Domestic Aviation: Barriers to Entry Continue to Limit Benefits of
Airline Deregulation (Testimony, 05/13/97, GAO/T-RCED-97-120).

GAO discussed competition in the domestic airline industry, focusing on:
(1) barriers to entry in the airline industry; and (2) the Department of
Transportation's (DOT) response to the recommendations in GAO's October
1996 report.

GAO noted that: (1) in its October 1996 report, GAO stated that little
progress has been achieved in lowering the barriers to entry since GAO
first reported on these barriers in 1990; (2) as a result, the full
benefits of airline deregulation have yet to be realized; (3) in
particular, operating limits in the form of slot controls, restrictive
gate leasing arrangements, and perimeter rules continue to block entry
at key airports in the East and upper Midwest; (4) several marketing
strategies give advantages to the established carriers; (5) these
strategies, taken together, continue to deter new as well as established
airlines from entering those markets where an established airline is
dominant; (6) these strategies' effect tends to be greatest, and
airfares the highest, in markets where the dominate carrier's position
is protected by operating barriers; (7) GAO recommended that DOT take
actions that GAO had previously suggested in 1990 to lower the operating
barriers; (8) moreover, GAO suggested that, absent action by DOT,
Congress may wish to consider revising the legislative criteria that
governs DOT's granting slots to new entrants and consider granting DOT
the authority to allow exemptions to National Airport's perimeter rule
to increase competition; (9) DOT concurred with GAO's recent findings
and expressed concern about "overly aggressive" attempts by established
airlines to thwart new entry; (10) to make it easier for new entrants to
obtain slots, DOT indicated that it would revise its restrictive
interpretation of the legislative criteria governing the granting of new
slots; (11) while this is a positive step, additional action will likely
be needed because the number of new slots that DOT can grant is very
limited; (12) in its report, GAO also recommended that DOT create a pool
of available slots by periodically withdrawing a small percentage from
the major incumbents at each airport and distribute those slots in a
fashion that increases competition; (13) DOT indicated that it is still
considering this action; (14) DOT did not agree with GAO's
recommendation that the Federal Aviation Administration consider an
airport's efforts to make gates available to nonincumbents when making
federal airport grant decisions; (15) DOT said that it would rather
address this issue on a case by case basis as problems are brought to
its attention; and (16) in light of the lack of progress over the past *

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

 REPORTNUM:  T-RCED-97-120
     TITLE:  Domestic Aviation: Barriers to Entry Continue to Limit 
             Benefits of Airline Deregulation
      DATE:  05/13/97
   SUBJECT:  Commercial aviation
             Airline industry
             Competition
             Airline regulation
             Airports
             Restrictive trade practices
             Transportation rates
             Air transportation operations
             Marketing
IDENTIFIER:  Washington National Airport (DC)
             Chicago-O'Hare International Airport (Chicago, IL)
             LaGuardia International Airport (New York, NY)
             John F. Kennedy International Airport (NY)
             Charlotte/Douglas International Airport (Charlotte, NC)
             Greater Cincinnati Airport (Cincinnati, OH)
             Greater Pittsburgh International Airport (Pittsburgh, PA)
             Minneapolis-St. Paul International Airport (Minneapolis, MN)
             
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Cover
================================================================ COVER


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

For Release
on Delivery
Expected at
2:30 p.m.  EDT
Tuesday
May 13, 1997

DOMESTIC AVIATION - BARRIERS TO
ENTRY CONTINUE TO LIMIT BENEFITS
OF AIRLINE DEREGULATION

Statement of John H.  Anderson, Jr.
Director, Transportation Issues,
Resources, Community, and Economic Development Division

GAO/T-RCED-97-120

GAO/RCED-97-120T


(341528)


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

  DOT -
  TWA -
  FAA -

============================================================ Chapter 0

Mr.  Chairman and Members of the Subcommittee: 

We appreciate the opportunity to testify on competition in the
domestic airline industry.  In April 1996, we reported that the
deregulation of the industry in 1978, as intended, has led to lower
fares and better service for most air travelers.\1 Deregulation's
benefits stem largely from increased competition spurred by the entry
of new airlines into the industry and established airlines into new
markets.  Nevertheless, some airports, primarily in the East and
upper Midwest, have not experienced such entry and thus have not
experienced the lower fares and better service that deregulation has
brought to other markets.  In October 1996, we reported that certain
industry practices, such as restrictive gate-leasing arrangements,
impeded entry, particularly at a number of major airports in the East
and upper Midwest.\2 Based on our findings, we made a number of
recommendations to the Department of Transportation (DOT) aimed at
addressing these barriers to entry and identified potential actions
the Congress might wish to consider. 

