basis of which
airline can offer the best combination of a low rate, adequate space,
and a timely departure.  Finally, AIC typically works with the
agricultural producers to prenegotiate a "through-rate" from Hilo to
Los Angeles. 

The dissimilar nature of competing airlines' interisland
services--and customers' concerns about confidentiality--made broad
empirical conclusions about interisland rates impossible.  We
discussed rate considerations during 10 interviews with small-package
delivery firms, freight forwarders, the U.S.  Postal Service (USPS),
Big Island agricultural producers, and one bakery.  Also, as part of
a structured survey, we solicited rate data from USPS and 36 private
companies.  Because the rates charged for interisland cargo shipments
are negotiated privately between the customers and the airlines, many
customers cited the need to keep these data confidential and declined
to provide them to us; others explained that data searches would be
time-consuming or that they lacked historical records.  (See app.  I
for full details on our data-gathering efforts.)

Nevertheless, we discovered a recurring view about rates.  While
several of the customers we contacted considered rates to be an
important factor in their shipping decisions, they explained that
rates must only be viewed relative to the services provided and to
the extent to which an airline's performance meets their
expectations. 

For example, a manager for one small-package delivery firm explained
to us that, while the rates AIC charges his company are reasonable
and competitive, this is outweighed by its poor performance with
regard to its aircraft's availability:  In December 1997, he said,
AIC's only aircraft was out of service on several occasions for
mechanical reasons.  He added that he would not like to see AIC's
exit because this would likely encourage Aloha and Hawaiian to
increase their own rates.  Still, he explained, spotty reliability to
date has kept his company from selecting AIC as a long-term partner
and has kept AIC from bringing meaningful competitive pressure to
interisland markets as a whole. 

According to some freight forwarders whom we interviewed, AIC's
service is valuable primarily because it provides an additional
shipping option as they make daily decisions regarding how to move
individual shipments at a given price.  However, for one executive,
the additional option is meaningful only when AIC's rates are set
below those of its competitors. 

According to this executive, when AIC's and Aloha's rates are
comparable for a particular interisland shipment, he often selects
Aloha because it consistently arrives on time and always provides a
backup aircraft quickly in the event of a mechanical breakdown. 

One freight forwarder expressed a preference for the daytime
belly-cargo service offered by Hawaiian Airlines because this service
is typically priced far below all-cargo service.  Nevertheless, this
customer asserted, the most important factor is that an airline
retain its ability to offer timely, reliable delivery of its goods. 
Precisely because belly cargo can be bumped from a daytime
interisland passenger flight, some customers prefer Aloha's and AIC's
all-cargo services. 

For their part, many Big Island agricultural producers told us that
rates are important but emphasized that their primary concern is
retaining the "through-service" that AIC operates from Hilo to the
mainland.  Retaining this service, they said, outweighs rate
considerations.  An official with the Hawaii Export Nursery
Association confirmed the farmers' remarks and added that it is
impossible to compare the rates that AIC charges for its
through-service to the rates charged either for Aloha's nighttime
all-cargo service or for Hawaiian's belly-cargo service because all
of the services provided are so dissimilar. 


      AIC'S EXIT OR OTHER EMERGING
      TRENDS COULD CHANGE THE
      DYNAMICS OF THE INTERISLAND
      MARKETS
---------------------------------------------------------- Letter :4.4

Unless new legislation is enacted extending AIC's right to operate
Stage 2 aircraft, after September 30, 1998, AIC will have to serve
its interisland customers using aircraft powered by quieter engines. 
Alternatively, the airline may decide to exit interisland markets. 
If AIC takes such a step, there could be a discernible effect on a
variety of interisland customers.  AIC's exit would likely reduce the
types of services offered to customers.  The effect would probably be
more dramatic for agricultural producers than it would be for
customers in other industries, as Big Island farmers who have
contracted with AIC would lose the ability to sell their goods in a
variety of U.S.  mainland markets.  In remarks reflecting the
importance of agriculture to the state's economy, Hawaii's
agriculture secretary explained to us that, unless another airline
fills the void, AIC's exit from interisland markets would affect the
pace at which Hawaii recovers from the stagnant economic growth of
recent years.  The extent to which rates might increase in AIC's
absence remains unclear because there were only a few instances in
which we were able to determine the effect AIC's market presence has
had on rates.  As a result, it is possible only to speculate on the
extent to which the airline's exit would cause cargo rates to
increase, if at all, on a marketwide basis. 

