Aviation Competition: International Aviation Alliances and the Influence
of Airline Marketing Practices (Testimony, 03/19/98, GAO/T-RCED-98-131).
Pursuant to a congressional request, GAO discussed the United States'
aviation relations with the United Kingdom, focusing on the: (1) status
of the various reviews of the proposed American Airlines/British Airways
(AA/BA) alliance being undertaken by the European regulatory agencies
and the Departments of Transportation and Justice; (2) competitive
impact of the proposed alliance; and (3) extent to which sales and
marketing practices of American Airlines and British Airways should be
considered in reviewing the alliance.
GAO noted that: (1) European regulatory agencies have nearly completed
their reviews of the proposed AA/BA alliance; (2) they are considering a
range of issues that would have to be addressed as a condition of
approving the alliance, including the number of slots and gates that
other airlines would need at London's Heathrow Airport to compete, as
well as American Airlines' and British Airways' marketing practices; (3)
the United Kingdom, which is also reviewing the proposed alliance, is
waiting for the European Commission to announce its draft remedies; (4)
in contrast, the Department of Transportation (DOT) has not yet begun
its formal review of the proposed alliance because neither airline has
filed all the documentation requested; (5) DOT has reiterated that it
will not approve the alliance until the United States successfully
negotiates an open skies agreement with the United Kingdom; (6) the
proposed AA/BA alliance raises significant competition issues; (7)
currently, the two airlines account for nearly 58 percent of the
available seats on scheduled U.S. and British airlines between the U.S.
and London; (8) in addition, they provide over 70 percent--and in some
cases all-of the available seats on scheduled U.S. and British airlines
between Heathrow Airport and several key U.S. airports, including
Chicago, Boston, and Miami; (9) as a result of this level of market
concentration, DOT's approval of the alliance would further reduce
competition unless, as a condition of approval, other U.S. airlines were
able to obtain adequate access to Heathrow; (10) although slots, gates,
and facilities are most important, most experts and some airline
officials with whom GAO spoke also recognize that American Airlines' and
British Airways' sales and marketing practices may make competitive
entry more difficult for other airlines; (11) practices such as frequent
flier programs and travel agent commission overrides encourage travelers
to choose one airline over another on the basis of factors other than
obtaining the best fare; (12) such practices may be most important if an
airline is already dominant in a given market or markets; (13)
ultimately, this may lead to higher fares than would exist in the
absence of these marketing practices; (14) even so, the experts agreed
that measuring the effect of these practices is nearly impossible; and
(15) mitigating their effect without banning them is difficult, and
banning them involves a trade-off between their anticompetitive effect
and the consumer benefits that some of them bring.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: T-RCED-98-131
TITLE: Aviation Competition: International Aviation Alliances and
the Influence of Airline Marketing Practices
DATE: 03/19/98
SUBJECT: Marketing
Airline industry
Airports
Airline regulation
Competition
Antitrust law
Foreign governments
International economic relations
Restrictive trade practices
Economic analysis
IDENTIFIER: Gatwick Airport (United Kingdom)
Heathrow Airport (United Kingdom)
London (United Kingdom)
European Union
Chicago-O'Hare International Airport (Chicago, IL)
Dulles International Airport (VA)
Atlanta-Hartsfield International Airport (Atlanta, GA)
John F. Kennedy International Airport (NY)
Logan International Airport (Boston, MA)
Miami International Airport (FL)
Brussels (Belgium)
Zurich (Switzerland)
Frankfurt (Germany)
Dallas-Fort Worth International Airport (TX)
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Cover
================================================================ COVER
Before the Subcommittee on Antitrust, Business Rights, and
Competition, Committee on the Judiciary, U.S. Senate
For Release
on Delivery
Expected at
2 p.m. EST
Thursday
March 19, 1998
AVIATION COMPETITION -
INTERNATIONAL AVIATION ALLIANCES
AND THE INFLUENCE OF AIRLINE
MARKETING PRACTICES
Statement by John H. Anderson, Jr.
Director, Transportation Issues,
Resources, Community, and Economic
Development Division
GAO/T-RCED-98-131
GAO/RCED-98-131T
(348053)
Abbreviations
=============================================================== ABBREV
AA -
BA -
DOT -
============================================================ Chapter 0
Mr. Chairman and Members of the Subcommittee:
We appreciate the opportunity to testify on the United States'
aviation relations with the United Kingdom (U.K.), our largest
aviation trading partner overseas. Access to London's Heathrow
Airport is important to any airline that desires to be a major
participant in the transatlantic market. However, our current
bilateral aviation agreement with the United Kingdom restricts the
number of U.S. airlines that can serve Heathrow to two
carriers--currently American Airlines (AA) and United Airlines. In
June 1996, AA and the United Kingdom's largest airline, British
Airways (BA), announced that they intended to form an alliance that
would allow both carriers to market each other's flights as their own
(referred to as "code-sharing") and that they would seek immunity for
the alliance from U.S. antitrust laws. Such alliances must be
approved by the Department of Transportation (DOT), and as a matter
of U.S. policy, DOT only grants antitrust immunity to such alliances
if there is an "open skies" agreement between the United States and
the foreign airline's country.\1 DOT's negotiations with the British
government were suspended in February 1997, and DOT is waiting to
learn when the British would like to reopen negotiations.
