Aviation Competition: Information on the Department of Transportation's
Proposed Policy (Letter Report, 07/29/1999, GAO/RCED-99-225).
The Department of Transportation (DOT) issued a proposed policy
statement last year designed to address unfair competitive practices by
major airlines against "new entrants"--new low-fare airlines that
entered their markets. DOT decided to develop its policy statement after
17 new entrant airlines complained that major airlines were unfairly
lowering their fares, boosting capacity on some routes, or both. Also,
DOT investigated two of the complaints and analyzed industrywide data on
pricing and capacity activities by major airlines. DOT's investigations
and analyses found possible unfair competitive practices by at least
five major airlines. DOT followed an informal process and began
developing the proposed policy statement in the summer of 1997. DOT did
not consider the policy to be a rule requiring notice and comment. DOT's
proposed policy statement generally addresses the complaints dealing
with price cuts or capacity increases that the Department received as
well as the practices that DOT identified in its investigations and
analyses of industrywide data. In addition, the proposed policy
describes practices that would trigger enforcement action.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: RCED-99-225
TITLE: Aviation Competition: Information on the Department of
Transportation's Proposed Policy
DATE: 07/29/1999
SUBJECT: Restrictive trade practices
Competition
Commercial aviation
Airline industry
Airline regulation
Agency proceedings
Reporting requirements
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United States General Accounting Office GAO Report
to the Chairman, Committee on the Budget, House of Representatives
July 1999 AVIATION COMPETITION Information on the
Department of Transportation's Proposed Policy GAO/RCED-99-225 GAO
United States General Accounting Office Washington, D.C. 20548
Resources, Community, and Economic Development Division B-281479
July 29, 1999 The Honorable John Kasich Chairman, Committee on the
Budget House of Representatives Dear Mr. Chairman: On April 6,
1998, the Department of Transportation (DOT) issued a proposed
policy statement designed to address unfair competitive practices
by major airlines against "new entrants"-new low-fare airlines
that entered their markets. You asked us to provide information on
the proposed policy to facilitate your review of the final policy,
which the Department is required to submit to the Congress before
implementing it. Specifically, we agreed to address the following:
(1) Why did DOT develop the proposed policy? (2) What process did
DOT use to develop the proposed policy? (3) Does the proposed
policy address the specific problems that led DOT to issue it?
Results in Brief DOT decided to develop its proposed policy
statement after receiving 17 complaints from new entrant airlines
alleging that major airlines were unfairly lowering their fares,
increasing capacity on certain routes, or both; investigating two
of those complaints; and analyzing industrywide data concerning
pricing and capacity activities by major airlines. DOT's
investigations and analyses indicated possible unfair competitive
practices by at least five major airlines. DOT concluded that the
best approach for addressing its concerns about this conduct was
to issue policy guidance on what, in its view, constituted unfair
competitive practices warranting departmental action. DOT did not
intend for the policy to discourage major airlines from competing
against new entrants; rather, it wanted to prevent extreme
behavior that was intended to drive a new entrant from a market.
By issuing the proposed policy, DOT expected to initiate a
national debate on the issues surrounding unfair competition. In
addition, DOT officials believed that this approach would help
with future enforcement regarding unfair competitive practices by
major airlines in response to new low-fare airlines. DOT followed
an informal process and began developing the proposed policy
statement in summer 1997. DOT did not consider the policy to be a
rule requiring notice and comment under the Administrative
Procedure Act. The act provides an exemption from certain
notification requirements Page 1
GAO/RCED-99-225 Aviation Competition Policy B-281479 when an
agency issues a general statement of policy. However, DOT
published the proposed policy in the Federal Register for public
notification and to obtain comments. DOT's proposed policy
statement generally addresses the complaints dealing with price
cuts or capacity increases that the Department received as well as
the practices that DOT identified in its investigations and
analyses of industrywide data. In addition, the proposed policy
described practices that would trigger enforcement action. The
policy described these practices as a major airline expanding its
capacity and selling a large number of seats at very low fares in
response to a low-fare airline entering its hub market. The
Department would consider such practices unfair competition if
they resulted in lower revenue for the major airline in the short
term than would result from a reasonable alternative strategy for
competing with a new entrant airline, such as matching the new
entrant's low fares on a limited basis and not significantly
increasing capacity. The Department received comments from several
major airlines and an industry trade association that questioned
the proposed policy's enforceability because of the vagueness of
the wording of critical elements. For example, the comments noted
that the proposed policy statement did not define "reasonable
alternative response," "very low fares," or "large number of
seats." DOT is revising the policy statement to address concerns
about vagueness as well as other comments. The Department expects
to issue the final policy statement in September 1999. Background
Deregulation of the airline industry in 1978 has led to lower
airfares and better service for most air travelers, largely
because of increased competition spurred by the entry of new
airlines into the industry and of established carriers into new
markets. In many markets, the entry of low-cost airlines, such as
Southwest, Vanguard, Spirit, AirTran, and Frontier, has resulted
in lower fares and better service. For example, according to DOT,
markets in which low-cost airlines compete with major airlines
have lower fares on average-often more than 50 percent lower-than
similar markets without such competition. In markets with low-fare
competition, matching the prices of this competition is generally
a reasonable response by major airlines. However, in recent years,
some low-cost airlines have complained that this behavior by major
airlines has not been reasonable and, instead, has been an attempt
to drive them out of certain markets. Page 2
GAO/RCED-99-225 Aviation Competition Policy B-281479 DOT has found
that recent trends indicate the level of competition may be
declining. The Department's data indicate that the number of
airline markets in the United States with two or more competitors
fell steadily from 1992 through 1996.1 The number of competitive
markets increased in 1997 to just over the 1995 level, but
remained below the levels established in 1992 and 1994. (See fig.