Our October 1996 report was the latest in a series of studies we have
conducted over the past decade on domestic airline competition.\3 As
requested, our testimony discusses (1) our findings and
recommendations concerning barriers to entry in the airline industry
and (2) DOT's response to the recommendations in our October 1996
report. 

In summary,

  -- In our October 1996 report, we stated that little progress has
     been achieved in lowering the barriers to entry since we first
     reported on these barriers in 1990.  As a result, the full
     benefits of airline deregulation have yet to be realized.  In
     particular, operating limits in the form of slot controls,\4
     restrictive gate leasing arrangements, and perimeter rules\5
     continue to block entry at key airports in the East and upper
     Midwest.  Likewise, several marketing strategies, including
     special incentives for travel agents and frequent flier
     programs, give advantages to the established carriers.\6 These
     strategies, taken together, continue to deter new as well as
     established airlines from entering those markets where an
     established airline is dominant.  The effect of these strategies
     tends to be greatest--and airfares the highest--in markets where
     the dominant carrier's position is protected by operating
     barriers.  As a result, we recommended in October 1996 that DOT
     take actions that we had previously suggested in 1990 to lower
     the operating barriers.  Moreover, we suggested that, absent
     action by DOT, the Congress may wish to consider revising the
     legislative criteria that governs DOT's granting slots to new
     entrants.  We also suggested that the Congress consider granting
     DOT the authority to allow exemptions to the perimeter rule at
     National Airport to increase competition. 

  -- In responding to our recent report, DOT concurred with our
     findings and expressed concern about "overly aggressive"
     attempts by established airlines to thwart new entry.  To make
     it easier for new entrants to obtain slots, the agency indicated
     that it would revise its restrictive interpretation of the
     legislative criteria governing the granting of new slots.  While
     this is a positive step, additional action will likely be needed
     because the number of new slots that DOT can grant is very
     limited.  In our report, we also recommended that DOT create a
     pool of available slots by periodically withdrawing a small
     percentage from the major incumbents at each airport and
     distribute those slots in a fashion that increases competition. 
     DOT indicated that it is still considering this action.  The
     agency did not agree with our recommendation that FAA consider
     an airport's efforts to make gates available to nonincumbents
     when making federal airport grant decisions.  Instead, DOT said
     that it would rather address this issue on a case by case basis
     as problems are brought to its attention.  In light of the lack
     of progress over the past 7 years, however, we believe that our
     recommendations, combined with our suggestions for potential
     congressional action, offer prudent steps to promote competition
     in regions that have not experienced the benefits of airline
     deregulation. 


--------------------
\1 Airline Deregulation:  Changes in Airfares, Service, and Safety at
Small, Medium-sized, and Large Communities (GAO/RCED-96-79, Apr.  19,
1996). 

\2 Airline Deregulation:  Barriers to Entry Continue to Limit
Competition in Several Key Domestic Markets (GAO/RCED-97-4, Oct.  18,
1996). 

\3 These products are listed at the end of this statement. 

\4 To minimize congestion and reduce flight delays, the Federal
Aviation Administration (FAA) has since 1969 set limits on the number
of operations (takeoffs and landings) that can occur during certain
periods of the day at four congested airports--Chicago O'Hare,
Washington National, and New York Kennedy and LaGuardia.  The
authority to conduct a single operation during those periods is
commonly referred to as a "slot."

\5 Rules governing operations at New York's LaGuardia and
Washington's National airports prohibit flights to and from those
airports that exceed a certain distance. 

\6 Established airlines include the nation's seven largest:  American
Airlines, Continental Airlines, Delta Air Lines, Northwest Airlines,
TWA, United Airlines, and US Airways. 