Over the past several years, we have issued a number of products on
international aviation issues, including our April 1995 report on the
competitive impacts of code-sharing alliances and our June 1997
testimony on competition issues in the U.S.-U.K. markets.\2 As
requested, for this testimony we drew on that body of work and
interviewed U.S. and foreign government officials responsible for
reviewing and/or approving the alliance, officials from airlines
affected by the alliance, consumer groups, and other aviation experts
to identify the major issues that they believe need to be considered
in deciding whether to approve the alliance. My testimony today will
address three questions: (1) What is the status of the various
reviews of the proposed AA/BA alliance being undertaken by the
European regulatory agencies and the U.S. Departments of
Transportation and Justice? (2) What would be the competitive impact
of the proposed alliance? and (3) To what extent should the sales
and marketing practices of American Airlines and British Airways be
considered in reviewing the alliance?
In summary:
-- European regulatory agencies have nearly completed their reviews
of the proposed American Airlines/British Airways alliance.
They are considering a range of issues that would have to be
addressed as a condition of approving the alliance, including
the number of slots and gates that other airlines would need at
London's Heathrow Airport to compete, as well as American
Airlines' and British Airways' sales and marketing practices.
The European Commission\3 anticipates its report proposing draft
remedies for the American Airlines/British Airways alliance will
be issued within the coming weeks. The United Kingdom, which is
also reviewing the proposed American Airlines/British Airways
alliance, is waiting for the European Commission to announce its
draft remedies. In contrast, the U.S. Department of
Transportation has not yet begun its formal review of the
proposed alliance. Because neither American Airlines nor
British Airways has filed all the documentation requested, the
Department does not yet consider the application complete. As a
result, Justice has not submitted formal comments on the
alliance. Once American Airlines and British Airways file all
of the requested documents, the Department of Transportation
initially proposed holding an "oral hearing" to help complete
its analysis of the issues in dispute. However, after receiving
comments from the airlines, it is now reconsidering the type of
hearing it may hold. In addition, the Department has reiterated
that it will not approve the proposed American Airlines/British
Airways alliance until the United States successfully negotiates
an open skies agreement with the United Kingdom.
-- The proposed alliance of American Airlines and British
Airways--the two largest carriers in the U.S.-U.K.
markets--raises significant competition issues. Currently, the
two airlines account for nearly 58 percent of the available
seats on scheduled U.S. and British airlines between the United
States and London. In addition, they provide over 70
percent--and in some cases all--of the available seats on
scheduled U.S. and British airlines between Heathrow and
several key U.S. airports, including Chicago, Boston, and
Miami. As a result of this level of market concentration, the
U.S. Department of Transportation's approval of the alliance
would further reduce competition unless, as a condition of the
approval, other U.S. airlines were able to obtain adequate
access to Heathrow. Each major U.S. carrier we spoke with, as
well as the other large British carrier that operates
transatlantic service to the United States--Virgin
Atlantic--emphasized that gaining a sufficient number of takeoff
and landing slots, gates, and facilities at Heathrow was
critically important to be able to compete effectively against
the alliance, and several expressed doubt that the proposed
alliance could be sufficiently restructured to prevent it from
being inherently anticompetitive.
-- Although slots, gates, and facilities are most important, most
experts and some airline officials with whom we spoke also
recognize that American Airlines' and British Airways' sales and
marketing practices may make competitive entry more difficult
for other airlines. Practices such as frequent flier programs\4
and travel agent commission overrides\5 encourage travelers to
choose one airline over another on the basis of factors other
than obtaining the best fare. Such practices may be most
important if an airline is already dominant in a given market or
markets. Ultimately, this may lead to higher fares than would
exist in the absence of these marketing practices. Even so, the
experts agreed that measuring the effect of these marketing
practices is nearly impossible. In addition, mitigating their
effect without banning them is difficult, and banning them
involves a trade-off between their anticompetitive effect and
the consumer benefits that some of them bring.
--------------------
\1 Generally, an open skies agreement removes all restrictions on air
travel between two countries and allows airlines to fly between the
countries when and where they want and to set fares in response to
market forces.
\2 International Aviation: Airline Alliances Produce Benefits, but
Effect on Competition Is Uncertain (GAO/RCED-95-99, Apr. 6, 1995)
and International Aviation: Competition Issues in the U.S.-U.K.
Market (GAO/T-RCED-97-103, June 4, 1997). Other related GAO products
are listed at the end of this statement.
\3 The European Commission plays a central role in carrying out the
activities of the European Union, a supranational organization that,
as of March 1998, is composed of 15 European countries known as
"member states." The European Commission--the European Union's
executive institution--initiates proposals for legislation, ensures
that provisions of the treaties that govern the European Union are
properly implemented, and represents the European Union in
international trade negotiations. The Commission's Directorate
General for Competition is responsible for investigating airline
alliances.
\4 Under frequent flier programs, passengers qualify for awards by
flying a certain number of miles with the sponsoring airline.
\5 A travel agent commission override is a special bonus commission
paid by airlines to travel agents or agencies as a reward for booking
a targeted proportion of passengers on their airline.
BACKGROUND
---------------------------------------------------------- Chapter 0:1
In the international sector, the routes that airlines can fly, the
frequency of their flights, and the fares they can charge are
governed by 72 bilateral agreements between the United States and
other countries. Many of these agreements, including the accord with
the United Kingdom, are very restrictive. Since the late 1970s, U.S.
policy has been to negotiate agreements that substantially reduce or
eliminate bilateral restrictions. DOT's Office of the Assistant
Secretary for Aviation and International Affairs, with assistance
from the State Department, is responsible for negotiating these
agreements and awarding U.S. airlines the right to offer the
services provided for in those agreements.
In January 1993, DOT granted antitrust immunity to the Northwest/KLM
alliance in conjunction with the U.S.-Netherlands open skies accord.