1.) Moreover, while the number of passengers benefiting from low-
fare competition grew steadily for years, the trend was reversed
in 1997, when both the number and percentage of passengers in
markets with low-fare competition declined. Figure 1: Number of
Markets With Two or More Competitors, 1992 Through Number of
markets 1997 14,000 13,000
12,000 11,000 1992 1994 1995 1996 1997 Note: The
Department was not able to provide us with data for 1993 or for
years prior to 1992. Source: U.S. Department of Transportation.
The aviation industry has several unique pricing and service
characteristics that set it apart from other industries and affect
how airlines compete. Airlines operate networks in which
passengers flying on the same segment of a flight may have
different origins or destinations. On any given flight segment,
typically there are passengers whose entire one-way trip is only
that segment (called "local traffic") and other passengers who are
connecting to or from other flights (called "flow traffic"). For
example, a flight from Washington, D.C., to Chicago would 1The
Department was not able to provide us with data for 1993 or years
prior to 1992. Page 3
GAO/RCED-99-225 Aviation Competition Policy B-281479 have
passengers traveling between the two cities as well as other
passengers who would connect to flights going to other cities.
Thus, when airlines set their prices for flights on a given
segment, they must be aware that if they sell too many tickets to
passengers traveling on only that segment, they risk supplanting a
passenger who could use that segment to fly on a more profitable
route. In addition, airlines charge different prices to different
passengers even when those passengers are flying to the same
place. For example, passengers traveling on short notice usually
pay more than passengers who are able to plan in advance.
Generally, the prices are set so that those passengers who require
the greatest flexibility pay the highest price and those who
require less flexibility pay lower prices. The airlines try to
fill as many seats as possible with passengers paying high fares.
However, rather than allowing seats to go unsold, the airlines
will sometimes sell unsold tickets at deep discounts to receive
some revenue from passengers who otherwise would not have taken
the flight. As a result, different passengers on any route or
flight segment may pay substantially different amounts for their
trips. Unique aspects of the air transportation industry allow
major airlines to respond quickly to competition with changes in
price and capacity. Using computerized reservation systems,
airlines can change their prices almost instantaneously as
competitive conditions change or as they manage the number of
seats remaining to be sold. Similarly, the number of seats
available on a particular route can change rapidly because
airlines can shift resources between markets much more readily
than firms in other industries. In response to market conditions,
an airline can increase its capacity on a route by increasing the
number of flights, the size of the aircraft, or both. The Proposed
Policy On April 6, 1998, DOT issued a proposed policy
statement regarding unfair Was Intended to exclusionary
conduct in the air transportation industry that was designed to
address unfair competitive practices by major airlines in response
to Address Unfair new entrant airlines that provide
competing service in the major airlines' Competitive Practices
hub airports.2 The proposed policy describes three practices that
would 2Specifically, the draft policy proposes that a major
airline is engaging in unfair exclusionary practices if, in
response to new entry into its hub markets, it pursues a strategy
of price cuts and/or capacity increases that either (1) causes it
to forgo more revenue than all of the new entrant's capacity could
have diverted from it or (2) results in substantially lower
operating profits-or greater operating losses-in the short run
than would result from a reasonable alternative strategy for
competing with the new entrant. The draft policy defines new
entrant airlines as independent airlines that have started jet
service within the last 10 years and pursue strategies of charging
low fares. Page 4
GAO/RCED-99-225 Aviation Competition Policy B-281479 trigger an
investigation by DOT. Specifically, DOT will initiate an
investigation when a major airline (1) adds capacity and sells a
large number of seats at very low fares, (2) carries more local
passengers at the new entrant's low fares than the new entrant's
total seat capacity, or (3) carries more local passengers at the
new entrant's low fares than the new entrant carries at low fares.