   AIRLINE BARRIERS TO ENTRY
   PERSIST AND PREDOMINANTLY
   AFFECT COMPETITION IN THE EAST
   AND UPPER MIDWEST
---------------------------------------------------------- Chapter 0:1

Operating barriers continue to limit competition and contribute to
higher airfares in several key markets in the upper Midwest and East. 
In some cases, these barriers have grown worse.  As a result, our
October 1996 report recommended that DOT take actions that we
originally suggested in 1990 and highlighted areas for potential
congressional action.  The report specifically addressed the effects
of slots, perimeter rules, exclusive-use gate leases, and marketing
strategies developed by the established airlines since airline
deregulation. 


      SLOTS
-------------------------------------------------------- Chapter 0:1.1

To reduce congestion, FAA has since 1969 limited the number of
takeoffs and landings that can occur at O'Hare, National, LaGuardia,
and Kennedy.  By allowing new airlines to form and established
airlines to enter new markets, deregulation increased the demand for
access to these airports.  Such increased demand complicated FAA's
efforts to allocate takeoff and landing slots equitably among the
airlines.  To minimize the government's role in the allocation of
slots, DOT amended its rules in 1985 to allow airlines to buy and
sell them to one another.  Under this "Buy/Sell Rule," DOT
grandfathered slots to the holders of record as of December 16, 1985. 
Emphasizing that it still owned the slots, however, DOT randomly
assigned each slot a priority number and reserved the right to
withdraw slots from the incumbents at any time. 

In August 1990, we reported that a few established carriers had built
upon the favorable positions they inherited as a result of
grandfathering to such an extent that they could limit access to
routes beginning or ending at any of the slot-controlled airports.\7
In October 1996, we reported that this level of control over slots by
a few established airlines had increased even further (see app.  I). 
As a result, little new entry has occurred at these airports, which
are crucial to establishing new service in the heavily traveled
eastern and midwestern markets. 

Recognizing the need for new entry at the slot-controlled airports,
the Congress in 1994 created an exemption provision to allow for
entry at O'Hare, LaGuardia, and Kennedy in cases where DOT "finds it
to be in the public interest and the circumstances to be
exceptional."\8 However, the exemption authority, which in effect
allows DOT to issue new slots, has resulted in little new entry
because DOT has interpreted the "exceptional circumstances" criterion
very narrowly.  DOT has only approved applications to provide service
in markets not receiving nonstop service, even if the new service
would result in substantial competitive benefits.  We found no
congressional guidance, however, to support this interpretation.  As
a result, we suggested in our October 1996 report that the Congress
may wish to revise the extraordinary circumstance provision so that
consideration of competitive benefits is a key criterion. 

Nevertheless, we indicated that action by the Congress would be
needed only if DOT did not act.  In our 1990 report, we had suggested
several options to DOT aimed at promoting entry at the
slot-controlled airports.  These options included keeping the
Buy/Sell Rule but periodically withdrawing a portion of slots that
were grandfathered to the major incumbents and reallocating them by
lottery.  Because DOT had not acted on any of our suggestions and the
situation had continued to worsen, we recommended in our October 1996
report that DOT hold periodic slot lotteries. 


--------------------
\7 Airline Competition:  Industry Operating and Marketing Practices
Limit Market Entry (GAO/RCED-90-147, Aug.  29, 1990). 

\8 FAA Authorization Act of 1994, P.L.  103-305, Section.  206.  The
number of flights at National Airport is further limited by federal
law to address local concerns about noise.  As a result of these
additional limits, the Congress chose not to extend DOT's exemption
authority to include National. 


      PERIMETER RULES
-------------------------------------------------------- Chapter 0:1.2

At LaGuardia and National airports, perimeter rules prohibit incoming
and outgoing flights that exceed 1,500 and 1,250 miles, respectively. 
The perimeter rules are designed to promote Kennedy and Dulles
airports as the long-haul airports for the New York and Washington
metropolitan areas.  However, the rules limit the ability of airlines
based in the West to compete because those airlines are not allowed
to serve LaGuardia and National--airports that are generally
preferred by more lucrative business travelers--from markets where
they are strongest.  For example, the rules keep the second largest
airline started after deregulation--America West--from serving those
airports from its hub in Phoenix.  By contrast, because of their
proximity to LaGuardia and National, each of the seven largest
established carriers is able to serve those airports from their
principal hubs. 