In April 1995, DOT issued the U.S. International Aviation Policy
Statement in which it reiterated its desire for open skies agreements
and endorsed the growing trend toward alliances between U.S. and
foreign airlines. Since issuing that statement, DOT has negotiated a
number of more liberal agreements, including open skies accords with
Germany and numerous smaller European countries. In 1996, the agency
granted antitrust immunity to the alliances between United and
Lufthansa, which is Germany's largest airline, and between Delta and
several smaller European carriers. In announcing their proposed
alliance, American Airlines and British Airways emphasized that they
are at a competitive disadvantage with these alliances because the
airlines in those alliances can, among other things, better
coordinate service and jointly set fares.
Despite success in negotiating open skies agreements throughout much
of Europe, DOT has had very little success with the United Kingdom,
our largest aviation trading partner overseas. The current U.S.-U.K.
accord, commonly known as "Bermuda II," was signed in 1977 after the
British renounced the prior agreement. Bermuda II restricts the
number of U.S. airlines that can serve Heathrow to two
carriers--currently American Airlines and United Airlines. DOT has
expressed increasing dissatisfaction with Bermuda II and attempted to
negotiate increased access for U.S. airlines to Heathrow.
Negotiations with the British take on particular importance because
of the size of the U.S.-U.K. markets. In 1996, 12 million
passengers traveled on scheduled service between the United States
and the United Kingdom, which is more than twice that for the
U.S.-Germany markets and three times that for the U.S.-France
markets.
Competition is restricted in the U.S.-U.K. markets because Bermuda
II, among other things, sets limits on the amount of service airlines
can provide and prevents all U.S. airlines, except American and
United, from flying to and from Heathrow. These restrictions on
competition result in fewer service options for U.S. and British
consumers. In addition, they also likely result in higher airfares.
However, the extent to which airfares are higher is uncertain. DOT
does not have data on the fares paid by passengers flown by BA or
Virgin Atlantic if those passengers' itineraries did not involve a
connection with a U.S. carrier, because it has generally not
required foreign airlines to report data from a sample of their
tickets, as it requires U.S. airlines to do.
Bermuda II's limits on competition also disproportionately affect
U.S. airlines. In contrast to the continuing restrictions placed on
U.S. airlines, the United Kingdom was successful in negotiating
increased access for British carriers to the U.S. markets in the
early 1990s. Partly as a result, between 1992 and 1996, the British
carriers' share of the U.S.-U.K. markets rose from 49 percent to 59
percent. As figure 1 shows, this gain by British Airways and Virgin
Atlantic has come primarily at the expense of the U.S. airlines that
are not allowed to serve Heathrow.
Figure 1: Share of Scheduled
Passenger Traffic Between the
United States and the United
Kingdom by Airline, 1992, 1995,
and 1996
(See figure in printed
edition.)
Source: GAO's analysis of DOT's international traffic data.
EUROPEAN REVIEWS CONSIDERING A
RANGE OF COMPETITIVE ISSUES;
U.S. REVIEWS PENDING
---------------------------------------------------------- Chapter 0:2
The proposed AA/BA alliance is subject to review by the European
Commission, several agencies within the U.K. government, and DOT.
The European Commission, the U.K. Department of Trade and Industry,
and DOT have decision-making authority over the proposed alliance.
The U.K. Office of Fair Trading and the U.S. Department of
Justice's Antitrust Division (Justice) have advisory roles and
provide analysis and comments to their respective decisionmakers.
According to officials, the process for reviewing the AA/BA alliance
is complicated by the fact that it is new and untested and some
European laws have not previously been applied to airline alliances.
The European regulatory agencies have nearly completed their reviews,
and the formal U.S. review has yet to get under way.
Both the European and the U.S. reviewers have access to extensive
information--including confidential proprietary data--to evaluate the
competition issues arising from the AA/BA and other alliances. This
information includes data on airline capacity, market shares on
specific routes, and passenger travel statistics.
EUROPEAN COMMISSION'S REVIEW
FORTHCOMING
-------------------------------------------------------- Chapter 0:2.1
In July 1996, because of concerns about the anticompetitive effects
of the alliances, the European Commission's Directorate General for
Competition initiated a review of the proposed AA/BA alliance and
three other ongoing alliances: United/Lufthansa/SAS;
Delta/Swissair/Sabena/Austrian Airlines; and Northwest/KLM. This
review is examining a broad range of competition issues on AA/BA,
including access to slots and facilities at Heathrow Airport; the
frequency of service offered by AA and BA, which would dominate the
market at Heathrow; and AA/BA's sales and marketing practices, such
as frequent flier programs, travel agent commission overrides,
corporate incentive agreements,\6 and computer reservation system
practices.
The European Commission's Directorate General for Competition expects
to issue its draft remedies for addressing the anticompetitive
effects of AA/BA within the coming weeks. Officials added that their
reports on other alliances should be done soon afterwards.\7 Various
parties then have the opportunity to provide comments and possibly
participate in oral hearings on the draft remedies. After it obtains
comments from the interested parties, the Directorate General for
Competition prepares a document outlining its recommendations on
whether to approve the alliance with conditions or to withhold
approval, and submits the document to the European Commission's
Member States Advisory Committee\8 for review. After the Advisory
Committee's review, the Directorate General for Competition
incorporates appropriate comments and prepares its draft final
ruling, which either lays out the conditions that must be met in
order for the alliance to be approved or disapproves the alliance.
It becomes the ruling of the Commission when it is adopted by the
European Commission's College of Commissioners.\9 Thus, the European
Commission's final decisions are not expected for several more
months.
--------------------
\6 These agreements represent offers by airlines to corporate clients
for fares that are discounted from the prices that are otherwise
applicable. They may be stated as percentage discounts from
specified published fares.
\7 European Commission officials told us that, although they
initiated their reviews of all four alliances at the same time, they
do not expect to have their proposed draft remedies for each
completed at the same time, since the competitive problems are
different in each case. European Commission officials expect to
announce their draft remedies on the United/Lufthansa/SAS alliance,
Delta/SwissAir/Sabena/Austrian alliance, and Northwest/KLM alliance
soon after the report on AA/BA.