The proposed policy also states that these actions must result in
lower local revenue for the major airline than would result from a
reasonable alternative response. The proposed policy states that
DOT does not intend to discourage major airlines from competing
against new entrants at hub markets. Matching the new entrant's
low fares on a limited basis and not significantly increasing
capacity would be permissible under the proposed policy, but
extreme behavior intended to drive the new entrant from the hub
market would trigger enforcement. DOT would determine whether
carriers had engaged in unfair practices and decide whether to
initiate enforcement on a case-by-case basis (see app. I). DOT
Developed Evidence Before DOT began developing the proposed
policy statement in summer of Possible Unfair 1997, it
received 32 complaints from airlines, travel industry
associations, Practices Members of Congress, and
others concerning unfair competition in the airline industry.
Seventeen of the 32 complaints dealt with new entrant airlines'
concerns about unfair pricing and capacity increases by larger
airlines. The remaining complaints addressed concerns such as
access to gates and other airport facilities, display biases in
computerized reservation systems that would result in a major
airline's flight being listed ahead of a new entrant's flight, and
unfair use of travel agent commissions. Many of the complaints
dealt with more than one issue. (See fig. 2.) The Department
received the complaints in various ways, including letters,
meetings, and telephone calls. Page 5
GAO/RCED-99-225 Aviation Competition Policy B-281479 Figure 2:
Issues Addressed in 32 Complaints Received by DOT, 20
Number of complaints March 1993 Through May 1997 17 15 12 11
10 9 5 2
2 0 CRSs Gates Pricing
Other Capacity Commissions Issues addressed Notes: Some complaints
addressed more than one issue. "CRSs" refers to computerized
reservation systems; "commissions" refers to commissions paid to
travel agencies. Source: U.S. Department of Transportation. The 17
complaints of unfair pricing and capacity increases were raised
from March 1993 through May 1997, involved 7 major airlines and 10
new entrants, and included at least 27 routes.3 For example, in
May 1997, Reno Air complained about Northwest Airlines' practices
in the Detroit-Reno market. According to Reno Air, Northwest
entered the market only after Reno Air had indicated that it would
serve the market. After Reno Air initiated service, the airline
alleged that Northwest substantially undercut its fares and
increased service to become the dominant airline in the market.
Then, when Reno Air reduced its service in the market, Northwest
also reduced service, according to Reno Air. As shown in figure 3,
the complaints DOT received encompassed many of the major
airlines' hub airports, including Atlanta, Dallas/Fort Worth,
Denver, Detroit, Minneapolis/St. Paul, and Pittsburgh. 3In some
cases, the routes were not specified. Page 6
GAO/RCED-99-225 Aviation Competition Policy B-281479 Figure 3:
Routes Cited in 17 Complaints Concerning Pricing and Capacity That
Were Received, March 1993 Through May 1997 Minneapolis/ St. Paul
Detroit Pittsburgh Denver Atlanta Dallas/Ft. Worth Source: U.S.
Department of Transportation. According to DOT officials, they
handled some of the 17 complaints from new entrant airlines by
informally negotiating with the parties. In some cases, DOT
initially requested further information from the airlines.