While the limit at LaGuardia was established by the Port Authority of
New York & New Jersey, National's perimeter rule is federal law.\9
Thus, we suggested that the Congress consider granting DOT the
authority to allow exemptions to the perimeter rule at National when
proposed service will substantially increase competition.  We did not
recommend that the rule be abolished because removing it could have
unintended negative consequences, such as reducing the amount of
service to smaller communities in the Northeast and Southeast.  This
could happen if major slot holders at National shift their service
from smaller communities to take advantage of more profitable,
longer-haul routes.  As a result, we concluded that a more prudent
course to increasing competition at National would be to examine
proposed new services on a case by case basis. 


--------------------
\9 The Metropolitan Washington Airports Act of 1986 (P.L.  99-591,
sec.  6012). 


      LONG-TERM, EXCLUSIVE-USE
      GATE LEASES
-------------------------------------------------------- Chapter 0:1.3

Opportunities for establishing new or expanded service also continue
to be limited at other airports by restrictive gate leases.  These
leases permit an airline exclusive rights to use most of an airport's
gates over a long period of time, commonly 20 years.  Such long-term,
exclusive-use gate leases prevent nonincumbents from securing
necessary airport facilities on equal terms with incumbent airlines. 
To gain access to an airport in which most gates are exclusively
leased, a nonincumbent must sublet gates from the incumbent
airlines--often at non-preferred times and at a higher cost than the
incumbent.  Since our 1990 report, some airports, such as Los Angeles
International, have attempted to regain more control of their
facilities by signing less restrictive, shorter-term leases once the
exclusive-use leases expired.  Nevertheless, our 1996 report
identified several airports in which entry was limited because most
of the gates were under long-term, exclusive use leases with one
airline. 

Although the development, maintenance, and expansion of airport
facilities is essentially a local responsibility, most airports are
operated under federal restrictions that are tied to the receipt of
federal grant money from FAA.  In our 1990 report, we suggested that
one way to alleviate the barrier created by exclusive-use gate leases
would be for FAA to add a grant restriction that ensures that some
gates at an airport would be available to nonincumbents.  Because
many airports have taken steps since then to sign less restrictive
gate leases, we concluded in our 1996 report that such a broad grant
restriction was not necessary.  However, to address the remaining
problem areas, we recommended that when disbursing airport
improvement grant monies, FAA give priority to those airports that do
not lease the vast majority of their gates to one airline under
long-term, exclusive-use terms. 

Figure 1 shows the six gate-constrained airports that we identified
and the four slot-controlled airports.  All of them are located in
the East or upper Midwest, and as a result, affect competition
throughout those regions.  In 1995, these 10 airports accounted for
approximately 22 percent of the nation's 517 million scheduled
passenger enplanements. 

   Figure 1:  Airports Identified
   as Having Limited Entry Due to
   Slot Controls, Perimeter Rules,
   or Exclusive-Use Gate Leases

   (See figure in printed
   edition.)


      MARKETING STRATEGIES
-------------------------------------------------------- Chapter 0:1.4

Even where airport access is not a problem, airlines sometimes choose
not to enter new markets because certain marketing strategies of
incumbent airlines make it extremely difficult for them to attract
traffic.  Taken together, these strategies have created strong
loyalties among passengers and travel agents and have made it much
more difficult for competing airlines to enter new markets.  In
particular, they deter new as well as established airlines from
entering those markets where an established airline is dominant. 

Two strategies in particular--booking incentives for travel agents
and frequent flier plans--are targeted at business flyers, who
represent the most profitable segment of the industry, and encourage
them to use the dominant carrier in each market.  Because about 90
percent of business travel is booked through travel agencies,
airlines strive to influence the agencies' booking patterns by
offering special bonus commissions as a reward for booking a targeted
proportion of passengers on their airline.  Our discussions with
representatives of the nation's largest travel agencies confirmed the
importance of these booking incentives.  For example, a senior travel
agency executive told us that when one established airline attempted
to enter a number of markets dominated by another established
airline, the nonincumbent complained that the travel agency was not
booking passengers on its flights in those markets.  The travel
agency, according to the executive, told the nonincumbent that it
could not support it in those markets because the agency had an
incentive agreement with the incumbent airline involving those
markets.  As a result, the nonincumbent later pulled out of those
markets. 