Other emerging trends could also change the dynamics of Hawaii's
interisland air cargo markets.  Major U.S.  cargo airlines could
begin to provide scheduled interisland service using Stage 3
aircraft, in direct competition with Aloha's and AIC's all-cargo
services.  For instance, FedEx may decide to operate its own
interisland service, and could do so if greater volumes of
interisland cargo in future years were to make this service
cost-efficient.  Such a decision would likely lead FedEx to sign
fewer contracts with AIC for interisland service.  This would affect
AIC's economic fortunes, as the airline would lose the business of
tropical flower cultivators and other customers who must ship
time-sensitive items.  In addition, several major passenger airlines
could expand nonstop service from outerisland communities to the
mainland or initiate additional interisland cargo services. 
According to a state official with whom we spoke, several services
that are planned or proposed would affect incumbent airlines'
pricing, as well as the types of services that these airlines
continue to offer. 


   AGENCY COMMENTS
------------------------------------------------------------ Letter :5

We provided copies of a draft of this report to the Department of
Transportation (DOT) and the Federal Aviation Administration (FAA)
for their review and comment.  To obtain comments, we held
discussions with DOT and FAA officials, including DOT's Director,
Office of Aviation and International Economics, and the FAA staff
attorney responsible for the agency's interpretation of turnaround
service.  DOT and FAA generally agreed with the information in our
report and provided technical corrections, which were incorporated
into the report where appropriate. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :6

To determine the basis on which FAA revised its interpretation of
turnaround service, we obtained detailed legal positions prepared by
AIC, Aloha Airlines, and Hawaiian Airlines.  In Washington, D.C., we
met with attorneys for AIC and Aloha, as well as with the FAA
attorney responsible for drafting the agency's initial and revised
interpretations of turnaround service.  The FAA attorney provided us
with the agency's current position on whether AIC has the legal right
to operate interisland service after September 30, 1998, and with
documentation indicating how FAA's interpretation evolved over time. 

To determine the effect of AIC's entry on competition in Hawaii's
interisland air cargo markets, we prepared a structured survey to
solicit information pertaining both to the rates charged and to the
services provided.  However, we were unable to obtain sufficient rate
data from this survey to conduct a comprehensive marketwide analysis. 
We then conducted 17 personal interviews during January 1998 in
Hawaii.  In Honolulu, we met with AIC, Aloha, and Hawaiian;
interisland cargo customers; state officials responsible for
transportation, agriculture, justice, and natural resources policy;
and an independent private economist.  In Hilo, we met with
agricultural producers who cultivate tropical plants and flowers
destined primarily for U.S.  mainland markets.  See app.  I for a
complete description of our scope and methodology.  We conducted our
review from August 1997 through April 1998 in accordance with
generally accepted government auditing standards. 


---------------------------------------------------------- Letter :6.1

As arranged with your office, unless you publicly announce its
contents earlier, we plan no further distribution of this report
until 10 days after the date of this letter.  At that time, we will
send copies to the Secretary of Transportation; the Administrator,
FAA; the Director, Office of Management and Budget; and other
interested parties.  We will send copies to others upon request. 

If you have any questions, please call me at (202) 512-2834.  Major
contributors to this report are listed in app.  II. 