\8 This committee is composed of competition and transport officials
from each of the member states.
\9 As of March 1998, the College of Commissioners was composed of 20
members proposed by the member states.
UNITED KINGDOM AWAITING
EUROPEAN COMMISSION'S DRAFT
REMEDIES
-------------------------------------------------------- Chapter 0:2.2
The U.K. Department of Trade and Industry is conducting its own
review of the proposed AA/BA alliance.\10 It has asked the U.K.
Office of Fair Trading to investigate and provide advice on the
proposed alliance. The Office of Fair Trading investigation, which
began in June 1996, examined a broad range of issues raised by the
proposed alliance, including competitive impacts of the alliance on
routes, hubs, and networks within the U.S.-European markets; the
frequency of service in the U.S.-U.K. markets; the pooling of
frequent flier programs; and access to slots at Heathrow. The Office
of Fair Trading issued a draft report in December 1996 that called
for AA/BA to, among other things, make available to other airlines up
to 168 slots per week at Heathrow for use only on U.S.-U.K.
transatlantic services and allow third-party access to their joint
frequent flier program in those cases in which that party does not
have access to an equivalent program. The report took into account
the views of third parties on conditions that should be placed on the
alliance to remedy competition concerns. Before they provide their
final advice on the proposed AA/BA alliance, the U.K. Office of Fair
Trading is awaiting the European Commission's publication of its
draft remedies. The Secretary of State for Trade and Industry will
decide on the case after receiving final advice from the Office of
Fair Trading.
The U.K. agencies reviewing the proposed AA/BA alliance are in
contact with the European Commission and have a duty to cooperate
with it. If the United Kingdom's decision on the proposed AA/BA
alliance differs from the European Commission's, the differences will
have to be reconciled. According to European Commission officials,
this could require a judgement by the European Court of Justice in
Luxembourg, which ultimately judges the sound application of the
European Union's treaties by the institutions of the Union or the
member states.\11
--------------------
\10 The Monopolies and Mergers Commission has an advisory role for
mergers but has had no detailed involvement to date concerning the
alliance.
\11 Although the European Union has responsibility for applying its
aviation laws, enforcement of those laws is left to the member
states.
U.S. REVIEWS NOT PROCEEDING
UNTIL AA AND BA COMPLETE THE
APPLICATION PROCESS
-------------------------------------------------------- Chapter 0:2.3
In the United States, DOT has the authority not only for approving
airline alliances, but also for granting those alliances immunity
from the antitrust laws. In determining whether to grant approval
and antitrust immunity for an airline alliance, DOT must find that
the alliance is not adverse to the public interest. DOT cannot
approve an agreement that substantially reduces or eliminates
competition unless the agreement is necessary to meet a serious
transportation need or to achieve important public benefits that
cannot be met or that cannot be achieved by reasonably available
alternatives that are materially less anticompetitive. Public
benefits include considerations of foreign policy concerns. In
general, DOT has found code-sharing arrangements to be procompetitive
and therefore consistent with the public interest because they create
new services, improve existing services, lower costs, and increase
efficiency for the benefit of the traveling and shipping public. As
with the other international code-sharing alliances that the United
States has approved, DOT officials explained that they will not
approve AA's and BA's proposed code-sharing alliance with antitrust
immunity unless the United States has reached an open skies agreement
with the United Kingdom.
According to U.S. law, DOT is to give the Attorney General and
Secretary of State "an opportunity to submit written comments about"
the application. In practice, DOT and Justice officials told us that
they stay in contact throughout the application process regarding
their respective analyses of airline alliances.
Justice's role is advisory and is performed pursuant to the Sherman
Antitrust Act and the Clayton Act, which set forth antitrust
prohibitions against restraints of trade. To determine if a proposed
alliance is likely to create or enhance market power and allow firms
to maintain prices above competitive levels for a significant period
of time, Justice applies its Horizontal Merger Guidelines, which
describe the analytic framework and the specific standards to be used
in analyzing mergers and alliances. A key concern is whether entry
into the market would deter or counteract a proposed merger's
potential for harm.
DOT officials told us that in reviewing other code-sharing alliances,
the Department did not apply any written set of guidelines in its
analysis. Rather, DOT has discretion in deciding the factors it will
analyze and in past applications for international code-sharing
alliances has considered issues raised in petitions by interested
parties. Those issues generally involved market power between
particular hub airports, except in one instance. In response to
United's application for antitrust immunity in its code sharing with
Lufthansa, TWA contended that Lufthansa's control over travel agents,
both through dominance of the computer reservation system and through
commissions and override payments, was a serious impediment to new
airlines' entry into the U.S.-Germany marketplace. In making its
final decision, DOT addressed the concern about the computer
reservation system, but wrote that other forums were more appropriate
for addressing the other concerns.
DOT has considered, but not always completely agreed with, Justice's
comments on the extent to which particular code-sharing alliances
pose threats to competition in individual markets. In the case of
United/Lufthansa, for example, Justice was concerned that competition
could be reduced in two nonstop markets--Chicago-Frankfurt and
Washington D.C. (Dulles)-Frankfurt. DOT agreed, and "carved out"
(i.e., withheld antitrust immunity from) specific airline operations
in those two markets. In considering Delta's proposed alliance,
Justice identified seven nonstop markets that raised concerns of
reduced competition. DOT agreed with Justice on three markets
(Atlanta-Brussels, Atlanta-Zurich, and Cincinnati-Zurich) and
withheld antitrust immunity for specific operations there; DOT
generally disagreed with Justice and imposed different conditions on
the other four city-pairs, each of which involved travel from New
York.