According to Department officials, they investigated two
complaints and shared information about those two investigations
as well as information about three other complaints with the
Department of Justice. According to a DOT official, 15 of the 17
complaints are closed and 2 that were under investigation remained
open in June 1999. According to Department officials, their
investigations indicated possible unfair competitive practices by
two major airlines. For example, in one case, DOT found evidence
that a major airline was specifically targeting new entrant
airlines. Documents obtained from the airline indicated that when
a new entrant obtained 5 percent of a local market, the major
airline's strategy was to respond aggressively, in stages, with
the intent of Page 7
GAO/RCED-99-225 Aviation Competition Policy B-281479 driving the
new entrant out of the market. First, the airline matched the new
entrant's low fares, but with restrictions-such as requirements
for the advance purchase of tickets and a Saturday night stayover-
then it eliminated the restrictions, and, finally, it increased
the number of seats available at the low fare. The Department's
analysis of data on fares, revenues, and the number of passengers
for one route indicated that the major airline was selling such a
large number of tickets at the low fare offered by the new
entrant, that it sold low-fare tickets to many passengers who
would otherwise have paid higher fares, resulting in substantially
lower revenue from the route than it would have realized if it had
been seriously attempting to bolster its revenue. Over the first
year that the new entrant served the route, the major airline
shifted traffic from high-fare categories to low-fare categories,
which resulted in a significant decrease in revenue for the major
airline despite a significant increase in passengers over that
period. In addition, the Department examined at least 40 to 50
routes on which other major airlines competed with new entrants or
with Southwest Airlines4 and found behavior that caused it
concern. For the analysis, DOT used data for 1992 through the
first quarter of 1997 that it collected routinely from airlines on
fares, traffic, and revenue. For three major airlines, DOT found
examples of pricing or capacity behavior similar to the behavior
it identified in its investigations. The Department published
several of these examples in August 1998.5 For instance, the
Department reported that during the first quarter of 1996, a new
entrant airline started service on a 450-mile route. The major
airline serving the route initially did not increase its sale of
low-fare seats, and its revenue for the first two quarters of 1996
changed very little. However, during the third quarter of 1996,
the major airline greatly expanded its capacity and increased the
number of seats it sold at low fares by almost half. During that
quarter, the major airline's revenue on that route dropped by
about a third. (See fig. 4.) The new entrant left the market the
following quarter, after which the major airline sold fewer seats
at low fares and sold a large percentage of its seats at higher
fares. The major airline's average fares were about $190 just
before the new entrant began service, fell to just over $80 when
it was competing with the new entrant, and rose to almost $250 6
months after the new entrant departed the market. 4Southwest
Airlines is considered a low-fare airline but has been in
operation since before deregulation and, therefore, is not a new
entrant. 5U.S. Department of Transportation, "Competition in the
U.S. Domestic Airline Industry: The Need for a Policy to Prevent
Unfair Practices." Page 8
GAO/RCED-99-225 Aviation Competition Policy B-281479 Figure 4:
Total Passengers and Total Revenue for a Major Airline Competing
Passengers in thousands
Revenue (dollars in thousands) 10 With a New Entrant Airline
70 9 60 8 50 7 40
6 30 Quarter 1 Quarter 2 Quarter 3
Quarter 4 Quarter 1 5 1996 1996
1996 1996 1997 Passengers Revenue
Note: The new entrant entered the market in the first quarter 1996
and left the market in the fourth quarter 1996. Source: U.S.
Department of Transportation. Information from these
investigations and analyses was presented to senior DOT officials,
who concluded that the best approach for addressing the
Department's concerns about pricing and capacity-setting was to
issue policy guidance on what the Department viewed as potentially
unfair competitive practices that warranted formal enforcement. In
particular, the Department took this approach because the
Secretary of Transportation wanted to have a national dialogue on
the concerns regarding unfair competition. In part, that dialogue
took the form of meetings that the Department held with industry
and community groups after the proposed policy statement was
issued. In addition, according to a Department official, this
approach would help with future enforcement since the lack of a
description of unfair competitive practices concerning pricing and
capacity-setting had inhibited DOT from taking enforcement actions
in the past. Page 9
GAO/RCED-99-225 Aviation Competition Policy B-281479 Complaints of
Unfair DOT continued to receive complaints of unfair
competitive practices after it Practices Continued After began
developing the proposed policy statement in summer 1997. From DOT
Developed the September 1997 through February 19986-
while DOT was developing the Proposed Policy policy
statement-it received seven complaints against major airlines from
other airlines, Members of Congress, an industry association, and
city officials. After issuing the proposed policy-from late April
1998 through May 1999-the Department received an additional 21
complaints from similar groups as well as travel agents and state
officials. Eleven of the 28 complaints concerned pricing or
capacity increases. For example, in April 1999, the Attorney
General of Minnesota complained that Northwest Airlines appeared
to be offering low fares and increased capacity in selected
Minneapolis-St. Paul markets in anticipation of the inauguration
of scheduled service by a new entrant-Sun Country Airlines-on June
1, 1999. The remaining 17 complaints concerned issues involving
access to gates and airport space, computerized reservation
systems, travel agent commissions, and airline ticketing
practices. Twenty-five of the 28 complaints have been closed, and
3 are pending further action by the Department. According to DOT
officials, the Department has a total of five open complaints-two
were received prior to its developing the proposed policy, and
three were received since it issued the proposed policy. On May
13, 1999, the Department of Justice filed an antitrust lawsuit
against American Airlines, charging that the airline tried to
monopolize service to and from Dallas/Fort Worth by driving out
low-fare airlines. The lawsuit specifically focused on American's
responses to Vanguard Airlines, Sun Jet, and Western Pacific on
four Dallas/Fort Worth routes to Wichita, Kansas; Kansas City,
Missouri; Long Beach, California; and Colorado Springs, Colorado.