Similarly, frequent flier programs solidify the dominant carrier's
position in a market.  Since their inception in the early 1980s,
these programs have become an increasingly effective tool to
encourage customers' loyalty to a particular airline.  The travel
agencies with whom we spoke noted that business travelers often
request to fly only on the airline with which they have a frequent
flier account.  As such, entry by new and established airlines alike
into a market dominated by one carrier is very difficult,
particularly since a potential entrant must announce its schedule and
fares well in advance of beginning service, thus giving the incumbent
an opportunity to adjust its marketing strategies.  In many cases, we
found that airlines have chosen not to enter, or quickly exit,
markets where they do not believe they can overcome the combined
effect of booking incentives and frequent flier programs and attract
a sufficient amount of business traffic. 

In our 1996 report, we found that the effect of these marketing
strategies tends to be the greatest--and fares the highest--in
markets where the dominant carrier's position is protected by
operating barriers.  Overall, fares were 31 percent higher in 1995 at
the 10 airports affected by the operating barriers than at the other
33 airports that comprise FAA's large hub classification.  Moreover,
the highest fares were at Charlotte, Cincinnati, Pittsburgh, and
Minneapolis--markets where a single airline accounts for over 75
percent of passengers and operating barriers persist.  However, we
also noted that the marketing strategies produced consumer benefits,
such as free frequent flier trips, and concluded that short of an
outright ban, few policy options existed that would mitigate the
marketing strategies' negative impact on new entry. 


   WHILE DOT'S RECENT ACTIONS
   REPRESENT POSITIVE FIRST STEPS,
   ADDITIONAL ACTIONS WILL LIKELY
   BE NEEDED
---------------------------------------------------------- Chapter 0:2

In its January 1997 response to our report, DOT stated that it shared
our concerns that barriers to entry limit competition in the airline
industry.  The agency indicated that it would include competitive
benefits as a factor when determining whether to grant slots to new
entrants under the exceptional circumstances criterion.  While this
is a positive step, additional action will likely be needed because
the number of new slots that DOT can grant is very limited. 
Recognizing this, DOT committed to giving careful consideration to
our recommendation that it hold periodic slot lotteries. 

DOT also agreed with our position that action may be needed at some
airports to ensure that nonincumbents are able to obtain competitive
access to gates.  However, DOT did not concur with our recommendation
that FAA make an airport's efforts to have gates available to
nonincumbents a factor in its decisions on awarding federal grants to
airports.  According to DOT, the number of airports that we
identified as presenting gate access problems is sufficiently small
that the agency would prefer to address those problems on a case by
case basis.  The agency emphasized that in cases where incumbent
airlines are alleged to have used their contractual arrangements with
local airport authorities to block new entry, the agency will
investigate to determine whether the behavior constituted an unfair
or deceptive practice or an unfair method of competition.  If so, the
agency noted, it will take appropriate action. 

Finally, DOT expressed concern about potentially overly aggressive
attempts by some established carriers to thwart new entry.  According
to DOT officials, since our report, several smaller carriers have
complained to DOT that larger carriers are employing anticompetitive
practices, such as predatory pricing--the practice of setting fares
below marginal cost in an effort to drive competitors out of markets. 
According to DOT officials, the agency has expressed its concern to
the established carriers involved and has notified them that it is
investigating the allegations. 


-------------------------------------------------------- Chapter 0:2.1

Mr.  Chairman, this concludes our prepared statement.  We would be
glad to respond to any questions that you or any member of the
Subcommittee may have. 