Sincerely yours,

John H.  Anderson, Jr.
Director, Transportation Issues


SCOPE AND METHODOLOGY
=========================================================== Appendix I

To gain perspectives on whether, legally, American International
Cargo (AIC) can continue to provide turnaround service, we obtained
detailed legal positions from AIC, Aloha Airlines, and Hawaiian
Airlines.  In Washington, D.C., we conducted personal and/or
telephone interviews with attorneys for AIC, Aloha, and the state of
Hawaii.  Also in Washington, we met with the Federal Aviation
Administration (FAA) attorney responsible for drafting the agency's
initial and revised interpretations of turnaround service.  The
attorney provided us with the agency's current position on whether
AIC has the legal right to operate interisland service after
September 30, 1998, and submitted documentation indicating how FAA's
interpretation has evolved over time. 

To gain a full understanding of the key factors affecting the
transport of air cargo throughout Hawaii, we solicited information
pertaining both to the rates charged and the services provided.  We
attempted to obtain data on rates charged for interisland service
during calendar years 1994, 1995, 1996, and 1997 (through October). 
Obtaining a substantial amount of empirical data from this 4-year
period would have permitted us to conduct a complete economic
analysis and to draw meaningful conclusions regarding the effect that
AIC's November 1995 entry may have had on the rates charged by all
airlines operating in the interisland markets.  However, we were
unable to obtain sufficient rate data to conduct such an analysis and
to draw such conclusions. 

We used two methods to gather information regarding the potential
effect of AIC's entry on interisland rates.  First, we sought data
from AIC, Aloha, and Hawaiian, which are the three airlines carrying
significant amounts of cargo throughout the state of Hawaii. 
Although AIC provided us with the basic rates that it charged its 20
largest customers during 1996, these data alone could not provide us
with the historical perspective necessary to draw meaningful
conclusions.  For a proper historical analysis of the rates charged
prior to AIC's entry as well as since its entry, we would have needed
to obtain similar data from other airlines and from these airlines'
customers.  Although Aloha provided us with cargo yields per pound
since 1993 and with a list of its key customers, neither Aloha nor
Hawaiian was able to share historical, customer-specific rate
information. 

Second, in a mailed survey, we solicited information from 37 of
AIC's, Aloha's, and Hawaiian's interisland customers.  These
customers included small-package delivery firms, freight forwarders,
and agricultural producers.  Thirty customers declined to provide us
with the level of detail that we needed, despite our pledge of
confidentiality.  Customers cited concerns ranging from
confidentiality clauses with airlines and the time-consuming nature
of data searches to the absence of historical records as reasons for
failing to provide the information.  Taken together, the level of
detail that we obtained was not sufficient to allow for meaningful
analysis of interisland air cargo rates.  Although we were unable to
collect sufficient data with regard to the rates paid, we were able
to use the survey as a means to identify candidates for structured
personal interviews conducted during January 1998. 

During January 1998, we conducted 17 structured interviews in order
to understand further the impact that AIC's entry may have had on
interisland air cargo markets.  In Honolulu, we met with officials
from AIC, Aloha, and Hawaiian, and we toured the airport facilities
of AIC and Aloha, observing both airlines' cargo operations there. 
Also in Honolulu, we interviewed several freight forwarding
companies; two national small-package delivery firms; officials from
Hawaii's departments of Transportation, Agriculture, Justice, and
Land & Natural Resources; an independent economist with the Bank of
Hawaii; an official of the U.S.  Postal Service; and a Delta Air
Lines cargo representative.  In Hilo, we met with a variety of
agricultural producers who cultivate tropical plants and flowers
destined primarily for mainland markets.  We also met with the
executive officers of two key agricultural associations--the Hawaii
Export Nursery Association and the Hawaii Shippers' and Florists'
Association.  We did not provide a pledge of confidentiality for
information obtained from personal or telephone interviews. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II

Aaron Casey
Alice Feldesman
David Hooper
Joseph Kile
Steve Martin
Marnie Shaul
John Skeen


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