Justice charged that American repeatedly sought to drive these
small start-up airlines out of Dallas/Fort Worth by adding flights
and cutting fares. According to Justice, after American drove out
a new entrant, it reestablished high fares and reduced service.
The suit further alleged that for the flights that American added,
the costs exceeded the revenues generated. According to Justice,
American expected to recoup those temporary losses by charging
higher fares after a new entrant ceased operations. For example,
according to Justice, American increased fares for the Dallas/Fort
Worth-Wichita route by more than 50 percent after Vanguard stopped
serving that market. American has stated that it merely matched
the fares that Vanguard set and that its actions on the
Dallas/Fort Worth routes will prove to be nothing more than 6DOT
did not receive any complaints from June through August 1997. Page
10 GAO/RCED-99-225
Aviation Competition Policy B-281479 those of a tough competitor
in a highly competitive industry. American filed a response to the
complaint on July 13, 1999. DOT's Process to In
summer 1997, DOT's Office of the Assistant Secretary for Aviation
and Develop the Proposed International Affairs and the Office of
the General Counsel began developing the proposed policy
statement. Since DOT considered the policy Policy Statement Has
to be exempt from the notice and comment requirements under the
Been Informal Administrative Procedure Act, it
followed an informal process in developing it. DOT's early efforts
in developing the proposed policy focused on defining unfair
competitive practices. In addition, the Department of Justice and
the Federal Trade Commission (FTC) reviewed and commented on the
proposed policy before it was issued. DOT Followed an Informal
From summer 1997 through early 1998, staff from DOT's Office of
the Process Assistant Secretary for
Aviation and International Affairs and the Office of the General
Counsel developed and drafted the policy statement. Meetings among
senior officials from these offices were held during this period
to review and comment on the proposed policy. The document was
revised in an iterative manner based on comments from within the
Department. During this process, the Secretary of Transportation
decided to issue a policy statement. A general statement of policy
does not have to follow certain procedures established under the
Administrative Procedure Act-such as issuing in the Federal
Register a proposed rulemaking for public comment and then a final
rule. Although DOT does not consider the proposed policy to be a
rule subject to notice and comment requirements, the Department
did publish it in the Federal Register for public notification and
to obtain public comments. Initially, DOT allowed a 60-day period
for filing comments and a 90-day deadline for filing reply
comments. DOT extended the deadline for filing comments until
September 25, 1998. DOT established a docket for receipt of public
comments and, according to Department officials, received over
5,000 comments by the final deadline. Additional comments were
received after the deadline passed. DOT allows late comments to be
considered. Comments by some major airlines suggest the proposed
policy is a rule that should be subject to the notice and comment
provisions of the Administrative Procedure Act. For example, an
industry association and a major airline stated that the proposed
policy was a substantive rule because it would proscribe specific
conduct by major airlines. Because Page 11
GAO/RCED-99-225 Aviation Competition Policy B-281479 DOT did not
follow certain provisions of the act, some commenters further
stated that the Department did not provide sufficient information
to constitute adequate notice and a meaningful opportunity for
interested persons to comment on the proposed policy. In
particular, some major airlines commented that DOT provided
insufficient information in the public record about its informal
investigations and other data supporting the policy. However, some
small airlines, which would be defined as "new entrants" under the
policy, commented that the policy statement was in compliance with
the Administrative Procedure Act. For example, one airline stated
that the policy was an interpretive, rather than a substantive
rule, because the policy did not create new requirements or change
existing ones. Under the Administrative Procedure Act, an
interpretive rule or a general statement of policy is exempt from
the notice and comment requirements of the act. DOT's Efforts
Focused on DOT's early efforts to develop the proposed policy
focused on defining Defining Unfair unfair competitive
practices in terms of pricing and levels of capacity and
Competitive Practices revenue. Reducing prices to increase
business and match the prices of new competitors is generally a
reasonable competitive response. However, the Supreme Court has
ruled that this behavior is not always reasonable and has defined
it as predatory pricing under the antitrust laws when a company
(1) sets prices below an appropriate measure of costs and (2) has
a reasonable likelihood of recapturing its losses by setting
higher prices after its competition leaves the market.7 For the
airline industry, the appropriate measure of cost is often
considered to be the incremental cost of serving additional
passengers. DOT's proposed policy on unfair competitive practices
by major airlines differs from predatory pricing under the
antitrust laws because it focuses on a firm's forgone revenue
rather than the relationship between the firm's prices and costs.