PERCENTAGE OF DOMESTIC AIR CARRIER
SLOTS HELD BY SELECTED GROUPS
=========================================================== Appendix I

Airport           Holding Entity                                   1986          1991          1996
----------------  ---------------------------------------  ------------  ------------  ------------
O'Hare            American and United                                66            83            87
                  Other established airlines                         28            13             9
                  Financial institutions                              0             3             2
                  Post-deregulation airlines                          6             1             1

Kennedy           Shawmut Bank, American, and Delta                  43            60            75
                  Other established airlines                         49            18            13
                  Other financial institutions                        0            19             6
                  Post-deregulation airlines                          9             3             7

LaGuardia         American, Delta, and US Airways                    27            43            64
                  Other established airlines                         58            39            14
                  Financial institutions                              0             7            20
                  Post-deregulation airlines                         15            12             2

National          American, Delta, and US Airways                    25            43            59
                  Other established airlines                         58            42            20
                  Financial institutions                              0             7            19
                  Post-deregulation airlines                         17             8             3
---------------------------------------------------------------------------------------------------
Notes:  Numbers may not add to 100 percent due to rounding.  Some
airlines that held slots have gone bankrupt, and as a result,
financial institutions have acquired slots. 

Source:  GAO's analysis of data from FAA. 


RELATED GAO PRODUCTS
============================================================ Chapter 1

Airline Deregulation:  Barriers to Entry Continue to Limit
Competition in Several Key Domestic Markets (GAO/RCED-97-4, Oct.  18,
1996). 

Changes in Airfares, Service, and Safety Since Airline Deregulation
(GAO/T-RCED-96-126, Apr.  25, 1996). 

Airline Deregulation:  Changes in Airfares, Service, and Safety at
Small, Medium-Sized, and Large Communities (GAO/RCED-96-79, Apr.  19,
1996).  Airline Competition:  Essential Air Service Slots at O'Hare
International Airport (GAO/RCED-94-118FS, Mar.  4, 1994). 

Airline Competition:  Higher Fares and Less Competition Continue at
Concentrated Airports (GAO/RCED-93-171, July 15, 1993). 

Airline Competition:  Options for Addressing Financial and
Competition Problems, Testimony Before the National Commission to
Ensure a Strong Competitive Airline Industry (GAO/T-RCED-93-52, June
1, 1993). 

Computer Reservation Systems:  Action Needed to Better Monitor the
CRS Industry and Eliminate CRS Biases (GAO/RCED-92-130, Mar.  20,
1992). 

Airline Competition:  Effects of Airline Market Concentration and
Barriers to Entry on Airfares (GAO/RCED-91-101, Apr.  26, 1991). 

Airline Competition:  Weak Financial Structure Threatens Competition
(GAO/RCED-91-110, Apr.  15, 1991). 

Airline Competition:  Fares and Concentration at Small-City Airports
(GAO/RCED-91-51, Jan.  18, 1991). 

Airline Deregulation:  Trends in Airfares at Airports in Small and
Medium-Sized Communities (GAO/RCED-91-13, Nov.  8, 1990). 

Airline Competition:  Industry Operating and Marketing Practices
Limit Market Entry (GAO/RCED-90-147, Aug.  29, 1990). 

Airline Competition:  Higher Fares and Reduced Competition at
Concentrated Airports (GAO/RCED-90-102, July 11, 1990). 

Airline Deregulation:  Barriers to Competition in the Airline
Industry (GAO/T-RCED-89-65, Sept.  20, 1989). 

Airline Competition:  DOT's Implementation of Airline Regulatory
Authority (GAO/RCED-89-93, June 28, 1989). 

Airline Service:  Changes at Major Montana Airports Since
Deregulation (GAO/RCED-89-141FS, May 24, 1989). 

Airline Competition:  Fare and Service Changes at St.  Louis Since
the TWA-Ozark Merger (GAO/RCED-88-217BR, Sept.  21, 1988). 

Competition in the Airline Computerized Reservation Systems
(GAO/T-RCED-88-62, Sept.  14, 1988). 

Airline Competition:  Impact of Computerized Reservation Systems
(GAO/RCED-86-74, May 9, 1986).  Airline Takeoff and Landing Slots: 
Department of Transportation's Slot Allocation Rule (GAO/RCED-86-92,
Jan.  31, 1986). 

Deregulation:  Increased Competition Is Making Airlines More
Efficient and Responsive to Consumers (GAO/RCED-86-26, Nov.  6,
1985). 


*** End of document. ***