In the case of the proposed AA/BA alliance, U.S. reviews are
essentially on hold. DOT cannot move forward with its review of the
alliance until AA and BA file the necessary documents to make their
application complete. DOT officials do not believe that AA and BA
will complete their application until after the European Commission
issues its draft remedies on the alliance, and BA officials confirmed
that to us. Once DOT determines that the application is complete,
interested parties--including Justice--will have 30 business days to
comment on the alliance. Interested parties and AA/BA will then have
another opportunity for rebuttal comments.
According to its regulations, DOT may order a full evidentiary
hearing at the end of the comment period. Requests for DOT to hold
an oral evidentiary hearing must specify the material issues of fact
that cannot be resolved without such a hearing.\12 However, DOT has
the discretion by statute whether to hold a hearing, even if
requested to do so by the Attorney General or Secretary of State.
Although the AA/BA application is not complete, DOT has already
proposed holding an oral hearing before a departmental
"decisionmaker" so that interested parties can express in person
their particular opinions and views on the issues concerning the
AA/BA alliance. AA and BA have characterized any type of hearing as
merely a delaying tactic. Six airlines opposing the proposed AA/BA
alliance, on the other hand, have argued that the kind of hearing DOT
has proposed is not sufficient; they contend that questions of fact
could only be adequately explored and resolved with an oral
evidentiary hearing before an administrative law judge. For example,
AA and BA have contended that slots are easily obtainable at Heathrow
and that Gatwick is an available and competitive alternative. Other
airlines have testified that it is impossible to obtain slots at
Heathrow that are timely and competitive, that Gatwick is full, and,
in any event, that Gatwick is not a reasonable alternative to
Heathrow, especially for business travelers. DOT has told us that it
may reconsider its proposed schedule for reviewing the AA/BA
alliance, along with the type of hearing it would hold.
We are not in a position to assess whether material issues of fact
remain to be resolved in the proposed AA/BA alliance, but we believe
it is critical that DOT avail itself of all empirical data in making
its determination. Although DOT considers code-sharing agreements to
be procompetitive, it has not collected sufficient data to fully
analyze the long-term effects of such alliances. In our 1995 report
on alliances, we found that DOT's ability to monitor the impact of
alliances was limited because foreign airlines are not required to
report data from a sample of their tickets involving travel to or
from the United States.\13 In addition, U.S. carriers were not
required to report traffic flying on a code-share flight. Since that
report, DOT has required foreign airlines in alliances that have been
granted antitrust immunity to report data on traffic to and from the
United States. Even so, alliances have not been sufficiently studied
to determine their long-term consequences or to allay fears that such
alliances may hinder competition in the long term.
--------------------
\12 In the application of Delta and its European alliance partners
for antitrust immunity, TWA argued that DOT should hold an oral
evidentiary hearing. DOT rejected the request, responding that it
was "unnecessary to resolve the relevant issues of fact."
\13 International Aviation: Airline Alliances Produce Benefits, but
Effect on Competition Is Uncertain (GAO/RCED-95-99, Apr. 6, 1995).
AA/BA ALLIANCE WOULD DOMINATE,
AND COMPETITION WOULD DECLINE
UNLESS SUBSTANTIAL NEW ENTRY
OCCURRED
---------------------------------------------------------- Chapter 0:3
The proposed AA/BA alliance has network benefits and could increase
competition in markets between the United States and the European
continent, the Middle East, and Africa because the number of
alliances competing in these markets would increase from three to
four. However, it raises serious competition issues in U.S.-U.K.
markets. Competition issues arise because, under the alliance,
rather than competing with each other, the two largest airlines in
U.S.-U.K. markets would in essence be operating as if they were one
airline. For the month of March 1998, an analysis of Official
Airline Guide data indicates that AA and BA account for nearly 58
percent of the seats available on scheduled passenger flights between
the United States and London. Moreover, as of March 1998, the two
airlines account for 37 of the 55 total daily roundtrips (67 percent)
between the United States and Heathrow offered by scheduled U.S. and
British airlines.\14
AA and BA currently compete with one another from six U.S. airports
to Heathrow\15 and from Dallas to London's Gatwick airport. New
York's importance--Kennedy and Newark--is underscored by the fact
that the market between these airports and Heathrow accounts for
nearly one-fifth of all U.S.-London service and is more than three
times the size of the Los Angeles-Heathrow market. At five of the
seven airports where AA and BA compete--Kennedy, Chicago, Boston,
Miami, and Dallas--these two airlines account for over 70 percent of
the service, and at Los Angeles, they account for almost 50 percent.
In addition, in Boston, AA and BA currently are the only carriers
that serve Heathrow, and in the Dallas market, they are the only
nonstop competitors. Figure 2 shows the location of seven cities
where AA and BA currently compete with each other.
Figure 2: Seven Cities Where
AA and BA Directly Compete With
Nonstop Service to London
(See figure in printed
edition.)
Note: "H" denotes service to Heathrow; "G" denotes Gatwick.
Our review of current competitive conditions in the New York-Heathrow
(Kennedy and Newark) market indicates that substantial new entry
would need to occur to provide competition because of the (1) size of
the market, (2) large share of that market currently held by AA and
BA, (3) frequency of service in that market--15 flights a
day--provided by the two airlines (compared with 3 daily flights by
United and 3 daily flights by Virgin Atlantic), and (4) substantial
portion of the market accounted for by time-sensitive business
travelers. New entry could come from Delta and TWA, which have hubs
at Kennedy, and from Continental from its hub at nearby Newark. In
the Boston and Chicago markets, new nonstop service may offset the
effect on competition caused by joining the two largest competitors
in those markets.