DOT's policy defines unfair competitive practices as fare cuts and
capacity increases resulting in short-term revenue losses that
will be recouped after the competitor is driven from the market.
DOT noted that it can be difficult to determine when the airlines'
normal practices of cutting prices and increasing capacity would
be illegal predatory pricing under the antitrust laws because of
the industry's cost characteristics, among other things. 7See
Brooke Group Ltd. v. Brown & Williamson Tobacco Corporation, 509
U.S. 209 (1993). Page 12
GAO/RCED-99-225 Aviation Competition Policy B-281479 DOT believes
that because airlines incur costs over their entire route
networks, defining the cost of serving a route or the incremental
cost of serving additional passengers depends on the circumstances
involved. For example, DOT noted that the incremental cost of
serving an additional passenger depends on whether that passenger
can be served on a flight that is less than full or if that
passenger would displace another passenger on the flight. The
incremental cost of a passenger on a flight that would otherwise
fly with an empty seat is very low. However, according to DOT, the
incremental cost of another passenger on a full flight is the
forgone revenue from the passenger who would be displaced because
the flight is full. In addition, DOT noted that if the airline
decides to add flights or use larger aircraft, the incremental
cost would be the additional cost associated with those decisions.
Other Federal Agencies Several months before issuing the
proposed policy statement, DOT met Involved in Developing the
with officials from Justice and FTC, who reviewed and commented on
the Proposed Policy document. DOT consulted with
these agencies because of their responsibility for enforcing
federal antitrust laws. According to officials from Justice and
FTC, their comments mainly dealt with the description in the
policy statement of their agencies' respective missions and
responsibilities. DOT revised the language of the proposed policy
statement to address those concerns. Staff from the Office of
Management and Budget did not formally review the policy statement
but, along with staff from Justice and FTC, attended meetings held
by DOT to review drafts of the policy statement. DOT Expects to
Issue the Senior DOT officials have stated that they plan to
issue the final policy in Final Policy in September
1999. The Department has been revising the policy statement
September 1999 based on the comments that it
received. The Congress required DOT to send it the final policy
and mandated that the policy will not become effective until at
least 12 weeks after it is received.8 Prior to issuing the final
policy, the Congress also required the Department to send it a
report on competitive practices in the airline industry. The
report is to include (1) a description of and examples of
complaints received by the Secretary concerning acts of unfair
competition or predatory pricing in the airline industry; (2) a
description of options available to the Secretary for addressing
acts of unfair competition or 8See P.L. 105-277. The law states
that the 12-week period includes only weeks in which the House of
Representatives is in session for at least 1 day. Page 13
GAO/RCED-99-225 Aviation Competition Policy B-281479 predatory
pricing; (3) an analysis of the policy statement, including
information on the impact of the final policy on such things as
scheduled service to small and medium-sized communities, air
fares, and members of frequent flyer programs; and (4) a
description of the manner in which the Secretary plans to
coordinate the handling of complaints against air carriers filed
with the Secretary and similar complaints filed with the Attorney
General. DOT staff are preparing the competitive practices report
and expect to deliver it to the Congress in September along with
the final policy. Proposed Policy In issuing the proposed
policy statement, the intent of DOT was to address Addresses
Potential what it viewed as potentially unfair competitive
practices by some major airlines and to help with future
enforcement by identifying some practices Problem Practices,
that would trigger an enforcement proceeding. DOT's proposed
policy and DOT Plans statement generally addresses the
complaints dealing with price cuts and capacity increases that the
Department received as well as the behaviors Revisions to Improve
that DOT identified in its investigations and analyses of
industrywide data. Its Enforceability As we discussed earlier
in this report, DOT's proposed policy statement addresses unfair
competitive practices in the form of a major airline expanding its
capacity and selling a large number of seats at very low fares,
which results in lower revenue in the short term than would result
from a reasonable alternative strategy for competing with a new
entrant airline at the major airline's hub airport. However, DOT
acknowledges that the policy's description of unfair competitive
practices may be vague and plans to revise it. The proposed policy
statement generally addresses 16 of the 17 complaints dealing with
alleged price cuts or capacity increases that DOT received prior
to developing it. One complaint of alleged price cuts did not
cover routes from a hub airport of a major airline and, therefore,
would not be covered by the proposed policy. Another complaint
included four routes, only one of which would be covered by the
proposed policy because it was the only route that included a hub
airport of a major airline. According to DOT, the 10 new entrant
airlines that made these complaints started operations within the
last 10 years and, therefore, would be encompassed by the proposed
policy. For the most part, the complaints did not mention whether
the major airlines involved received lower revenues in the short
term because of their actions; therefore, we were not able to
assess whether the complaints dealt with this aspect of the policy
statement. Page 14 GAO/RCED-99-225
Aviation Competition Policy B-281479 Similarly, the proposed
policy statement addresses the pricing and capacity-setting
practices that DOT identified in its investigations and analyses
of industrywide data. In its two investigations, DOT examined new
entrant airlines' complaints that the major carrier in particular
markets added capacity and matched or undercut the new entrants'
fares. In one complaint, the new entrant specifically mentioned
that the major airline's actions were designed to force the new
entrant to leave the markets and did not constitute a legitimate
competitive response to new entry. As we discussed earlier in this
report, in one investigation, DOT also found that the major
airline's pricing and capacity-setting activities resulted in
substantial diversion of its revenue, behavior the proposed policy
statement addresses. In addition, DOT's analyses of industrywide
data indicated that three other major airlines exhibited behavior
that is addressed by the proposed policy statement. As we
discussed earlier in this report, DOT's analyses of major
airlines' practices in markets in which they were competing with
new entrants showed that the major airlines greatly increased the
total number of seats sold, but earned substantially less revenue
because they were selling so many seats at low fares. Finally, DOT
intends the proposed policy statement to help with future
enforcement by describing practices that would trigger an
investigation. The Department, however, has received comments from
several major airlines and an industry trade association that
question the proposed policy's enforceability. For example, the
trade association commented that the proposed policy is "riddled
with vague and undefined terms, and no carrier can know in advance
whether its response to a new entrant will later be judged
unreasonable by DOT." The commenter noted that critical terms in
the proposed policy-such as "reasonable alternative response,"
"very low fares," and "large number of seats"-are undefined and do
not provide meaningful guidance to airlines in distinguishing
prohibited from permitted practices. These concerns were echoed in
other comments. Such vagueness, according to a major airline, will
lead to arbitrary enforcement. Another major airline, commenting
on the vagueness of the proposed policy, stated that the policy
imposes an impossible burden on major airlines to guess at its
meaning as well as how the marketplace and competitors will react
to the airline's price and capacity offerings. In addition, one
smaller airline commented on the need to revise the wording of the
three "triggers" for enforcement, noting that they could be
construed more broadly than the Department intended. According to
senior Department officials, the policy statement is being revised
to Page 15 GAO/RCED-99-225 Aviation
Competition Policy B-281479 address concerns about vagueness as
well as other concerns raised in the comments. Agency Comments
We provided the Office of the Secretary of Transportation with a
draft of this report for review and comment. The Deputy Assistant
Secretary for Aviation and International Affairs and the Assistant
General Counsel for Aviation Enforcement and Proceedings advised
us that they generally agreed with the information presented in
our report. They also provided several technical corrections,
which we incorporated as appropriate. Scope and To
address this report's three objectives, we interviewed officials
from Methodology DOT's Office of the General Counsel and
Office of the Assistant Secretary for Aviation and International
Affairs. To gather information on why DOT developed the proposed
policy statement, we also obtained from the Department
documentation of complaints it received about unfair competition
practices. To determine what process DOT used to develop the
proposed policy, we reviewed the Department's docket for public
comments on the process it used. We also interviewed officials
from the Department of Justice, FTC, and the Office of Management
and Budget to obtain information on DOT's consultations with them.
To determine if the proposed policy statement addressed the
problems identified in the complaints, we compared the proposed
policy statement with the list of complaints we obtained from DOT.