In the event of the alliance, time-sensitive business travelers in
the Dallas-London and Miami-London markets will have fewer nonstop
options and thus will likely pay higher fares for nonstop service.
In the Dallas-London market, AA and BA are currently the only
competitors providing nonstop service. In the Miami-London market,
the number of nonstop competitors would fall from three to two.
Several carriers told us that it is unlikely that a new U.S.
competitor would attempt nonstop London service from either Miami or
Dallas, since no carrier besides American maintains a large enough
network from either of those airports to provide critical "feed"
traffic. As a result, DOT will need to carefully examine the unique
circumstances associated with these markets.
At another eight U.S. cities, either BA or AA has a monopoly on
nonstop service to either Heathrow (two cities) or Gatwick (six
cities). In our October 1996 report on domestic competition, we
found that competition was most limited and airfares highest in
markets dominated by one airline.\16 Figure 3 shows the location of
eight cities where either AA or BA has a monopoly.
Figure 3: Eight Cities in
Which AA or BA Is the Only
Carrier Providing Nonstop
Service to London
(See figure in printed
edition.)
Notes: "H" denotes service to Heathrow; "G" denotes Gatwick.
According to AA and BA representatives, with an open skies policy,
the alliance would likely switch much of the current Gatwick service
to Heathrow.
US Airways plans to begin Philadelphia to Gatwick service in April
and hopes to begin Charlotte to Gatwick service in May.
If slots at Heathrow were made available, several U.S. carriers
might serve London from their primary or secondary hubs.\17 These
slots would provide new competition to AA and BA on several routes
that they currently monopolize. In particular, U.S. carriers could
provide new nonstop service in the Philadelphia, Charlotte, and
Pittsburgh markets. They could also provide new nonstop service from
cities that are currently unserved with nonstop flights, such as
Cleveland.
In addition to increased nonstop competition, carriers could provide
consumers with new one-stop options to compete with the alliance's
nonstop services in markets that include their primary or secondary
hubs. For example, if Northwest Airlines, which is one of the
largest carriers in Seattle, could serve Heathrow from its hub in
Minneapolis, consumers in Seattle would have more and better
connecting opportunities to Heathrow, and hence competition would be
greater than it is today with BA's being the only nonstop carrier.
However, for time-sensitive travelers, these one-stop options may not
be very competitive. Consumers in cities such as Des Moines or Fargo
with no nonstop service to London, would experience an increase in
the number of one-stop options offered by competing airlines to
Heathrow.
--------------------
\14 In several markets, other foreign carriers provide service
between U.S. cities and London. For example, Air New Zealand
provides service through Los Angeles to Heathrow.
\15 These airports are Boston, Chicago O'Hare, Los Angeles, Miami,
New York Kennedy, and Newark.
\16 Airline Deregulation: Barriers to Entry Continue to Limit
Competition in Several Key Domestic Markets (GAO/RCED-97-4, Oct. 18,
1996).
\17 The other six major U.S. airlines' primary hubs for
transatlantic service are Chicago (United), Detroit (Northwest),
Newark (Continental), New York (Delta and TWA), and Philadelphia (US
Airways). In general, these airlines' secondary transatlantic hubs
are Atlanta (Delta), Houston (Continental), Minneapolis (Northwest),
Charlotte (US Airways), St. Louis (TWA), and Washington Dulles
(United). However, carriers may also choose other locations as key
cities in their networks for international service. For example,
Delta currently serves Gatwick from both Atlanta and its other
international hub, Cincinnati. Also, until February, Continental was
authorized to serve London Gatwick from its Cleveland hub.
AIR CARRIERS VARY ON THE
EFFORT NEEDED TO OVERCOME
COMBINED AA/BA STRENGTH
-------------------------------------------------------- Chapter 0:3.1
When we testified last June on the proposed alliance, representatives
from six major U.S. airlines told us that they would need a total of
38 daily roundtrip slots (or 532 weekly slots) at Heathrow, along
with gates and facilities, to compete with the AA/BA alliance. For
this testimony, we discussed the issue of access to Heathrow with
officials from each major U.S. carrier, as well as with Virgin
Atlantic. This time, some were not as clear on the number of slots
they would need to be competitive. The officials emphasized that
gaining a sufficient number of commercially viable slots, gates, and
facilities at Heathrow was critically important for them to be able
to compete effectively against the alliance, and several expressed
doubt that the proposed alliance could be sufficiently restructured
to prevent it from being inherently anticompetitive.
The carriers' representatives expressed a range of views on the
actions needed to compete effectively against the proposed alliance.
For example, officials from Continental discussed the importance of
flight frequency, which they argued is vital for business travelers,
who represent the most valued passenger because of the revenue
generated by business travel. For Continental to be able to compete
in the New York-London market, where, they said, AA/BA would operate
what amounts to a virtual shuttle, they argued that an additional
three flights between Newark and London on top of their current
schedule would not be sufficient. They believed they would need an
additional six flights per day.
Officials from United Airlines, which already participates in a
global alliance, suggested that their alliance would compete
effectively with AA/BA for many points beyond Heathrow. However,
because of the importance of Heathrow, they would like to create a
greater presence for their entire alliance. Thus, United officials
did not indicate a desired number of slots and gates needed at
Heathrow but spoke about the importance of having its STAR alliance
partners (Air Canada, Thai, Varig, SAS, and Lufthansa) operate out of
a single terminal at Heathrow.
On the other hand, officials from Delta, which also participates in a
global alliance, found the proposed AA/BA alliance to be highly
anticompetitive and argued that the best way to protect the traveling
and shipping public would be to disapprove the proposed alliance.
Failing that, Delta officials have testified that the respective
governments should guarantee that competing carriers will have
unrestrained opportunities to provide service between the United
States and London and receive a significant number of commercially
viable slots and airport infrastructure to support those services.
They suggested a minimum of 800 weekly peak-period slots would be
required to provide sufficient competition at Heathrow.
Virgin Atlantic officials concluded that determining the number of
slots needed for a carrier to compete successfully in the U.S.-U.K.
markets is difficult, but that BA would need to divest itself of a
"very large" number of slots to make successful competition by
another airline (besides American) a realistic possibility.
As we testified last year, as a practical matter, because of a
limited number of slots available at Heathrow, AA and BA would likely
need to have slots transferred from them and made available to
competing airlines. If the proposed alliance is approved and the
regulatory agencies decide how many slots and gates should be made
available, it is uncertain how long it would take the British
Airports Authority, which owns and operates seven U.K. airports,
including London's Heathrow and Gatwick airports, to actually make
them available to new airlines. For example, according to the
British Airports Authority, it probably will not have the facilities
to allow the STAR alliance to locate all of its members within the
same terminal until Heathrow opens the new Terminal 5, which is not
scheduled to open before the fall of 2004.
If approved, the AA/BA alliance would bring a history of competitive
service to London. Many other airlines that do not have a history of
service to London, on the other hand, would have no such advantage.
DOT will have to address this issue because it will be critical for
new carriers to obtain access to commercially viable slots, as well
as needed gates and facilities, at the same time as the proposed
alliance begins joint operations. Some have suggested that AA and BA
"phase in" their alliance over time, in part to give other carriers
the time needed to establish themselves. If this happened, new
airlines' operations should be phased in to coincide with the
alliance.
AIRLINE SALES AND MARKETING
PRACTICES MAY FURTHER ENHANCE
MARKET DOMINANCE OVER SMALLER,
NONALIGNED, AND NEW ENTRANT
CARRIERS
---------------------------------------------------------- Chapter 0:4
According to airline officials, aviation experts, and consumer groups
we interviewed, restrictions on access to slots and gates at Heathrow
Airport are the most significant barriers to competition in U.S.-U.K.
markets, but sales and marketing practices--which include frequent
flier programs, travel agent commission overrides, multiple listings
on computer reservation systems, and corporate incentive
programs--may also reduce competition. They do so by reinforcing
market dominance at hubs and impeding successful entry by new
carriers and existing carriers into new markets, which can lead to
higher fares. However, measuring the impact of these practices on
fares is difficult, and limiting them would involve a trade-off
between their anticompetitive effect and the consumer benefits that
some of them bring.
In October 1996,\18 we reported that sales and marketing strategies,
when used by incumbent airlines in U.S. domestic markets, make it
difficult for nonincumbents to enter markets dominated by an
established airline. The strength of these programs depends largely
on an airline's route networks, alliance memberships, and hubs. If
an airline is already dominant in a given airport, these programs
will serve to reinforce this dominance. In particular:
-- Travel agent commission overrides encourage travel agencies to
book travelers on one airline over another on the basis of
factors other than price.
-- Frequent flier programs encourage travelers to chose one airline
over another on the basis of factors other than price.
-- Corporate fare agreements make it more difficult for
point-to-point carriers to compete for corporate business.
-- Bias in the computer reservation systems, in which multiple
listings of a single flight offered by an alliance partner crowd
the first few screens in U.S. systems, makes the booking of an
alliance flight more likely.
In our October report, we noted that travel agent commission
overrides and frequent flier programs are targeted at business fliers
and encourage them to use the dominant carrier in each market.
Because business travelers represent the most profitable segment of
the industry, airlines in many cases have chosen not to enter, or
quickly exit, domestic markets where they did not believe they could
overcome the combined effect of these strategies and attract a
sufficient amount of business traffic.
AA, which is credited with having first created frequent flier
programs in 1981, is reputed to have the largest frequent flier
program in the world, with more than 30 million members. Continental
has more than 15 million members. European airlines, on the other
hand, tend to have much smaller frequent flier memberships. BA's
program, for example, has approximately 1 million members. The
difference in memberships compared with U.S. carriers is due to
their relative newness among European carriers and U.S. programs'
tending to allow members to accumulate miles for activities other
than flying (e.g., through car rentals or stays at hotels), while
European carriers' programs are more restrictive in scope.
Some airline officials we interviewed expressed concern that the
scope of AA's and BA's combined route network and flight frequency,
in combination with sales and marketing practices, would effectively
preclude competition by other carriers in the U.S.-U.K. markets,
especially at BA-dominated Heathrow. These carriers argued that the
alliance would be able to exercise such market power, especially in
relation to travel agents and corporate fare products, that other
carriers would not be able to attract key business traffic.
Officials from Continental Airlines told us that the problem with the
sales and marketing practices of the combined AA/BA alliance would be
their effect on enhancing AA/BA's dominance of market share. They
said that rather than restrict AA/BA in combining their frequent
flier programs, travel agent commission overrides, corporate
incentive agreements, and computer reservation system practices, DOT
should not grant antitrust immunity to AA/BA. TWA officials also
said that these sales and marketing practices are anticompetitive and
their use by the proposed alliance should be restricted. Officials
from Virgin Atlantic, noting the strength and market dominance of AA
and BA, questioned whether any mitigating conditions would be
sufficient to limit the competitive advantage the two airlines would
have if joined in a code-sharing partnership.
However, United, Delta, and Northwest--each of which participates in
its own global code-sharing alliance--generally disagreed that any of
these sales and marketing practices represented significant barriers
to their ability to compete. United told us that its alliance would
compete with any other both in terms of their networks and their
various sales and marketing practices. US Airways also indicated
that it was not concerned with sales and marketing practices, as long
as it had access to sufficient Heathrow slots and gates.