Similarly, we compared the proposed policy statement with DOT's
findings from its investigations and analyses. For this last
objective, we also analyzed comments in the docket about the
enforceability of the proposed policy statement. To determine
DOT's authority to promulgate the proposed policy statement, we
reviewed the Administrative Procedure Act and the provisions of
title 49, U.S. Code, concerning DOT's authority to enforce
competitive practices in the airline industry. We also interviewed
officials from DOT and the Department of Justice. We conducted our
work from December 1998 through July 1999 in accordance with
generally accepted government auditing standards. We are providing
Rodney E. Slater, Secretary of Transportation, with copies of this
report. We will make copies available to others on request. If
Page 16 GAO/RCED-99-225 Aviation
Competition Policy B-281479 you or your staff have any questions
about this report, please call me at (202) 512-2834. Key
contributors to this report are listed in appendix II. Sincerely
yours, John H. Anderson, Jr. Director, Transportation Issues Page
17 GAO/RCED-99-225 Aviation
Competition Policy Appendix I DOT's Authority to Prohibit Unfair
Aviation Competition The Department of Transportation's (DOT)
legal authority to undertake enforcement actions against airlines
engaged in unfair practices affecting competition in the industry
stems from sections 40101 and 41712 of title 49, U.S. Code. In
section 40101, the Congress directed DOT to consider the following
issues, among others, to be in the public interest: (1) the
prevention of predatory or anticompetitive practices in the
airline industry; (2) the avoidance of unreasonable industry
concentration, excessive market domination, monopoly powers, and
other conditions that would allow an airline to unreasonably
increase fares, reduce service, or exclude competition; and (3)
the encouragement of entry by new and existing air carriers. Under
section 41712, DOT has authority to prohibit business practices
that are deceptive practices or unfair methods of competition. The
Congress originally granted the legal authority in section 41712
to the Civil Aeronautics Board (CAB). When CAB was abolished in
1984 during the process of airline deregulation, the Congress
granted DOT that same legal authority to prohibit unfair or
deceptive business practices. DOT and CAB have used this authority
to address various practices, including deceptive practices
involving ticket agents, advertising and sale of air
transportation, and carrier-owned computerized reservation
systems. In some areas-such as deceptive advertising-DOT has taken
enforcement action, including assessing penalties. In addition,
DOT has adopted regulations in areas such as computerized
reservation systems. DOT has a range of compliance tools
available. The Department has informally negotiated with the
affected parties to resolve a problem-the Department refers to
this as "jawboning." The Department has informally investigated
some complaints and asked the parties to provide relevant data and
documents.9 In addition, section 41712 authorizes DOT to conduct a
formal investigation and hearing on unfair practices.10 DOT can
initiate this activity on its own or after receiving a complaint.
DOT first determines whether an enforcement proceeding is
warranted. Next, DOT notifies the affected parties that an
enforcement proceeding is commencing or notifies the complaining
party that no such proceeding will be instituted. The DOT Deputy
General Counsel and Assistant General Counsel for Aviation
Enforcement and Proceedings have overall responsibility for the
9DOT can conduct informal investigations using the procedures
described in 14 C.F.R. 305 (Rules of Practice in Informal
Nonpublic Investigations) and can collect information using the
authority provided under 49 U.S.C. 41708. 10Procedures for
investigations for enforcement and subsequent legal proceedings
are described in subpart B of 14 C.F.R. part 302 (Aviation
Proceedings Before the Office of the Secretary). Page 18
GAO/RCED-99-225 Aviation Competition Policy Appendix I DOT's
Authority to Prohibit Unfair Aviation Competition prosecution in
the proceedings. If necessary, the Assistant General Counsel may
develop an information request to gather facts from the affected
parties. If the Assistant General Counsel determines that
enforcement action is warranted, a complaint is filed, and the
proceeding is assigned to one of the Department's administrative
law judges for a formal hearing. If the judge determines that a
violation has occurred, the judge may order the airline to "cease
and desist" from the illegal conduct and, under certain
circumstances, impose civil penalties. Failure to comply with an
order could also result in fines. The judge's decision may be
reviewed by the Department, and the U.S. Court of Appeals has the
authority to review the Department's final order. At any point in
the process, the Deputy General Counsel and Assistant General
Counsel can settle a case with the party involved. Lastly, DOT can
refer cases to the Department of Justice, which has the authority
to enforce federal antitrust laws. Until May 1999, when Justice
filed a lawsuit against American Airlines, it had never used that
authority to file an antitrust lawsuit concerning predatory
pricing in the airline industry. Page 19
GAO/RCED-99-225 Aviation Competition Policy Appendix II GAO
Contacts and Staff Acknowledgments GAO Contacts John H.
Anderson, Jr., (202) 512-2834 Janet Barbee, (202) 512-8856
Acknowledgments In addition to those named above, Sharon Dyer,
Joseph Kile, Teresa Spisak, and Michael Volpe made key
contributions to this report. (348137) Page 20
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