Outside experts on airline competition had varying opinions on the
degree to which sales and marketing practices stifle competition.
While none had done research specifically on how these practices
affect international air transport markets, some said frequent flier
programs do not raise entry barriers for large worldwide carriers
because they all have relatively strong frequent flier programs and
extensive route networks. However, point-to-point carriers may be at
an additional disadvantage when competing against carriers with both
large route networks and strong frequent flier programs. For
example, while AA and BA are perceived to have considerable
advantages in their frequent flier programs compared with other
nonallied or point-to-point airlines, the differences are relatively
minor when compared with other U.S.-European alliances. Even so,
these experts said it is almost impossible to measure the degree to
which sales and marketing practices impede competition.
We were unable to obtain any data on these sales and marketing
practices. The airlines are not required by law to report this
information to DOT, and GAO has no right of access to commercially
owned data. However, we know of at least two lawsuits alleging that
BA has engaged in certain sales and marketing practices that are
anticompetitive in nature. However, because these actions have not
yet entered the trial phase, we have been unable to obtain detailed
information on the alleged economic damage stemming from BA's
practices, or BA's evidence to the contrary.
In past alliances, DOT has not restricted partner airlines in their
use of frequent flier programs, travel agent commission overrides, or
corporate fare packages. It has, in some of the alliances, withheld
antitrust immunity from the airlines' coordination of the management
of their financial interests in computer reservation system
companies. While restrictions on other sales and marketing practices
would be unprecedented, the European Commission, as noted earlier, is
considering whether to address sales and marketing practices with all
alliances. DOT and some U.S. carriers are concerned that the
European Commission would so broadly regulate the industry's
practices.
The outside experts we interviewed concurred that restrictions on
sales and marketing practices in alliances should not be imposed.
They believed that any restrictions on the pooling of frequent flier
programs, for example, would reduce the benefits that accrue to
travelers while doing nothing to address the underlying issue of
market dominance. Moreover, they said it would be difficult to limit
alliance members' use of these marketing practices without
eliminating them altogether; banning them involves a trade-off
between their anticompetitive effect and the consumer benefits that
some of them bring.
--------------------
\18 Airline Deregulation: Barriers to Entry Continue to Limit
Competition in Several Key Domestic Markets (GAO/RCED-97-4, Oct. 18,
1996).
-------------------------------------------------------- Chapter 0:4.1
In summary, Mr. Chairman, as a result of the challenges in
addressing the barriers to entry at Heathrow, significant
intergovernmental agreement will be needed well beyond the scope of
prior open skies agreements. If the U.S. government is successful
in obtaining an open skies agreement with the United Kingdom, and
that agreement provides for sufficient access to Heathrow,
significant new entry in the U.S.-U.K. markets would likely provide
substantial benefits for consumers in both countries in terms of
lower fares and better service. However, because these markets have
been heavily regulated for 2 decades, the incumbent airlines enjoy a
competitive advantage over new carriers in the U.S.-London markets.
Because of AA's and BA's dominance at certain airports and extensive
networks, that advantage may be further strengthened by sales and
marketing practices. Thus, it will be important that new competitors
are able to initiate their service no later than the time at which
the AA/BA alliance becomes operational.
How much access would be needed for other airlines to effectively
compete, and what other conditions should be imposed on the alliance
can only be determined after careful analysis of the facts to ensure
that over the long run, consumers benefit. While we recognize that
ultimately, decisions on all conditions must inevitably reflect
numerous policy judgments, public policy should be based on
significant quantitative analysis of the factors at issue, rather
than anecdotal evidence. At least four governmental bodies--DOT,
Justice, the European Commission, and the U.K. Department of Trade
and Industry--have the ability to get the data needed for such
analyses. Only then can the public be assured that such important
international policy is grounded on a sound basis and that consumers
benefit, both in the short and long term.
Mr. Chairman, this concludes my prepared statement. Our work was
conducted in accordance with generally accepted government auditing
standards. We would be pleased to respond to any questions that you
or any Member of the Subcommittee may have.
RELATED GAO PRODUCTS
International Aviation: Competition Issues in the U.S.-U.K. Market
(GAO/T-RCED-97-103, June 4, 1997).
International Aviation: DOT's Efforts to Promote U.S. Air Cargo
Interests (GAO/RCED-97-13, Oct. 18, 1996).
Airline Deregulation: Barriers to Entry Continue to Limit
Competition in Several Key Domestic Markets (GAO/RCED-97-4, Oct. 18,
1996).
International Aviation: DOT's Efforts to Increase U.S. Airlines'
Access to International Markets (GAO/T-RCED-96-32, Mar. 14, 1996).
International Aviation: Better Data on Code-Sharing Needed by DOT
for Monitoring and Decisionmaking (GAO/T-RCED-95-170, May 24, 1995).
International Aviation: Airline Alliances Produce Benefits, but
Effect on Competition Is Uncertain (GAO/RCED-95-99, Apr. 6, 1995).
International Aviation: DOT Needs More Information to Address U.S.
Airlines' Problems in Doing Business Abroad (GAO/RCED-95-24, Nov.
29, 1994).
International Aviation: New Competitive Conditions Require Changes
in DOT Strategy (GAO/T-RCED-94-194, May 5, 1994).
International Aviation: Measures by European Community Could Limit
U.S. Airlines' Ability to Compete Abroad (GAO/RCED-93-64, Apr. 26,
1993).
Airline Competition: Impact of Changing Foreign Investment and
Control Limits on U.S. Airlines (GAO/RCED-93-7, Dec. 9, 1992).
Airline Competition: Effects of Airline Market Concentration and
Barriers to Entry on Airfares (GAO/RCED-91-101, Apr. 26, 1991).
*** End of document. ***